Cancellation of the basis of business on the grounds of Corona? #03
(Photo by Benedikt Geyer on Pixabay)
The effects of the current pandemic are massively disrupting the business basis of many companies – with the consequence that § 313 of the German Civil Code (BGB) could possibly be applied.
Read here the assessment of Dr. Philip Rödiger LL.M.oec. He is a lawyer as well as a specialist lawyer for commercial & company law and a specialist lawyer for tax law and a consultant (DStV e.V.) for business succession with his office in Munich.
Germany, Europe and almost the entire world are currently in a state of emergency. The highly contagious virus Covid 19 or SARS-CoV-2 has caused public and economic life in Germany to be suspended to an unavoidable minimum. This state of affairs has now lasted for a year, with some temporary relaxation. It is obvious that this is a drastic measure for thousands of businesses, with the corresponding economic consequences. Thus, the distortions of the pandemic will continue to affect our society and especially the economy for a long time to come. The effects of the pandemic could lead to the applicability of § 313 of the German Civil Code (BGB) as well as to the discontinuation of the basis of the contract.
313 of the German Civil Code (BGB) – Disturbance of the Basis of the Contract
(1) If circumstances which have become the basis of the contract have changed seriously after the conclusion of the contract and if the parties would not have concluded the contract or would have concluded it with different content if they had foreseen this change, adjustment of the contract may be demanded to the extent that one party cannot reasonably be expected to adhere to the unchanged contract, taking into account all circumstances of the individual case, in particular the contractual or statutory distribution of risk.
(2) A change of circumstances shall be deemed to have occurred if essential ideas which have become the basis of the contract turn out to be wrong.
(3) If an adjustment of the contract is not possible or cannot reasonably be expected of one party, the disadvantaged party may withdraw from the contract. The right of withdrawal is replaced by the right of termination for continuing obligations.
§ 313 BGB thus regulates the disruption of the basis of a contractual relationship. A distinction is made between the cessation of the basis of the contract (I) and the absence of the basis of the contract (II). It is quickly clarified whether a contract exists. However, it is much less clear what is meant by the basis of the contract.
The standards for assessing the basis of a transaction follow the consideration that every contract is concluded by the parties in view of certain existing circumstances, without which the contract cannot fulfil its purpose. If, after the conclusion of the contract, a complete change of these existing circumstances occurs which was not foreseen by either party and which completely calls into question the meaning and purpose of the agreement, there is a disturbance of the basis of the transaction. It would be incompatible with the principle of good faith (§ 157 BGB, § 242 BGB) if in this case the disproportionately disadvantaged party to the contract were to be held to the contract on unchanged terms. The basis to which the parties are to adhere in each case can be understood as both subjective and objective basis of the contract.
Subjective basis of the contract
The subjective basis of the contract is understood to be the ideas on which the parties to the contract based their agreement and allowed themselves to be guided; this has now been codified in § 313 II BGB.
Objective Basis of the Contract
As a rule, the parties will not think about circumstances which they take for granted when concluding the contract. These can be, for example, the economic system, the currency or private autonomy in civil law. They must therefore be circumstances essential to the conclusion of the contract of which neither party was aware. For these circumstances, insofar as a significant change occurs that makes the fulfilment of the contract appear pointless and futile, it applies that a continuation of the disproportionately disadvantaged party to the contract on unchanged terms would be contrary to the principle of good faith. The same applies, of course, if these circumstances cease to exist completely. § 313 BGB is applicable to all contracts under the law of obligations, i.e. also to preliminary contracts. Thus, § 313 BGB is potentially relevant for every commercial enterprise. This is because there are numerous contracts under the law of obligations in every business, such as supply or purchase contracts for goods, materials, goods or energy.
According to the facts, § 313 BGB requires a hypothetical consideration in addition to factual circumstances. The parties would not have concluded the contract or would have concluded it with different content if they had foreseen the change. The relevant point in time is the time of the conclusion of the contract. Finally, it must be unreasonable for one of the parties to adhere to the contract. For the unacceptability of the unchanged implementation of the contract, it is generally necessary that adherence to the original regulation would lead to unacceptable hardship and a result that is no longer compatible with law and justice. All circumstances of the individual case must be taken into account and the interests of both parties must be weighed. The question of unreasonableness is measured by whether the limits of risk allocation have been exceeded. There is no room for taking into account disturbances of the basis of the contract if, according to the contractual or legal regulation, the party who now invokes the disturbance has to bear the risk. Nor does a disturbance result from an unforeseen clear advantage for one of the contracting parties. Insofar as, as a result of the political or social reactions to a pandemic, only the general financial situation of one of the contracting parties is affected, so that it is made more difficult or impossible for it to fulfil its contractual obligations, § 313 BGB does not apply. And insofar as the fulfilment of a contractual obligation to perform is prohibited by an intervention of the legislator, not § 313 BGB but § 275 I case 2 BGB applies (cf. von Göler (ed.) / Arvid Siebert / § 313). Accordingly, § 313 BGB only applies if the contractual services can still be provided in principle, but their content, which was assumed by both parties, has fundamentally changed as a result of the political reactions to the pandemic. This may be the case, for example, if the sale of goods becomes impossible due to a legally imposed lockdown.
The basic idea behind the legal institution of the omission of the basis of the contract is that it would be unreasonable and inequitable to adhere to the contract on the originally agreed terms (von Göler (ed.) / Arvid Siebert / § 313). The legal consequence can therefore only be an adjustment of the contract to the actual existing conditions in line with the interests of the parties according to the standard of reasonableness for the parties and taking into account their contractual will as far as possible. The tension between the respective different interests with regard to the contract requires that the interference in the existing contractual provision is to be kept as low as possible. § 313 I BGB grants this claim to the disadvantaged party. It is therefore an objection. The priority is for the parties to negotiate an adjustment of the contract. Depending on the circumstances of the case, instruments of contract adjustment include:
- A reduction or cancellation of a liability
- The granting of partial payments or a deferral of the payment obligation
- The increase of a devalued consideration
- The establishment of claims for the retransfer of the object of sale
- Compensation for loss of profit or reimbursement of expenses
- A change in the distribution of risk between the parties
Withdrawal from the contract or termination
It is conceivable that an adjustment of the contract is not possible or not reasonable for the party affected by the disruption. In such a case, § 313 V BGB grants the subsidiary option of terminating the contract by rescinding it. For the rest, the general requirements apply to such a rescission. Continuing obligations are to be assessed differently. Pursuant to § 313 III S. 2 BGB, the right to terminate the contract replaces the right of rescission. Continuing obligations are those obligations the performance of which is not limited to one-off services but covers a more or less long period of time, since they involve either permanent conduct or recurring individual services at certain periods of time. In this respect, continuing obligations differ from contracts for delivery by instalments as so-called genuine successive delivery contracts, so that new obligations to perform arise in each case during the term. Furthermore, § 314 BGB also provides for termination for cause.
Subjective Basis of Business
It is questionable whether the closure of many shops ordered by the authorities results in the loss of the subjective basis of the transaction. The subjective basis of the business is the sum of the circumstances which the parties considered and were guided by when concluding the contract. It cannot be assumed that at the time of the conclusion of the contract before the outbreak of the pandemic, any of the contracting parties had thought about whether they would still be allowed to continue their own business or to operate their own business in the future. Since the closure of shops and businesses by order of the authorities for a period of several weeks was almost certainly not considered by either party at the time of the conclusion of the contract, the Corona pandemic does not lead to a loss of the subjective basis of the contract.
Objective Basis of Business
Each party will have assumed that it will be possible for it to continue to operate and run the business in the future in the same way as in the past. Both parties have taken this for granted. Through the lockdown, this taken-for-granted moment has proven to be a mistake. Therefore, the objective basis of the business has ceased to exist. This legal institution is in principle also applicable to the effects of the Corona pandemic.
Sales contracts and similar contracts
After the normative and real elements of the offence are fulfilled, the hypothetical element is additionally required. It must be unreasonable for the disadvantaged party to remain bound by the original contract. Whether this element is present must be assessed in the context of a case-by-case consideration. Even if the Corona pandemic basically fulfils the requirements for the applicability of § 313 BGB, only the decisive element in the respective individual case can be considered as the constituent element of the hypothetical element.
After case law at the beginning of the pandemic was very cautious about applying § 313 BGB to Corona-related case constellations, this has changed in the course of the last year (von Göler (ed.) / Arvid Siebert / § 313). For example, in its final judgement of 22 September 2020 on case no. 3 O 4495/20, the LG München I ruled in favour of a tenant who had sued for a reduction in rent. The Regional Court affirmed a lapse of the basis of the contract on the grounds “that the parties had manifestly not considered the consequences of an occurring corona pandemic and infection protection measures by the state and thus would hardly have concluded the contract (cf. § 313 I, II BGB).”
Example fashion shop
A fashion shop has already ordered the collection for this spring in autumn of the previous year. In the week in which the goods were to be delivered, the shop was already closed due to the lockdown. The shop is allowed to reopen in the last week of April. At this time, the spring fashion as seasonal goods is already no longer in demand and can no longer be sold. The contractual services – delivery of the goods and sale at a significant discount – can still be provided in principle, but the value estimated by both parties has fundamentally changed as a result of the political reactions to the pandemic. It is not evident why this risk – which is not foreseeable for either party – should be borne solely by the operator of the fashion shop. On the other hand, it will have been possible and reasonable to operate an internet shop during the lockdown. Therefore, an appropriate compensation would be a noticeable price reduction by the supplier (§ 313 I BGB).
Example of a manufacturing company
A manufacturing company specialising in the production of lifts for ergonomic work in industry has ordered an important component for an eight-month demand in advance in anticipation of a continuing good economy. This involves 10,000 pieces for the production of 3,000 machines. However, due to the pandemic and the associated economic slump, the manufacturer expects to be able to produce a maximum of 500 machines in the estimated period. Here, too, it is not clear why the machine manufacturer should bear the risk alone, which is not apparent to either party. In this case, it would seem to be a fair balance of interests that the order can be reduced to 500 units, but at a – possibly significantly – higher unit price for the purchased parts (§ 313 I BGB). In this case, the managing director not only has the possibility but also the obligation to renegotiate the contract in order to minimise the financial damage to the company.
Example Cosmetics Manufacturer
A cosmetics manufacturer has concluded a contract with a testimonial for a period of two years. The six-figure fee is divided in half for each year of the contract term. The testimonial’s performance obligations include the promotion of the product in social media by the celebrity as well as two photo shoots and participation in promotional events. The cosmetics manufacturer’s products are also sold in its own stores, which are decorated with the testimonial’s photos. When the lockdown occurs, just under half of the contract period has elapsed and one photo shoot has been completed. Due to the lockdown, the further photo shoot for the new collection cannot take place. Customers can no longer see the photos of the testimonial in the shops because they are closed. All promotional events have been cancelled for a longer period of time. The cosmetics manufacturer no longer wants to pay the second half of the contract fee. The lack of purpose of the existing contract is due to the lockdown. There is no discernible reason why one of the contracting parties should bear this risk alone, so that the cosmetics manufacturer is entitled to an adjustment of the contract. This could consist of extending the contract period. A second photo shoot is cancelled without replacement, and in return the fee still due is significantly reduced (§ 313 I BGB). Here, too, the manager has not only the possibility but also the obligation to renegotiate the contract in order to keep the financial damage to the company as low as possible.
A pub has concluded a beer purchase agreement with a brewery including a minimum purchase quantity and a term of three years. The pub has only recently opened and the operator has been forced to personally enter into the contract with the guaranteed minimum purchase. Due to the recent opening, the pub’s capital cover is too low for it to survive the lockdown and several weeks without revenue. It has to close. The brewery demands that the operator fulfil the contract and make a monthly payment for a minimum quantity of beer. In this case, too, there is no apparent reason why the pub operator should bear the risk alone. In this case, he is entitled to terminate the contract according to § 313 V S. 2 BGB. In addition, the establishment can claim an insurance benefit due to corona-related closure – if such a business interruption insurance existed. This was decided by the Magdeburg Regional Court in its final judgement of 6 October 2020 on case no. 31 O 45/20.
The Corona pandemic will open up the possibility for most entrepreneurs to renegotiate such contracts that were already concluded before the lockdown occurred, with reference to § 313 BGB. In this context, it applies to both contracting parties that a proper balance can only be found by taking into account the interests of both sides. However, the possible idea of being able to disengage from contracts without having to provide one’s own services is, as a rule, an illusion.
A detailed commentary on the discontinuation of the basis of the contract pursuant to § 313 BGB can be found in the BGB commentary, directly available: