The outbreak of the COVID-19 pandemic in our daily lives, its rapid expansion and the measures adopted by the executive branch to curb or, as far as possible, mitigate its effects, have generated a short circuit in our usual legal and economic traffic.
At this time, it is difficult to determine the level of impact that the pandemic will have on society and its business fabric, although the latest government estimates state that the country’s Gross Domestic Product will fall by around 9%, and that recovery will take place in the form of an asymmetric vine, with a very intense drop in economic activity and a foreseeable more gradual recovery from the second half of the year.
In this context and on the verge of a new economic recession, with unemployment estimated at 19% and a more than predictable contraction in consumption, the law must emerge as a tool for peace in the face of the multiplicity of conflicts that are already emerging in companies, as well as the usual relations between business people and their namesakes and the market in general.
One of the most relevant questions facing legal operators is that of determining the effectiveness that should be given to the common will of the parties, elevated to contractual status, in a preCOVID-19 economic context that is significantly different from the current one and that is projected in the medium term. Much has been written during the first weeks of the confinement, with greater or lesser rigour, either about the unilateral power of a party to withdraw from a monetary obligation; or to suspend it temporarily; or about the success in suspending or modulating the effects of a contract and its content, all under the pretext of an event of force majeure linked to the unpredictability and effects of the pandemic. In some professional forums, it has even been heard recently that the solution to all evils would be the general and quasi-indiscriminate application of the rebus sic stantibus clause, with temporary non-performance of contractual benefits being promoted as a measure of pressure to force a negotiation with the counterparty.
We will not enter here into complex doctrinal debates that should be the subject of another forum and, above all, of a slow and prudent reflection, far removed from particular interests. Our objective in these brief lines is to offer the reader a basic legal perimeter from which he can correctly evaluate the risks to which he will be subject in an eventual conflict originated in a contract of successive tract, caused by the excessive burdensome nature of one of the parties, always in a commercial or business context and without entering into an evaluation of the own and specific solutions existing in consumer relations.
1. The premise from which to proceed is the general rule that the contract is law between the parties
This statement should be qualified, given that the obligations arising from contracts have the force of law, and since then they are binding on compliance with them as the law itself, as agreed and without any limitations other than those established by the law itself. It is said that the parties must submit to the law of the contract as well as to the legal rule, and the judge must likewise impose respect for it (Lacruz).
As a principle, only the common will of the parties can make the link generated by the contract more flexible, modify or extinguish it. Where the law does not intervene, or better indicated where the legislator has not considered intervening, the contract has the content given to it by the parties. Legal certainty and economic traffic in a market economy, and therefore of free exchange, of loss and gain, are bound to this result, since in this context the effectiveness of the contract cannot be made dependent on the subsequent, subjective and constant expectation of each of the parties.
It is not possible, therefore, to attempt to alter the content of an obligation without the consensus of the counterparty, except for very specific exceptions that we will see below. However, it is possible to excuse performance of the obligation and exempt liability for it only when the law provides for such a possibility, i.e. in cases where it is impossible to perform the service for reasons not attributable to the obligor. However, impossibility of performance is not equivalent to excessive hardship of performance, and this must be distinguished in a first analysis of the question, so as not to lead to erroneous results.
This general rule is intended to provide the necessary legal certainty in a free market context, preventing the parties from unilaterally altering the content of their declarations and commitments, which have been elevated to contractual status. Each party’s performance is the one freely and voluntarily accepted by it, and must be the object of exact compliance, even if subsequent events make payment more onerous.
It is the responsibility of each party, and with a greater duty of diligence in legal and commercial transactions, to provide contractually for the subsequent occurrence of new circumstances that may lead to greater burdens. The general rule must be broken only when certain unforeseeable or unavoidable events occur in which the change of circumstances is of such magnitude as to alter the scope within which the contract was in equilibrium according to the design given by the parties. In the present context, can it be said that the effects of the COVID-19 pandemic on certain continuing contracts are already of such a magnitude that they objectively require a rebalancing of performance?
2. First exception to the general rule: The implied clause rebus sic stantibus
Although the impact of the pandemic on the global and local economy is undeniable, it is difficult to foresee its definitive effects today, and in view of this initial uncertainty it is risky to say that such an extraordinary remedy as the rebus doctrine should be applied immediately and across the board, since the pillars that it must demolish are precisely those on which the legal security of economic traffic in a market economy is based.
In all contracts, a clear distinction is made between three phases: the first is the generation or completion of the contract; the second is the execution of the contract; and the third is the termination of the contract. The so-called rebus clause is projected on the executive phase of the contract, within what De Castro called “the continued influence of the cause” in his magnificent book The Legal Business.
In successive legal relationships (leases, continuous services, operating licenses, supply, distribution in all its variants), or of undetermined duration (contracts subject to conditions and terms) it is undeniable that subsequent events, external and alien to the parties, may lead to the frustration of the specific purpose of the business. The cause, from this perspective, is said to be the influence of the continued effectiveness – and efficiency – of the contract itself, making it possible for the party on whom the frustration of the contractual purpose falls to take legal action for the equitable adaptation of the performance, or failing that, for the termination of the relationship. It should be noted that the frustration must be very significant, supervening, caused by an external event beyond the control of the parties and continuing over time.
However, it should be stressed that the rebus clause has no legal place in our current 19th century codes – civil and commercial – without prejudice to its introduction in the various proposals for new codes currently before Parliament. Historically, it has been the case law of our Supreme Court that has rescued it from the shelves to address, casuistically and with extreme restriction, cases where the use of equity was required.
In short, in order to determine whether a contract’s services must be adapted to a new reality, the latter must be projected in a relevant and continuous manner on the specific cause of the contract. It is the specific cause of the contract that must be evaluated and thus determined: (a) whether the circumstances that have arisen are beyond the control of the parties, unforeseeable and unavoidable; (b) whether they have a profound impact on the performance of the services provided by the parties, removing and modifying the scope within which the contract was in equilibrium; and (c) whether, objectively, by continuing to perform the contract without adapting the services to the new reality, its original character of reciprocity is lost, in accordance with the nature and specific circumstances of each business.
As De Castro states, from the examination that should be carried out to determine whether the clause is applicable, a warning should necessarily be made so as not to fall into a conceptual error: the concrete cause or the reciprocity of benefits should not be questioned on a subjective level, since this would lead to an interested and opportunistic application of the remedy. On the contrary, it will be necessary to consider what response is appropriate to the nature of the contract, or on the same terms if, for example, an onerous contract may give rise to the consequences of a gratuitous contract or a random contract.
After almost two months of total or partial restrictions on certain economic activities, and on the verge of a gradual reopening of shops and services, the truth is that it cannot be said that most of the successive contracts subject to reciprocal services of an economic nature and directly affected by the restrictions imposed have been altered to such an extent that the content of the services needs to be rebalanced so as not to lose their original character of reciprocity. That losses have arisen from the temporary closure of establishments open to the public is evident and notorious, as is also the fact that investments are being made to adapt businesses to the new reality. But the real impact that the new reality post COVID-19 will have on businesses is an unknown quantity that is yet to be deciphered, without it being possible to affirm -and to a lesser extent prove- that it will be of such magnitude that it will shake the foundations on which the contracts were built.
We must not forget that the success of a procedural claim depends on being right, and on proving it sufficiently. Since it will be up to the debtor of the service -which has become unbalanced due to the alteration of circumstances- to prove the profound impact of the new circumstance on his business, the hasty filing of lawsuits claiming the application of the rebus clause, without waiting to obtain empirical results that will allow the real impact on his activity or business to be assessed after the resumption of the activity, is presumed to be reckless.
3. Second exception to the general rule: the breakdown of the business base
The breakdown of the basis of the business is only one more step in the influence that the concrete and objective cause projects on the effectiveness of the contract, when the contract deploys its own effects beyond its conclusion.
A theory of Germanic origin has been admitted by our Supreme Court in a context similar to that of the rebus clause, i.e. when the change of circumstances is so relevant that it makes no sense to maintain the link. It could be argued that the breach of the basis is an aggravated case of altered circumstances, in which it is no longer possible to accommodate the contract by means of the rebus clause, so that it is appropriate to extinguish the link without serious and essential breach, in which case it is appropriate to resort to the mechanism of the resolution for breach. Obviously, this figure arises in a context in which the contract is governed by a fixed term and must be observed by both parties, since otherwise it would be possible to terminate and/or withdraw from the contract with notice in accordance with the provisions of the contract itself, or otherwise in accordance with the requirements of good faith.
As with the rebus clause, the theory of the breach of the basis of the contract requires a departure from what both parties expect and what has led them to conclude the contract, in order to focus on the examination of its objective basis, thus each circumstance whose existence or subsistence is objectively necessary for the contract – in accordance with the meaning of the intentions of both parties – to be maintained as a meaningful regulation (Larenz). Of course, we are also very far from what might be considered the motives or reasons of each of the parties for concluding a given contract, inasmuch as any modification of such motives or reasons (e.g., situations of a personal or economic nature not elevated to a condition) cannot in any way be opposed to the opposing party on the grounds of a breach of contractual equilibrium.
If there is a break in the basis of the business, it is no longer a question of adapting the services to the new circumstances, but of definitively resolving the contractual relationship because the end has been frustrated. Just as the application of the rebus clause requires sufficient evidence of the profound and direct effect of the circumstances on the service, making it more burdensome to the point of objectively breaking the balance of the service, so the application of the doctrine of breach of the basis of the business must provide the court with precise evidence that objectively responds to the allegation of the definitive frustration of the cause or purpose of the business.
4. Contracts where the necessary budget for the application of one of the two exceptions referred to above can be examined
If there is one thing that differentiates the legal-commercial regulation of contracts from their civil counterpart, it is the severity of the consequences in the event of non-compliance. Our Code of Commerce warns that terms of grace or courtesy in the performance of commercial obligations are not allowed, and that once the obligation has expired it automatically falls into arrears without the need for an express request to the debtor, with the obligation to pay the default interest provided for in the contract, or in the law. This is necessary because compliance with commercial obligations, in due time and form, is essential in the legal and economic business traffic.
The above statements are not an obstacle to defend that, in the face of certain extraordinary and exceptional circumstances, mechanisms of flexibility and accommodation of the services, their form and time of performance are provided. For example, Article 416-2 of the first proposal for the Commercial Code of 2013 provided for the “excessive cost of the contract” as a mechanism for its renegotiation and adaptation. However, this provision has been eliminated in the current draft of the new Commercial Code, which is currently in hibernation in the parliamentary process. Pending its final impetus, the current Proposal of the Second Section of Commercial Law, of the Preliminary Draft Law of the Commercial Code after the Opinion of the Council of State, does not provide in its Book Four (on commercial obligations and contracts in general), a specific solution to the case of excessive onerousness of the contract, since its regulation and location, in general, in the future Civil Code is deemed sufficient (Article 1213 of the Proposal for the Modernization of the Civil Code).
It is not insignificant that both proposals to modernize our codes take this issue into account, since they ultimately seek to introduce general solutions that are either based on legal systems close to ours or are offered by case law, which zealously admits both the rebus clause and the theory of the rupture of the basis of the business as a mechanism to correct, exceptionally, cases of excessive aggravation of contractual burdens. It is also in this sense that work has been done at the European level to address the various processes of harmonisation of European contract law – for example, Article 6:111 of the Principles of European Contract Law or “Lando Principles”; as well as the Common Framework of Reference, Draft CFR for European Private Law, Articles III.- 3:301 and 302.
However, the fact that our Supreme Court has admitted exceptions to the principle of invariability of contracts does not mean that the exceptional should become the rule, and the rule the exception. In commercial traffic, the rebalancing of services in contracts of a continuous or successive nature may prove necessary in those where the cost of the service may become economically unsustainable as a result of a sudden, unforeseeable alteration that directly and inevitably affects the principle of reciprocal utility or mutual convenience: Supply contracts, distribution contracts with exclusive rights, franchises, licences for the exploitation of industrial or intellectual property rights or business services may be analysed and reviewed if they are affected by the essential alteration of the value of the mutual services. This happens in extraordinary cases where the price agreed for the input is no longer acceptable to the supplier without incurring qualified losses; when the agreed fee for the use of an intangible asset becomes uneconomic, beyond reasonable risk and due to supervening and unforeseeable circumstances; or when compliance with the provision of a service leads to repeated losses for the party providing the service in order not to fall into default. However, we insist that we always place ourselves in exceptional cases where the remedy can be applied due to extraordinary and supervening circumstances that affect the specific cause of the business beyond the control of the risks that the parties must assume in a standardized market context.
5. In particular, on leases for non-housing use – of premises –
The Supreme Court has been reluctant to apply these remedies when it has had to make decisions in cases of leasing of business premises, both when the alleged circumstances were detrimental to the lessor and when they were detrimental to the lessee. With the exception of the judgment of 15 October 2014, both an earlier judgment of 27 April 2012 and the subsequent and most recent judgment of 15 January 2019, deny the application of the rebus clause to leases between businesses, meaning that neither the context of economic crisis nor the extremely long duration of the contract can be the cause of activating the remedy, since, among other things, the parties must be diligent in identifying, defining and distributing and remedying their contractual risks in the contract itself.
It has been argued by authoritative doctrinal opinion that there is no obstacle to applying the rebus clause to non-housing leases in the current context of the COVID-19 and the corresponding obligation to temporarily close down retail activities. This assertion is based on the alteration of the commutability of the contract and the resulting excessive burden on the tenant.
In view of these assertions, after what has been argued here, we have irremediable doubts as to whether the scope of the commutative service has been altered, whether the perimeter within which the contract was moving in its proper balance has been distorted and whether the excessive cost is determined by the corresponding service to be paid by the lessor. Let us explain.
In the first place, because in the lease contract the reciprocal benefit consists of the delivery by the lessor of the thing for its use and enjoyment for a certain time, against payment of the certain price agreed. In this context, the lessor has to provide the lessee with the use of the thing free of claims by third parties, and restrictions on activity established at the administrative level are outside the scope of the performance at the lessor’s expense.
The lessor, upon delivery of the premises, fulfils his obligation to provide the service, and is only obliged to guarantee its use by carrying out the necessary repairs in order to maintain it in a state of use for which it was intended. For this reason, article 1.558 of the Civil Code provides that the rent to be paid by the lessee will be reduced if the repairs to be carried out by the lessor in his premises (and which are part of his contractual service) last more than forty days. The lessor has not failed to perform his service, so there are no initial reasons for not paying the rent.
Secondly, because we believe that the cause of the tenant’s obligation is not the operation of the business in the premises, but the use and enjoyment of the premises for a certain price. In the same way that, correlatively, the cause for the lessor’s obligation is the regular collection of rent for the transfer of the use of the premises, not for its economic exploitation by the lessee. It is here, in this causal fit that one finds the reciprocal utility or mutual convenience, or in the same sense the so-called value of the mutual benefits.
Thirdly, because the lessor is not liable for any disturbance that the lessee may suffer in the premises due to a third party. However, in such a case the tenant will have direct action against the disturbance (article 1560 of the Civil Code). The total restriction of activity imposed could lead to a claim against the public administration, if its assumptions are met and if the second paragraph of the provision itself is overcome, according to which “There is no de facto disturbance when the third party, whether the administration or a private individual, has acted by virtue of a right that corresponds to him. “The reciprocity and commutability inherent in the rental contract, which is onerous and bilateral, is not altered by the disturbance of use imposed by the Government on the tenant on a temporary basis. It is a different matter that the lessee has, in this context, neither the will nor the incentive to perform his service, but this is no reason to support the defended alteration of service, and to a lesser extent to make the lessor suffer from a problem that is alien to him and that he would not suffer from if he had decided to lease his premises for an activity of which they have not been restricted – food, health, etc.
Fourthly, because the Civil Code provides for a specific solution in the only lease where the tenant has an extraction or farming purpose, i.e. agriculture. Article 1575 provides that the tenant shall not be entitled to a reduction in the rent for sterility of the rented land or for loss of fruit resulting from ordinary fortuitous events; however, in the event of loss of more than half of the fruit, the rent may be reduced for extraordinary and unforeseen fortuitous events, unless there is a special agreement to the contrary. The reduction of rent is justified in the case of loss of more than half of the fruits, and therefore, without doubt, its application is analogous to the contract of lease of premises, since there is an evident identity of reason, the reduction of rent would only operate in those cases in which the tenant can prove that it is justified: (a) that the COVID-19 pandemic is equivalent to an extraordinary fortuitous case; and (b) that the direct causal relationship is the loss of half of its annual operating profit.
Fifthly, because the Legislator has already chosen to regulate an express solution for these contracts during the exceptional state of business closure. Being aware that the solution adopted by Royal Decree-Law 15/2020, of 21 April, does not satisfy either of the parties to the business relationship, and to a lesser extent the legal operators who have to provide a solution to this conflict, we must not simply disregard its effectiveness as a mechanism for correcting the damage caused to tenants and their businesses. In the Explanatory Memorandum of the rule, it is stated that in view of this situation generated by the COVID-19 pandemic, “it is appropriate to provide for specific regulation in line with the “rebus sic stantibus” clause, developed by case law, which allows for the modulation or modification of contractual obligations if the required requirements are met: unpredictability and unavoidability of the risk involved, excessive cost of the service due and good faith in the contract”; and that “It is considered appropriate to provide a response to address this situation and to regulate a procedure for the parties to reach agreement on the modulation of the payment of rent for premises”.
It is therefore noted that the Legislator has taken a position on the dispute, denying the possibility of reducing the rent during the planned period of total activity restriction, which is expected to last approximately two months. We insist on the fact that we may not like the proposed solution at all, but it is definitely the one adopted by the Legislator, so it is difficult to defend in court the application of the rebus clause, strictly during the temporary period regulated by the Royal Decree-Law. It will be a different matter if the negative effects of the pandemic extend temporarily to business far beyond these first few months, in which case we will find ourselves in a context of economic recession and crisis that may be treated as a disturbing element of contractual commutability, but with a very limited effect on the current doctrine of our High Court, which does not recommend its judicialisation.
The questions that arise and which must necessarily be addressed before the dispute is brought to court invite reflection and agreement. Thus, is not excessive cost taken into account when faced with a sudden event from which an extraordinary profit is derived from the business run by the tenant in the premises? In a lease contract for an annual economic benefit, but whose payment is agreed to be divided into twelve monthly payments of the same amount, what minimum period of time must be evaluated for it to be understood that economically there is a significant alteration in the circumstances? Is the economic crisis that may derive from the state of alarm sufficient cause to request the application of the rebus clause? Are the economic consequences of the restrictions or limitations on activity transferable to the lessor, who for his part also suffers the undeniable consequences of the pandemic in his own legal and property sphere? In the same way that the application of the rebus clause is required in this context, which is detrimental to lessees, will the same melon be opened when the lessor understands that there is a context that enables him to require an extraordinary update of the service?
6. By way of conclusion
The Contract in a market economy is the result of an interaction between the private will shaped by an alleged particular interest, and the law, which is in charge of watching over the common interests (Lacruz). The contract is thus constituted by the content of the will that the contracting parties have put into it, as well as by the determinations that derive from the law and equity. The limits imposed by the law on the freedom of agreement are no more than the expression of the Legislator on what he wishes to be taken into account at the time of contracting. Judicial intervention based on equity is only justified in very extraordinary cases, when the contract and its correlative obligations are subjected to a test of resistance that blows up the general principle by which the content that the parties gave to their will is understood to be invariable.
It is therefore important to bear in mind that any remedy for altering the content of the contract without the agreement of all the parties, all and any, obliges the party to initiate legal proceedings of uncertain result and long duration. While the litigious debate arises, it is not advisable to breach the obligation because it is not intended to break the link definitively, so it is necessary to resort to temporary procedural remedies to circumvent the obligation and accommodate it cautiously to what is intended. To all this must be added the fact that there is no guarantee of effectiveness in the application of the rebus clause or the doctrine of breach of contract basis as a means of defence to justify non-performance of the correlative performance. There are too many pitfalls to be overcome, and these lead to predictions of business, cost and opportunity inefficiencies, except in very specific cases.
Common sense, coherence, the long-term economic planning of companies, the stability of production and the social function of every economic operator in the market should make those who maintain an intransigent and short-term position in the current social context seriously reconsider. If the contract is born from the will, from the pact, from the agreement between the capable, that same will of pact or agreement between the capable must re-emerge to temporarily accommodate the reciprocal interests in an objective perimeter of just balance, far from particular interests and crematory criteria of opportunity. It must be society and legal operators who, once again, responsibly take over the function that our legislator does not know how to do or does not want to do, promoting agreed solutions that are more agile, quicker, more efficient and with similar content to those that can be achieved extraordinarily well in the courts.
To this end, it is essential to approach a negotiation process with guarantees and legal certainty, advising to duly document both the initial and respective negotiation positions, as well as the final result achieved, which must be accompanied by general principles as relevant as the exercise of rights in accordance with the requirements of good faith, to ensure in a fair manner the preservation of the contract, as well as to respect the word given and one’s own explicit acts that position the expectation and trust of the other party in a given legal consequence. From Addvante, we put ourselves at the disposal of our clients to successfully deal with this process.