On March 11, 2020, following the rapid spread of COVID-19, the World Health Organization declared it to be a world-wide pandemic. The outbreak of COVID-19 is extraordinary and its implications profound. In this note we consider how force majeure provisions in commercial contracts, and the doctrine of frustration under the Israeli law, may be engaged in the context of the COVID-19 crisis.
Force Majeure Provisions – Israeli Law
Israeli law does not include a legislative definition of force majeure; however, agreements of significance to their parties often contain contractual provisions aimed to handle events that are outside the reasonable control of the parties and which would prevent a party from performing contractual obligations.
As would be typical in other jurisdictions, three elements usually appear in force majeure provisions: an event that arguably constitutes force majeure; impracticality – the event would be beyond the reasonable control of the affected party; and causation – there would be a causal connection between the event and the inability of the party to a contractual obligation.
Other elements also appear frequently, but not universally, in these provisions. Those would include foreseeability – requiring that the event could not have been anticipated, foreseen or expected; mitigation – requiring the affected party to have taken all commercially reasonable steps to avoid, mitigate or minimize the event and its consequences; and notice – requiring timely notification, sometimes alongside the submission of evidence that demonstrate that the elements of force majeure have indeed occurred.
Typically, Israeli contracts that include a definition of force majeure refer to it using broad terms such as an “act of God” or an event that is “outside the reasonable control of the party affected”. These phrases are usually followed by a non-exhaustive list of illustrative force majeure events, including wars, armed conflicts and force of nature events.
When a force majeure provision makes specific reference to a pandemic, epidemic, plague or disease, its applicability to the COVID -19 pandemic may be easier to assert. If the provision does not include such language, however, it will be necessary to consider whether it may be said that the outbreak of COVID-19 is an event that is “outside the control of the party” or an “act of God”.
Some support for the proposition that the outbreak of COVID-19 may constitute an “act of God” or an event that is “outside the reasonable control of the party affected” may be found in the inclusion of “pandemic” as a typical illustration of force majeure in model clauses of leading arbitration institutions, such as the International Chamber of Commerce (The ICC Force Majeure Clause 2003); in the declarations of relevant governmental authorities, such as China’s Council for the Promotion of International Trade that has issued certain Chinese companies “force majeure certificates” in the wake of the COVID-19 outbreak; and in case law.
For instance, in Rexing Quality Eggs v. Rembrandt Enters., Inc., 360 F. Supp. 3d 817 (S.D. Ind. 2018), the Court was required to determine whether avian flu constituted a force majeure defence in the context of an agreement to sell cage-free eggs. In that case, since the provision did not contain explicit language encompassing the flu, it was necessary to determine whether the situation amounted to “other acts or events beyond the reasonable control of a party hereto”. While the claim was rejected due to its particularities, the Court noted that avian flu “may plausibly constitute an unforeseeable event precipitating a dramatic change in market conditions”.
Clearly, at this early stage, it would be premature to express a firm opinion as to the correct classification of COVID-19 and its legal implications on existing contracts.
Among other considerations, applying a force majeure provision would be a function of the degree of impairment of the affected. Some contracts require that the party be “prevented” by the force majeure event; others set the bar lower, requiring that the party’s ability to perform the obligation under the contract be “impeded” or “hindered”.
The impact of a force majeure event may be direct and relatively easy to legally analyze. However, more difficult questions arise where the force majeure event adversely affects profitability. Traditionally, an economic downturn or other unfavorable business conditions that resulted from an unforeseen event would not by themselves suffice to substantiate a force majeure defense, yet, what will be the outcome in this profoundly new, world-wide catastrophe, is entirely unclear at this point.
Regardless, the duty to take commercially reasonable steps to avoid, minimize and mitigate the event and its consequences, must be kept in mind. Some contracts require to demonstrate that there are no alternative ways to perform the contract; others require timely notification, sometimes alongside the submission of evidence demonstrating that the elements of force majeure were indeed met.
Depending on applicable circumstances, a successful invocation of a force majeure provision can lead, inter alia, to a suspension of contractual performance for the duration of the force majeure event, extension of time to perform an obligation until the force majeure event ends, exemption of what would otherwise be a violation of contractual obligations, or excusing the consequences of such a violation. Most contracts do not prescribe termination as the primary remedy for force majeure situations, at least not without the passage of a predetermined period of time.
The Doctrine of Frustration
Israeli contract law includes a doctrine of frustration, anchored in Article 18 of the Israeli Contracts Law (Remedies for Breach of Contract) (1970). Frustration is a defense that a breaching party may invoke against claims for the enforcement of a contract or for compensation (performance damages). Article 18 reads:
“(a) Where the breach of contract is the result of circumstances which at the time of making the contract the person in breach did not know of or foresee and should not have known of or foreseen, and which he could not have avoided, and the performance of the contract under these circumstances is impossible or fundamentally different from what was agreed between the parties, the breach shall not give cause for enforcement of the contract or for compensation.
(b) In the cases referred to in subsection (a), the Court may, whether or not the contract has been rescinded, require each party to restore to the other party what he received under the contract or, at his choice as provided in Article 9 [of the Law], to pay him the value thereof, and require the breaching party to indemnify the injured party for reasonably incurred expenses and liabilities reasonably contracted by him for the performance of the contract, all if and in so far as the Court deems it just to do so in the circumstances of the case.”
Thus, to rely on this defense the breaching party must show that the severe circumstances were unknown and unforeseeable to it when the contract was signed. He must also show that these circumstances could not have been prevented, rendering performance of the contract impossible or materially different from what was originally agreed by the parties.
Israeli courts have interpreted and applied the doctrine of frustration narrowly, even holding that war does not constitute unforeseeable circumstances in the sense of the Article 18 of the Contractual Remedies Law, because Israel has always been under a state on conflict and emergency. Recently, however, lower courts have called for more flexibility in the interpretation and application of the frustration doctrine, in particular as to the un-foreseeability requirement.
When applied, Article 18(a) of the Contractual Remedies Law would lead to the termination of a contract rather than to its modification. Under Article 18(b), while the doctrine of frustration protects the breaching party from claims for enforcement or compensation, it does not shield from the restitution of goods or payments that were received from the injured party, nor from reliance damages.
Whether or not COVID-19 effects would allow parties to rely on Section 18 will depend on the nature of the contractual obligation and the particular circumstances. As noted above, at this early point in time it would be premature to make a firm assertion as to how Israeli courts will interpret the doctrine of contractual frustration in the unusual and extraordinary circumstances created by COVID-19.
As recently noted in the press the Ministry of Justice is considering whether to promote legislation that will set the outcome of COVID-19 based cases – those are expected to be numerous; if legislated, it would probably apply to force majeure and Section 18 cases alike.
Lease and Rent; International Sale of Goods
Under certain circumstances, Article 15 of the Lease and Rent Law (1971) exempts from the obligation to pay real estate rent, where the lessee is prevented from using the asset for the purposes of the lease due to unforeseeable reasons relating to the property or the access ways to it.
While determination as to the applicability of Article 15 to COVID-19 situations would be premature, it is interesting to mention a relevant Supreme Court case (CA 4893/14 Zuabi v The State of Israel (March 3, 2016)). Here the Supreme Court clarified that circumstances preventing the asset from being used may also include “legal prevention”. The Court also called for a less strict application of Article 15’s foreseeability test (relative to the frustration doctrine).
Article 79(1) of the Sales Law (International Sale of Goods) (1999) provides that a party will not be held responsible for non-performance if it can prove it resulted from an impediment that is beyond its control, could not have been reasonably foreseeable when the parties entered into contract, and the impediment and its consequences could not have been prevented or overcome. Under Article 79(3), temporary impediments will only temporarily excuse the obligor for the period for which the impediment exists.
Here too, the applicability of Article 79 will be the function of all relevant circumstances known at the time a determination is made. A firm position as to its applicability to COVID-19 situation would be premature. Interestingly, Israeli courts may refer to the United Nations Convention on Contracts for the International Sale of Goods, on which Article 79 is based (virtually verbatim). It is useful to note that the Convention does not specifically refer to “force majeure”, yet it is generally perceived to include natural disasters and epidemics as typical causes for an exemption of liability.
For example, a tribunal constituted under the rules of the China International Economic and Trade Arbitration Commission was willing to consider the outbreak of the SARS epidemic in 2002-2003 as an impediment beyond the control of the parties in the sense of Article 79 of the Convention. However, in the particular circumstances of that case, the Tribunal rejected the force majeure plea under Article 79 because the outbreak of SARS happened two months prior to the signing of that contract, and was as such foreseeable, thereby deeming the defense of Article 79 inapplicable (The L-Lysine Case, CIETAC Arbitration Award of March 5, 2005).
What Steps Can Your Organization Take?
In order to best prepare for different scenarios, organizations may consider taking several measures:
An organization claiming (or contemplating) force majeure
- An organization that considers itself affected by the outbreak of COVID-19 should be prudent and document any such effects and record the mitigating measures which it is adopting to prevent, minimize and mitigate the impact of the COVID-19 outbreak on its ability to perform its contractual obligations.
- The organization must ascertain the degree to which the event hinders its performance. As explained, different agreement set a different bar.
- The organization must identify what exactly affects its ability to perform its obligations. The outbreak of COVID-19 does not necessarily, in itself, stop a contract from being performed; it may well be its consequences. Identifying what is actually affecting the contract is important: whether it is the outbreak of the pandemic, as such, that prevents the party from performing its obligations under a contract? Or perhaps emergency measures taken by the government to suppress the spread of the pandemic (such as travel bans)? Or is it other disruptions in the party’s workforce due to consequences that flow from these events (such as budget cuts and layoffs), affecting contractual obligation?
- If the force majeure provision references foreseeability, the organization should consider whether this event could not have been be reasonably anticipated? For contracts entered after COVID-19 outbreak, this argument would become more challenging.
- Many contracts expressly require the impacted party to notify the other party within a specified timetable, or “as soon as possible” or “promptly after having become aware of the event”, and so forth. If so – notify. Even in the absence of a specific notification requirement, it may be advisable to notify the counterparty so as to avoid contentions of bad faith, waiver or acquiescence.
- Some contracts require the affected party to submit evidence in support of its claim. Even in the absence of any such obligation, it is nonetheless advisable to document relevant facts concerning the force majeure event.
- Caution is advised. Wrongful or premature claims could result in serious consequences, and even amount to a repudiation or a breach of the contract, entitling the counterparty to claim damages or to terminate the contract.
An organization receiving a force majeure notice
- An organization receiving a notice of force majeure should carefully examine the notification against the backdrop of the force majeure provision and determine whether the claim is consistent with the terms of the contract.
- The organization should also assess whether the duty to notify has been met in time, form and content, whether the contract requires the affected party to submit evidence of its claim, and if so whether such were provided.
- In its response strategy, the organization should also consider whether it is engaged in back-to-back contracts, and if so consider how the claim for force majeure affects its obligations vis-à-vis other related contracts to which it is a party and whether it too should issue a force majeure claim.
- Force majeure notices should not be ignored but rather properly and timely responded to. Given the complexity of the situation and of the arguments that can be made on each side, caution is required. The receiving party should of course document its actions, consider the options available to it following consultation with counsel, and cautiously incorporate the prevailing circumstances into its analysis and course of action.
Lastly, all parties to a contract in Israel must act in good faith. Force majeure articles should be exercised in good faith, and the response to them no less so. Baseless demands, a disregard of extreme events and similar actions and responses might fail to meet the good faith standard prescribed by Israeli Contract Law. This might have negative implications, as well as direct negative financial consequences.