Handling of Long-Term Supply Obligations in Case of Pandemic-Related Difficulties
The coronavirus continues to hold the global economy firmly in its grasp. Nearly every company is contending with the impact of the pandemic, particularly supply shortages, and higher costs are making it difficult for companies to meet their supply obligations (which are frequently dictated by long-term contracts). In this context, you will find information below about some issues in German law which are the topic of intensive discussion at the moment, summarized in overview form.
Basic Principles of Contractual Agreements
A key principle is pacta sunt servanda: contracts must be honored. Under the general principles of the German legal system, developments which result in added costs for one of the contracting parties, or even losses, typically have to be tolerated and do not furnish adequate grounds for (unilateral) adjustments of any kind.
But another principle is also playing a key role right now: contractual agreements (whether in the form of individually negotiated contracts or set down by means of standard terms and conditions) generally take precedence over general principles. Although the validity of standard clauses is subject to review to a certain extent, even in the b2b sphere (especially in case of litigation), companies should nevertheless look for and consider appropriate formulations in a "top-down" manner.
Acts of God and Force Majeure
In times when supply is consistent, prices are rising and materials are difficult or impossible to obtain, companies are eager to find a way out of their supply obligations or to secure a price adjustment. This is always possible if the contracting parties agree, but it can rarely be done unilaterally. Whether such possibilities exist depends primarily on the provisions of the contract. Very careful examination is required to determine whether and which of the requirements specified in the relevant clauses have been met. For example, if the question involves the "foreseeability" of extreme circumstances due to the pandemic, it is necessary to ask whether such circumstances were actually unforeseeable, certainly in the case of contracts concluded after March 2020.
If there are no contractual provisions in this regard, then the legal situation becomes relevant. The German Civil Code and Commercial Code do not expressly address the issues of "force majeure" or "acts of God" in this context. Instead, they consider issues such as "inability" in terms of § 275 of the Civil Code, "frustration of contract" in accordance with § 313 of the Civil Code and ordinary (or extraordinary) termination of contracts in accordance with § 314 of §§ 623 and 724 of the Civil Code. However, it is necessary to pay close attention to the requirements and consequences of the various statutes.
Once again: under the law, typical entrepreneurial risks do not furnish adequate grounds for the unilateral adjustment of existing obligations.
Procurement Obligation/Procurement Risk
If a supplier is subject to a procurement obligation, it is required to adhere to this obligation even if this means incurring an additional financial expense. All (reasonable) options for procuring the goods must be considered and exercised. This duty applies regardless of whether the supplier is responsible for a hindrance to supply. By law, strict requirements apply for releasing suppliers from their procurement obligations: the aforementioned statutes, § 275 of the Civil Code and § 313 of the Civil Code, come into consideration in this regard, for example. As a result, suppliers which are bound to supply certain materials should consider suggesting alternative materials to their customers and discuss whether they can be released from their obligations.
In German law, a duty to pay damages for non-performance of contractual obligations typically depends on negligence, i.e. the contracting party's failure to adhere to an appropriate extent to the due diligence requirements which it is expected to perform. With regard to supply chains, price changes, the availability of materials on the one side and supply obligations on the other, suppliers can be expected to set up and manage their supply chain in a manner consistent with their relevant situation (and knowledge), i.e. to make reasonable efforts in order to comply with their obligations. Suppliers would be well-advised to document the relevant measures.
Unilateral Contractual Adjustments or Extraordinary Termination
Unilateral adjustment of existing contracts or extraordinary termination conflicts with the basic principles mentioned above and is therefore possible to just a limited extent.
- Efforts to secure contractual adjustments based on "frustration of contract" in accordance with § 313 of the Civil Code often fail due to an inability to meet the applicable requirements. In particular, the contracting party must show that continuing to adhere to the contract would lead to an unbearable result which is "simply incompatible with law and justice." To date, the courts have tended to view even drastic increases in the price of raw materials as a typical entrepreneurial risk, and therefore one which the supplier can reasonably be expected to assume.
- A similar situation applies for the possibility of extraordinary termination for good cause in accordance with § 314 of the Civil Code. In this case as well, the supplier must show that it cannot be reasonably expected to continue the contractual relationship to the end after taking all circumstances into account and weighing the interests of both parties.
The law does not expressly address the ordinary termination of framework supply contracts. In accordance with recent case law, however, this possibility does come into consideration through analogous application of §§ 623 and 724 of the Civil Code. In this case as well, certain requirements have to be met:
- the contract must not contain any clause which excludes ordinary termination;
- the supply contract must represent a continuing obligation, i.e. cessation of the contractual relationship must not be defined in advance (whether in the form of a specific expiration date or through an identifiable event, such as a defined supply quantity);
- an "adequate" notice period must be observed in each case. This period may be based e.g. on the time needed to make changes to the company's product range.