Articles
19/08/2020
Corporate and Commercial

The impact of Coronavirus on commercial contracts subject to Italian law: the latest guidelines of the Supreme Court

[IMPORTANT NOTE: This document is updated as at 22 July 2020, given that the state of emergency and the related regulatory framework are constantly evolving, the contents of this memorandum may be subject to further changes.]

1. Introduction

Today the restrictive measures taken, in recent months, by the Italian government to deal with the epidemiological emergency of Covid-19 have been largely reduced within the national territory, retaining only those measures aimed at continuing to ensure social distancing, since the presence of Covid-19 has not yet been eradicated and, indeed, could give rise to upsurge in the near future.

Nevertheless, precisely in the light of the important measures adopted during the lockdown phase, it has often been necessary to examine the extent of the impact of said emergency measures on economic activities and on the legal relationships existing between the various economic operators, considering that the situation, besides affecting corporate aspects, production activity, has also had (and may continue to have) a significant impact on the supply chain and logistics. Indeed, the spread of Covid-19 and the extraordinary and urgent measures adopted have affected – also in Italy – sometimes considerably, the performance of commercial contracts, leading to delays in the fulfilment of the obligations provided for by various contracts or, in some cases, a real impossibility of performance.

In this respect, it is certainly useful to examine the latest statement of the Supreme Court in its Thematic Report No. 56, “Substantive new legislation on “emergency” anti-Covid 19 law in contractual and insolvency matters”, published on 8 July 2020 (the “Report”).

Indeed, in said Report, the Supreme Court acknowledged that the economic shock resulting from the spread of Covid-19 has given rise to two interconnected issues: (a) the management of contingencies which interfered with the original balance of contractual performance; and (b) the related legal and conventional remedies [1].

2. Force Majeure and possible remedies

2.1 The institutions of the Italian Civil Code

As we have already examined, the epidemiological emergency from Covid-19 has taken on characteristics that could classify it as an event of force majeure. In this respect, it should be noted that the Italian Civil Code does not provide a real definition of force majeure, although it does provide for some institutions whose application presupposes the occurrence of events that can be linked to the concept of force majeure. Indeed, for contracts subject to Italian law, without prejudice to the relevance of any contractual clauses, reference shall be made, in particular, to the following institutions:

  1. supervening impossibility of performance for reasons not attributable to the debtor (Articles 1218, 1256 and 1463 of the Italian Civil Code) [2];
  2. supervening hardship in performance (Articles 1467 et seq. of the Italian Civil Code) [3].

In any event, a case-by-case evaluation is of course necessary in order to activate the most appropriate remedy also in the light of the relevant contractual text.

In this framework, given the lack of case law on the subject, it is certainly useful to examine the statements of the Supreme Court on the abovementioned institutions.

First of all, the Court has pointed out that, in terms of remedies offered by the Italian Civil Code, the margin for termination due to supervening impossibility is particularly narrow since such remedy would seem to be feasible only when the performance under the contract has become completely and definitively impossible to render or to obtain.

This raises quite a few problems with regard to monetary obligations which, as such, as the Court itself has pointed out, never become impossible, “not being exposed to a material or legal objective impossibility, but only to a subjective impossibility, linked to the unavailability or scarcity of cash flow” [4].

Furthermore, considering that the restrictive measures adopted by the Italian Government had a limited duration in time, generally the impossibility of performance as a result of said measures was only temporary, thus giving per se no right to terminate the relationship and/or the obligation, simply becoming the debtor not responsible for the delay for as long as the performance is temporarily impossible.

In fact, in such a case, pursuant to the provisions of Article 1256 of the Italian Civil Code, the obligations will be extinguished only “if the impossibility continues until, according to the purpose of the obligation or the nature of the scope, the debtor can no longer be considered obliged to render the performance or the creditor is no longer interested in obtaining it”.

The Supreme Court also emphasises that, in the cases in question, performance can easily become only partially impossible, so that even the individual obligation cannot be extinguished, giving rise to a partial impossibility which, pursuant to Article 1464 of the Italian Civil Code, would result in the creditor being the only party allowed to decide to withdraw from the contract if not interested in the partial performance.

Secondly, the Report also examines the institution of supervening hardship. In this regard, the Supreme Court acknowledges that the containment measures may have unbalanced the economy of the legal transaction. Nevertheless, the Court also clarifies that supervening hardship in performance does not prevent the implementation of the interest pursued by the legal transaction, but “relates, instead, to the need to keep the risk of economic burden of the performance within normal limits, protecting the party from the risk of an exceptional economic worsening of the performance due to serious causes of disruption of socio-economic relationships” [5].

Therefore, it is expressly acknowledged that, in all commercial and productive sectors, the health, economic and social emergency caused by the spread of Covid-19 has caused (and continues to cause) consequences well beyond the normal area of risk of the contract which are characterized by an extraordinary, unpredictable and unavoidable nature such as to legitimize the affected party to take legal action for the termination of the contract.

Without prejudice to the foregoing, the Court highlights a heavy limitation also with regard to the remedy under examination: the fact that by its nature it destroys and does not to preserve the contract. In fact, “the remedy is intended to remove the obligation, not to rebalance the bilateral nature of the contract. Therefore, it ends up burning the bridges of business relationships as well as of relationships between private citizens, since it leads to the definitive termination of the relationship, not to the transitory reduction of the fees, which is not contemplated by Article 1467 of the Civil Code” [6]. This is hardly the objective of the disadvantaged contracting party: “Indeed, only the party favoured by the unbalance can avoid the termination of the contract, by offering to equitably modify the terms of the same (Article 1467, paragraph 3, of the Italian Civil Code)” [7].

To recall an important passage in the Supreme Court’s reasoning “Emergency cannot be dealt with by destroying the contract. Rather than releasing the debtor-entrepreneur from the obligation, it would be crucial to mitigate or reduce the scope of said obligation, where its fulfilment is hindered or made exhausting by the measures of containment on supplies, circulation of goods, company organization, all the more so if one considers that said measures are swirlingly adopted at various levels (national, regional, municipal) with a view to prevent the spread of contagion” [8].

2.2 Failure to perform and financial helplessness

Among the various consequences that the health emergency had (and continues to have) on the world system one cannot overlook the important economic-financial crisis which, among other things, has resulted in a sharp decrease in consumption. Although said decrease has certainly reached its peak during the so-called lockdown phase, it is likely that this situation will continue in the near future, stemming from an economic-financial crisis that is affecting the entire global system.

The reduction in consumption has led to a drastic reduction in turnover for all companies adversely affected by the situation, thus limiting the available liquidity which has impacted on the regular fulfilment of monetary obligations.

Despite the very difficult situation, the Court points out that, legally speaking, “the non-payment or late payment of sums due remains, at present and in principle, unjustified and chargeable” [9].

Indeed, the Supreme Court continues, “even within the constitutional framework of the principle of solidarity, the concept of impossibility of performance does not include, in fact, the so-called financial helplessness, even if determined by the cause of force majeure in which the current health emergency falls[10].

As already mentioned, there can be no objective and absolute impossibility of obtaining the money to fulfil the obligation, being money a fungible and imperishable asset.

Therefore, any difficulty in finding liquidity to meet one’s obligations is a risk that the debtor assumes and which cannot, as the Supreme Court points out, impact on the economic and legal spheres of its creditors.

2.3 Emergency intervention by the legislator

It should be recalled that in dealing with the repercussions of the epidemiological emergency on commercial and productive activities, the legislator has clarified, in Article 91, paragraph 1, of Decree Law no. 18 of 17 March 2020 (the ‘Cura Italia’ Decree), that compliance with the containment measures must always be assessed in order to exclude, pursuant to and for the purposes of Articles 1218 and 1223 of the Italian Civil Code, the debtor’s liability, also with regard to the application of any forfeiture or penalties connected with delayed performance or non-performance [11].

So, considering the ambiguity of the provision in question, the clarification of the Supreme Court is of great importance, which distinguishes two levels: (a) the liability of the defaulting debtor due to the need to comply with the measures of containment seems to have been already cancelled by virtue of Article 1218 of the Italian Civil Code; (b) the provision does not exclude, per se, the liability “to comply” with “anti-Covid” measures, but rather establishes that compliance with said measures shall be “always assessed” for the purposes of an action for liability.

Therefore, it is immediately clear that the company’s material and economic effort to adapt to the health requirements is not an automatic exemption from non-performance, but must in any case be taken into account by the court in the broader action for liability.

The Court has also examined the case of a debtor remaining inactive and in default, not by reason of compliance with a containment measure, but by reason of the debtor’s subjective perception culminating in the fear that the performance may endanger the safety of the debtor or of the debtor’s staff. In this case too, given that it is for the authority (and not for the individual debtor) to assess the epidemiological risks, non-performance, even if for noble reasons, would not be justified and would constitute, to all intents and purposes, a breach attributable to the debtor.

Hence, the Supreme Court affirms that the lightening of the burden of proof on the debtor established by the legislator shall be enforced simply by requiring courts not to deny per se that the need to comply with the “anti-Covid” provisions could amount to a “cause not attributable” to the defaulting party, therefore courts should take note of this circumstance in their considerations.

In any event, it will be for the debtor to prove the causal link between non-performance and compliance with the restrictive measures, it being sufficient, however, to prove that said measures stopped the performance, prohibiting or delaying an activity. This is understandable because it would not be possible to shift onto the creditor the burden of proof which indeed relates to circumstances beyond the creditor’s sphere of action (the debtor is the one who knows the details of its internal organisation and the relevant impediments).

Finally, the Court has also examined the case of obligations to give, in respect of which compliance with the requirements may prevent only part of the performance. In this case, the debtor may offer only the part of performance not affected by impossibility, without prejudice to the creditor’s right to refuse partial performance pursuant to Article 1181 of the Civil Code [12]. Nevertheless, if the creditor accepts to receive a partial performance, the creditor may in turn partially suspend its own performance (provided that this is in symmetry with the value of the other party’s partial performance), raising a partial objection of non-performance and provided that the principle of good faith is fully respected.

2.4 Preservation and renegotiation of the contract

As already mentioned in the preceding paragraphs, the remedies provided for by the legislator are remedies interrupting and not maintaining the contract. Indeed, they do not provide for the renegotiation of the contract, except only in the case of supervening hardship where, however, the right to avoid termination lies with the “beneficiary” and not with the party suffering the hardship.

Therefore, the Court wanted to emphasize that the current emergency has highlighted how the principle of the binding force of the contract lends itself to being considered as absolute if, as a result of circumstances subsequent to the entering into of the contract or anyway unknown at that time or, again, outside the sphere of control of the parties, the balance of the relationship is substantially distorted.

This has also revealed that, unlike what often happens in contracts concerning relations between Italian parties, international contracts frequently use clauses (e.g. hardship clause, force majeure clause) which aim, instead, to regulate from the outset any exceptional situations that may undermine the balance of the relationship, providing dedicated and specific remedies that do not necessarily imply, as a first solution, the termination of the relationship itself. In fact, such clauses tend to provide for an initial suspension of the performance of the contract or even the renegotiation of the contract.

While it is true that the remedy offered by the Italian Civil Code in case of supervening hardship is a remedy allowing only the party benefiting from the imbalance to maintain the contract, it is also true that in any case such remedy shows that the legislation is interested in preserving the contract.

The Court also states that, in dealing with the subject under examination, the concept of notion of cause seems not easy to apply in practice since “the carrying out of the company’s business is not the direct purpose of the contracts which are instrumental to its performance. Risk and profit are purposes unrelated although not unknown to one of the two contracting parties and therefore they do not fall within the causal perimeter. Moreover, in the absence of a direct common purpose, presumption is not taken into account!’ [13].

Given the above, where the parties have not conventionally regulated the management of any contingencies, it is necessary to ground the obligation of renegotiation on a different basis.

In this respect, the Court refers to Article 1374 of the Italian Civil Code [14] which is significant in outlining the judge’s direct intervention on the unbalanced contract, in compliance with a principle of corrective heterointegration of the contract according to fairness, pointing out as well that “the duty of contractual fairness is not only a general clause intended to regulate the negotiations, conclusion, interpretation and performance of the relationship, but is also a source to integrate the contract” [15].

As said, Article 1467 of the Italian Civil Code gives normative prominence to extraordinary and unforeseeable events that upset the economy of the contract, thus configuring a general principle of preservation of the contract balance, a principle that may result in the dissolution of the contract, or restoration of its equity through renegotiation.

Said article contains a non-mandatory provision that, as such, may be derogated from by both the will of the parties and the mandatory provisions of law which include precisely the rule imposing on the parties to behave in good faith (Articles 1175 [16], 1374 and 1375 [17] of the Italian Civil Code).

Therefore, the Supreme Court underlines that “good faith represents an important yardstick for approaching the problems related to the performance of the contract, having the value of public order, placing itself among the main principles of our social order and revealing an ethical base that meets the idea of an active or supportive social ethics” [18].

In fact, the Court recalls how in the past it has acknowledged good faith as the governance rule of discretion in the performance of the contract, since it is a principle ensuring that said phase be carried out consistently with what emerges from the reconstruction of the economic transaction that the parties intended to carry out.

On the other hand, with regard to the duty of fairness, the Supreme Court affirms that the same is considered as the internal limit to any subjective legal situation, avoiding that the observance of formal legality results in the sacrifice of material justice, thus disregarding the constitutional duty of solidarity [19] which, applied to contracts, integrally determines their content or effects and must guide both their interpretation and performance.

Therefore, the systematic extent of objective good faith in the performance phase of the contract pursuant to Article 1375 of the Civil Code postulates renegotiation as a necessary step for adjusting the contract to the circumstances and needs that have arisen.

To quote the Supreme Court, “The lack of cash flow is a widespread contagion, with respect to which the therapy is not the interruption of the contractual bond, but the suspension, postponement, reduction of the obligations attached thereto. […] The general clause of good faith becomes, in this perspective, a guarantee of correct behaviour in the implementation of the contractual provisions. By virtue of the economic and legal assessment of the good faith criterion and of the obligations of cooperation between the parties in the performance of the contract, the adjustment of the content of the contract connected with the obligation to renegotiate is not in contradiction with private autonomy, since it fulfils the function of accomplishing the result of the negotiations which the parties had originally set out to achieve, by adjusting the contractual rules to circumstances that have changed[20].

Not only that. The interpretation of the contract according to good faith, pursuant to Article 1366 of the Italian Civil Code [21], also lends itself to the identification of an obligation to renegotiate. Indeed, on the basis of said regulatory provision “it is possible to assume that the parties, if they had been aware thereof, would have anyway negotiated on the basis of the conditions that have arisen, since a negotiation based on a market situation not corresponding to reality would prove to be irrational. It follows that the refusal to renegotiate by a party, pursuant to Article 1375 of the Civil Code, results in opportunistic behaviour which the system cannot protect and tolerate” [22].

The obligation to renegotiate would therefore impose an obligation to start new negotiations and to conclude them fairly but not necessarily to conclude an amending contract. Therefore, as the Court clearly points out, “the party liable to renegotiate is not in default if, when the conditions requiring the revision of the contract exist, it promotes negotiations or positively responds to the request to renegotiate submitted by the other party and if it proposes rebalancing solutions that can be considered fair and acceptable in the light of the economy of the contract; of course it cannot be requested to agree to every claim of the disadvantaged party or to finalize the contract anyway, which clearly presupposes personal evaluations of economic and legal convenience that cannot be taken away from either party[23].

3. Conclusions

In the light of the above considerations, we summarize below the conclusions [24] reached by the Supreme Court based on fine reasonings on the institutions and the rationale underlying them, which are intended to protect the parties in order to deal with contract contingencies, such as those caused by the health emergency of Covid-19:

  1. if the bilateral nature of the contact is distorted by the current pandemic and the advantaged party fails to comply with its protection obligations towards the other party, allowing the latter only termination and compensation for damages would result in the demolition of the contractual relationship, a solution that both the principle of good faith and the already discussed obligation to renegotiate seek to avoid;
  2. thus, in such a situation the intervention of the court for the integration of the relationship which has become unfair would be justified. Such intervention would be admissible whenever the terms on which the parties intended to share the risk arising from the contract were to emerge from the contractual rules;
  3. apart from said scenario, the determination of the content of the contract is a matter solely for the parties to decide;
  4. in any case, should the parties be obliged to renegotiate, it could be assumed that the failure to do so would not only result in compensation for damages, but would also expose to specific performance pursuant to Article 2932 of the Italian Civil Code [25]. Therefore, the court could be given the power to stand in for the parties by delivering a judgment which takes the place of the renegotiation agreement not concluded, thus leading to the amendment of the original contract;
  5. of course, in this case, the court’s assessment shall necessarily be based on elements rigorously set out in the contractual rules. It is clear that this approach presupposes that it is possible, in the case at issue, to predetermine the precise outcome of the negotiations. There is therefore an urgent need to identify a parameter to which the contract should be adapted, which is not a simple exercise. Therefore, the court’s assessment of the negotiation activity carried out by the parties before the interruption of the renegotiation process will be of central importance, since it may leave a number of elements to decide.

In the light of the above considerations, the Supreme Court goes so far as to affirm that also the party affected by the contingency would have the power to invoke the restoration of equity of the unbalanced contract which, in onerous contracts, should be for the counterparty.

 

Edited by Lorena Possagno, Filippo Federici e Giulia D’Auria.

The content of this article is for information purposes only and is not, and cannot be intended as, professional advice. For further information please contact your counsel or send an email to the following address: corporate.commercial@advant-nctm.com.

 

 

[1] This review deals only with issues relating to the management of commercial contracts, without, therefore, dealing with the other issues examined in the Report, such as, for example, insolvency proceedings.
[2] Supervening impossibility means any situation preventing performance that cannot be foreseen and cannot be overcome through the effort that can legitimately be required of the debtor. Indeed, should the non-performing party prove that the breach of contract was the consequence of the impossibility of performance for “reasons not attributable to that party”, the latter may be held not liable. Supervening impossibility can be (i) permanent or temporary; and (ii) total or partial. Once the abovementioned conditions have been verified, the contractual obligation that has become impossible (a) is extinguished, with consequent (total or partial) legal termination of the contract if said impossibility is absolute and final; or (b) can be legitimately suspended, if said impossibility is only temporary. Where performance is directly prevented by the legislative measures taken by the government to deal with the current emergency situation, the so-called impossibility due to factum principis, defined as a cause of objective impossibility of performance resulting from an action or measure of the public authority (e.g. the obligation to suspend production and commercial activities), may occur. Since this is an objective impossibility, it will not be necessary to assess the existence of the characteristics that are typical of the impossibility, and the above mentioned provisions on supervening impossibility shall apply directly.
[3] The institution of supervening hardship on the other hand allows for the termination of contracts whose balance is altered by supervening events – extraordinary and not reasonably foreseeable at the time of entering into the contract – which do not fall within the normal area of risk of the contract and which make any of the performances underlying the contract excessively onerous or objectively debased in its value and/or usefulness. The counterparty interested in maintaining the contract may avoid termination by offering to equitably modify the terms of the contract.
[4] See Report, page 2.
[5] See Report, page 5.
[6] See Report, page 6.
[7] See Report, page 6.
[8] See Report, page 6.
[9] See Report, page 7.
[10] See Report, page 7.
[11] Pursuant to article 91, paragraph 1, of the Decree, “The following text is inserted in Article 3 of legislative decree No. 6 of 23 February 2020, converted with amendments by law No. 13 of 5 March 2020, after paragraph 6: «6-bis. Compliance with the containment measures set forth in this decree is always assessed for the purpose of excluding, pursuant to and for the purposes of Articles 1218 and 1223 of the Italian Civil Code, the debtor’s liability, also with regard to the application of any forfeiture or penalties connected with delayed performance or non-performance”.
[12] Article 1181 of the Italian Civil Code: “The creditor may refuse partial performance even if the performance can be divided, unless otherwise provided for by law or practice”.
[13] See Report, page 20.
[14] Article 1347 of the Italian Civil Code “The contract binds the parties not only to what is expressed therein, but also to all the consequences deriving therefrom according to the law, or, failing that, according to practice and fairness”.
[15] See Report, page 21.
[16] Article 1175 of the Italian Civil Code “The debtor and the creditor must behave according to the rules of fairness”.
[17] Article 1375 of the Italian Civil Code “The contract must be performed in good faith”.
[18] See Report, pages 21-22.
[19] See Article 2 of the Constitution according to which “The Republic acknowledges and guarantees the inviolable human rights, both as an individual and in the social formations where one’s personality develops, and requires the fulfilment of the imperative duties of political, economic and social solidarity.”
[20] See Report, page 23.
[21] See Report, page 24.
[22] See Report, page 24.
[23] See Report, page 25.
[24] See Report, pages 26-28.
[25] Article 2932 of the Italian Civil Code “If the party who is obliged to conclude a contract fails to fulfil the obligation, the other party may, if possible and not excluded under the contract, obtain a judgment having the effects of the contract not concluded. In the case of contracts having as their subject-matter the transfer of ownership of a specific thing or the creation or transfer of another right, the claim cannot be accepted if the party who brought it does not render its performance or does not offer to perform in accordance with the law, unless the performance is not yet due.”

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