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BRAZIL: The impact of COVID 19 on commercial agreements in Brazil.

Since the World Health Organization on March 2020 declared the outbreak of a global health pandemic, subsequently designated by the official name of COVID-19, the Brazilian economy is in disarray and therefore there have been damaging effects on public health, social relations and business transactions.

JOSE CARLOS VAZ E DIAS - 17.09.20

We have also undergone into the difficult dilemma of choosing between mitigating the effects of the health crisis on its citizens or avoiding further disruption of production lines and business. There is still the fear that negative effects of the crossroads between the reduction of productivity and the increase in unemployment have not yet been fully accounted for, with the consequent reduction in the consumption patterns of goods and products, due to the decrease of the population’s purchasing power.

As in many other countries, Brazilian authorities followed a physical distancing protocol to perform as a “cordon sanitaire”, with the aim of minimizing the spread of the disease and further contamination of its population by implementing a series of measures to promote social isolation, which has directly impacted companies’ ability to fulfil their contractual obligations. Commercial establishments, franchise units, supply and distribution centers have been forced to drastically decrease their operations or even temporarily close their doors to comply with the government pandemic control guidelines. It is not surprising that these guidelines, although necessary, were highly disruptive in the context of economic activities.

This scenario has resulted in numerous payment delays or non-payment of monetary commitments at all and requests for the revision and alterations of contractual obligations and, in some cases, even contractual termination, which in the past would have been accompanied by fines and indemnification. Another effect of the pandemic caused by COVID-19 has been the enhancement of the “Force Majeure Clause” in commercial agreements, especially franchise and distribution.

Brazil has coped with very few natural disasters or acts of Gods, therefore ”force majeure clauses” have been the last ones to be addressed by the parties in local transactions. In fact, stipulating “Force Majeure Clause” has been a hard exercise of convincement and explanations during the negotiations and drafting of the agreement. COVID 19 has unfortunately been regarded as a real case where force majeure plays a relevant part of the transactions.

Legal Scenario to Address Acts of God and the COVID-19

Brazilian Civil Code provides the understanding that contracts should be regarded as law between parties. This prevailing understanding derives from the “Pacta Sunt Servanda” Principle (mandatory force that converts commercial agreements), constructed by the Canon Law back in the XIII century based on moral rules such as "pacta quantumcunque nuda servanda sunt" (although naked, the agreements must be observed). This principle has been adopted by the Civil Law countries, as it ensures security and fairness to all parties and makes the possibility to renegotiate the contractual terms and conditions as exceptional.

The exceptional legal tools to an agreement can be found in the Civil Code where early termination without cause or negotiations of the terms and conditions of an agreement are secured to restore the balance between the parties and prevent unjust enrichment of one part at the expense of the other. To address manifest disproportion between the parties, Article 317 of the Brazilian Civil Code states the following: “When, for reasons that could not be foreseen, the value of the obligation owed and its value when it is performed become manifestly disproportionate, the judge may correct it, at the request of the party, in such a way as to ensure, as far as possible, the real value of the obligation.”[1].

Unforeseeable events are understood as “external events, independent of the parties' will, which they cannot foresee and which so alter the circumstances that, in the execution, the contract no longer corresponds not only to the will of the parties, as well as its objective nature.” [2], [3].

In parallel, Article 393 of the Brazilian Civil Code deals with the exclusion of liability for non-compliance due to acts of Gods or force majeure events: “The debtor is not liable for losses resulting from fortuitous events or force majeure, unless he has expressly made himself liable therefor. Sole paragraph. A fortuitous event or force majeure is an inevitable event, the effects of which were not possible to avoid or prevent” [4]

As for the differences, briefly and simply, we can say that the acts of God are events that cannot be predicted, unforeseeable and that are unavoidable by the contracting parties in commercial agreements. Cases of force majeure are human or natural facts that are unpredictable, or even predictable to a certain extent, but that cannot be prevented; for example the phenomena of nature, such as storms, hurricanes, lightning, etc. or human facts like wars, revolutions, and others [5]. The consequences arising from these facts or events must become insusceptible to repair and prevent the parties from fulfilling their obligations under a contract to exempt them from being penalized for contractual breaching.

The overall scenario is that parties of commercial agreements applying the law of land are covered when affected by unforeseeable events or force majeure, notwithstanding existing contractual stipulation. Nevertheless, drafting adequate force majeure provisions are highly recommended, as the provisions of the Civil Code and other laws are looked upon as principles. Moreover, clauses address better the peculiarity of each business, the unbalanced situations, and may set the events that are or are not looked upon as unforeseeable.

Franchise agreements are especially in need of such safeguarding clauses due to the very nature of its business. Although these agreements can vary significantly in content depending upon the franchise system, the execution of such a contract will take into consideration the long- term economic environment since the required investments will last to mature. It is worth noting that the zero-sum result implicit in commercial agreements such as future options or contracts, for instance hedges and derivatives, are contrary to the spirit of franchise settlements. Such arrangements are to be profitable to both parties.

It should also be stressed that the use of one’s ingenuity and know-how through a contract represents a breakthrough for many companies in modern societies. This leads to the establishment of a new paradigm regarding the production of goods or granting new or improved services.

It is a general consensus that the pandemic was not predicted by anyone and its consequences are mostly beyond the control of the parties, thus. The pandemic has been correctly deemed as an event of force majeure by our legal system, enabling the parties to find amicable, realistic and achievable solutions within their private interests contained in contracts and within legal possibilities. These solutions vary from either postponing or renegotiating their obligations in order to preserve their relationships or in the worst case scenario terminating their contracts . These legal measures, must, however, be assessed with caution, as the overall premise is that the pandemic itself is not sufficient to automatically justify contractual breaching. There has to be a proven contractual imbalance or excessive burden between the parties or a risk of unjust enrichment of one party at the expense of the other. Force majeure provisions help substantially justify the postponement or contractual renegotiation of a business relationship.

The Economic Freedom Law (Federal Law 13,874/2019) is also a piece of legislation that perceives the balance of the party and the re-arrangement of the obligation when the balance conditions under which the contracts were initially signed have changed substantially to the point of causing an imbalance between parties, making compliance impossible or too costly. This law highlighted the importance of minimal intervention in what was agreed between the parties and the exceptionality of contractual revisions. It assumed that contracts are and should kept balanced during their validity bearing in mind the peculiarities of the agreement and will of all parties. Therefore, force majeure situations - unforeseeable events that goes beyond the control of the contracting parties (also regarded as “acts of god”) - would justify the contractual alterations outside the events of the agreement.

Besides the existing legal framework that support the adequate balance of relationship between the contracting parties, the present Government decreed on March 20, 2020 a state of public calamity and emergency situation, which corroborates the exceptionality of the effects of COVID-19. This status of public calamity was followed by Federal Law 14,010 of June 10, 2020 (so-called “Pandemic Law”) with an initial effective date retroactive to March 20 2020. This Federal Law provides for the emergency and transitional legal regime for private legal matters until October 30, 2020. In practical terms, it suspended rules in the Civil Code and other legislation (not revocation or modification of Civil Code provisions or any other law addressing fortuitous event or force majeure, but simply suspension) that are incompatible with the exceptional period of social, economic and personal turbulence caused by the COVID-19 pandemic. This is a major emergency diploma with no innovation, as it aims to provide greater tranquility by formalizing in legal text solutions that have prior support in our legal system based on principles and general clauses to act against COVID-19.

Other measures that have been taken at the private sphere are the efforts by the Brazilian Franchise Association (ABF) to unite its members around agendas that can somehow extenuate the crisis faced by franchisors/franchisees alongside the Government, Shopping Centers and Banks. These measures include supporting the negotiation for franchise units to be exempt from paying rent, tax benefits and extension of payment periods for taxes, payroll tax reduction, creation of credit lines with specific characteristics to serve retailers and franchisees to reduce the impacts of an abrupt fall in revenue, and even alternatives that would allow companies not to fire their personnel.

Concluding Comments

Contracts serve as a visual representation of a relationship and a record of commitment for both parties to achieve a common goal. It also holds each party to their original agreement. At their very core, contracts can represent a sound commercial relationship. When two parties forge a beneficial connection for both sides, the agreement can last years. The achievement of a reliable solution to provide a feasible juridical framework for companies in Brazil, in line with the need of very particular and unique times, reinforces that the observance of the principle of the Preservation of Contracts (through revisions and alterations when necessary) rather than terminating contracts, is a demonstration of good faith that should rule business relations. Therefore, maintaining contracts in force contributes to keeping both suppliers and vendors up and running, fundamental for the good health of any economy, especially during and after a prolonged crisis as the present one.

Notwithstanding that the impact suffered by different economic sectors really differs according to the type and circumstances of the contract, as well as due to external variables, the Brazilian Civil Code alongside with the guidelines issued by the Government aim to guarantee a fair and neutral set of principles for all parties. Nevertheless, the applicable laws are regarded as principles and the peculiarities of the business transaction dealt with by the parties, especially in franchising and distribution relationship are better dealt with by specific and well drafted clauses, especially the force majeure and “recognition of business risk” clause, among others.

The relevance of well drafted force majeure clauses dismisses the idea that the pandemic alone impacts or unbalances all contracts to the same extent and, precisely for that reason, would justify an immediate breach of obligations, revision or even the termination of all contracts.

Furthermore, in several cases, the impossibility of fulfilling the obligations under the contract is only momentary, which also would not justify extreme solutions such as termination.

Therefore, these matters should be treated with caution, as the worst scenario would be one in which the pandemic would entail to massive and indiscriminate breach of contracts that would contribute directly to the collapse of the economy itself.

 

[1] Law nº 10.406 01/10/2002 article 317 - http://www.planalto.gov.br/ccivil_03/leis/2002/l10406.htm

[2] NERY JÚNIOR, Nelson; NERY, Rosamaria de Andrade. Código civil comentado. 8ª ed., São Paulo: RT, 2011. p. 589.

[3] (TJSP; Apelação Com Revisão 9142407-42.2001.8.26.0000; Relator (a): Carvalho Viana; Órgão Julgador: 3ª Câmara (Extinto 1° TAC); Foro de São Caetano do Sul - 1ª. Vara Cível; Data do Julgamento: 19/03/2002; Data de Registro: 15/05/2002).

[4] Law nº 10.406 01/10/2002 article 393 - http://www.planalto.gov.br/ccivil_03/leis/2002/l10406.htm

[5] ACS, Caso Fortuito e Força Maior - © Tribunal de Justiça do Distrito Federal e dos Territórios – TJDFT https://www.tjdft.jus.br/institucional/imprensa/campanhas-e-produtos/direito-facil/edicao-semanal/caso-fortuito-e-forca-maior

[6] https://www.abf.com.br/carta-da-abf-aos-orgaos-publicos-setor-financeiro-e-industria-de-shopping-center/

 

José Carlos Vaz e Dias, IDI Member

Bruna Valois, Vaz e Dias Advogados Associados

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