Have you entered into a contract with your business partner, but due to the current situation surrounding the coronavirus, you are unable to fulfill your contractual obligations? Or have your negotiations with a new potential business partner been successful, and do you need to “seal the deal” by signing a contract during the outbreak and spread of COVID-19? In this article, we will explore the issue of damages, particularly in commercial legal relationships, focusing primarily on circumstances that exclude liability and how to incorporate them into a contract so that you are as protected as possible.
Damages should be understood as property loss that can be expressed in monetary terms (both actual damages and lost profits are compensated). Compensation for damages is closely related to liability for damages, as the relationship between compensation for damages and liability for damages can be understood as a relationship between cause and effect. Simply put, for compensation for damages to occur, the conditions for liability for damages must first be met. Liability for damages is divided into subjective and objective liability. This classification is significant for the regulation of legal relationships established under Act No. 513/1991 Coll., the Commercial Code (so-called commercial law relationship) or under Act No. 40/1964 Coll., the Civil Code (so-called civil law relationship). Subjective liabilityrequires fault, and the party is relieved of liability if it proves that it did not cause the damage (for further details, see Section 420(3) of the Civil Code). Thus, a subjective element—fault—is required to establish liability. Strict liability(also referred to as liability for risk) does not require fault, and a party breaching its contractual obligation is liable for such a breach regardless of whether the breach was intentional or unintentional, or whether the party intended to breach its obligation at all. In such a case, the party may be relieved of liability only if it proves the existence of circumstances excluding liability, as a result of which it was unable to perform its obligation (for further details, see Section 373 of the Commercial Code).
1. Legal relationship established under the Commercial Code (so-called commercial legal relationship)
If, as a legal entity, you have entered into or have an existing contract with another legal entity (e.g., a business partner), the basic legal framework for your contractual relationship is based on the Commercial Code. It is important to note here that the Commercial Code is based solely on strict liability, which means that as the breaching party, you can only be relieved of liability if circumstances excluding liability exist. The legal definition of circumstances excluding liability is set forth in Section 374(1) of the Commercial Code: “(1) An obstacle that arose independently of the will of the obligated party and prevents it from fulfilling its obligation shall be considered a circumstance excluding liability, provided that it cannot reasonably be expected that the obligated party would have averted or overcome this obstacle or its consequences, and furthermore, that it could have foreseen this obstacle at the time the obligation arose.It follows from the above that, in order for the obligated contracting party not to be liable for failure to fulfill its contractual obligations, all of the following conditions must be met simultaneously:
- the obstacle arose independently of the contracting party’s will (here one can also see the difference between the nature of subjective and objective liability, where subjective liability requires fault),
- the obstacle prevents the obligated contracting party from fulfilling its contractual obligation,
- the impossibility for the obligated contracting party to avert or overcome the existence of the obstacle, and
- the unforeseeability of the obstacle.
An important factor in connection with liability for damages is also the fulfillment of the so-called duty to notify within the meaning of Section 377 of the Commercial Code, pursuant to which the breaching party is obligated to notify the other party that, taking all circumstances into account, it will breach its obligation, or that it is already breaching its obligation (in particular, the obligation to notify the nature of the obstacle and its consequences). Otherwise, the other contracting party is entitled to compensation for the damages it has incurred. The aforementioned provision of the Commercial Code is not mandatory, meaning that the contracting parties may agree otherwise for a specific case.
A. Incorporating Circumstances Excluding Liability for Damages into the Contract
In practice, situations often arise where the contracting parties specify directly in the contract what should be considered a circumstance excluding liability for damages, either by defining such circumstances or by listing specific examples. We recommend that you and your business partner specify in the contract what constitutes circumstances excluding liability for damages, or at least list specific circumstances excluding liability for damages, because if a specific situation meets all the defining characteristics of circumstances excluding liability, or if a specific situation is directly designated as a circumstance excluding liability in the contract and such a circumstance is the cause of your failure to fulfill your contractual obligation, you, as the potential breaching party, are not in default regarding the performance of your obligations under the contract and, at the same time, are not in breach of the contract, and therefore the other contracting party is not entitled, due to the existence of circumstances excluding liability, to withdraw from the contract (unless this is expressly provided for in the contract) and nor to claim damages or payment of a contractual penalty from you.
In this case (i.e., where circumstances excluding liability for damages are stipulated in the contract), it is indeed necessary, for the very assertion of a circumstance excluding liability for damages, to examine not only whether the specific event meets the definition (all its elements) of the circumstances excluding liability for damages that the contracting parties have stipulated in the contract (or whether the given situation is directly designated in the contract as a circumstance excluding liability for damages), but it is also necessary to assess whether the given situation/obstacle is in fact the cause of the contracting party’s failure to fulfill its obligation properly and on time. For example, if the government were to issue a regulation under which drug manufacturers and distributors are not authorized to produce and distribute a certain batch of drugs in larger quantities to their business partners, on the grounds that such drugs are needed due to a state of emergency and the need to ensure drugs for all citizens, a manufacturer and distributor of such medicines who has entered into a contract with a customer, in which the contracting parties have defined circumstances excluding liability, is not liable for damages caused to the customer as a result of delivering a smaller quantity of medicines than agreed upon in the contract. This is primarily because a specific situation has arisen that not only meets the defining characteristics of circumstances excluding liability for damages but is also the cause of the supplier’s failure to fulfill its contractual obligations as a contracting party in a proper and timely manner. If a drug manufacturer and distributor were to supply the customer with a smaller quantity of drugs than agreed upon and justify their actions solely by claiming that the criteria for circumstances excluding liability for damages are met, such an entity would be liable for damages, as there is no cause (causal link) for the failure to fulfill the obligation properly and in a timely manner.
B. Failure to include circumstances excluding liability for damages in the contract
If your contract does not include a definition of circumstances excluding liability for damages (or if your contract lists only a few examples of such circumstances),
the statutory definition of circumstances excluding liability for damages contained in the aforementioned Section 374(1) of the Commercial Code applies. In such a case, the general definition of liability for damages contained in the aforementioned Section 373 of the Commercial Code is also indispensable for establishing liability for damages.
A contracting party is relieved of liability only if it proves the existence of grounds for exemption (i.e., circumstances excluding liability under the law). It should be noted here that when relying on the law for compensation for damages, grounds for exemption do not apply to the breaching party’s obligation to pay a contractual penalty, i.e., the liable party is obligated to pay the contractual penalty even if circumstances excluding liability exist. For this reason as well, we recommend that our clients include a definition of circumstances excluding liability in the contract (or specify their exact enumeration in the contract).
2. Legal relationship established under the Civil Code (so-called civil law relationship)
Here, we would simply note that a contractual relationship established under the Civil Code is governed by different principles regarding the attribution of liability for damages, as the Civil Code is based not only on strict liability but also on fault-based liability (the need for a contracting party to prove that it did not cause the damage).
