COVID-19: The law on fortuitous events or 'force majeure' and termination of contract due to unforeseen circumstances in Latin America

Latam - 20 / 01 / 2021

Latam Commentary

The situation caused by the pandemic has brought an increase in breach of contract proceedings around the world, including in Latin America. It is therefore helpful to know how concepts such as fortuitous, force majeure, and hardship events are defined. We take a look at these in the legislation of Chile, Colombia, Mexico and Peru.

From time to time, events beyond the parties' control occur which have a general effect on all contracts and make us reassess certain legal concepts and the way they operate. Those circumstances are usually local so their effects are confined to the country or region in question. Recently, however, due to COVID-19 and its consequences, every jurisdiction has seen interruptions or delays to contracts, or contracts being rendered directly impossible to perform, along with the ensuing disputes between obligees, who demand unqualified observance of the stipulated terms, and obligors, who try to seek relief by claiming factors beyond their control which have precluded or obstructed performance.

Although the effects have been seen in many areas, a few types of contracts have been particularly impacted by disputes, such as real estate lease agreements and construction contracts, among others. Latin America has been no exception, and although many differences have been resolved through direct negotiations between the parties, a significant increase has been noted in the number of judicial proceedings on these matters as a consequence of the pandemic. In this context, each country's law on fortuitous events or force majeure and termination due to supervening hardship, also known as unforeseen circumstances, takes on an especially important role, and needs to be analyzed by the courts in order to resolve the disputes which have been, and will continue to be, brought before them.

CHILE

Fortuitous event or force majeure

In Chile, a fortuitous event is a concept defined by law in article 45 of the Civil Code, which relieves the obligor from liability for delay or impossible performance.

There are three requirements: (i) it must be an unforeseen event for the parties, and they could not reasonably have covered its occurrence when they entered into the contract; (ii) it also must be unavoidable for them, meaning that they cannot prevent its consequences; and, finally, (iii) it must be beyond their control, meaning that it cannot have been caused by any of them.

The combination of those requirements in each specific case must be proven by the person claiming the event.

Chilean law allows the parties, by agreement, to modify both the requirements for the ability to rely on a fortuitous event, as well as the evidence to prove both the event itself and its effects. It is therefore common to find contractual provisions altering the provisions in the law that apply secondarily for matters not stipulated by the parties.

Although there is not a great deal of Chilean case law on fortuitous events or force majeure, from the precedents that do exist it may be concluded that the courts take a strict view in relation to the unforeseeability and unavoidability requirements, and demand a high standard of proof for them. Moreover, the courts’ analysis of each specific case is highly subjective, in relation to the obligor’s specific circumstances and the standard of care that may be demanded of them, so much so that judgments in relation to the same facts have produced different outcomes, in which an event has been considered to constitute a fortuitous event or force majeure, in certain circumstances for the obligor; and in others, the ability to rely on that extenuating circumstance has been denied.

It should be noted that, unlike in other jurisdictions, no legislation has been enacted in Chile to regulate the effects of COVID-19 and the consequences arising from it for contracts, other than for very specific matters such as employment. Therefore, the rules that will be applied to resolve disputes in court will be those agreed in the respective contracts, if any, or, alternatively, those established in the general civil legislation.

Termination due to supervening hardship (doctrine of unforeseen circumstances)

It consists of the obligor being entitled to be excused from performance of an obligation where an unexpected event beyond the control of the contracting parties has rendered the obligation unduly onerous. It is disputed whether it can be relied on in Chile, because there is no law on the subject and it must be justified on the basis of principles of contractual fairness.

Academic opinion has established three requirements. First of all, it must be an event which was unforeseeable at the time the obligation came into existence, meaning that, in normal circumstances, it could not have been known before it occurs. Then, it must be outside the control of the parties, and, lastly, although it does not have to render performance of the obligation physically and absolutely impossible, it must considerably hinder it, render it prohibitively more onerous or cause substantial and serious detriment to the obligor, while the obligee receives undue benefits.

According to the case law, to date the doctrine of unforeseen circumstances has been applied in Chile on a very exceptional and restricted basis, except in relation to disputes submitted to be heard by arbitrators who have been given powers to resolve the disputes as their good judgment and sense of fairness dictate, in which the doctrine has been more widely accepted and applied.

There are currently two bills which seek to write unforeseen circumstances into Chilean law, and which, if enacted, would lead to widespread judicial review by local courts of contracts on the basis of supervening hardship.

COLOMBIA

Fortuitous event or force majeure

In Colombia, a fortuitous event or force majeure are defined by article 64 of the Civil Code as an unexpected event which cannot be avoided. Although in the context of civil law there is no distinction between both concepts and both relieve the obligor from liability, in relation to public procurement the courts have adopted a twofold point of view, according to which a fortuitous event is an internal event, which occurs within the field of activity of the party that causes the loss, and which, consequently, does not excuse a party from liability; whereas force majeure is an external event unrelated to that activity which does relieve the obligor from liability.

For a fortuitous event or force majeure to exist, the case law in Colombia has established the following requirements:

a. Unforeseeability, i.e. that within life’s ordinary calculations or normal circumstances, it was not possible for the agent or obligor to anticipate its occurrence in advance. The criteria which have been crafted by the case law to determine whether an event is unforeseeable relate to: (i) its normality and frequency; (ii) the probability of its occurrence; and (iii) whether it is unexpected, exceptional and surprising in nature.

b. Unavoidability, i.e. neither the event nor its consequences could have been avoided, and they made it completely impossible for the agent to act as required. In other words, the case law has established that to relieve the obligor from liability it is not sufficient for the event to hinder performance of the obligor’s obligations, instead it must render their performance impossible. In fact, the basis for relying on these concepts to relieve the obligor from liability lies in the fact that nobody may be expected to do the impossible.

c. Externality, in that the case law has pointed out that force majeure or a fortuitous event must originate from an activity outside that engaged in by the agent who is accused of causing a loss. Therefore, an event which originates from conduct engaged in by the agent or for which they are responsible cannot be considered force majeure or a fortuitous event. For example, a transport company cannot be relieved from liability due to a mechanical fault in a vehicle. In this respect, the case law has also pointed out that anyone who seeks to benefit from the organized and permanent operation of a hazardous activity, cannot expect inevitably to be allowed to use the irregularities which appear in the goods used for this purpose as an argument to avoid their liability.

If these three requirements are met, the obligor may be relieved from liability, unless they have incurred a delay in delivering the item concerned and that item would not have been damaged if it had been delivered to the obligee or if the cause was their fault. The burden of proving the occurrence of a fortuitous event or force majeure lies with the person claiming it.

It has repeatedly appeared in Colombian case law that since the classification of an event as force majeure or fortuitous event must be made in each specific case, by considering the timing, manner and place involved in its occurrence to confirm whether it meets the requirements, there are no events which per se constitute a fortuitous event or force majeure.

For the above reasons, in Colombia it is not possible to classify COVID-19 or its effects automatically as a fortuitous event or force majeure, instead it needs to be examined in each specific case whether they can be considered as such.

Termination due to supervening hardship (doctrine of unforeseen circumstances)

In Colombia, the legislative basis for the doctrine of unforeseen circumstances is found in article 868 of the Commercial Code, which provides that where extraordinary, unexpected or unforeseeable circumstances, after the conclusion of a contract requiring ongoing performance, alter or aggravate the future performance of an obligation held by one of the parties, to such an extent that it causes hardship, that party may seek a revision of the contract.

In the context of public procurement, article 27 of Law 80 of 1993 establishes contractual balance between the parties as a principle determining that equality or equivalence must be maintained in the contract between the parties’ rights and obligations and if it is upset for reasons not attributable to whoever is affected, the parties must adopt as soon as possible the measures needed to restore it.

The requirements for the doctrine of unforeseen circumstances to apply in Colombia are basically as follows:

a. It must be a contract requiring ongoing, periodic or deferred performance (it does not apply to contracts requiring instant performance or aleatory contracts).

b. Unforeseeability, i.e. unusual events which could not be foreseen at the time of contracting.

c. The facts must be outside the control of the parties.

d. They must cause hardship in the performance of the contract. In this respect, the Supreme Court has pointed out that the imbalance in obligations must be true, serious, essential, major, huge and significant.

e. The obligation concerned must be for future performance. The case law has pointed out that the revision of a contract due to unforeseeable circumstances is not allowable if the obligation, despite the hardship which it caused, had already been fulfilled.

It therefore becomes clear that the doctrine of unforeseen circumstances is not the same as force majeure, since, while both share the requirement of unforeseeability, this is not so in relation to the requirement of unavoidability, which makes it absolutely impossible for the obligor to fulfill their obligations.

In addition, unlike force majeure or a fortuitous event, the effects of relying on the doctrine of unforeseen circumstances are, on the one hand, a revision of the contract so as to correct, restore or adjust the imbalance; or, on the other hand, termination of the contract, avoiding the harmful consequences that breach would carry for the obligor. However, the party concerned cannot choose between adjustment and termination; this decision lies with the judge in each particular case. Furthermore, the burden of proving the unforeseen circumstances lies with whoever claims they exist.

MEXICO

Fortuitous event or force majeure

Pacta sunt servanda is a principle set out in articles 1796 and 1797 of the Federal Civil Code and in article 78 of the Commercial Code under which the parties are obliged to fulfill their contractual obligations according to the terms and conditions subject to which they were agreed.

However, Mexican civil law also recognizes the general principle of law that nobody may be expected to do the impossible in articles 1847 and 2111 of the Federal Civil Code. Under this principle it is recognized that sometimes the breach of an obligation cannot be attributed to the obligor because of the occurrence of events which were beyond their control, which they could not have foreseen, or which, although foreseeable, they could not have prevented.

Civil and commercial legislation in Mexico does not expressly define what should be considered a fortuitous event and force majeure, but these concepts, as well as the doctrine of unforeseen circumstances, are based on the revision of events occurring after the conclusion of a contract, which are unforeseeable or inevitable and in general, which substantially alter the conditions that constituted the basis for entering into it.

On the basis of the principle of freedom of contract recognized in Mexican law, the parties are allowed to define the scope, requirements to enforce it and effects of a fortuitous event or force majeure in relation to the performance of contractual obligations.

Although it is common to include these types of clauses, if they have not been stipulated in the contract the parties are subject to the provisions in the applicable legislation (in the context of civil law, in the local civil codes, in the context of administrative law, in the applicable law, and additionally, as for commercial contexts, in the Federal Civil Code, applicable secondarily) and case law principles. Under the law generally applicable to determine whether an event may be classed as a fortuitous event or force majeure, the following must be revised and proven:

The event cannot be attributed to the obligor;
The event must be unforeseeable or although foreseeable, is inevitable;
It must unavoidable, making it absolutely, physically or legally impossible for the obligor to perform their obligations;
Impossible performance of the obligation must be general, i.e. it must be impossible for anyone to perform the act in the existing circumstances.

The parties are only bound in a fortuitous event or force majeure if they have caused or contributed to it, if that liability has been expressly accepted or if the law imposes this on them.

In order to determine the consequences of the revision of a fortuitous event or force majeure scenario, the provisions stated in the contract concerned must be observed. It usually involves being excused from some of their obligations under the contract, an alteration of the agreed time limits, no updating of contractual penalties or even termination of the contract with no liability for the parties. If nothing is stated in the contract, the consequence is relief for the party whose obligations under the contract were rendered impossible to perform.

Termination due to supervening hardship (doctrine of unforeseen circumstances)

Unlike the case of a fortuitous event or force majeure in which the event must render performance of the obligation absolutely impossible, under the doctrine of unforeseen circumstances, the event in question does not have to completely impede performance of the obligation, but instead may render it more onerous for one of the parties.

It is important to note that the doctrine of unforeseen circumstances is only applicable to obligations under civil or commercial contracts where the applicable legislation provides that the rebus sic stantibus principle is applicable and in the following cases:

Contracts requiring ongoing performance;
Contracts with installment obligations, unless they are aleatory contracts;
It must be physically or legally impossible for one of the parties to perform their obligations, or
The obligations of one of the parties are more onerous than those originally agreed.

The doctrine of unforeseen circumstances proposes modification of the financial terms and conditions of a contract or, where appropriate, termination of the contract. In the context of administrative law sometimes this type of clauses is adopted in contracts or there are financial rebalancing procedures in mechanisms like concessions.

It is also important to note that some courts in Mexico have gone so far as to decide that the doctrine of unforeseen circumstances does not apply in commercial contexts, because article 78 of the Commercial Code establishes the absolute supremacy of the freedom of contract of the contracting parties over fairness and a balance of obligations.

Due to the pandemic caused by COVID-19, the Federal Public Authorities and local governments have issued a number of decisions affecting various sectors and industries which have had implications regarding whether or not fortuitous event and force majeure scenarios can be revised in various contracts.

PERU

Fortuitous event or force majeure

In Peru a fortuitous event or force majeure is regulated in articles 1315, 1316 and 1317 of the Civil Code. Peruvian law provides that since it is an extraordinary, unforeseeable and unavoidable event, which impedes the performance of an obligation or gives rise to partial, late or defective performance, it is treated as a cause beyond the party's control. Since a fortuitous event or force majeure is an event that renders performance of an obligation impossible, the varying degrees of impact that this circumstance may have on performance are: total, partial, permanent or temporary. Accordingly, Peruvian legislation establishes different consequences:

If the obligation could not performed due to a fortuitous event or force majeure, the obligation will be extinguished;
If impossible performance is temporary, the obligor is not liable for the delay, as long as it lasts;
Even if impossible performance is temporary, the obligation is extinguished if the cause giving rise to nonperformance lasts until the obligor, in accordance with the basis of his obligation or the nature of the performance, can no longer be considered to be bound to perform it; or until the obligee justifiably loses interest in the performance of such obligation or it is no longer of use to them.
In cases in which the obligation can only be partially performed, if this were not of use to the obligee or if the obligee did not have a justified interest in the partial performance of such obligation, the obligation is also extinguished; otherwise, the obligor is obliged to perform the obligation, and reduce the consideration, if any.

It should be emphasized that the fortuitous event or force majeure does not only consist of physical factors, which physically render performance impossible, but can also consist of legal factors. These would include the government restrictions ordered in Peru for the purpose of controlling the COVID-19 pandemic, and which consisted of measures such as the mandatory restriction of social contact and the closure of borders, provided that the restrictions had an impact on the performance of obligations, rendering them impossible.

No information is currently available regarding the courts’ response to the disputes over fortuitous events or force majeure which arose in relation to COVID-19. However, in the context of public procurement, the Public Procurement Supervisory Body – OSCE (an entity attached to the Peruvian Ministry for Economy and Finance) issued on March 25, 2020 Statement No. 005-2020-OSCE, in which it was established that the declaration of emergency due to COVID-19 “constitutes a force majeure situation which may affect the contractual relationships entered into under public procurement legislation, both on the part of the contractor and on the part of the Contracting Authority”. That was the only statement that was issued by the OSCE in this respect, and was aimed at clarifying the legal consequences of the impact of the restriction of social contact or movement (points 2 and 3 of the statement) on the performance of contracts subject to public procurement legislation. The Peruvian government's interest in preventing disputes was made clear when it stated that due to the restriction of movement requests could be filed for extension of time limits, or even the suspension of the terms of contracts subject to such specific legislation.

Hardship for performance

The COVID-19 pandemic and the issuing of government rules to alleviate or minimize its impact are events which might not necessarily have rendered performance of obligations impossible, but could have impacted the original economic balance of the contract.

Article 1440 of the Peruvian Civil Code defines an event in which in commutative contracts the contractual balance originally established by the parties may be found to have been upset, due to the occurrence of supervening, extraordinary and unforeseen events. Unlike the force majeure factor, which temporarily or permanently impedes performance of the obligation, in the case of hardship, performance is possible, but in a scenario of economic imbalance between the obligations.

In accordance with the national case law, hardship is found by comparing the values of the obligations at the time it is performed. For the purposes of conducting this analysis it is completely irrelevant to consider the specific financial situation or assets and liabilities of the parties involved. It is merely a question of comparing from an economic perspective, the ratio between the values of the obligations after the occurrence of an unforeseeable event which alters the economic values involved.

If that process confirms that the economic balance of the contract has been upset, then the injured party can request a reduction to their obligation or an increase in the consideration to make the economic imbalance disappear. If that adjustment is not possible, or the obligee so requests, the court will declare termination of the contract (which does not apply to obligations that have already been performed).

The important thing then will be to compare the value of an obligation with the value of the associated consideration, and determine whether an economic loss exists for one of the contracting parties which far exceeds the risk inherent in the transaction which they must reasonably assume, and that obligation really is intolerable for them, but not impossible.