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Managing Contractual Performance in Times of Sanitary Crisis: The Spanish Law Perspective

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The unprecedented health crisis arising from the novel Coronavirus disease (“COVID-19”) and measures enacted by the Spanish Government to contain the spread, has in some cases affected contractual performance. The construction and the energy sectors have been particularly affected. There are often contractual mechanisms to address unforeseen events or a change of circumstances. Also, the doctrines of force majeure and rebus sic stantibus are part of Spanish law and they may invoked in due course if all the requirements are met.

 

Spain's response to the sanitary crisis

The COVID-19 pandemic and measures introduced by governments in response have had a significant impact on the economic circumstances affecting a wide range of projects and deals, including the ability for parties to perform under existing contracts. Spain has faced one of the most severe outbreaks, prompting the Spanish Government to declare a state of alarm on 14 March 2020 under Royal Decree (“RD”) 463/2020, and to implement drastic measures to address the economic and sanitary crisis affecting a wide range of industries and sectors. For example, the Spanish Government declared the temporary closure of all non-essential business,1 implemented strict restrictions on the freedom of movement that prevent personnel from entering work places and job sites,2 postponed all administrative and procedural deadlines, which may impede the ability to obtain a licence necessary to commence operations or construction, in order to fulfil contractual obligations.3 Parties may additionally be unable to obtain certain supplies, materials or goods, as border closures and the temporary closure of businesses have caused severe disruptions to international supply chains.

If a party’s ability to perform a contractual obligation has been affected by COVID-19 or government measures taken in response, the first step is to examine the terms of the contract to determine whether any provision may apply to exempt liability for non-performance for force majeure or changed circumstances.4 This will be the approach of Spanish courts when seized of such claims. In the event that the contract does not contain a specific provision regulating force majeure or hardship, a party may look to the protections offered by the applicable law of the contract. Spanish law offers protections to parties whose contractual performance has been impacted by force majeure, impossibility and change of circumstances (rebus sic stantibus). Certain measures the Spanish Government adopted in relation to employment contracts5 and public contracts,6 reflect a general understanding that depending on the specific circumstances of the case, certain events may be deemed to constitute force majeure. On force majeure, in 20067 and 2012,8 the Spanish courts already found that the sanitary crisis arising from the SARS and influenza outbreaks may be the type of force majeure events that excuse contractual performance. Therefore, it is possible that the Spanish courts may also find the COVID-19 pandemic a force majeure event that justifies failure to perform under a contract, but there must be a direct link between the event and the inability to perform.

 

Contractual provisions excluding liability

The construction and oil and gas sectors have been negatively impacted by the COVID-19 pandemic, and as will be explained below, due to the nature of engineering, procurement and construction (“EPC”) contracts (also known as turnkey construction contracts) and long-term LNG sale and purchase agreements, parties are particularly at risk of significant losses when unforeseeable events or a change of circumstances occur.

Force majeure and EPC contracts

EPC contracts entail a certain level of risk as a contractor is required to deliver a complete facility to the employer for a lump sum and by a certain date. The contractor’s failure to perform will result in monetary liabilities for the contractor, often in the form of liquidated damages. Spain’s measures addressing the sanitary crisis have in a number of cases resulted in difficulties for contractors to perform under the relevant contract. Workers have been unable to enter construction sites due to restrictions on the freedom of movement, and the closure of all non-essential economic activity temporarily prevented all construction. Additionally, contractors are facing challenges in obtaining goods, resulting from a disruption in international supply chains.

The International Federation of Consulting Engineers (“FIDIC”) is an international standards organisation for consulting engineering and construction, well known for its construction contract templates, commonly used for various types of construction works, including EPC contracts.9 The FIDIC Yellow and Silver Books provides an excuse for non-performance of a contractual obligation in the event of Force Majeure,10 which is defined as an event or circumstance which: (i) is beyond a party’s control; (ii) the party could not reasonably have provided against before entering into the contract; (iii) having arisen, such party could not reasonably have avoided or overcome it; and (iv) it is not substantially attributable to the other Party.11

Sub-Clause 18.1 [Exceptional Events] of the FIDIC Yellow and Silver Books also provides a non-exhaustive list of events and circumstances which may constitute Force Majeure or an Exceptional Event. Whilst ‘pandemic’ is not listed,12 this does not exclude the availability of Force Majeure relief, if performance is affected by COVID-19, provided that the event satisfies the general requirements of the clause. Obligations to make payments which are due are not excused by Force Majeure or Exceptional Events clauses. A party seeking to rely on the clause must give notice to the other party of the event or circumstances constituting Force Majeure and shall specify the obligations, the performance of which is prevented.13 Relief in the event the Force Majeure or Exceptional Events clause applies is generally limited to extensions of time (i.e. no prolongation costs), except for the events listed in the relevant provision. In addition to Force Majeure, a contractor may also consider relying upon other provisions of the contract for delays which can be said to be attributable to governmental authorities.14

As restrictions are eased and work is reassumed, new health and safety measures will translate into lower productivity and potential increases in costs. In such cases, contractors may consider seek further adjustments in the contract price and extensions of time under adjustment clauses for changes in laws, which are generally prescribed in construction contracts.15

Hardship and gas price review clauses

Hardship clauses aim to protect parties from the occurrence of events which fundamentally alter the equilibrium of the contract, and make contract performance much less profitable for a party.16 LNG sale and purchase agreements generally establish a contractual formula that is used to calculate the price of the oil. However, a sharp decline in the demand for oil as a result of travel restrictions and a reduction of economy activity alongside geopolitical tensions, has caused an unprecedented drop in the price of oil. Whilst the duration of the change in the value of oil is still yet to be known, it shows the need to have price adjustment mechanisms in place, to protect against potential losses arising from changed circumstances.

Gas price review clauses in long-term gas sale and purchase agreements aim to ensure a long-term guarantee of supply whilst preventing against losses arising from a fluctuating market, by allowing the revision of the contract price formula when the contractual price no longer reflects the market value of gas. The clauses generally require a requesting party to establish that:

  • A ‘significant’ or ‘substantial’ change has occurred in the ‘buyer’s market’;
  • The change occurred before the ‘review date’;
  • The change was beyond the control of the party requesting a price review; and
  • The change must have, or be likely to have, an effect on the market value of gas in the buyer’s market.

An example of a gas price review clause related to economic conditions in Spain can be found in a 1995 contract for the sale of LNG between Atlantic LNG Company of Trinidad and Tobago and Gas Natural Aprovisionamientos, SDG, SA, made public in 2008 in the context of the confirmation of an arbitral award.17 Article 8.5(a) of the contract entitled a party to request a revision of the contract price:

“If at any time either Party considers that economic circumstances in Spain beyond the control of the Parties, while exercising due diligence, have substantially changed as compared to what it reasonably expected when entering into this Contract… and the Contract Price resulting from the application of the formula set forth in Article 8.1 does not reflect the value of natural gas in the Buyer’s end-user market…”

The clause contained an agreement to arbitrate if the parties were unable to agree on a price revision within six months. Such gas price review clauses seek to ensure that the price of gas under gas sale and purchase agreements are flexible and can be adapted to address changes of circumstances that affect the underlying economic balance of the transaction.

 

Spanish law on force majeure and hardship

Spanish law on force majeure

In the event that the applicable contract does not contain a force majeure or a hardship clause, a party may still be protected by the applicable law, if they have not specifically excluded the application of such protections in the contract. If a contract is governed by Spanish law, Article 1105 of the Spanish Civil Code on force majeure should apply, which states that “outside of the cases specifically mentioned in the law and those stated as such in the obligation, no one shall be liable for events which cannot be foreseen, or which, being foreseen, should be inevitable”.

The Spanish Civil Code does not define what will constitute force majeure; the definition is found in case law. The Spanish Supreme Court has found that for an event to amount to force majeure the following elements must be met:18

  • The event must be unpredictable, in the sense that it is an extraordinary and unusual event that was unforeseeable and exceeds what a diligent person could have expected at the time of execution of the contract;
  • The event must be inevitable, meaning that it is impossible to avoid even when using the greatest care; and
  • There must be an absence of fault on the side of the party seeking to invoke force majeure.

Depending upon the factual circumstances, a court may find that the existence of force majeure: (i) exonerates a party from liability if it has failed to comply with an obligation; (ii) temporarily suspends compliance with obligations in cases in which the effects are transitory; or (iii) releases a party from the obligation to fulfil its obligations if performance is rendered impossible (Articles 1182 and 1184 of the Spanish Civil Code).

Additionally, the force majeure clause in the Convention for the International Sale of Goods (“CISG”), to which Spain is a party, will be particularly useful for companies seeking to avoid liability for failing to comply with its obligations under a contract for the sale of international goods, as a result of the COVID-19 outbreak or particularly restrictive government measures. The CISG applies to all contracts for the international sale of goods between parties from two different countries, if both home states are party to the CISG; provided that the parties have not excluded its application in the contract.19

Hardship under Spanish law: Rebus sic stantibus

Whilst not codified in Spanish law, the hardship concept is reflected in the Spanish Supreme Court’s jurisprudence in relation to the rebus sic stantibus clause.20 According to Spain’s Supreme Court, for rebus sic stantibus to apply there must be:21

  • An extraordinary, unforeseeable and unpredictable alteration to the circumstances that existed at the time the agreement was entered into, to the circumstances existing at the time of performance;
  • An exorbitant disproportion between the balance of benefits and obligations of the parties under the contract; and
  • No other contractual remedy is possible for the solution of the problem.

Whether the rebus sic stantibus clause will apply to a specific situation will require a case-by-case analysis of the circumstances affecting the contract.22 It is important to note that the jurisprudence creates a very high standard, which will be difficult for most cases to meet. A finding of rebus sic stantibus implies that the reason for entering into the contract disappears as the basic economic purpose is frustrated or becomes unachievable for one of the parties.23 A court may modify the obligations agreed to by the parties in order to rebalance the parties’ obligations and benefits under the contract, or terminate the contract for the benefit of the non-complying party.24

 

Arbitration

Many contracts of a cross-border nature will be affected by the COVID-19 pandemic and the measures taken by governments to combat the spread. Such disputes are best resolved in a neutral international forum through the process of international arbitration. This is especially true when considering the difficulties currently faced by domestic courts in having to adapt busy in-person court rooms to online virtual hearings. Due to the cross-border nature of international arbitration much of the process is already completed virtually, with limited in-person meetings. Arbitral institutions, arbitrators and lawyers have thus quickly and seamlessly been able to adapt to the new environment, and are now able to hold the entire arbitral process virtually.

 

1 Royal Decree Law (“RDL”) 10/2020 of 29 March, Preamble II, Article 1.
2 RD 436/2020 of 14 March, Article 7.
3 Id., Third Additional Provision; RD 8/2020 of 17 March, Ninth Additional Provision.

4 Spanish Civil Code, Article 1091: “Obligations arising from contracts have the force of law between the contracting parties, and must be complied with in accordance with the provisions thereof.”
5 Under RD 8/2020 of 17 March 2020, Article 22: “1. Contract suspensions and reductions in working hours that have their direct cause in loss of activity as a consequence of COVID-19, including the declaration of the state of alarm, which implies suspension or cancellation of activities, temporary closure of places with public influx, restrictions on public transport and, in general, on the mobility of people and/or goods, lack of supplies that seriously impede the continued development of the activity, or in urgent and extraordinary situations due to the contagion of the workforce or the adoption of preventive isolation measures decreed by the health authority, which are duly accredited, will be considered as coming from a situation of force majeure, with the consequences derived from article 47 of the revised text of the Statute of Workers, approved by Royal Legislative Decree 2/2015, of October 23.”

6 RD 8/2020 of 17 March, Article 34: “1. Public contracts for services and supplies of successive provision, in force at the entry into force of this royal decree-law, concluded by entities belonging to the Public Sector…whose execution becomes impossible as a consequence of COVID-19 or the measures adopted by the State, the autonomous communities or the local Administration to combat it, they will be totally or partially suspended from the moment the de facto situation that prevents their provision occurs and until said provision can be resumed. For these purposes, it will be understood that the provision may be resumed when, having ceased the circumstances or measures that were preventing it, the contracting authority notified the contractor of the end of the suspension.
When, in accordance with the provisions of the preceding paragraph, the execution of a public contract will be totally suspended, the contracting entity must pay the contractor the damages and losses actually suffered by it during the suspension period […] The application of the provisions of this section will only proceed when the contracting authority, at the request of the contractor and within five calendar days has appreciated the impossibility of executing the contract as a result of the situation described in its first paragraph…”
7 Provincial Court of Madrid, Judgment No. 169/2006 of 2 November 2006 (“This is, indeed, an unusual, unforeseeable and unavoidable situation (Article 1105 of the Civil Code) which, for reasons beyond the control of the person who made the reservation, interfered with the plaintiff’s clients ability to make the planned journey to Toronto”).
8 Provincial Court of Barcelona Judgment 346/2012 of 8 June 2012 (“It is certain that the sudden and unexpected appearance of influenza A, which is proven by the defendant, created a change in the planned trip”).
9 FIDIC publishes various standard contracts to be used for construction works, large-scale machinery supplies, infrastructure projects, consultancy services, etc. Each suite is comprised of three books: the Red Book focuses on building and civil engineering works designed by the employer; the Yellow Book covers conditions of contracts for plant and design-build; the Silver Book is for EPC/turnkey projects.
10 Clause 18 of the FIDIC 2017 Books covers “Exceptional Events”, which replaced the Force Majeure provision in Clause 19 of FIDIC’s 1999 versions.
11 FIDIC Silver, Yellow and Red Books 2017, Clause 18.1 [Exceptional Events] of the Conditions of Contract.
12 Restrictions imposed by governmental authorities may arguably amount to a “lock out”, which is an event listed under Sub-Clause 18.1 [Exceptional Events] of the Conditions of Contract, entitling a party to prolongation costs.
13 FIDC Silver, Yellow and Red Books 2017, Sub-Clause 18.2 [Notice of an Exceptional Event] of the Conditions of Contract.
14 FIDC Silver, Yellow and Red Books 2017, Sub-Clause 8.6 [Delays Caused by Authorities] of the Conditions of Contract.
15 FIDC Silver, Yellow and Red Books 2017. Sub-clause 13.6 [Adjustments for Changes in Laws] of the Conditions of Contract.
16 See UNIDROIT Principles, Article 6.2.2.
17 Atlantic LNG Company of Trinidad & Tobago v. Gas Natural Aprovisionamientos SDG SA, UNCITRAL, Final Award, 17 January 2008.
18 Spanish Supreme Court Judgment No. 3190/1965 of 7 April 1965 (“Considering that for an event to give rise to the exemption from liability referred to in Article 1105 of the Civil Code, it is necessary that the following requirements, among others, are additionally met: that it is unforeseeable, because it exceeds the normal course of life (Spanish Supreme Court Judgment of 2 January 1945), or that it is inevitable (Spanish Supreme Court Judgment of 23 March 1926), insurmountable (Spanish Supreme Court Judgment of 17 June 1964) or irresistible (Spanish Supreme Court Judgment of 10 November 1924); that it is not due to the will of the alleged debtor (Spanish Supreme Court Judgments of 10 December 1930, 20 June 1950 and 9 May 1960); that by application of sections 1182 and 1184 of the Civil Code, it is impossible to comply with an obligation previously contracted and prevents the origin of what may occur, in accordance with the provisions of articles 1092 and 1093 of the Civil Code; and that between the said result and the event that produced it, there is an efficient nexus of casualty, as this Chamber pointed in its Ruling of 4 of June 1902”).
19 Article 1.1 CISG. See also Article 79.1 of the CISG (“A party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences”) and Article 79.3, which provides that the exemption from performance has effect for the period during which the impediment exists. The party must additionally give notice of the impediment and the effect on its ability to perform, as is the case for most force majeure clauses.
20 See for example, Spanish Supreme Court Judgment No. 644/2012 of 8 November 2012 (“Although the economic crisis alone does not allow the buyer to withdraw from the contract, it cannot be ruled out, in general terms, that such an occurrence may be permitted by applying the ‘rebus sic stantibus’ rule…”); Spanish Supreme Court Judgment No. 820/2013 of 17 January 2013: “The contested judgment is formally based on Articles 1182 to 1184 of the Civil Code, which are narrowly linked to the fortuitous case contemplated in article 1105, but materially it applies the doctrine of the rebus sic stantibus clause, which in its foundation is closer to articles 7 and 1258 of the Civil Code (which refer to the performance of obligations in good faith)…in view of the credit crunch caused by the economic crisis and the difficulties experienced by home buyers in gaining access to what had previously been their usual means of financing, i.e. mortgage loans”); Spanish Supreme Court Judgment No. 822/3012 of 18 January 2013; Spanish Supreme Court Judgment No. 309/2013 of 26 April 2013: “Resolution to be agreed upon, applying the basis of the deal doctrine (in Spanish doctrina de la base del negocio), which has already been mentioned, especially in relation to the rebus sic stantibus clause, in the judgments of 14 December 1940, 14 June 1953, 30 June 1948, 12 June 1956, and 23 November 1962, the latter rejects the application of that clause and takes into consideration the imbalance between the benefits as it ‘affects the basis of the deal”; Spanish Supreme Court Judgment 591/2014 of 15 October 2014; Spanish Supreme Court Judgment No. 237/2015 of 30 April 2015.
21 Spanish Supreme Court Judgment No. 333/2014 of 30 June 2014, Second Legal Basis, describing the requirements as an ‘extraordinary disruption’, ‘disproportionate’ and ‘radically unforeseeable circumstances’; Spanish Supreme Court Judgment No. 591/2014 of 15 October 2014, Third Legal Basis, requiring an ‘extraordinary alteration’, ‘disproportionate’ and ‘radically unforeseeable circumstances’; and Spanish Supreme Court Judgment No. 64/2015 of 24 February 2015.
22 For instance, Sub-Clause 18.6 [Release from Performance under the Law] of the Conditions of Contract in the 2017 FIDIC Silver, Yellow and Red Books provides that, under the applicable law, a party may be released from performance, as a result of an exceptional event or an event outside the control of the Parties, if they fail to agree on an amendment for the continued performance of the Contract.
23 Spanish Supreme Court Judgment No. 64/2015 of 24 February 2015, Second Legal Basis citing Judgments of 30 June 2014 and 15 October 2014, Second Legal Basis, “[T]he contrast of the so-called objective basis of the deal allows us to conclude that the change of circumstances has resulted in the disappearance of the basis of the deal when (i) the primary economic purpose of the contract, whether expressly provided for or derived from the nature or meaning of the contract, is frustrated or becomes unattainable; (ii) the balance of the contract, expressed in the equivalence or proportion between the performances, practically disappears or is destroyed, so that it is no longer possible to see an interplay between performance and consideration.”; Orduña Moreno, F.J., La cláusula "rebus sic stantibus" y la crisis derivada del coronavirus, Aranzadi digital 1/2020, Ed. Aranzadi, 2020.
24 Munar Bernat. P., Cláusula rebus sic stantibus, Tribunal Supremo y crisis económica: estado de la cuestión, LA LEY mercantil, Nº 16, La Ley 4717/2015 Sección Contratación mercantil, comercio electrónico y TICs, Julio-Agosto 2015, Wolters Kluwer.

 

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