Covid-19 and compliance with lease agreements

The rebus sic stantibus clause as a tool for modifying or terminating lease contracts in cases of serious affectations by COVID-19, and the current criteria of the Supreme Court.

In these turbulent days, when the media and social networks abound with alarming news about the fall of the stock markets, not enough attention is being paid to events that are part of everyday life for the majority of the population, such as having to pay rent if economic resources have been reduced or have directly disappeared.

We can all be thinking of relatives or people we know who, either because of their work circumstances or because they own small businesses whose activities, such as bars or restaurants, have been forced to close by decree, are wondering what to do with the leases of their homes or business premises.

And these are not the only cases, since there is chaos in which, in not so small companies, even if they do not have an activity that has been directly closed, their turnover has fallen to levels that the effort they have to make to be able to meet all their obligations is enormous, sometimes even impossible

In some cases, large office building owners are preventing their tenants from accessing their rented office space.

To provide a single solution to all these cases, and many others that are certainly occurring, is absolutely impossible since, as we professionals in this sector know, each issue is unique and requires an analysis of the situation in a specific way.

Thus, the case of a landlord closing an office building will not be the same, since we could find ourselves before a serious contractual breach for not facilitating the tenant the peaceful enjoyment of the rented property, as the situations in which the business / commercial activities have been prohibited by decree.

In any case, the aim is to highlight the legal principles that must be taken into account in the field of leasing and to see how they can be combined with such exceptional circumstances as those we are currently facing.

The starting point of our legal system cannot be other than that of legal certainty, which in the field of private contract law would have one of its main exponents in the famous Latin aphorism “pacta sunt servanda” according to which, the contract binds the contracting parties and must be fulfilled punctually, without excuse or pretext.

This principle is reflected throughout our legal system, as is the case, among others, with Article 1256 of the Civil Code, which states that the validity and performance of contracts cannot be left to the discretion of one of the contracting parties.

In short, and since it is not a question of making great doctrinal disquisitions, what we must know is that our legal system is based on a fundamental principle that contracts must be fulfilled on their own terms, without any of the parties having the capacity to decide unilaterally whether to stop fulfilling their obligations or decide to fulfil them in a different way than agreed.

Under this principle, this pandemic should not be a cause or motive that justifies any of the parties taking a unilateral decision to breach a contract, as would be the case of not paying rent or preventing access to the rented property, or to modify the content of their obligations, as would be the case of paying less than the agreed rent.

If our legal system did not provide for other solutions, this article would come to an end, and we could state quite categorically that, despite the pandemic, the parties of a lease contract, unless they reach an agreement, have to comply with the contractual conditions provided for, with no other possibility.

But the truth is that the principle is not as fixed as it might at first appear.

In the first place, even if it is not a breach of the principle, the lease may already provide a mechanism whereby the content of the respective obligations may be changed in response to changing circumstances. This is the case, quite often, in leases of premises in shopping centers, where the rent is distributed into two instalments, one fixed and constant which is normally updated in line with changes in the Spanish CPI, and the other variable and undetermined, but determinable on the basis of the tenant’s turnover.

In such cases, the contracting parties already foresaw the possibility that, due to a variety of circumstances, there would be a decrease in the turnover and since, the tenant’s obligation to pay became excessively expensive in such a way that the principle of balance of services was violated, it was necessary to modify the amount of the rent accordingly.

There is no need to seek other solutions in these cases, as the contract itself provides them, so by strictly complying with the agreement, and therefore following the principle of “pacta sunt servanda“, the tenant’s obligations are readjusted to the new circumstances.

But the truth is that, with the exception of this type of contract in which the clause determining the rent according to the invoice is very common, in the majority of rental contracts, whether for housing use or for use other than housing, it is not usual this type of agreement.

Under other scenarios, which are the vast majority, how inflexible is the principle of “pacta sunt servanda”?

If we take the literal provisions of the Spanish Civil Code, which is the basis of Spanish private law, there are no variations on that principle. Therefore, unless the parties agree, each must comply with what it has agreed, and if they do not comply, it is likely that their actions are a contractual breach of sufficient importance to give the other party the power to demand contractual compliance or its termination, with the corresponding compensation for damages caused to the party that did comply with its obligations.

At this point, it is interesting to talk precisely about compensation for damages because these days we are seeing some tenants expressing their intention not to pay rent by excusing themselves in “force majeure”

It is very important to bear in mind that force majeure is not a cause that justifies total or partial failure to comply with contractual obligations (failing to pay or paying lower rent, respectively) but, according to Article 1105 of the Civil Code, it is a cause that exempts from liability those who do not comply with their obligation due to an unforeseeable and unavoidable circumstance. This means that, in the event that one of the parties fails to comply with its obligations and the other party judicially demands compliance or requests the resolution and, in both cases, the petition is accompanied by a request for damages, the judge may consider not to order the payment of damages if the noncompliance is due to a cause of force majeure, but in no case may he absolve the debtor for its noncompliance and must decree the contractual resolution or the forced compliance of the obligation, as the case may be.

Having made this clarification, the only possibility that exists to modify the contractual conditions, or even to terminate the contract, is to apply the jurisprudential doctrine linked to the aphorism rebus sic stantibus.

The legal concept behind this aphorism concludes that in the event that circumstances arise that make the obligations assumed contractually by one party excessively onerous or expensive, so that the balance of performance that should exist in any contractual relationship is broken, the party affected by these circumstances may request that its obligations be modified to recover the lost balance, or even that the contract be terminated.

The first thing that needs to be said about this concept is that, as indicated, it is not included in the Spanish Civil Code, unlike other foreign legal systems, which have it incorporated into their substantive rules.

It is therefore a jurisprudential and doctrinal creation that has traditionally been merely used by the courts, insofar as it contradicts the principle of “pacta sunt servanda” and therefore conflicts directly with the principle of legal certainty.

But it is also true that on the last few occasions that the Supreme Court has had occasion to rule on its nature, it has broadened its scope of application, so that, although it remains restrictive in application, it has extended its scope.

As the Supreme Court has had the opportunity to state specifically in relation to leasing contracts on the occasion of the serious consequences of the financial and real estate crisis from just few years ago, there has now been a progressive change from the traditional conception of this figure to the social reality of the moment so that “(…) the assessment of the regime of application of this figure tends towards a fully standardised configuration in which its necessary prudent application does not derive from the previous classification (…)”. Therefore, we must no longer refer to this concept as something “dangerous”, as the Supreme Court itself had qualified it, but as a concept that must be understood as standardised within our legal system in accordance with how it has been used in other European systems, although this does not mean that its claim should not be subject to certain rules:

• Change of circumstances in relation to the circumstances in which the contract was granted in such a way as to alter the balance of mutual benefits.
• The change of circumstances is reasonably unforeseeable: the concept of unpredictability is no longer so strictly defined in its previous interpretation that it is no longer a question of “abstract” unpredictability but of “reasonable” unpredictability, so that the parties could not reasonably have foreseen that such a change of circumstances might occur.
• “Excessive burden as an indication of the breakdown of the equivalence of the parties’ consideration (principle of contractual commutability), particularly in cases where the economic or operational activity, due to the change in circumstances, results in repeated losses (economic non-viability) or the complete disappearance of any profit margin (lack of remuneration for the service)”.

In conclusion, and considering all the above, we can conclude that, in such extraordinary and unforeseeable scenarios as those we are experiencing these days, compliance with lease agreements must be governed by the following rules:

1. All contracts must be complied with on their own terms, and neither of the parties may unilaterally fail to comply with or modify the content of their obligations.
2. If the contract already contains clauses providing a solution to exceptional situations such as a strike or an epidemic, it is these clauses which must provide a measure of the effects these circumstances will have on the contract, either by modifying obligations or even by terminating the contract itself.
3. Force majeure only determines the absence of liability of the party that fails to comply with its contractual obligations due to the occurrence of an unforeseeable and unavoidable event, however, it cannot lead to the modification of the contractual obligations or even to the justified termination of the contract.

Only in the event that the contract does not provide for a change of circumstances surrounding the contractual performance which is reasonably unforeseeable, and which makes the obligations of one of the parties excessively onerous causing unequal performance, can the rebus sic stantibus clause be applied to modify the contractual obligations (principle of the preservation of legal transactions) and in certain cases even cause the termination of the contract.

Obviously, nuances are always decisive in the field of law, but in any case, this is only an approximation to a field that will certainly generate a lot of controversy in the coming months, so we will need to pay attention to its judicial application once the Courts and Tribunals return to its usual functioning.