Coronavirus – impact on implementation of construction contracts and lease agreements
The growing risk of SARS-CoV-2 coronavirus and actions taken by public authorities, including the introduction of the state of the epidemic, is reflected in the legal situation of entrepreneurs, especially in terms of contractual liability. The current situation significantly affects the implementation of construction contracts, lease agreements and relations with business partners.
Force majeure and contractual liability
The attempt to frame the epidemic leads to the conclusion that we are dealing with force majeure. Although there is no definition of force majeure in the Civil Code, it is assumed to be an external event which is unpredictable and which could not have been prevented, and which must be cumulative.
In order to assess the impact of force majeure in the form of the coronavirus epidemic on the execution of a specific project, the individual analysis of each factual situation is necessary. First of all, it is necessary to verify the content of the contract parties’ binding clauses in terms of force majeure. If such clauses are not provided for in a given agreement, or if the catalogue determining the circumstances of force majeure does not contain an epidemic, it does not immediately make it impossible to refer to the force majeure. The regulation of the Civil Code provides that the debtor is liable for non-performance or improper performance of the agreement on the basis of fault. The debtor may discharge his liability by proving that the non-performance or improper performance of the agreement is caused by reasons beyond his control and not attributable to him, and is therefore, for example, the result of force majeure.
Below we will first discuss how the consequences of an epidemic may affect the parties’ obligations under a construction contract. A party invoking force majeure will have to prove that improper performance of the contract (in particular, its cessation of work or delay in its completion) is closely linked to the occurrence of force majeure. The contractor’s cessation of construction works may not result solely from the announcement of an epidemic. It is necessary to prove that the contractor cannot perform its duties as a result of circumstances for which it is not responsible, which may result either from legal (restrictions imposed by the authorities on the performance of its activities) or factual circumstances (for example, a shortage of workers caused by quarantine or the need to care for children shortages of construction materials resulting from the suspension of their production, the closure of construction warehouses or the closure of state borders if they were to be imported from abroad). The contractor is obliged to prove the above circumstances and their impact on the performance of the obligation, and the Investor has the right to demand evidence to confirm the obstacles. In case of improper performance of the obligation due to reasons not attributable to the contractor (in particular delay in performance), the contractor will not be liable to the investor, in particular it will not be obliged to pay contractual penalties.
It should be remembered that a party who invokes the fact of force majeure is only discharged from liability until the effects of that state reach it, i.e. until such time as it could not realistically meet its obligations. As soon as workers return from quarantine, deliveries are resumed or access to construction materials is gained, the condition that caused the suspension of construction works will cease.
In consideration of the prevailing epidemic, it remains to be decided whether, in the case of construction contracts, we will potentially have to deal with a subsequent impossibility of performance. Under this concept, if one of the counter-performance becomes impossible due to circumstances for which neither party is responsible, the parties’ obligations expire. The party who was to fulfil the obligation cannot claim the counter-performance and, if it has already received it, is obliged to return it. If one of the parties’ obligations become partially impossible, that party loses the right to the corresponding part of the counter-performance. However, the other party may withdraw from the contract if the partial performance was irrelevant to it because of the nature of the obligation or the purpose of the contract intended by that party.
As a consequence, in the case of construction contracts, we may potentially have to deal with the above discussed situation of inability of the contractor to provide. In such a case, the obligations of the parties would expire and the works performed so far would be subject to settlement, unless the investor proves that partial performance of the works is irrelevant to it. Nevertheless, the situation of expiry of the obligations under the construction contract due to the subsequent impossibility of performance in practice seems rather improbable. In order to be able to accept the impossibility of performance, three elements must occur together. First, the inability to perform must be objective (neither the contractor nor any other entity can perform the work under the construction contract), second, complete (the investor’s interest cannot be satisfied in any other way than performance) and third, permanent (the contractor’s inability to perform cannot be temporary). The state of the epidemic is undoubtedly temporary in nature, hence the state of inability to perform construction work contracts will not be permanent and will not constitute a case of subsequent inability to perform. As a consequence, in the case of construction contracts, we will rather deal with a delay in the performance of an obligation not attributable to the contractor than with an inability to perform resulting in the expiry of the parties’ obligations. Once the obstacles resulting from the epidemic (in particular the restrictions introduced by the authorities) have ceased to exist, the contractor will be able to start performing the contract and complete the construction works.
In such a situation, we recommend an analysis of the concluded agreements in order to determine the consequences that may be associated with the cessation of each party’s obligations.
The announcement of a state of epidemic emergency by the Regulation of the Minister of Health of 13 March 2020, and then the introduction of certain restrictions, orders and prohibitions in connection with the occurrence of the state of epidemic by virtue of the Regulation of the Minister of Health of 20 March 2020 and the Regulation of the Council of Ministers of 31 March 2020, caused that the performance of obligations under the lease agreements concerning premises in shopping centres is under question. When analysing the impact of the epidemic on the conditions of lease agreements, in the context of the restrictions introduced, a division into two groups of lease agreements should be made. The first group will include tenants of premises or space in retail properties with an area exceeding 2000 m2, whose activity has been temporarily restricted under the above regulations. The second group will include those tenants whose activity has been restricted under the regulations, but whose subject of lease is located outside retail properties with an area exceeding 2000 m2. Therefore, the second group will include not only tenants operating, inter alia, restaurants, cafés, bars in premises located outside shopping centres, but also tenants providing hotel services, hairdressing and beauty services or fitness clubs.
Situation of tenants under restrictions whose premises are located in retail properties with an area exceeding 2000m2
On 31 March 2020, the Sejm adopted an amendment to the coronavirus law, which is one of the elements of the so-called anti-crisis shield. The solutions contained in the act refer, among others, to the situation of tenants of areas located in large-area shopping centres.
According to the amendment, during the period of the ban on operating in shopping centres with a sales area of more than 2000 m2, mutual obligations of the parties to the lease, tenancy or other similar agreement by which the commercial space is to be used, expire. This means that the tenant is not only exempt from the obligation to pay rent, but also from the obligation to pay the service charges paid directly to the landlord or marketing fee related to the operation of the centre. Undoubtedly, the exemption will not apply to fees paid directly by the tenant to utility providers under agreements concluded by them on their own. The above solution is certainly not beneficial to landlords, who, while being deprived of any fees from tenants, are at the same time obliged to pay fees related to the current maintenance of the shopping centre and common areas, such as electricity, water or security and cleaning services. The Act does not introduce any compensation for the landlord for loss of rent due to the expiry of the tenant’s obligations.
After cancelling the ban, the tenant should submit to the landlord an unconditional and binding offer of intent to extend the lease agreement on the existing terms and conditions, for the period of the ban extended by six months. The offer should be submitted within three months of ban removal. The provision concerning the termination of the lease agreement will cease to bind the landlord when the deadline for submitting the tenant’s offer expires ineffectively (i.e. three months from the date of ban removal).
It should be noted that the provision concerning the offer to extend the lease is ambiguous. The very definition of the tenant’s statement as an ‘offer’ may suggest that it is an offer procedure under the Civil Code and thus the landlord would be entitled to reject it or submit a counter-offer. The amendment, however, does not resolve this issue, but it multiplies further doubts.
As it results from the justification of the amendment, if the tenant does not submit an offer within the prescribed deadline, it is considered that the temporary expiration of the agreement has not occurred. In such a situation, the tenant will be obliged to pay the amounts due under the lease agreement in full for the entire duration of the ban, and the lease agreement will continue to be in force, under the existing conditions. If the tenant submits an offer to extend the lease agreement, the lease period will be extended by the duration of the ban increased by six months, and the tenant will maintain the exemption from charges under the lease agreement for the duration of the ban. As noted above, it is not clear whether the landlord is entitled to reject the tenant’s offer; however, the wording of the provision suggests that if the tenant’s offer is rejected, the landlord continues to be bound by the provisions relating to the expiry of the tenant’s obligation to pay rent and other charges under the agreement (the only case where these provisions cease to bind the landlord is if the period for the tenant to make an offer expires without effect).
The wording of the provision on the expiration of mutual obligations under the lease agreement indicates that the legislator was only concerned with their temporary “exclusion” for the duration of the ban. From the date of the end of the ban, the lease agreement starts to be in force again under the existing conditions, hence the tenant is obliged to pay the rent and other charges in full. However, the landlord will only have the right to request payment for the ban period after the three-month deadline for submitting a tenant’s offer to extend the lease agreement.
If the tenant does not submit an offer to extend the lease agreement within the period specified in the Act, it will not be able to take advantage of the exemption of fees for the duration of the business activity ban. However, it is questionable whether in such a situation the tenant could invoke the fact of force majeure during the period covered by the ban if it proves that the non-performance of its financial obligations under the lease agreement is the result of a coronavirus epidemic. Such an interpretation is supported by the provision according to which the introduced regulations do not violate the provisions of the Civil Code governing the states in which legal restrictions on freedom of business activity are introduced. On the other hand, such an interpretation would be contradictory to the essence of the introduced provisions, which grant the tenant exemption from rent on condition of submitting an offer to extend the lease period.
The amendment provides that agreements concluded before the date of its entry into force, i.e. before 1 April 2020, the lease period expiring between 1 April and 30 June 2020, will be extended under the existing terms and conditions until 30 June 2020, provided that the tenant submits an appropriate statement to the landlord. The above regulation applies to lease agreements for all premises, not only those located in shopping centres with an area exceeding 2000m2.
Automatic renewal of the agreement cannot be expected by the tenants who:
- during a period of at least 6 months of the lease agreement’s term before 1 April 2020 were in arrears with the payment of fees related to the premises for at least one settlement period, if the total value of arrears exceeds the rent for one month,
- during the term of the lease:
- used the premises in a manner contrary to the agreement or the intended use of the premises,
- neglected the obligations associated with the premises, resulting in damage to the premises,
- rent, sublet or give the premises (or part of them) for free use without the required written consent of the landlord.
According to the Act, it will be impossible to terminate the tenant’s lease agreement or the amount of rent until 30 June 2020.
Situation of tenants under restrictions on business activity, where the subject of lease is located outside shopping centres with an area exceeding 2000m2
The provision that the mutual obligations of the tenant and the landlord under the lease agreement expire for the duration of the epidemic will not apply to tenants for whom the subject of the lease is located outside large-area shopping centres and whose activity has been restricted due to the introduced restrictions. This group of tenants will include, inter alia, tenants operating restaurants, cafés and bars in premises located outside shopping centres, tenants operating hairdressing and beauty services or fitness clubs, as well as tenants providing hotel services.
Until 30 June 2020, landlords will not be able to terminate both the lease agreements of this type and the amount of rent. The provision concerning the extension of the lease agreement until 30 June 2020 shall also apply to these agreements, provided that the tenant submits a relevant declaration. The group of tenants who will not be able to benefit from such automatic extension will also be the same. This provision shall not apply to tenants whose activities are restricted by the provisions of the regulations, but the premises are not the subject of the lease under the agreement. This will apply, inter alia, to tenants of entire buildings, including hotels.
Since this group of tenants will not be covered by the provisions on the expiry of the obligations during an epidemic, the scope of the obligations of the parties to the lease agreement relating to restrictions on the tenant’s activity resulting from the introduction of a state of epidemics should be considered. For this group of tenants, the provisions of the respective lease agreements should be considered first. In many cases they contain provisions concerning force majeure and inability to use the leased property temporarily. However, if the agreement does not contain such provisions, or if the situation is not reflected in them, the solutions of the Civil Code shall apply.
Basically, the introduced restrictions on conducting business activity do not affect the possibility of the landlord fulfilling its obligation to make the leased subject available to the tenant for use. As a consequence, the tenant will remain obliged to pay the rent on this account. In practice, however, due to the prohibition introduced, an entrepreneur subject to the restrictions will not be able to operate the leased object. Due to the lack of income, this may result in significant difficulties in paying the rent and other charges related to the subject of lease. The issue of whether, in connection with the situation, tenants conducting business activity subject to the prohibition will be obliged to pay rent or whether they have the possibility to temporarily withhold payments related to the lease agreement should be considered in this respect.
As in the case of construction contracts, the question arises here as to whether we can discuss the subsequent impossibility of performance in this situation. Adopting such a solution would mean that if, due to the restrictions on conducting business activity, the landlord cannot in practice make the premises available to the tenant for the purpose of conducting the activity specified in the agreement, then the tenant is not obliged to pay rent for the entire duration of such situation. However, such a line of reasoning does not seem appropriate, as the impossibility of performance must meet three cumulative features: objectivity, completeness and durability. In the context of the lease agreement this would have to mean that neither the tenant nor any other entity can carry on any activity of a given type in the premises (objectivity), according to the agreement the premises were intended for carrying on a given type of activity and using them for other activities is impossible (completeness) and there are no prerequisites for stating that the legal status which makes it impossible to carry on a given type of activity would change (permanence). However, the introduced restrictions of specific types of activity are temporary in nature, so the resulting state of inability to perform the lease agreements will not be permanent and will not constitute a subsequent inability to perform.
It should be considered whether the introduced legal solutions limiting the possibility of operating a certain type of business and possible claims of tenants in this respect can be considered in terms of defects of the subject of lease. Pursuant to the regulations, in the event of defects in the leased object which limit its suitability for the agreed use, the tenant may demand an appropriate reduction of the rent for the duration of such defects. Moreover, the tenant may terminate the lease without notice, if the subject of the lease is defective, which makes it impossible to use the subject of the lease as stipulated in the agreement, and such defects are not remedied by the landlord despite the received notice, or such defects cannot be remedied.
The Civil Code does not define the concept of a defect in the leased object. The case law recognizes a defect only if it is inherent in the subject of lease, finds its cause, which ultimately adversely affects the usable qualities, limiting its suitability for the agreed use. However, it should be ruled out that the term “defect” should not be extended to all external circumstances that only affect the leased object. Such external circumstances should be regarded as factors which cannot be effectively opposed by making appropriate modifications to the subject of the lease, and a different interpretation of the concept of a defect would lead to an unjustified extension of the landlord’s liability. The fact if the premises have defects is determined by whether they are suitable for the agreed use in accordance with the characteristics and purpose of the premises, i.e. whether they have the features agreed upon by the parties in the agreement and required by the applicable regulations. In the context of a coronavirus epidemic, it would be too far-reaching to consider that the premises are affected by such a defect, which would justify the tenant taking advantage of the possibility to reduce the rent or even to terminate the lease without notice periods. Indeed, the current restrictions on the operating of the business do not apply to the premises as such, but to the type of business carried out in them.
Finally, we analyzed the possibility of demanding a rent reduction by the tenant. However, the Civil Code does not provide for a solution analogous to a tenancy agreement in the case of a lease, where the tenant may demand a rent reduction for a given economic period in which the ordinary income from the tenancy has been significantly reduced for reasons for which the tenant is not responsible. No provision also gives the tenant the right to withhold payment of the rent in full. Considering the decrease in the tenant’s income, independent of the tenant, connected with the existing epidemiological situation and restrictions on its activities, the need to pay the rent in full could be qualified as an event threatening the tenant with a gross loss. Thus, the tenant would be entitled to take legal action under the rebus sic stantibus clause, invoking an extraordinary change in relations that could not have been foreseen when concluding the agreement and demanding, for example, termination of the lease. The current situation leaves no doubt that in the near future the effectiveness of invoking this clause will be tested in practice before the common courts.
In conclusion, it should be emphasized that very serious doubts are raised by the fact that the legislator introduced regulations significantly improving the situation of tenants of premises in large-area shopping centres, while completely ignoring the interest of other tenants, whose activity was also limited due to the introduction of the epidemic. Such a situation seems to indicate that we are dealing here with unequal treatment of particular groups of tenants, which may constitute a basis for questioning the introduced solutions. Nevertheless, it is worth emphasising that in the case of premises owned by the State Treasury or local government units the Act gives tenants the opportunity to obtain rent postponement, spread the arrears over instalments, and even to cancel the rent for the duration of an epidemic emergency or epidemic.
Author: Ewelina Cieślak
In the upcoming period, we will keep an eye on and highlight the solutions implemented that affect the functioning of businesses, public authorities and courts. We will cooperate with our clients on an ongoing basis in order to apply the already existing legal tools to the exceptional circumstances existing so far. In case of questions or doubts we are at your disposal.