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23 March 2020
The ongoing global outbreak and spread of novel coronavirus 2019 (COVID-19) is a dramatic event of global proportions, with far-reaching implications for a wide range of areas. The spread of COVID-19 directly affects many aspects of commerce and business – both domestic and international.
This article summarises the principal legal ramifications of the outbreak for contract law – an area on which, to date, the COVID-19 outbreak has had a significant impact.
The spread of COVID-19 affects consumer (ie, business-to-consumer) contracts, as well as commercial contracts between sophisticated businesses (ie, business-to-business contracts). This is particularly true with respect to agreements entered into before the outbreak of the virus, whose performance has been disrupted or frustrated as a result of the various restrictions that have recently come into effect.
In previous crisis situations (including the September 11 terror attacks and the 2008 financial crisis), business entities found themselves trying to get out of contracts that suddenly became difficult (or even impossible) to perform. Similar challenges are likely to arise with respect to agreements signed before the outbreak of the virus, whose performance has been disrupted or frustrated in the current circumstances. Contract law in Israel provides several tools for dealing with such situations, including:
Contract law views a contract as a mechanism for risk allocation between the contracting parties and, therefore, the parties' obligations are generally determined on entering the contract. However, in light of the inability to foresee all risks, the occurrence of some events may cause a contract to expire without being performed.
Under the doctrine of frustration, a party breaching a contract may have a defence against claims for performance damages or specific enforcement if circumstances arise that were unknown or unforeseeable to the breaching party when it entered into the contract and could not have been prevented, rendering performance of the contract impossible or materially different from what was originally agreed.
Historically, the Israeli courts have made little use of this doctrine and the Supreme Court has even ruled(1) that war does not constitute unforeseeable circumstances (since Israel is considered to be under a constant security threat). Thus, in practice, this doctrine was considered a 'dead letter'.
However, in recent years, the trend in Israeli case law has been to loosen the requirements for determining whether an event amounts to frustration and to focus on whether it is possible to foresee the effect of the exceptional event on the contractual relationship (as opposed to foreseeing the occurrence of the exceptional event).(2)
The doctrine of frustration leads to termination of a contract, rather than to its change. The doctrine deals with circumstances under which the contract cannot be fulfilled and enforced.
Therefore, while the doctrine of frustration protects the violating party against a claim for enforcement of a contract (or for performance damages), it does not protect the breaching party from other claims, such as restitution of goods or payment that it has received from the injured party, or reliance damages (meant to compensate the injured party for expenses incurred in order to fulfil the contract).
Moreover, the courts have developed the 'approximate performance doctrine' (also known as the 'cy-pres doctrine'), providing that when it becomes impossible for one party to perform a contract as agreed, the other party is entitled to substitute performance that best approximates the consideration promised to it in the original contract. Under this doctrine, a court may order a party that is precluded from performing a contract as agreed to perform it in a manner that reflects the parties' understandings as closely as possible.
While the doctrine of frustration was meant to address situations where external circumstances make performance of a contract impossible or materially different from the parties' original agreement, it is uncertain whether this doctrine should apply if a contract becomes economically unprofitable (a losing contract). On the one hand, performance of the contract is fundamentally different from the parties' original agreement – therefore, the doctrine of frustration could apply. On the other hand, contract law presumes that increased costs entailed in performing a contract are part of the inherent risk assumed by contracting parties. To refute this presumption and apply the doctrine of frustration, a party must prove that the scope and unforeseeability of the increased cost exceed the risk that that party could reasonably be viewed as having assumed.
The unprecedented COVID-19 outbreak is likely to give rise to applications of the frustration doctrine. Companies that were forced to cancel transactions that could not be carried out, delays in transportation of goods and cancellation of events and conferences because of the instructions of the Ministry of Health are all cases where the frustration doctrine may protect a non-performing party against claims for enforcement or performance damages.
Commercial contracts between sophisticated parties customarily include force majeure clauses to allocate risks between the parties in unforeseen circumstances.
In general, these clauses include a list (either closed or open) of agreed-on circumstances (typically, natural disasters, difficult weather conditions, war and terror events) that would amount to force majeure. When they occur, the parties subject to the force majeure are released (either temporarily or permanently) from their obligations under the contract or the contract as a whole could expire without imposing obligations on the parties.(3)
In general, when parties agree in advance on the circumstances that constitute force majeure, they also include various preconditions for applying the clause (eg, providing or receiving notices within a strict timetable). Parties that believe that the clause applies in a case must act accordingly.
Force majeure clauses can be the subject of disputes over interpretation. For example, historically, force majeure clauses generally have not included a global health emergency among the relevant circumstances, and thus a party disagreeing with a counterparty's assertion of force majeure may claim that such a situation is not force majeure if it does not appear in the defined list of events.
In general, the Israeli courts tend to respect force majeure clauses as drafted and pay careful attention to the language of the specific agreement.
The Supreme Court recently ruled, in a series of cases regarding the interpretation of commercial contracts between sophisticated players (eg, large companies), that decisive weight should be given to the language of the contract, based on the presumption that such parties are well represented and invest significant resources in formulating their agreements.
If transactions are cancelled or cannot be performed (including cancellations of flights and large-scale events) as the result of explicit instructions from the authorities (including the Ministry of Health), it is reasonable to assume that the Israeli courts would be open to applying doctrines of force majeure or frustration; hence, parties unable to perform a contract for these reasons would have defences against claims for performance damages or enforcement.
Nonetheless, if performing the contract is impossible (because of unforeseeable circumstances or the applicability of force majeure) the non-performing party may be obligated to approximate performance and, in any case, would not necessarily be protected against claims for restitution or reliance damages.
How should companies deal with their customers when they are forced to cancel a transaction following orders from the authorities (including the Ministry of Health), ordering the cancellation of flights to many destinations and the cancellation of large-scale events, or when consumers wish to cancel transactions at their own initiative?
In case of flight or event cancellations pursuant to orders of the Ministry of Health, the dealer must refund payment to consumers or offer a substitute product.
If a consumer asks to cancel a transaction on their own initiative and not as the result of the explicit orders of the Ministry of Health, or if the transaction was performed as a remote sale transaction (ie, online or by phone), the consumer who purchased accommodation, transport or leisure services or event tickets has the right to cancel the transaction within the later of 14 days after the date on which it was entered into (not counting the day on which the transaction was entered into) or from receiving the agreement, so long as there are more than seven working days until the date on which the service is to be provided.
Senior citizens, new immigrants and disabled persons have a broader right to cancel a remote sale transaction from the date of making the transaction, until four months after the later of the date of the transaction or their receipt of the agreement, as long as a conversation (including by chat) took place between the dealer and the consumer prior to execution of the transaction. The cancellation fees are fixed at the lesser of 5% of the transaction or NIS100.
The Consumer Protection Law 1981 applies fully to Israeli dealers, regardless of the involvement of external suppliers. Thus, even if an Israeli dealer contracts with a foreign supplier in connection with a transaction with an Israeli consumer, the Israeli dealer must refund the entire payment to the consumer where the Consumer Protection Law applies, even if the dealer itself does not receive a refund from its foreign supplier. The refund must be effected within 14 days of the dealer's receipt of the cancellation notice and the dealer must provide the consumer a copy of the cancellation confirmation.
Israeli dealers that provide a service entirely abroad must offer two alternatives to consumers:
Consumers have the right to select one of the alternatives. If the alternatives were not presented to the consumer, the cancellation provisions of the Consumer Protection Law will apply.
For further information on this topic please contact Avraham Well, Gil Orion, Ronald Lehmann or Noa Barhum at Fischer Behar Chen Well Orion & Co by telephone (+972 3 694 4111) or email (email@example.com, firstname.lastname@example.org, email@example.com or firstname.lastname@example.org). The Fischer Behar Chen Well Orion & Co website can be accessed at www.fbclawyers.com.
(3) There is also precedent for the principle that the question of frustration should be considered in light of a force majeure clause (Civil Appeal 6916/04, Bank Leumi Leisrael Ltd v Attorney General of Israel, Paragraph 94).
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