Settlements related to non-culpable impossibility
An issue concerning businesses at present is the problem of settlements between them resulting from non-culpable inability to perform contracts. This is an area that may require the Parliament’s intervention if current regulations prove insufficient.
Due to the closure of a number of facilities (restaurants, cinemas, some retail outlets), businesses are incurring huge losses. As a result, doubts are arising on issues such as:
- How to perform settlements?
- Are existing contracts still binding?
- Can a contractor’s payment be withheld?
There is no ready answer that fits all cases, and each case should be dealt with individually. However, some directions can be identified as a basis for the parties to negotiate. These are based on relevant provisions of the Polish Civil Code.
Where one of the mutual performances has become impossible due to circumstances for which neither party is responsible, the party that was to provide the performance cannot claim the mutual performance, and if it has already received it, it is obliged to return it in accordance with the provisions on unjust enrichment.
If the performance of one of the parties has become only partially impossible, that party loses the right to a proportionate part of the mutual performance. (We write more broadly about possible withdrawal from the contract and the clause on extraordinary change of circumstances in the article “Businesses’ contractual obligations in a time of pandemic”).
Therefore, the question now requiring an arrangement between the parties is whether the performance can be satisfied in whole or in part, and if it can be satisfied only in part, how much of the consideration for the performance should be satisfied by the other party. The amount of consideration for partial performance is an area for business negotiations between the parties.
A party whose performance has become totally impossible as a result of circumstances for which it is not responsible, but has previously received the performance from the other party, is obliged to return it under the provisions on unjust enrichment. Therefore, it has a duty to return the benefit in kind, and if this is not possible, to return its value. The obligation to return the benefit covers not only what the party directly obtained, but also everything that was obtained in the event of disposal, loss or damage in exchange for that benefit or as a remedy for damage. However, the provisions on unjust enrichment provide that the obligation to return the benefit or its value is extinguished if the person who obtained the benefit has exhausted it or discarded it in such a manner that he is no longer enriched, unless when discarding or exhausting the benefit, he should have taken into account the obligation to return it.
Furthermore, under provisions on unjust enrichment, a benefit cannot be claimed back, among other reasons, if fulfilment of the benefit satisfies the principles of social coexistence. The rationale of the principles of social coexistence as a basis for refusing to reimburse all or part of the performance may raise the most doubts today. The general clause of the principles of social coexistence refers to different factual circumstances. As a result, the effect of its application may vary depending on the circumstances of the case, and it is difficult to formulate any general indications here.
Principles of social coexistence call for an individual approach to the issue, and for alleviation of rigorous application of regulations in exceptional situations. The law is created for typical needs and, as we see today, does not always take emergency situations into account.
Refraining from fulfilling performance
In these difficult times, businesses should analyse the situation on an ongoing basis and also act rationally without exposing their companies to risk. The law recognises such possibilities by providing that performances that are the subject of obligations under reciprocal contracts (reciprocal performances) should be made simultaneously unless it follows from the contract, the law, or a decision of a court or other competent authority that one of the parties is obliged to make an earlier performance. If reciprocal performances are to be made simultaneously, either party may withhold performance until the other party offers its reciprocal performance.
Therefore, in certain situations, businesses may withhold their performance if the performance of the other party is in doubt. However, when applying this mechanism, it is important to bear in mind not only the current situation, but also the past cooperation with the customer or supplier in question, and the fact that this may affect future business relations between the parties.
In addition, the other party’s poor financial standing gives rise to a right to refrain from fulfilling the obligation. If one of the parties is obliged to make a reciprocal performance earlier, and the performance by the other party is doubtful due to its financial condition, the party obliged to make the earlier performance may withhold the performance until the other party offers its reciprocal performance or provides security. A party that was aware of the bad financial condition of the other party when executing the contract does not have these rights.
Therefore, when a business learns after conclusion of the contract that the counterparty is in a difficult financial situation that may result in non-payment, it may at that time withhold its performance until offered reciprocal performance or obtaining security. However, at present, it must be considered that many businesses may be faced with payment gridlock, which requires analysis in a broader perspective. In particular, the following information should be taken into account:
- Are the problems of a temporary nature?
- What will be the consequences for the company of potential termination of cooperation with a given contractor?
- To what extent is performance of the contract feasible in the future?
- What kind of security can be obtained?
Abuse of right
It is also worth mentioning the concept of abuse of subjective rights, provided for in Art. 5 of the Civil Code. According to this provision, a right may not be exercised in a manner contrary to its socio-economic purpose or principles of social coexistence. Such an act or refraining from acting by the holder of a right is not regarded as lawful exercise of the right, and is not legally protected.
This provision is intended to prevent the application of the law in a schematic manner leading to immoral consequences or defeating the purpose for which the law was established. Therefore, the denial of legal protection must be justified by the existence and demonstration of special circumstances, in the realm of universally recognised values (Warsaw Court of Appeal judgment of 27 June 2019, case no. I ACa 233/18).
An allegation of abuse of rights may also apply to businesses, as confirmed by the Supreme Court, which also pointed out that the general clause in Art. 5 of the Civil Code does not shape subjective rights or change rights arising under other provisions. When the adversary raises the objection of abuse of rights, it should demonstrate that exceptional circumstances arose, such as the nature of the damage suffered by the injured party, the reason for the delay, the duration of the delay, as well as the conduct of the parties to the contractual relationship (Supreme Court judgment of 6 June 2019, case no. II CSK 200/18).
As a result, when pursuing their claims on the basis of existing contracts, the parties should also take into account the possibility of these arguments being raised by counterparties affected by the coronavirus epidemic.
Under the current circumstances, relations between businesses should be approached on an individual basis, as legal regulations are not keeping up with the evolving economic situation caused by the COVID-19 pandemic. The anticipated package of state aid to businesses may improve businesses’ situation, particularly in the industries most affected by the crisis.
Due to an extraordinary change of circumstances, businesses may agree with their counterparties on issues concerning their current business relations by concluding temporary annexes to contracts. It is also worth including reservations in annexes providing for certain solutions so that if state aid to certain industries has a significant impact on the economic or financial situation of either party, the provisions of the annex should not subsequently prove harmful to the other party.
Dr Kinga Ziemnicka, attorney-at-law, M&A and Corporate practice, Wardyński & Partners