16
Apr2020

Food for thought. Safeguaring the ongoind contracts during the state of emergency, as seen in practice

The economic and tax measures taken during the state of emergency for the protection of the business environment and the economic system are no longer a novelty for individuals, either natural or legal persons, involved in ongoing contractual relations; this is because the Costaș, Negru & Asociaţii – Lawyers’ Civil Partnership has been providing legal advice on contractual matters, according to the wishes and proposals of our clients.

The most frequent requests revolve around two types of legal relationships, derived from lease agreements and bilateral promises of sale. Next, we will proceed to the punctual analysis of the real issues arising in practice, respectively the enforcement of force majeure, unilateral denunciation of the contracts or, in more tragic scenarios, the termination of the ongoing contracts. For an easier understanding, we shall group the analysis into two categories: one dedicated to lease agreements and one concerning the promises of sale.

  1. Concerning Lease Agreements

By Government Emergency Ordinance no. 29/2020, published in the Official Journal no. 230 of the 21st of March 2020, the issue of legal relationships derived from lease agreements was considered by art. X paragraph (1). In order to benefit from a deferred payment of the rent exclusively during the state of emergency (and not from a definitive exemption of the payment), enterprises must fulfil, in a cumulative manner, the following conditions:

a. holding the status of small and medium-sized enterprises, as defined by Law no. 346/2004 on stimulating the setting up and development of small and medium-sized enterprises, as modified and amended;

b. the enterprises have interrupted their activity as a whole or in part, based on the decisions issued by the competent public authorities, during the state of emergency;

c. the enterprises possess the emergency certificate issued by the Ministry of Economy, Energy and Business Environment;

d. the rent must be due in exchange for the use of the property having the special destination of registered office or secondary office.

The questions that were raised most often in this context were, from the small and medium-sized enterprises tenants, why they are unable to invoke force majeure in such contracts, respectively why there is a simple deferral of rent being discussed, as opposed to an exemption in payment. All these questions came in the context in which, at the time of the drafting of the lease contracts, various terms giving various effects to force majeure were introduced.

The answer fit for the general case (independent of the contractual provisions derogating from articles 1351, 1557 and 1634 of the Romanian Civil Code) arises from a guiding principle in civil law: genera non pereunt (generic goods do not perish). As a result, we explained to our clients, in layman’s terms, that as long as the debtor of an obligation to give a sum of money is solvable, they are expected to pay.

The legal explanation for which force majeure, translated into contractual plan as an unforeseen impossibility of execution, does not produce effects regarding the obligation to pay a sum of money (in this case, the rent), starts from its very nature of an absolute obligation of result, so that the debtor is obliged to fulfil his obligation even in the event that the promised result was not obtained as a result of a force majeure event.

The legal basis for this opinion is art. 1634 par. (6) of the Romanian Civil Code, according to which ”If the obligation relates to generic goods, the debtor cannot invoke the unforeseen impossibility of execution.”. Moreover, one of the conditions identified by the specialised legal doctrine (Liviu Pop, Ionuț-Florin Popa, Stelian Ioan Vidu, Civil Law. Obligations, Universul Juridic Publishing, Bucharest, 2015, page 553) for the enforcement of force majeure / unforeseen impossibility of execution is the following: the object of the obligation must constitute any benefit, except for the one that has as an object generic goods.

We can thus conclude that a notification sent by the debtor of the obligation to pay the rent (the lessee) to the creditor of this obligation (the lessor), based on the civil institution of force majeure, in order to obtain the ”pardon” of the rent payment, will lack any effect, in the absence of contractual terms that would expressly provide otherwise. Regardless of the existence of contrary contractual clauses, the salvation of the contract depends on the goodwill of the lessor.

The legal truth was difficult to swallow by some traders who wanted to safeguard the contracts and the legal relationships derived from these contracts, but who complained about a possible financial inability to successfully meet such an endeavour.

For this reason, we advocate for carrying out negotiations for the modification of the lease agreements, with the utmost inventiveness and, why not, compromise, so that the contractual benefits are rebalanced without the need to access a court of law (and using the unpredictable institution of… unpredictability).

In the absence of hardship clauses that oblige to renegotiation in cases in which the performance of a contractual obligation would become excessively burdensome for one of the parties, the fate of the contract depends, at first, on the willingness of the parties, and second, on their business consciousness (and, we would add, the resorting to specialised legal assistance). In other words, a renegotiation obligation does not exist for the parties in the absence of a hardship clause, so that the termination of the contract remains an option at any time.

This is the time when the parties to the lease must understand certain legal matters:

  • the difficulty of the situation in which the tenant is found, but also the continued fulfilment of the lessor’s obligation to ensure the use of the property by the lessee, which also includes the storage of the goods of the small and medium-sized enterprise, the provision of security, the access to utilities, etc.;
  • the financial difficulty of the tenant, but also the binding force of the contract concluded by the enterprise;
  • the economic difficulty of the tenant, but also the facilities that they can benefit from under the ordinances issued by the Government in the context of the spread of the pandemic (for example, but not limited to the benefit of technical unemployment for the employees, therefore the expenses with the wages being significantly reduced).

We emphasise to our readers that the analysis carried out by our firm always moulds according to the given case, and of special interest for us remain the contractual clauses agreed upon by the parties that establish, through the will of the parties, other effects of the force majeure or, why not, specific ways of invoking / notifying it.

To the extent that the salvation of the contract no longer appears as an option for either of the parties, there is always the possibility of resorting to the legal and / or contractual ”exit” solutions from the legal relationships. We consider, in particular, the easiest way: unilateral denunciation, with the specification that there is always the possibility of resorting to other civil law institutions, conditioned by other aspects, such as the termination of the contract (”reziliere”).

To the extent that we do not discuss the rental of housing, so that the provisions of art. 1824–1825 of the Romanian Civil Code are applicable, the supplementary legal provisions contained in art. 1276–1277 of the Romanian Civil Code become of interest. According to these provisions, in contracts with successive or continuous execution – category in which we include the lease agreements – the right of unilateral denunciation can be exercised with the respect of a reasonable period of notice, without the denunciation having effect on the obligations already executed or in the course of execution.

In a recent case managed by our firm, the parties of the fixed-term lease of a premise intended to be used for commercial activities made use of the possibility conferred by art. 1276 par. (3) of the Romanian Civil Code and established a consideration for the unilateral denunciation of the contract amounting to the equivalent value of eight rents. However, the mechanism envisaged by the parties departed from these provisions, so that the denunciation would take effect before the benefit was executed, and the amount due as consideration would have been compensated with the bank guarantee of good execution paid at the time of the conclusion of the contract, which reached the value of three rents.

The tenant tried to evade the payment of the amount of money representing the consideration of the unilateral denunciation, invoking the lack of fault and… force majeure. If the issue of the latter has been resolved with regard to payment obligations, we draw attention to the fact that the benefit was agreed by the parties independently of fault, representing, in reality, a mere price of the denunciation.

  1. Concerning the bilateral promise of sales and purchase of real estate:

Crises generate drama in a manner directly proportional to the opportunities they provide.

During the Covid-19 pandemic, as well as during the prolonged emergency state and its associated military decrees, the real estate market is one of these sources, otherwise inexhaustible. The collision between the interests of the promising sellers and the promising buyers becomes inevitable, crashing someone’s dreams on the one hand, and providing speculative opportunity (graceful or less, depending on the potential), on the other hand.

We have advised both.

At times, the promising buyer tried to mitigate the dramatic effects of the arisen situation, while sometimes they intended to capitalize upon it (facts and data being on their side) and thus renegotiate the bilateral promise, despite the absence of any hardship clauses or any other similar agreements.

Certainly, the core of the issue can be summed up in the following manner: how does force majeure impact the contract (the bilateral promise of sale and purchase) from the perspective of the promising buyer? The answer: it does not necessarily and automatically constitute force majeure. Consequently, the correlative question addressed by the lawyer: what is it aimed for? Eventually, at times, we do act as magicians.

The relevant singularity of the bilateral promise of sale and purchase of real estate represented the price stipulated to be paid via bank loan, on the date stipulated for the contract signing in authentic form (notarized agreement). Nonetheless, the acquiring of the bank loan never being stipulated as a condition for the signing of the sale contract itself. Therefore, although the contractual provision regarding the bank loan constitutes a contractual risk that shall be borne solely by the promising buyer, it is plenarily capable of overturning the expectations of the parties regarding the execution of the agreement. In particular, the bank with which the promising buyer has initiated negotiations regarding the loan acquisition, has already proceeded to communicating letters of information regarding the prolongation of the loan acquisition procedure due to the current situation (Covid-19 pandemic, the emergency state as well as the associated military decrees) with a corresponding 2-month period from the previously estimated duration. It is important to note that the bilateral promise has been signed before WHO declared the Covid-19 outbreak as a pandemic, and before the Romanian President has declared an emergency state.

The legal implications for the good client were circumscribed to (1) a clause that stipulated that the failure to acquire the bank loan constituted a reason for contract termination, and such determined the applicability of the penalty clause, as well as (2) to a clause that stipulated that in case the value of the bank loan is less than the sum regulated to be paid as a price, the promising buyer is obliged to procure the difference from personal resources. Meanwhile, the stake for the bad client regarded the opportunity to capitalize over this prolongation and proceed to renegotiation of the agreement itself due to the plunging of the real estate market. There was no ugly client.

To what extent the applicable institution or remedy represents force majeure, hardship, the civil institution of lesion, denunciation or penalty clause, and therefore the termination of the contract, a significant part of the legal world has issued vague and inconclusive opinions regarding these types of agreements, stating that „it depends case by case”. Sometimes there is no need to analyse a case by case scenario since the civil law states explicitly which conditions are imperative to be met in order to have a certain institution or remedy applicable. Therefore, by exclusion, certain vagueness can be cleared right away, without giving space to unfounded illusions. Moreover, the consequences of the applicability of these remedies or institutions are the key ones, since parties frequently imagine different outcomes than the ones provided by the law, for example, when they opt to invoke the force majeure.

Herein, the lawyers intervened, providing the relevant analysis necessary to manage the situation.

Therefore, the premises of the case (a) implied a potential obstruction brought by the bank regarding the loan acquisition necessary for the payment of the price, (b) which as a consequence entailed a risk for the promising buyer to be contractually liable and therefore cause the termination of the agreement, as well as the applicability of the penalty clause (losing, in this case, the advance payment), (c) since no denunciation clause has be agreed upon, and (d) due to the intervening of the exceptional situation as Covid-19 pandemic, the emergency state and the associated military decrees.

(a) force majeure, an inconvenience rather than an upper hand

Force majeure (Article 1351 of the Civil Code), within contractual obligations, manifests itself as a forced impossibility of execution (Article 1557 of the Civil Code). Meanwhile, no exoneration occurs in reference to the payment obligation, is case of force majeure considering (Article 1634 (4) of the Civil Code). Money never disappears. It can always be replaced by… other money.

Furthermore, the bilateral promises of sale and purchase represent agreements that give birth to an obligation perform. The promises stipulate mandatory clauses that shall be included in the sale and purchase agreement that ought be completed at a specific date set by the parties, clauses that have already been negotiated and are essential for the validity of the sale and purchase agreement. In any case, the obligation to pay the price does not arise from the bilateral promise, but from the sale and purchase agreement in a notarized form, at the time of its signing, since the translational effect of ownership arises validly exclusively from the notarized version of the sales and purchase agreement. Hence the reason why the provisions within Article 1670 of the Civil Code stipulate that, in absence of a contrary provision, the sums of money paid on the bases of the bilateral promise represent an advance payment, not the price itself. The parties, nonetheless, have already irrevocably negotiated the price of the sales and purchase agreement and cannot revise it without legally activating contract liability, such as the penalty classes.

Under these circumstances, the legitimate question that arises is the following: if force majeure (the forced impossibility of the contract execution) is not eligible to be invoked in reference to an obligation of paying a sum of money, and…. the bilateral promise of sales and purchase does not give birth to such an obligation, is the promising buyer allowed to invoke this exoneration cause in their favour? The answer in a correlative question from is: what are exactly the obligations that the promising buyer cannot fulfil due to force majeure?

Hence the utility of bottom to top analysis, especially in reference to the effects that arise due to applicable force majeure, and therefore the conclusion whether is it convenient or not to recourse to it.

It is crucial to note that the obligation to perform way arises on the bases of the bilateral promise – namely to show up at the public notary in order to give your consent in an authorized form for the sales and purchase agreement – is mandatorily in correlation with the negotiated price, as in inherently to an obligation to pay a certain sum on money. Since this interpretation is debatable, the options are as follows: (1) in case the promising buyer is considered to be obliged to pay a sum of money (since this obligation shall arise at the moment the sales and purchase agreement is signed by the parties in a notarized form, corroborated with the fact that the price cannot be revised), force majeure shall never constitute a reason for exonerating the relevant party of its obligation to pay that specific amount of money – the provisions of art. 1634 (4) of the Civil Code are explicit; (2) in case the obligation that arises from the bilateral promise is analysed independently of the already negotiated price that is not due yet, it is important to note that the forced impossibility of execution results in termination of the bilateral promise; or, in this case, the bilateral promise is dissolved and the parties are restored to their previous situation before that of the bilateral promise, without the penalty clause being applicable.

Nonetheless, if we go back to the main reason due to which the promising buyer cannot fulfil their obligation to perform, particularly those regarding the acquisition of the bank loan timely, our humble opinion is that this constitutes a contractual risk assumed solely by the promising buyer, and not an external, unpredictable, absolutely invincible and inevitable event.

The sole exception, in this case, represents the situation of no show up at the public notary due to a military decree (a fact that could not have been predicted at the moment of the parties signed the bilateral promise), a fact that literally bars the relevant party from being present at set date at the notary in order to agree over the sales and purchase contract (in this case, the only consequence shall be the suspension of the contract, and not its termination, since the impossibility is essentially temporary). Otherwise, the invoked force majeure would have superfluous grounds. In such case we appreciate that even the provisions of Article 1557 (2) of the Civil Code are not applicable, therefore the promising seller is not being allowed to suspend its own obligations (arisen from the bilateral promise), and the promising buyer not being able to benefit of a prolongation of all the due dates set out within the bilateral promise.

The objective risk caused by the forced impossibility of execution is as follows: qualifying the behaviour of the promising buyer as unjustly refusing to sign the sales and purchase agreement, therefore terminating the promise, enforcing the penalty clause and keeping the sum paid in advance.

(b) hardship gains legitimacy in the face of force majeure

Compared to force majeure, hardship represents a basis for adapting the contract when its execution has become excessively burdensome due to an exceptional change of circumstances, which obviously makes it unjust for the debtor to execute the obligation derived from the contract. More precisely, the aim is to adapt the contract and, only as an ultimate alternative, to terminate it. It is important to note that both adaptation and termination are ordered exclusively by the court. To be clear, hardship is linked to a manifestly unfair disproportion of the benefits, but it does not prevent the execution of the contract, while force majeure is transposed into a forced impossibility of execution (temporary or definitive).

In order to be able to enforce the civil institution of hardship, it is necessary for the promising buyer to immediately initiate renegotiation procedures. This renegotiation can be pursued on the basis of Article 1271 of the Civil Code (hardship), as well as on the basis of Article 1170 of the Civil Code (negotiation and execution of contracts in good faith). The promising buyer cannot oblige the promising seller to renegotiate (and even more so to conclude the contract under other conditions, in the absence of hardship clauses), but must submit due diligence to try to renegotiate, otherwise the court will not be able to proceed to adaptation of the contract, being forced to reject the court claim as inadmissible.

Further, since on the basis bilateral promise, an obligation to perform is being born on behalf of the promising buyer, namely the obligation to show up at the public notary in order to conclude the sales contract in authentic form, the question is how can the court adapt the contract. Prior to this clarification, it is necessary to specify that in the event that the court will consider that it cannot adapt the contract, it will order its termination without the incidence of contractual liability, so that the penalty clause borne by the promising buyer shall not operate. However, adapting the contract does not mean validating an option to reduce one’s own obligations as requested by the party claiming to be affected by the economic/ real estate crisis, or as speculated by it. It is not excluded that the court shall validate the contract and therefore the contractual liability of the promising buyer shall operate in all its glory.

In order to adapt the contract, that the court tires to resolve the manifest disproportion between the benefits between the parties, caused by the exceptional situation intervened after the conclusion of the promise, due to the Covid-19 pandemic, the emergency situation, respectively due to the military ordinances. All these measures imposed by the competent authorities consequently generated an economic crisis and inherently a real estate one, which altered the behaviour of banks, determining them either to delay certain procedures, either to tighten up conditions for granting loans.

The disproportion is required to be expressly revealed to the court, taking into account the principle of availability: (1) either in the form of the request for the extension of the payment term calculated from the date of conclusion of the contract in authentic form, (2) or in the form of… adapting the obligation to perform derived from the bilateral sales promise. This very last possibility of adaptation is precisely the core of the problem.

If the obligation to perform (to show up in front of the public notary in order to conclude the sales contract in authentic form under the essential conditions already negotiated) is interpreted as indissolubly confined to the payment of a sum of money, the court may actually adapt the price stipulated in the promise and to which the promising buyer will be obligated once the sale contract is concluded in authentic form. Specifically, to show up in front of the notary public for the purpose of concluding the sales contract in authentic form is decisive if at the date set for the conclusion of the contract, the price becomes excessively onerous in relation to the value of the property. However, even if there is no price of the promise to be adjusted, the obligation to present oneself in front of the notary public for the conclusion of the contract is analysed by reference to the agreement meant to be given for the negotiated essential clause on the price, which leaves room for the court to manoeuvre on the basis of hardship.

If, however, the court will appreciate that the bilateral promise gives rise only to an obligation to perform (to conclude the future contract) and not to an obligation to pay a price/ as sum of money (this one not due, the price being only firmly negotiated; when talking about real estate property, only a contract concluded in authentic form is able to transmit the property and therefore able to give rise to it), the court will not have anything to adapt. In this context, the question is whether the court can order the adaptation of an obligation derived from the contract as a result of a contractual non-performance, such as an obligation that is not correlative to the main object of the contract. Specifically, although there is no obligation to pay the price to be adapted in order to remove the unfair disproportion, the court will proceed to adapting… the obligation to pay the penalty clause, stipulated as a sanction for contractual non-performance. However, because this sanction is a mandatory incident in correlation with the resolution of the contract, the answer is obvious: since the contract whose adaptation is demanded ceases as a result of the resolution, there is no benefit that has to be adapted, since the contract itself does not survive and is therefore cannot be executed. In our opinion, it is debatable whether a contractual sanction can be adapted, since the rule aims to adapt the benefits of each party, and not the consequences of not performing them. The reasoning is also clear: there are no reciprocal benefits in order for the adaptation of the contract to operate, the obligation to pay the amount as a penalty clause being correlative to a non-performance of the contract, not to a benefit.

Hence, the limits of adapting a bilateral promise of sales under hardship.

Finally, the manifest disproportion occurs as well in forms other than related to the price of the property, or the term of payment of the remaining price as a result of contracting a bank loan. A devaluation of the currency on the market is imaginable as well.

Maximum precaution is advised in this respect to the object of the renegotiation. The risks in this regard consist in assimilating the conclusion of an additional contract (for extending the term for the conclusion of the contract in an authentic form) to an explicit acceptance of the exceptional situation that occurred after the conclusion of the contract. Which, of course, will make the judicial action in adapting the contract inadmissible, the unpredictability of the hardship… not existing anymore. However, we do not exclude the possibility of arguing that the exceptional situation began to manifest itself under unforeseen and unimagined aspects only after the first renegotiation, the effects and implications of the exceptional situation represented by the pandemic not being fully assumed/ understood. In this context, if the adaptation requested in from of the court will be related to the price correlated to the significant devaluation of the property, not before „verifiable” symptoms appear on the real estate market, it cannot be argued that the implications of the exceptional situation have been foreseen and assumed by the promising buyer by signing the additional act (to extend the term of the contract). No one can validly accept something one does not know. The disproportion has not yet occurred. Therefore, there is no ground for renegotiation and so it cannot be argued that at an earlier time, at the conclusion of the additional act (to extend the term), the implications of the exceptional situation generating disproportion were assumed or accepted implicitly.

(c) the civil institution of lesion, a fantasy

Provided the court  qualifies the obligation derived from the bilateral promise of sales as an obligation to perform, that indissoluble contains an obligation to pay a sum of money, the only situation in which the incidence of lesion can be imagined (Article 1221 of the Civil Code) is that if one of the parties, taking advantage of the state of need, the lack of experience or the lack of knowledge of the other party, stipulates in their favour a benefit of a considerably higher value than the value of its own benefit, at the date of the conclusion of the contract. Nonetheless… the lesion must exceed half of the value, at the time of the conclusion of the contract, of the benefit promised or executed by the lesioned party. However, since the pandemic, the state of emergency and the military decrees have caused such a devaluation only after the conclusion of the contract, we cannot legitimately consider of the incidence of the civil institution of lesion.

Even if the conditions of lesion are met, the promising buyer can request in court the annulment of the bilateral promise, and not for a reduction of the price. This last possibility occurs only if, as a result of the request for annulment, the promising seller opts and therefore expressly asks the court to reduce the price accordingly because it chose to give up the termination of the contract.

(d) the eternal and faithful girl – the contractual renegotiation based on good faith (Article 1170 of the Civil Code)

Since the adaptation or termination of the bilateral sales promise for hardship is not unthinkable, the parties have, at any time, at their disposal the remedy of renegotiation as a procedure prior to the adaptation of the contract in court, or simply essentially as a manifestation of the good faith between the parties (that might be extremely rare). Of course, provided the fact that the binding force of the contract is in no way affected or suspended by this approach.

(e) if it all fails, go for proof of non-fulfilment of the conditions for the incidence of contractual liability, therefore the inapplicability of the penalty clause, or the reduction of the penalty clause by a court of law

 Coming back to more pragmatic aspects, a penalty clause such as the one in this case might be ineffective if it the bank’s refusal to grant the loan is due to the quality of the construction or is inherently related to the builder, so to the promising seller. The reason is essentially clear: no one can plead their own fault in support of their interests. That, of course, determines the inapplicability of the clause.

The judicial request for the reduction of the penalty clause as being abusive, that is, representing excessive compensation (Article 1538 of the Civil Code), can also be a perfectly legitimate option.

In conclusion, it is redundant to mention that the second Presidential Decree prolonging the state of emergency reveals the complexity of the status quo, a virulent cold shower for the contractual parties that hoped to go through the emergency situation, sneakily, without explicitly revising and adjusting its legal situation of relevant contractual relationships. Therefore, existing remedies need to be harnessed as an attempt to limit the harm caused by what humanity has not seen in over 100 years.

This article was prepared for the website of Costaș, Negru & Asociații, by our attorneys, Ms. Irina Galiș (Arad Bar Association) and Ms. Xenia Burghelea (Bucharest Bar Association).

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