ASHURST PARIS | CORPORATE UPDATE 20 Mar 2020 COVID-19 - impact on the performance of French contracts and overview of the legal consequences

Covid-19 epidemic obviously impacts the economy worldwide, including France in particular since the enactment by the French Government of restrictive and then lockdown measures on 16 March. Commercial relationships are, at minimum disturbed, or in certain cases, just stopped. In these extraordinary circumstances, is the 'defaulting' party in breach of its contractual obligations under French law and therefore liable for such default, or should the 'defaulting' party be exempted from its liability or even authorized to exit from the contract ? French law indeed provides limited legal grounds to avoid liability in case of a default, or to terminate a contract, if conditions are met. French law also provides that external circumstances may allow to renegotiate the terms of the contracts. This note focuses on force majeure, material adverse change clauses, unexpected changes concept and hardship clauses under French private law. Further communications will follow shortly dedicated to French public law, as well as a particular focus from a real estate perspective. 

Possible grounds to avoid contractual liability in case of non-performance of obligations under French law

French law offers a limited range of cases to avoid contractual liability in case of non-performance of a contract.

Force majeure

The French Minister of Economy declared on 28 February 2020 that the Covid-19 would be considered as a force majeure event. As a result, some companies, unable to meet their contractual obligations, have begun to declare force majeure to protect them from breach of contract claims. However, the public declaration from the French Minister will not supersede French law and its requirement that the 'defaulting' party shall evidence that certain conditions are met to be allowed to claim for force majeure.

The concept of force majeure is set forth in article 1218 of the French Civil Code. It mandatorily applies to all contracts governed by French law, even if not expressly referred to therein. French Civil Code provides that "in contractual matters, there is force majeure where an event beyond the control of the debtor, which could not reasonably have been foreseen at the time of the conclusion of the contract and whose effects could not be avoided by appropriate measures, prevents performance of his obligations by the debtor". Three cumulative criteria must be met: the event must be beyond the control of the party invoking force majeure. The event shall not be reasonably foreseeable at the time of the conclusion of the contract and the event must totally prevent the performance of its obligation by the party invoking force majeure.

French courts adopt a case by case analysis and tend to take a strict approach regarding the force majeure criteria. To date, French judges have never qualified an epidemic as being a force majeure event, considering that the required conditions were not met. Indeed, in the cases submitted to French Courts, the epidemics were well known as recurring phenomenon affecting the involved countries, and hardly fatal (e.g. SRAS epidemic of 2003, dengue fever in the French West Indies, chikungunya epidemic, swine flu (grippe porcine)).

Covid-19 epidemic is obviously of an incomparable dimension. It seems reasonable to consider that it was not foreseeable before 30 January 2020 (date of declaration of the epidemic by the World Health Organisation) or maybe even before 29 February 2020 in France (date of the official declaration of the epidemic in France). Similarly, the Covid-19 epidemic should be considered as obviously being beyond the control of the party invoking force majeure. The evidence which will probably be more difficult to provide in certain cases is the one attesting that the party concerned is totally unable to perform its obligation despite the implementation of all possible measures. Of course, this will be easily proven when a governmental measure has prohibited certain activities (such as events regrouping people, closure of restaurants etc). But for the vast majority of the situations, the analysis may not be so straightforward. Indeed, the restrictions imposed by French government and even the lockdown do not, per se, prohibit or render impossible all activities; people are still authorized to go to work if they cannot work remotely; and remote work allows the continuity of service for many economic sectors. A case by case analysis will therefore be needed.

In addition, it must be stressed that even if a party successfully demonstrates to the Court that it was totally prevented from performing its contractual obligations because of Covid-19 epidemic which would constitute a force majeure event, the contract will only be terminated and the parties discharged from their obligations if the prevention is permanent or if the delay resulting from such prevention justifies the termination of the contract. To the contrary, if the prevention is temporary, performance of the obligations will only be suspended and postponed (unchanged) to a time when performance is possible. Given the nature of the Covid-19 epidemic, it might be anticipated that in many cases the Courts may consider that the performance of the obligations is only postponed and can be performed at a later stage. 

In contracts governed by French law, the parties may also have agreed to go beyond the provisions of article 1218 of the French Civil Code and to contractually agree that certain circumstances defined in the contract will be considered as being force majeure events, with associated consequences. In such case, the question of whether Covid-19 pandemic will be qualified as force majeure will depend on the specific wording concerned, to be reviewed on a case by case basis. 

MAC Clauses 

In the current circumstances, the applicability of material adverse change (MAC) clauses may also particularly focus interest. MAC provisions are often included in facilities agreements and share purchase agreements, conditioning the completion of the transaction to the absence of occurrence of a material adverse event (MAE) or change (MAC) during the period between signing and closing. If such change or event occurs, the party benefitting from this clause may refrain from performing its obligations under the contract without being in default; the contract itself being then terminated.

The nature of the event or change characterizing the MAC or MAE will depend on the specific definition set forth in the concerned contract. Indeed, this mechanic is purely contractual. The most common MAC clauses are 'business MAC' clauses (vs 'market MAC' clauses) referring to events affecting the target company's activity or its results. Market practice has developed different types of business MAC (with or without financial thresholds for instance), but almost all of them expressly exclude certain events from the definition of MAE or MAC, such as typically, 'matters or changes with affect the general evolution of the financial markets or general business or economic conditions'. Given the general impact of Covid-19 epidemic, it is not impossible that it may be considered as captured by such exclusion when/if existing in the concerned contract. In such case, the MAC clause would not be exercisable, and both parties should perform their obligations under the contract. No doubt that the market practice will revisit the drafting of the MAC clauses in the near future given the Covid-19 epidemic. 

Legal grounds to renegotiate the terms of the contracts: Legal and contractual protection from unexpected changes

If the 'defaulting' party is not in a position to evidence a force majeure situation, or if the contract considered does not contain a MAC clause allowing to terminate the contract, it may however be able to renegotiate the terms of the contract given the extraordinary situation triggered by the Covid-19 epidemic. 

Renegotiation by application of French law on unexpected events ("imprévision")

French law has recently codified the practice of hardship clauses by introduction of the 'unexpected changes' concept (imprévision) in article 1195 of the French Civil Code ¹. It is defined as "a change of circumstances which was unforeseeable at the time of conclusion of the contract ²  which renders performance excessively onerous for a party which had not accepted to bear that risk".

As a preliminary remark, it must be underlined that this regulation should apply only to contracts concluded as from 1st October 2016 ³. Furthermore, since the codification of this concept in French law, a very large proportion of French agreements (in particular facilities agreements, share purchase agreements, joint venture agreements, and commercial leases) expressly exclude the application of the provisions of article 1195 of the French Civil Code, the parties having waived their rights in this respect. They are generally not waived in long-term commercial agreements, construction leases, long term leases (baux emphytéotiques). Therefore, the first step will be to check in the contract concerned whether the application of the legal 'unexpected changes' regime has been waived or not. If not, the following should be considered further.

As for the force majeure (cf. supra 1.1) the change of circumstances shall not be reasonably foreseeable at the time of the conclusion of the contract. For the same reason as indicated above, this criteria should probably be considered as met with respect to Covid-19 epidemic (for contracts concluded before the declaration of the epidemic).

Contrary to what is required to qualify the force majeure, the concept of 'unexpected changes' contains a lower threshold and requests that the performance of the obligations remains possible (and must be performed, see below) but the change of circumstances renders such performance excessively onerous for a party who has not accepted (even implicitly) to bear that risk. 

There might be a greater chance that the Covid-19 meets the standard of 'unexpected change' than the standard of force majeure. One can imagine in particular that the 'excessively onerous' criteria can be met if the aggrieved party, because of restrictive or lockdown measures, must adjust or reorganise its whole supply/production chain or transport logistics and if this triggers massive additional costs. In any case, French courts will, as with force majeure, proceed on a case by case analysis.

However, one of the conditions imposed by French law is that, despite 'unexpected change', the aggrieved party actually continues to perform its obligations. A party having ceased to perform its obligations will therefore not be allowed to launch a request for renegotiation of the contract. 

Assuming the conditions above are met, the party suffering the consequences of an 'unexpected change' may request the other party to renegotiate the contract (e.g. price, rates, duration or other key terms).

Ultimately, if no agreement is reached between the parties, any of them may request the judge to assess and impose amendments to the contract, or to terminate it on a date and under conditions determined by such judge.

Contractual hardship clauses 

Despite the French law regime above in case of 'unexpected change' (imprévision), the parties of commercial contracts in particular often elect to either complement contractually this legal mechanic, or to waive it and replace it by a purely contractual hardship clause. 

Hardship clauses have been developed by the practice and are largely used in long term commercial contracts. Their aim is precisely to agree in advance that the parties will re-discuss the terms of their relationship in case of a change in circumstances having effects on the economy of the agreement and triggering a hardship for one of them.

The change in circumstances allowing a party to launch such discussion phase is generally defined in general terms such as: 'changes in economic or market conditions', 'event outside the control of the parties', 'substantial change in business, monetary, technical or commercial conditions'. Subject of course to reviewing each concerned contract on a case by case basis, it is however likely that the Covid-19 epidemic will meet such condition under numerous hardship clauses. 

Furthermore, such change must alter the economics of the contract and create a hardship for one of the parties. Usual drafting is often as follows: 'as a result of which that party suffers material hardship in complying with the agreement', 'hardship caused to either party by complying to perform the contract at the agreed prices'. However, similarly to the case above on 'unexpected changes' in French law, the performance of the contract must still be on-going.

As mentioned above in 2.1, there are certainly many cases in practice where the effects of the restrictive or lockdown measures due to Covid-19 have imposed certain reorganisation/adjustment for the performance of contracts triggering significant additional costs, but nevertheless not preventing totally such performance. 

Therefore, if the above conditions are met, the aggrieved party may request the hardship clause to be applied. Hardship clauses generally provide for a negotiation period to be opened, with an escalation process if no agreement is reached in a defined period of time. The parties may end to find an agreement on amended terms of the contracts to take into effect the change of circumstances; such amendments may for example concern the delay for performance, prices, volume of orders etc. 

The consequence of a failure to agree on amended terms depends on each specific contract, but in practice, it is often the right for the aggrieved party to request for the termination of the contract subject to prior notice.

Within the current context of Covid-19 epidemic, one can imagine that changes to the contract could be envisaged between the parties, may be for a temporary period of time, until the date on which the economic and market conditions come back to normality.