Does Covid-19 Void Contracts?

Barnea Jaffa Lande & Co.

The inter-ministerial team assembled to examine the consequences of the Covid-19 crisis on contractual agreements has recently published its recommendations.

The team was comprised of representatives from the Ministry of Finance, the Ministry of Economy, the Bank of Israel, the National Economic Council, and the Consumer Protection and Fair Trade Authority. It was assembled to develop a proper legal response to contractual questions arising out of the Covid-19 crisis, and to establish the proper legal policy to mitigate the impact of the crisis on contractual agreements.

The team considered whether the coronavirus pandemic should be viewed as a force majeure event that releases a party who breached a contract from liability for that breach. Such determination has a potential impact on many sectors of the economy, particularly the entertainment and events market and the private childcare sector. In addition to sectors specifically impacted, certain types of activities, such a commercial rent, were also especially affected.

The team examined whether there was a legal solution that could resolve the distress of various parties to a contract. Its first and primary recommendation was that parties to a contract ought to negotiate in good faith and work in cooperation in order to address the impact of the coronavirus on the performance of the contract.

This conclusion was reached after reviewing the various legal approaches to the circumstances constituting “frustration” in Israeli law. The team found there is no single and certain position as to the legal implications of the disruptions created by the Covid-19 crisis. The team emphasized the courts’ broad discretion on the application of the frustration of contract doctrine or the implementation of other legal theories to adjust a contract to an extreme change in circumstances. The primary legal tool emphasized by the team is the principle of good faith, especially given the wide range of contractual arrangements for the allocation of legal and commercial risks that the parties incorporate into their contracts.

The team saw fit to emphasize that the Covid-19 crisis created extreme and rare circumstances that were unforeseeable, neither the circumstances themselves nor their ramifications on the parties’ ability to perform contracts. The unforeseeability of an event is the first component for establishing a force majeure claim. However, the team noted that an event’s unforeseeability is in itself insufficient to determine the parties may be free from upholding a contract.

Therefore, team’s recommendations state that the Covid-19 crisis is not a magic expression that is sufficient to release one from contractual obligations. The recommendations also do not provide a practical solution to most cases and do not interfere with the allocation of risks between the parties as agreed in the original agreement.

The reference to the principles of good faith, and the determination that the crisis and its consequences are unforeseeable, in the legal sense, necessitates genuine negotiation between the parties and will not allow a party to refuse to negotiate contractual adjustments to the circumstances. That is, the recommendations encourage the parties to compromise and share in the damage that the Covid-19 crisis has created.

The team also considered contracts that include an explicit provision regarding force majeure, and determined that even these are not immune to judicial intervention, especially when dealing with standard form contracts, based on the principle of good faith and the rules of interpretation.

It is interesting to note that the Ministry of Finance expressed reservations about the team’s position on the unforeseeability of the Covid-19 crisis and its implications, and instead held that it could not be determined sweepingly that the crisis was not foreseeable. In other words, various force majeure provisions in a contract may address risk allocation between the parties in similar external circumstances, where the performance of a contract is frustrated or delayed. This position could affect, for example, parties to contracts with the state, when it comes to negotiating adjustments due to the crisis.

Therefore, the recommendation that the parties should negotiate, cooperate, and make an effort to perform contracts may also have implications for parties who believe they have strong contractual provisions and that their risk allocation as drafted in the contract addresses such circumstances as well. This is because the refusal to make adjustments may be considered as a lack of good faith on the refusing side and turn them into the breaching party.

In this respect, the Ministry of Finance’s position is that negotiations should take into account the aid the parties to the contract may be entitled to from the state. This consideration that negotiating parties can consider in discussing adjustments, and it touches on the financial harms the parties suffered as a result of the crisis.

In light of the concern that coronavirus disputes will place a significant burden on the courts, the team notes that proposals to advance alternative dispute resolution proceedings for such disputes are still being considered.

Second Recommendation – Setting Specific Arrangements for Certain Markets

In light of the singularity of certain markets, in which there is a clear consumer aspect, the team recommended a number of specific arrangements. At the same time, it resisted intervention in markets that have a complex commercial character, such as commercial rent.

  • Handover of a purchased apartment from the developer-contractor – For apartments to be handed over to buyers during the period between March 15, 2020, and April 1, 2021, the team recommended reducing compensation for delays in the first 120 days of delay to half the rent amount of a comparable unit. Simultaneously, the buyer’s obligations regarding the payment schedule will be delayed as well. This arrangement requires a legislative amendment.
  • Cultural events and performing arts – The team recommended a legal arrangement whereby a consumer who purchased a ticket to a performance that was canceled be given an alternative ticket, to be used for a period of 12 months. If at the end of this period the ticket is still not used, the consumer will be entitled to a refund. The team noted such outcome may be supported by the current law and would not require a legislative amendment.
  • Events – The team recommended it would be appropriate to intervene in a manner that incentivizes parties to find a solution. The team found that despite the distress of event venue owners, inter alia, due to high overhead expenses, there is no legal justification to impose such expenses on consumers, and another solution must be found. Therefore, the team deferred to the guidelines developed by the Consumer Protection and Fair Trade Authority, which propose that for events scheduled for the period of time when activity was prohibited or when strict limitations on the number of celebrants were in effect, effectively preventing the event’s occurrence, if the consumer cannot reach a new agreement with the venue owner and the date of the event has passed, the consumer may terminate the contract at a cost of 10% of the total contractual obligation, not exceeding NIS 10,000. As to events scheduled for dates that allowed holding the event with only limited restrictions (at least 250 celebrants), it was proposed that the parties negotiate to adjust the contract to the circumstances, including the number of meals and their price. In the absence of agreement, the consumer may terminate the contract at a cost of 15% of the total contractual obligation, not exceeding NIS 15,000.
  • Private childcare – The team proposed a model that implements the following guiding principles: compensation for the days the childcare facility was not in operation, either by offering extra operating days or refunding money, except for vacation days for holidays that occurred during that time, and setting the date of return to normal activity as May 10, 2020, whereupon the parties once again became subject to the original contractual obligations.

Going Forward

In preparation for a second wave of restrictions due to the virus, it was proposed to enact legislation authorizing the Minister of Justice to promulgate special regulations regarding the allocation of harms between parties to a frustrated contract, in sectors where the minister saw fit to do so. This proposition stems from concern about a flood of litigation in such markets and the potential to find a simple arrangement that would create quick certainty while also preserving fairness. However, the Ministry of Finance had reservations about this proposal and it would require a legislative amendment.

Another central point discussed at length by the team concerns the adoption of the proposal to amend the laws of frustration based on the Civil Codex Bill. This bill was drafted as far back as 2011. In terms of the laws of frustration, it grants courts broader discretion to apply more flexible mechanisms to the circumstances of frustration or force majeure. These include, inter alia, examining the risk allocation instead of the event’s foreseeability, mechanisms for mutual compensation, mechanisms for delaying obligations, and recognition of partial frustration. In this context, this recommendation cannot be of any remedy to contractual parties at this time.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Barnea Jaffa Lande & Co.

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