On 31 December 2019, the World Health Organization was informed of a series of cases of pneumonia, later on identified to be a new type of coronavirus— now known as the Coronavirus disease 2019 (COVID-19). With the COVID-19 outbreak, countries are faced with public health challenges, as well as increasing concerns on the outbreak's impact not only on tourism but also on the economy in general, and various key industries operating within its borders.
Asian companies have reported major layoffs across the region. Governments are stepping in to mitigate losses arising out of disruptions in trade. Meanwhile, Asian markets are struggling to adapt due to interruptions in the operations of major providers of goods and services in the region. On a global scale, growth of the world economy has been stunted by the outbreak.
COVID-19 and the situation in the Philippines
President Rodrigo Duterte declared a state of public health emergency on 9 March 2020. Three days later, he announced that a community quarantine would be imposed on Metro Manila. As of 19 March 2020, there are 217 confirmed cases of COVID-19 in the Philippines. Of the 217 cases, 17 persons have died.
On 16 March 2020, President Duterte declared an enhanced community quarantine (ECQ) covering the entire Luzon island. The duration of the ECQ is presently from 17 March 2020 until 14 April 2020. Key features of the enhanced community quarantine include: (a) strict home quarantine in all households limiting movement to accessing basic necessities; (b) limited operations of private commercial establishments to those providing basic necessities; (c) suspension of mass public transportation and restrictions on land, air, and sea travel.
Effect on Contractual Obligations
No doubt, these measures, while necessary, will have a significant impact on the conduct of business in the Philippines. Disruption of supply chains, inability to meet customer demands, missed project deadlines, non-delivery of raw materials or finished goods, limited manpower, restrictions on commercial operations - these are some of the issues companies operating in the Philippines are presently contending with.
How can contractual obligations be complied with under the present circumstances? What remedies are available in the event of breach due to the outbreak? These are the questions that are bound to arise as a result of COVID-19 and the ECQ.
There are recognized legal principles that allow contracting parties relief or release from obligations resulting from extra-ordinary situations.
Fortuitous Event / Force Majeure
The principle of force majeure provides that no person shall be responsible for a fortuitous event, i.e., events which could not be foreseen or which, though foreseen, were inevitable. This may refer to natural occurrences such as floods or typhoons, or an "act of man," such as riots, strikes or wars. Aside from the event being one that is unforeseeable or unavoidable, the following must all be established:
- The cause of the breach of the obligation must be independent of the will of the party seeking to be released from the obligation
- The event must be such as to render it impossible the fulfillment of the obligation in a normal manner
- The party seeking release must be free from any participation in or aggravation of the injury to the other party.
No liability attaches notwithstanding a contractual breach when these requisites are present. The exceptions are: (a) when the law expressly so specifies, e.g. a possessor in bad faith is liable for deterioration or loss of the thing possessed despite a fortuitous event; (b) when it is otherwise agreed by the parties, i.e. by contractual stipulation; and (c) when the nature of the obligation requires the assumption of risks, e.g. business risks that may be inherent in the nature of the business.
The scope of what constitutes force majeure may be contractually expanded or limited by the parties. Therefore, companies should (a) review the force majeure clauses of their contracts (b) assess their exposure under such clauses; and (c) determine whether there is a need to revisit or renegotiate the same to protect their interests.
Whether a party may invoke force majeure in the context of COVID-19 will ultimately depend on surrounding factual considerations, including: (a) the particular actions taken by the parties (e.g., mitigation measures); (b) the nature of the obligations involved; (c) the stature or level of expertise of the parties; (d) the nature of the subject matter of the contract; (e) the business risks assumed by the parties, if any; and (f) the damages or disadvantages arising from the material event.
Legal or physical impossibility
The Philippine Civil Code provides that the debtor in obligations to perform a service shall also be released when the obligation becomes legally or physically impossible without the fault of the obligor.
There is legal impossibility when an act is prohibited by law or prevented by law (e.g., non-renewal of residence and work permit of an employee, preventing him/her from continuing his/her work). On the other hand, there is a physical impossibility where an act can no longer be accomplished by reason of its nature. This rule does not apply to obligations "to give", such as the payment of rentals or the delivery of an object.
It is insufficient to merely allege impossibility without showing the factual circumstances that could relieve parties from their obligations. In addition, it should be determined whether performance has become wholly impossible or not (albeit belatedly or to a limited extent). In the latter case, the debtor cannot rely on legal or physical impossibility as a ground for non-performance.
Philippine jurisprudence has not provided clear guidance on the distinctions between force majeure or impossibility. It may be said, however, that while the two principles are related they nevertheless bear some distinctions. While force majeure focuses on the nature of the event that resulted to the breach (i.e. whether the event foreseeable or unavoidable), legal or physical impossibility focuses on the obligation undertaken by the parties (i.e. whether the obligation become impossible to perform).
In force majeure situations, the events are of such nature that one of the parties is no longer able to comply with its obligation in a normal manner. While in some instances, there is still a possibility that the obligation can be complied with, it is no longer possible for the party to be able to do so in a normal manner, e.g. within the time period agreed upon.
On the other hand, the principle of legal or physical impossibility focuses on whether or not a party is still able to comply with the obligation. This would include situations where the service sought to be provided has been rendered impossible to perform by reason of the act of the other party.
Difficulty beyond the contemplation of the parties
Contracts are generally entered into in light of certain prevailing conditions. Once such conditions cease to exist, the contract also ceases to exist. Under Article 1267 of the Philippine Civil Code provides, when the service has become so difficult as to be manifestly beyond the contemplation of the parties, the obligor may also be released therefrom, in whole or in part.
It should be stressed that, as a rule, parties to a contract are presumed to have assumed the risks of unfavorable developments. The principle of extreme difficulty applies only in absolutely exceptional changes of circumstances and only with respect to obligations to do (e.g. provide a service), not obligations to deliver objects. In determining whether an exceptional change of circumstance is present, several factors must be considered, such as the nature of the obligations involved, the disadvantages arising from the unforeseen event, and the business risks assumed by the parties.
Loss and destruction of a determinate or generic thing
For obligations to deliver a specific object, the obligation may be extinguished if it is lost or destroyed without the debtor’s fault, and before the debtor is in delay (Philippine Civil Code, Article 1262). However, the debtor may still be held liable for such loss or destruction if (a) there is a contractual stipulation expressly making the debtor liable in such a situation; and (b) the nature of the obligation requires the assumption of the risk of loss or destruction. As for obligations to deliver a generic thing, the loss or destruction of such does not extinguish the obligation to deliver.
Actions to Consider
In general, each of the above-mentioned principles constitute grounds which a parties to a contract may consider invoking either as a defense or a means to manage potential disputes. Due to the impact of COVID-19 on business and commercial activities, companies should expect their respective counterparties to start considering their legal options in relation to these principles, especially if such counterparties have been encountering difficulties in performing their contractual obligations. The following are some actions that companies may consider taking:
- Review existing contracts, try to anticipate which of these are at risk of being affected (e.g. production facility closures, delays in the deliveries, and ability of parties to pay) and determine whether renegotiation of terms is a feasible option.
- Consider any steps they may be taken in order to avoid or mitigate any potential adverse impact of COVID-19, e.g. alternative suppliers or alternative delivery methods.
- Identify available remedies, whether or not provided in the contract, in anticipation of potential litigation, e.g. mediation/conciliation, dispute boards, and other alternative dispute resolution mechanisms.
- Keep abreast of latest developments, including measures undertaken by the government, as they are relevant to determining the applicable remedies.
- Consider these action steps in relation to contracts currently being negotiated.