Coronavirus 2019 (COVID-19) and Contracts


CORONAVIRUS 2019 (COVID-19) AND CONTRACTS

Coronavirus 2019 (COVID-19)  and Contracts

ABSTRACT:

The subject of this study is the examination of the rights that Turkish law offers with respect to the termination/amendment of contracts following the COVID-19 outbreak which can be qualified as a social disaster.

Articles 136 (Faultless Subsequent Impossibility) and 138 (Hardship) of the Turkish Code of Obligations (“TCO”) can be considered as the most relevant dispositions. Given that the TCO art. 136 and 138 are default related provisions, this analysis will touch base also on force majeure and hardship clauses set forth in contracts as well as the relevant actions to be taken following the occurrence of such events. In case of absence or unsuitability of such clauses, considering that the main purpose shall be maintaining the balance of interests of the contracting parties, the application of art. 136 leading to termination of contracts due to force majeure or art. 138 regarding the adaptation of contracts through courts without termination can be considered.

In the current circumstances, the goal of the contracting parties shall be negotiating in good faith and, if possible, agreeing on the fate of the mutual obligations the balance of which has been disrupted due to the current social disaster. In case the parties are unable to reach an agreement, the abovementioned legal provisions may be applied. Although no disposition is set forth under the TCO regarding the temporary impossibility institution which is accepted by the Turkish Supreme Court, it is evident that the temporary impossibility is arising from the nature of the situation. Therefore, the application of this institution by the judicial authorities may come to the agenda in relation to the contractual obligations affected by COVID-19. In such a case, criterion of toleration period shall be applied and when such period is exceeded, the contract shall be deemed as terminated. In many contractual relationships, in particular the performance of pecuniary debts, it cannot be concluded that the performance of the obligation becomes impossible. In such an event, and depending on the specific circumstances, the hardship of the obligation and the application of art. 138 may be analysed.

The novel Coronavirus 2019 (COVID-19), which was first detected in Wuhan, China on 31 December 2019, was placed in the pandemic (epidemic) category on 11 March 2020 by the World Health Organization. Following such decision, which will certainly have various legal and economic outcomes, the fate of the currently ongoing contracts has become an actual problem.

            In a situation where a number of countries have been forced to put life on a standstill, there is a risk many contractual relationships to reach deadlock. In Turkey, as in many other countries, the transportation, tourism, culture-art-entertainment are the main sectors adversely affected by the pandemic. However, the negative effect will not be limited to only these sectors and it is already seen that a substantial part of the economic life has been disrupted. Accordingly, business life actors are seeking options enabling them to temporarily or permanently terminate or amend the contracts to which they are parties. However, it may not be possible to terminate or amend all contractual relationships via mutual agreement.

This means that the legal disputes will increase in the upcoming period. In order to maintain the process management of legal disputes correctly, first of all, the possibilities provided under the Turkish contracts law should be carefully evaluated and the applicable legal provisions should be determined. We will present these possibilities and our interpretations below.

  • In order to evaluate the impact of COVID-19 on contracts, first we need to give it the correct qualification.
  • In the doctrine social disaster is considered to be a change unsettling the social existence (Sozialexistenz) and having the capacity to affect the entire population or majority of the population such as war, earthquake, epidemic. (For detailed information on this matter please refer to Baysal, Başak, The Adaptation of Contract in Turkish Law, Hardship, 3rd Edition, Istanbul, 2019, N. 562).
  • Taking into account the above-mentioned definition and COVID-19 being placed in the pandemic (epidemic) category by World Health Organization, it can be easily concluded that COVID-19 may be qualified as a social disaster.
  • However, the qualification of COVID-19 as social disaster may not be sufficient for the settlement of legal disputes. Since the interests of contracting parties are equally protected, it is important that the risk arising from such fact is shared equally between the parties. The manner of such risk sharing may be determined in accordance with the particularities of each concrete contractual relationship.
  • The extent of the negative effect of the current social disaster on the contractual obligations can be divided into two main categories:

 

  1. Impossibility of performance as a result of force majeure; or
  2. Performance is still possible, but has become excessively onerous
  • With respect to such two scenarios, there are applicable dispositions set forth under the TCO: faultless subsequent impossibility (art. 136) and hardship ( art. 138). Emphasis should be placed on the differences between these two institutions and the solutions that best balance the interests of the parties. (For detailed information on this matter please refer to , Baysal, Başak, “The Adaptation of Contract in Turkish Law”, in The Effects of Financial Crises on the Binding Force of Contracts-Renegotiation, Rescission or Revision, (Ed. Başoğlu), Springer, 2016, Chapter 19).
  • Given that the relevant articles of the TCO are default rules, contracting parties may have agreed on different solutions in their contracts. Therefore, first of all, contractual clauses shall be reviewed. In case of absence of any contractual provision regarding force majeure events, the relevant articles of the TCO shall come into effect. Such two possibilities shall be examined separately.

POINTS TO TAKE INTO ACCOUNT, IN CASE THE CONTRACT INCLUDES SPECIFIC PROVISION REGARDING THE IMPACT OF A PANDEMIC ON THE PERFORMANCE

  • In order to determine the impact of COVID-19 on a contractual relationship, all provisions of the contract should be considered and interpreted together. Only this approach will allow us to understand the risk allocation between the parties. Within this scope, as a first step, it should be examined whether there is any provision in the contract regarding force majeure or hardship or not. (For detailed information on this matter please refer to Baysal, N. 686 ff).
  • In case of absence of such force majeure clauses, the entire agreement should be interpreted in the light of the relevant provisions of the TCO.
  • It is likely that the use of force majeure and hardship clauses in long term commercial contracts will increase in the upcoming period due to COVID-19. The issue of the interpretation of such clauses shall be encountered while settling legal disputes.
  • It is worth stressing that in contracts, very often force majeure and hardship clauses are used together and in some cases the boundaries between such institutions are unclear. In some force majeure clauses it is possible to observe the results (adaptation, renegotiation etc.) arising from hardship. (Baysal, N. 441). This is a natural consequence of the principle of freedom of contract. In such a scenario, the correct interpretation of such clauses will be of great importance. If a force majeure clause set forth in a contract contains provisions regarding the hardship , notwithstanding the title of the clause, it shall be considered as a hardship clause.
  • The first serious problem occurs due to vague expressions used in such clauses and the parties may fall into conflict regarding the meaning assigned to such vague expressions.
  • The contracting parties may list the situations leading to the adaptation or termination of the contract and agree on the results in a limited manner. In case it is agreed that some changes enable the adaptation of the contract, such changes may be listed (natural disasters, epidemic, war, strike, fire, law amendment etc.). If this option is preferred, the fact that whether listed situations are numerus clausus or not may be a matter of dispute.
  • It can be interpreted that the events listed in the force majeure clause are not limited, if a catch-all expression or expressions such as “in such cases”, “in similar cases” or “any other event beyond control” are used.
  • In practice, however, it is more likely that provisions which contain broad expressions lead to problems and disputes.
  • For the purpose of adapting the contract to the changed conditions, the most frequently used method by the parties is setting forth a provision reflecting the parties’ agreement to renegotiate. The obligation of renegotiation is considered as the most characteristic outcome of the hardship clauses.

Renegotiation will enable the parties to evaluate the changed situation and to restore the balance of a contract, submit an offer/a counter offer in accordance with the good faith principle. Parties should try to reach a mutual agreement to the best of their abilities and should not block and cut the negotiations in a manner contrary to the good faith. 

  • The fact that whether above mentioned contract clauses cover COVID-19 situation or not will create an important discussion in the upcoming period.
  • It is quite difficult to draft perfect and complete contractual force majeure or hardship clauses. In practice, the provisions of the contract, which can be considered complete in terms of both the conditions and the method of the adaptation of the contract, are not frequently encountered. Usually, mutually agreed force majeure and hardship clauses contain gaps. Although in general such rules envisage the adaptation of contracts in certain situations, they do not set forth exactly the method of adaptation. Force majeure and hardship clauses are limited to the risks predicted by the contracting parties. In case any situation exceeding parties’ prediction occurs, contracts are adapted or terminated in accordance with the general legal principles. However, it is certain that such contractual provisions change the risk assessment between the contracting parties. (For detailed information please refer to Baysal, N. 686 vd.).
  • Another important development regarding COVID-19 is the “force majeure” certificates. For instance, force majeure documents have been given by China Council for the Promotion of International Trade (CCPIT) to companies affected by the pandemic. In the upcoming period, the impact of such documents on contracts will be also discussed.

POINTS TO TAKE INTO ACCOUNT, IN CASE THE CONTRACT IS SILENT REGARDING THE IMPACT OF PANDEMIC ON THE PERFORMANCE

  • In case any force majeure or hardship clause is not present in a contract with respect to a party having difficulties to perform its obligations, the articles of the TCO regarding the debtor’s default (art. 117 ff), faultless subsequent impossibility (art. 136) and hardship (art. 138) may be taken into consideration.
  • Since COVID-19 is considered as a situation for which the debtor is not responsible and is beyond his control, faulty impossibility institution should not be applicable in the normal circumstances. However, in case the agreement is concluded at a date when COVID-19 was foreseen or supposed to be predicted and the debtor cannot perform its obligation afterwards, the creditor may raise a claim regarding the faulty impossibility (TCO art. 112). Accordingly, the debtor may be obliged to compensate the damage incurred by the creditor.  
  • 136 deals with the faultless subsequent impossibility including the force majeure cases: (1) An obligation is deemed extinguished where its performance has become impossible due to circumstances not attributable to the obligor. (2) In a bilateral contract, the obligor thus released is liable for the consideration already received pursuant to the provisions on unjust enrichment and loses his counter-claim to the extent it has not yet been satisfied. This does not apply to cases in which, by law or contractual agreement, the risk passes to the obligee prior to performance.(3) In case the obligor does not notify the obligee without any delay that the performance of the obligation has become impossible and does not take necessary precautions for prevention of increase in damages, the obligor is liable to compensate any damage arising therefrom.”
  • In many of its decisions, the Turkish Supreme Court has accepted “epidemics” as an event of force majeure[1].
  • It is undisputable that the decision regarding the closure of enterprises or transportation barriers taken by the administrative authorities are considered as force majeure events for the entities affected by those events. However, claiming only the deterioration in financial conditions as a force majeure event shall not be always acceptable. It should not be forgotten that the impossibility of pecuniary debts is not accepted. However, it is possible to adapt a pecuniary debt, e.g. a rental payment obligation, in case the conditions of TCO art. 138 are met.
  • In fact, the situation stipulated under art. 136 is a permanent impossibility event that leads to the extinguishment of a debt. However, very likely, the impact of COVID-19 on long term contractual relationships such as lease, will only cause temporary impossibility instead of permanent. Generally, the performance of the obligation may be deemed to have become excessively difficult or temporarily impossible. Having said that, it is very difficult to establish whether there is temporary impossibility or delayed performance, hence a default of the debtor.
  • Under the TCO, there is no provision setting forth the temporary impossibility. The subject has been discussed in doctrine and the jurisprudence. One approach states that the temporary impossibility does not extinguish the debt but leads in principle to the default of debtor. Another approach defends that in case of a temporary impossibility, provided that it is coherent with the parties’ hypothetical wills, the performance date shall be delayed until the disappearance of the impossibility (or the event leading to that). (For detailed information regarding this discussion and approaches please refer to Baysal, N. 622 ff.). The Turkish Supreme Court also supports the latter approach.
  • Following the Turkish Supreme Court General Assembly of Civil Chambers decision dated 28.04.2010 and numbered 2010/15-193-235, the principles set out below were adopted in the decisions of the Turkish courts.

Decision of Turkish Supreme Court General Assembly of Civil Chambers dated 28.04.2010 with the merits no 2010/15-193, decision no 235: “Impossibility of performance is one of the debt extinguishment reasons. According the TCO art. 117/1 “If the performance of the debt becomes impossible due to reasons that the debtor cannot be held responsible of, the debt extinguishes.” Impossibility of performance is subjected to some divisions considering the reasons of occurrence. One of such divisions is the division of objective impossibility (permanent impossibility)-temporary impossibility. In case the impossibility of performance is in question not only for the contracting parties but for everyone, it is considered as the objective impossibility. In fact, in the event of an objective impossibility, the contract is invalid pursuant to article 20 of (the former) Code of Obligations and the termination of the contract is not required accordingly. However, when temporary impossibility is the case, the performance of the contract depends on the occurrence of certain event. Only if such event occurs, performance of the contract may be claimed. (…) Undoubtedly, the existence of temporary impossibility, brings with the question of how long will the parties be bound by the contract. The relevant rule, in accordance with the ‘pacta sunt servanda’ principle is that the contract is binding to its parties. However, there are some particular events during which accepting the parties as bound with the contract both hinders their economic liberty and eliminates the opportunity to contract with another party. In practise, the period during which parties are kept bound by the contract in case of a temporary impossibility is defined as “toleration period”. It is required to examine whether such period is expired or not taking into consideration in each specific case.”

  • The Turkish Supreme Court has accepted that in case of a temporary impossibility, parties remain bound by the contract until the tolerance period expires (or is deemed to have expired). It is accepted that tolerance period is determined separately in each concrete case. If the impact of COVID-19 on contractual obligations is considered within the scope of temporary impossibility, in case of a dispute, it will be required that the tolerance period is determined separately in each specific case and following the expiration of such period, the debtor’s obligation shall be extinguished.
  • Taking into account that the temporary impossibility issue is highly disputable under Turkish law and that the end of COVID-19 period is not yet known, it is quite early to state whether the institution of temporary impossibility is deemed fit for possible disputes arising from the contracts affected by the COVID-19.
  • As explained above, given that the result of the impossibility institution set forth under the Turkish Code of Obligations is the extinguishment of the debt, there is a risk that the contract relation enters into a liquidation process. Termination of the contract will not be deemed as the best economic solution in every case in particular when long term contracts are in question. There are many contracts where it is in the contracting parties’ interests to continue the contract following the decrease or disappearance of the COVID-19 related risk. Therefore, TCO art. 138 stipulating the adaptation of contracts may offer a more suitable solution. Considering that all obligations, in particular pecuniary obligations do not become impossible, it would be more appropriate to mention that in many cases performance of obligations are rendered onerous. Accordingly, with respect to the possibility where TCO art. 136 may not be applicable, TCO art. 138 shall provide more effective solutions. Already now there are many contractual relationships under which the performance of the obligations has been rendered excessively onerous.
  • The institution of “adaptation of contracts” has reached to a legal ground with the art. 138 of TCO titled as “Hardship”. According to this article, “ In case an extraordinary event which was not foreseen and not expected to be foreseen by the parties during the conclusion of the contract occurs due to a reason not attributable to the debtor, and if the conditions present during the conclusion of the contract have been changed to the detriment of the debtor to such an extent that demanding performance from the debtor would be contrary to the good faith rules, and if the debtor has not yet performed his/her debt or has performed his/her debt by reserving it’s rights arising from hardship, the debtor shall be entitled to request the adaptation of the contract to the new circumstances, or to rescind the contract where such adaptation is not possible by the judge. In continuous contracts, in principle, the debtor shall use the right to termination instead of the right to rescind.” 138 has been adopted as an exception of the pacta sunt servanda principle.
  • The Conditions required for the implementation of art. 138 and the adaptation of the contract to the changed circumstances may be listed as follows (For further information regarding the conditions of TCO art. 138 please refer to Baysal, 496 ff.):
  • An extraordinary event which was not foreseen and not expected to be foreseen by the parties during the conclusion of the contract must have occurred;
  • Such event must not have raised due to a reason attributable to the debtor;
  • As a result of the extraordinary event, the conditions present during the conclusion of the contract must have been altered to the detriment of the debtor to such an extent that requesting performance from the debtor would breach the good faith rules; and
  • The debtor either must have not yet performed its obligation or has performed its obligation by reserving its rights arising from the hardship.
  • Whereas the force majeure is a problem of non-performance and impossibility, TCO art. 138 is applicable in case of a barrier rendering the performance onerous without leading to the impossibility (Baysal, N. 225). With respect to COVID-19, the division between such institutions is unclear.
  • As all sectors have not been adversely affected from COVID-19, and the question whether during the conclusion of the contract COVID-19 was foreseen or not, or, to be more precise, whether the impact of COVID-19 on each contract was foreseen or not, will be surely a subject of discussion during the possible disputes. It seems like this issue will lead to important discussions in the jurisprudence. Therefore, contracting parties should not easily conclude that they are rescued from their obligations due to COVID-19.
  • It is accepted that by the virtue of the good faith rule that parties should take steps for renegotiating their contracts prior to the adaptation of the contract (Baysal, N. 803 vd). In any case it is important and advisable that to the extent possible, parties renegotiate the conditions of their contracts by gathering together and trying to find solutions to overcome the possible impacts of COVID-19 on their contracts. There are many positive outcomes both legally and economically arising from the renegotiation process of the contract.
  • As regards to the question whether the conditions of art. 138 have been met or not will be a subject of discussion in the upcoming period, but in order not to exclude the application of such provision, it is required to perform the obligations with a reservation.
  • Finally, at this point, we would like to mention that the impact of the changed circumstances occurred following the conclusion of the contracts will be different on aleatory contracts. Security contracts, insurance contracts, construction contracts with income sharing mechanisms may be given as examples of such contracts. Adaptation of aleatory contracts is a highly disputable issue and their adaptation is considered difficult under art. 138. However, in case the risk threshold is extremely exceeded, the adaptation may still be in possible (Baysal, N. 739 ff.).

It is certain that COVID-19 will have impacts on contracts, but at this stage, both determining its legal results and estimating how it will be analysed in judicial decisions is not possible. Nevertheless, we are of the opinion that in accordance with our explanations, it is really important to consider the below mentioned issues:  

  • Clauses regarding the force majeure and the hardship may have been set forth in contracts. In case such clauses are present, the solution should be sought firstly in accordance with their provisions. Parties should review their contracts attentively and determine whether there is a force majeure or hardship clause or not.
  • In case such clauses exist, particular attention should be paid on their scope and whether any determination has been made within the relevant clause regarding the epidemics. Even if it is not clearly drafted, it should not be forgotten that the interpretation of the contract may also be effective to reach a conclusion.
  • Contracting parties should bear in mind that “pacta sunt servanda” rule is the underlying principle and by taking attentive and prudent steps may prevent possible disputes. Besides, such a prudent behaviour and doing what is required on their part in accordance with the good faith rule, will be in favour of the party acting accordingly.
  • Performing an obligation which has not become impossible, is a requirement of the pacta sunt servanda However, art. 138 grants the possibility of adapting contracts to the altered circumstances. COVID-19 may be deemed as an unforeseen, extraordinary alteration that has occurred after the conclusion of contracts, but its impact may not be the same to all contracts. The critical point is the unpredictability of the impact of the extraordinary change, that occurred following the conclusion of the contract. An aggrieved contracting party who did not foresee such impact and from whom the performance of the obligation may not be expected in accordance with the good faith rule, may have the adaptation right. In any case, it is required to act meticulously while performing the contractual obligations. If an obligation is going to be performed in the event of hardship, the performance must be made with a reservation of rights, otherwise there is a risk that rights arising from TCO art. 138 are lost.
  • With respect to the possibility of the application of art. 136 and art. 138 of the TCO to the contracts impacted by COVID-19, firstly, it is advised that contracting parties gather together and try to find solutions.
  • When a legal dispute arises, it may be claimed that the contract is terminated automatically due to impossibility in accordance with TCO art. 136. However, in this scenario, it may be encountered a defence alleging that temporary impossibility is the case and the toleration period, which is accepted in the practice of the Turkish Supreme Court, has not expired yet.
  • As explained above, termination of the agreement will not be deemed as the best economic solution in every case, in particular when long term agreements are in question. There are many agreements where it is in the best interest of the contracting parties to continue the agreement following the decrease or disappearance of the COVID-19 related risk. Therefore, TCO art. 138 stipulating the adaptation of contracts may offer a more suitable solution. Considering that all obligations, in particular pecuniary obligations do not become impossible, it would be more appropriate to mention that in many cases performance of obligations are rendered difficult. Accordingly, with respect to the possibility where TCO art. 136 may not be deemed as applicable, TCO art. 138 can provide more effective solutions. Already now there are many contractual relationships under which the performance of the obligations has been rendered excessively onerous. It is required that the adaptation is requested from the court pursuant to TCO art. 138. Therefore, we must repeat that in order not to exclude the application of TCO art. 138 in the upcoming period, the obligations should be performed with a reservation.
  • To sum up, the adaptation of contract reveals a problem of sharing the risks. Which party will bear the risk arising from COVID-19? It would be misleading to conclude that COVID-19 automatically grants the contracting parties the rights arising from the breach of the contractual obligations. It should not be forgotten that any contracting party’s decision of non-performance requires a prior detailed legal assessment. Otherwise, the risk of encountering legal or contractual penalties such as paying significant compensation amounts due to a breach of obligation in any possible legal dispute is highly possible.

Finally, it is worth repeating that the answers of to the questions how long this process, which has gained acceleration upon the categorization of COVID-19 as pandemic, will continue or how this process will be completed, are unclear. Therefore, it is early to make any conclusions about how the abovementioned legal explanations will be reflected in judicial decisions and disputes. In case of the risk that contractual obligations are not performed, the situation of the debtor and the creditor should be assessed in accordance with each concrete case. At this point, we are of the opinion that it would be useful for the contracting parties to gather together as much as possible and renegotiate their contractual relationships that have been affected by the current hardship.

 

[1] Decision of the Turkish Supreme Court General Assembly of Civil Chambers dated 27.6.2018 with the merits no 2017/90, decision no 2018/1259: “Force majeure is an extraordinary event which occurs outside of activity and enterprise of the responsible party or the debtor leading to the breach of a general behaviour norm or a debt in a manner absolute and inevitable, that cannot be foreseen and resist. Natural disasters such as earthquake, flood, fire, epidemics are considered as force majeure.”

 

Decision of Turkish Supreme Court 9th Civil Chamber dated 20.11.2018 with the merits no 2016/14140 and the decision no 2018/21011: “The reasons preventing employee from working should occur around the employee. Reasons arising from the workplace and preventing employee from working are not included within the scope of this article. For example, closing down the work place is not considered as force majeure. (Turkish Supreme Court 9th Civil Chamber, D. 25.04.2008, merits no: 2007/16205 and decision no: 2008/10253) However, the barriers of transportation due to natural disasters such as flood, snow, earthquake, quarantine due to epidemics are force majeur events”.