Giulia Keese Montanhesi
Lawyer at Marcos Martins Advogados
In a business culture in which cultivating contacts, fostering connections and expanding commercial relations was the path to success, the sudden breakdown of contractual relations seemed to many entrepreneurs to be the only measure in the face of the crisis that has taken hold in the world as a result of Covid-19.
In the face of the health emergency, most companies were surprised by the sudden stagnation of the economy, a frozen workforce, unstable markets and customers, low demand, lagging cash flow, supplier defaults, travel restrictions, logistical closures and a shortage of raw materials.
After the first impact of the pandemic, where we saw sudden terminations of contracts and significant defaults on obligations globally, the business environment began to adjust to the new conditions and, consequently, seek to re-establish the balance of relationships as a way of overcoming the crisis, rebuilding reliability and credibility in the market and demonstrating contractual good faith for the gradual resumption of business.
In addition, there has been a move by experts and the courts to use various contract resolution tools to review contracts, based on the principle of contract preservation.
Therefore, as an incentive to preserve commercial relations, we will present the following legal theories that reveal opportunities for re-establishing business equilibrium, preserving alliances, market confidence in the business and adapting to the “new normal”, with the least possible disruption to contractual relations.
Unforeseeable circumstances and force majeure
The legal basis that is most aligned with the idea of the unpredictability of unavoidable natural or human events is the occurrence of unforeseeable circumstances or force majeure, under the terms of article 393 of the Civil Code. Widely used in today’s contracts, this rule stipulates that the debtor will not be liable for damages resulting from these events if they have not expressly been held responsible for them in the contract.
Although the terminological differentiation of these concepts is much debated by specialists, the majority of doctrine and case law is that epidemics and pandemics are unforeseeable, unavoidable events and constitute unforeseeable circumstances or force majeure to give rise to contractual revision. Thus, in order to review the pre-established conditions, it is necessary to demonstrate the causal link between the extraordinary event and the desired adaptation, i.e. prove the correlation between the pandemic and the intended rebalancing measure.
In this scenario of sudden changes, the theory is an ally for discussing a way to accommodate the parties, without definitive termination. It is therefore advisable to explain how the social and economic effects of the current crisis are making certain obligations more difficult and to readjust the form of compliance, while preserving, in particular, the economic health and good relations of the parties.
The new reality indicates that most contracts will seek to include this clause to regulate contract renegotiation caused by adverse events. We believe and defend here the ability to use this clause to shape the legal and commercial relationship to various exceptional and extraordinary scenarios that may arise, without the contracting parties having to withdraw.
Theory of unforeseeability or excessive onerosity
In this case, new and unforeseeable facts that overburden one side of the relationship can be sufficient reason for adjustments to the quantity of the product, price increases or decreases, changes to the conditions under which goods are sent, the durability of the contract, adjustments to the services provided, among others.
The existence of the theory of excessive onerosity, also known as the theory of unforeseeability[1], seeks to make these adjustments when there is a contractual imbalance between the parties due to a new fact, in order to allow the legal relationship to continue.
The theory presupposes that the parties have entered into a contract on equal terms and conditions, but that the proportionality and fairness of the relationship have been affected by a new unforeseeable event, so that they must be corrected or re-established in order for the contract to achieve its objectives.
The theory is based on the idea that termination should be the last option and should only be considered when any possibility of fulfilling the main purpose of the contract is unfeasible.
Unfulfilled contract exception or insecurity exception
The unfulfilled contract exception or insecurity exception[2] is the theory in which, once proportional and specific duties have been agreed between equals, one party cannot demand that the other fulfill an obligation without fulfilling their own.
The thesis can acquire a resolutive effect, i.e. if neither party complies with what has been determined, the deal will be extinguished and resolved. However, if it is in the interest of the parties, the spontaneous non-compliance of both parties in these circumstances can allow the exception to become a tool for renegotiating, altering and adjusting commitments bilaterally and equitably, in favor of preserving the business and the binding force of contracts.
Objective good faith and the Economic Freedom Act
Good faith[3] has always been one of the foundations of Civil Law and has taken on substantial importance with the new configuration of commercial relations.
The principle in its objective condition[4] imposes on contracting parties the obligation to act honestly and in accordance with normal ethical standards, with transparency, loyalty and probity, in order to enable the parties to achieve the objectives intended by the contract.
In this sense, objective good faith imposes ancillary obligations on the parties and, in this case, the inflexibility and maintenance of a contract that is evidently unequal and excessively onerous for one of the parties could be an infringement of this principle, since the other would be taking advantage of this imbalance.
Along the same lines as the other theories, the Economic Freedom Act, by amending article 421-A of the Civil Code, states that “civil and business contracts are presumed to be equal and symmetrical until the presence of concrete elements that justify the removal of this presumption”. The text, in addition to recognizing the relativity of the binding force of contracts[5], confirms its mitigation in exceptional cases, such as the current scenario.
It is important to emphasize that, for the economy in general and for the very preservation of business relations, it is essential to maintain the balance of the original moment of the contracts. This article and the other provisions of the new law reflect this desire and seek to increase the strength of private autonomy and exceptional review.
Social Function of Contract
The theory of the social function of the contract[6], also guaranteed in the Economic Freedom Act and increasingly present in day-to-day discussions, seeks to preserve the business deals and private autonomy as much as possible, giving the agreements signed a function for society as a whole, in addition to what they already symbolize and represent for the parties.
Inspired by the constitutional principle of the social function of property, it can also be conceptualized as a parameter for imposing limits on the freedom to contract, for the sake of the common good. Those who wish to contract must observe the laws, norms and general principles of law, as well as the moral and ethical norms of society and the collective and social interests of that culture and place.
Therefore, the social function of the Contract is consolidated as yet another reason to avoid contract terminations and the extinction of businesses, sincethese (even if private interests are paramount) create jobs, generate resources for the national economy, protect the environment, generate quality of life and indirectly influence an entire community, to a greater or lesser extent.
An international perspective
On an international level, civilizations based on Civil Law rules, in comparison to those based on Common Law, have major differences when it comes to the positivization of theories related to unexpected events.
Unlike Brazil, countries that adhere to Common Law (such as England or the United States) do not always include the unpredictability of events in local law, leaving it up to precedents to apply the remedies available in the event of breach of contract and invalidation of penal clauses, as well as through the concepts of “frustration of purpose ‘ (or frustration of the contract), ’Hardship”, “impracticability ‘ and ’force majeure” (or force majeure ).
In short, these theories express the idea of release or discharge from an obligation, through the occurrence of an event independent of the will of the parties, unforeseeable and unavoidable or inexcusable. Not only for resolution purposes, they are even more relevant for rediscussion when there is an economic imbalance in the contract and in cases of purchase and sale of goods.
Dispute resolution
When it comes to business disputes arising from contracts, there are other means of resolving conflicts besides the judicial system. The biggest question that is raised when it is proposed that the review take place in court is whether there is undue or even mistaken judicial interference in contracts.
As is well known, law judges are not experts in the matters discussed in each case, and sometimes specific knowledge (price issues and other commercial aspects) that the judge lacks , but that certain arbitrators, experts, mediators and conciliators have, will be indispensable .
Mediation, conciliation and arbitration have established themselves as excellent ways of seeking a technical and decision-making balance in commercial matters and are essentially recommended for their speed, technicality and confidentiality.
In this sense, even the choice of the most appropriate means of resolving the dispute must be observed by the contracting parties, in order to preserve their autonomy and provide an opportunity for a consensual outcome.
Final considerations
In addition to all of the above, the encouragement to renegotiate contracts and concern for existing business is being present in the most recent policies of banks and creditors. The intention to maintain a fruitful business relationship is shared by both parties, as the lawyer Rafael Tridico faria pointed out in his article “Debt restructuring and out-of-court reorganization”.
Thus, considering all these tools for preserving contractual obligations and the recovery scenario we are experiencing, we believe that a favorable environment has been created for the recovery and strengthening of companies, in their most diverse sizes and segments.
Any questions? Talk to our lawyers and get advice.
[1] Articles 317, 478, 479 and 480 of the Civil Code.
[2] Article 476 of the Civil Code.
[3] Articles 113, 187 and 422 of the Civil Code.
[4] There is a doctrinal distinction between subjective and objective good faith.
[5] The obligatory force of contracts or the principle of obligatory contracts is represented by the Latin brocardo “pacta sunt servanda” (pacts must be complied with) which stems from the need for security in business and determines that contracts signed and valid, under the autonomy of each person’s will, must be complied with.
[6] Articles 421 and 2.035, sole paragraph, of the Civil Code.
