11 May Effects of acts of God or force majeure on the fulfillment of contractual obligations within a real estate lease agreement.
Given the global pandemic caused by SARS-CoV2 virus (COVID-19), on March 30th, 2020, an executive order was published in the Federal Official Gazette (DOF, by its acronym in Spanish) declaring a health emergency due to force majeure. As a consequence, many establishments, factories and businesses considered as “non-essential activities” have been forced to suspend operations, which has placed landlords and tenants in the need to renegotiate the terms of their contractual relationships.
The General Theory of Obligations establishes that the external cause (of natural or human origin) that makes the fulfillment of a contractual obligation impossible, that could not have been foreseen or that, even foreseen, could not be avoided, is called an Act of God or force majeure event. Acts of God or force majeure events are considered one of the main exclusions of contractual liability within a lease, or other civil or commercial agreements.
Although the distinction is doctrinal, since any Act of God refers to events of nature and force majeure refers to acts of man, these concepts have in common an unpredictable and inevitable nature for the parties, and thus, the impossibility of fulfillment of their respective contractual obligations. This is why, whatever the meaning of the two expressions is, their effects are identical and there is no interest in making this distinction.
Within to the previous concepts, any order or prohibition emanating from public authority that makes it impossible to fulfill an obligation may be included, such as the prohibition of manufacturing, marketing, import or export and the suppression of any industry, among others.
Based on the principle, no one is bound to the impossible, the debtor who is unable to fully comply with its contractual obligations, the consequences of the Act of God or force majeure event will be as follows: (i) the debtor is released from its obligation; (ii) it does not assume civil legal liability, and therefore, there is no obligation to indemnify for losses and damages; and (iii) it shall not be bound to pay penalties.
It is important to note that the principle no one is bound to the impossible will not be applicable when the debtor has expressly accepted the liability for the breach, even by an Act of God or force majeure event. The foregoing is due to the autonomy of the will, by means of which the debtor can accept torts for non-compliance caused by an Act of God or force majeure event. Hence the importance of carefully reviewing the terms agreed in the specific agreement, in order to determine whether an established clause provides Acts of God or force majeure events, and the way in which it binds – or releases – the parties.
However, when it comes to lease agreements, this autonomy of the will that has been alluded to, may have certain limits in accordance with certain local laws, such as the state of Chihuahua, Coahuila, Guanajuato or Jalisco. This limitation consists in that the waiver of the tenant’s right to request the interruption or reduction of the lease amount, or the termination of it as a consequence of an Act of God or force majeure, would not be valid according to the civil legislation of said states. It should be noted that real estate and rights over them will be governed by the law of the place of its location, so it will always be essential to consider local legislation.
Now, in order to determine when an Act of God or force majeure event takes place with respect to a certain agreement, the following elements shall be considered: (i) a cause beyond the control of the tenant; (ii) non-resistible nature; and (iii) subsequent to the formation of the obligation. Also, the connection between the event and the impossibility to fulfill an obligation must be verified.
It is important to distinguish between the impossibility of fulfilling contractual obligations, from the contractual imbalance that could be caused by a partial impediment to comply with the terms of the agreement. Under this second scenario, the treatment would be different and the Theory of Unpredictability or the Rebus Sic Stantibus principle could be applicable. This principle may be invoked, under certain scenarios, in order to recover the contractual balance caused by an extraordinary event that caused an excessive burden (hardship) and broken the contractual equity.
Regarding this theory, some clarifications should be made:
I. This right of the tenant is not waivable.
II. The contract shall not be random, but of long-term or successive performance, and the requesting party shall have fulfilled its contractual obligations up to that time.
III. Although only certain estate civil laws -and not federal commercial codes- contemplate the hardship event, there could be arguments based on contractual good faith principles and human rights protected under international conventions and the federal constitution that could serve as basis to claim the application of this principle in commercial contracts.
In the case of lease agreements in which the Act of God or force majeure event affects tenant, it is always recommended to negotiate or mediate the best conditions for both tenant and landlord in order to ensure that the losses for both parties are the least significant possible. During negotiations, the parties must understand the negative effects suffered, the tenant may have suffered the effects of closure of operations for governmental orders, but the landlord will also suffer other effects due to financial commitments with third parties, among others.
The parties should seek together different alternatives other than those they would have accepted under regular conditions. Court litigation may not be recommended as a first alternative considering, among others, the duration, litigation costs and effects to the contractual relationship.
Should you have any additional questions or comments, please do not hesitate to contact us.