—Timothy Joseph N. Lumauig, Partner
—Justine Abigail C. Sablan, Associate

The World Health Organization (WHO) has declared the coronavirus disease (COVID-19) as a pandemic. As a result, governments all over the world have issued various restrictions in their efforts to contain the virus in their respective countries. In adopting these measures, day-to-day transactions have been hampered, which has caused interruption of economic activities, posing serious financial effects on all kinds of businesses.

In the Philippines, one of the more extreme measures being implemented is the “Enhanced Community Quarantine” (ECQ), which has limited the movement and operations of business establishments in the nation’s capital and other parts of the country to accessing only of basic or essential necessities. With the further extension of the ECQ up to 15 May 2020 in parts of the country,   restricted manpower and revenue-generating activities, continued disruption of supply chains, and potential chain reactions of collectability issues threaten to cause a domino effect of default in obligations. Naturally, majority of businesses are keen to mitigate – if not altogether avoid – liability for breaches of contracts.

A common question arising is whether the COVID-19 pandemic and the corresponding imposition of the ECQ be treated as force majeure / fortuitous event or other similar principle under Philippine Law and if such, what is their ultimate effect on contractual obligations?

Force Majeure in General under Philippine Law

A party may be exempt from contractual liability by reason of force majeure if the following requirements are met:^[1]

1. The breach of the obligation is independent of the will / outside the control of the debtor;
2. The events must be either unforeseeable or unavoidable;
3. It becomes impossible for the debtor to fulfill the obligation in a normal manner; and
4. The debtor is free from any participation in or aggravation of injury to the creditor.

Force majeure generally includes acts of God, such as floods, typhoons and other natural catastrophes, as well as acts of man beyond the control of the contracting parties such as war, riots, and laws, orders, and regulations imposed by the government.^[2]

By its very nature, COVID-19 and the resulting ECQ may fall under the general definition of force majeure. Article 1174 of the Civil Code of the Philippines, however, provides exceptions to force majeure, which includes contractual stipulations between parties. Thus, a determination of whether force majeure applies begins with a review of contracts between the parties.

Examining Force Majeure Provisions in Contracts

While force majeure provisions as a whole are commonly stipulated between contracting parties, the specific wording of these clauses may differ from contract to contract. Consequently, the definition, standards and even consequences set in force majeure clauses will have to be examined on a case to case basis. To navigate these clauses, parties may look out for these typical contractual points for guidance:

• Express definition and/or limitation of the coverage of force majeure. Clearly, if the contract expressly provides a “pandemic”, “epidemic” or “contagious outbreak” as an instance of force majeure, then COVID-19 should qualify as such. Existing commercial agreements, however, will not likely be as clear. Thus, contracting parties will have to determine whether their force majeure provisions provide for a list of instances, and whether the COVID-19 situation will fall under any of those instances. Force majeure provisions may also contain “catch-all” provisions, which would allow a contracting party some leeway to treat the existing situation as a force majeure event.

• Degree of disruption contemplated in the performance of an obligation. Does the contract determine the standard or degree of the relief from the obligation? For instance, is it triggered by an absolute “prevention” from the performance of the obligation or, to a lesser degree, will a mere “delay” in the performance already be construed as force majeure?

• Identify the specific consequences of force majeure. Rather than outright exempting a party from liability, force majeure provisions may instead suspend the performance of an obligation for a period of time. Taking note of these specified periods may particularly become more significant as the ECQ is extended. For instance, force majeure provisions with suspension of obligations for a period of 30 or 45 days would likely have continued under the initial ECQ and its extension to April 30. With the further extension to May 15, however, provisions with similar periods may already be deemed terminated instead.

From there, parties will likewise have to determine how to claim force majeure, which typically involves written notice requirements to the other party.

Note, however, that contractual effects of force majeure may not necessarily be found in standalone force majeure provisions. Effects of force majeure or unforeseen / unavoidable events in general may be embedded in other provisions of a contract. For instance, termination clauses may effectively state that an unforeseen or unavoidable event preventing the completion of an obligation is a ground for termination. Similarly, covenants and events of default (EOD) provisions may contain carve-outs for unforeseen or unavoidable events, which would likewise have the effect of a party avoiding an EOD or breach in a covenant.

Thus, contracting parties should take a closer look at the specific force majeure provisions in their contracts as a whole. In connection with this, parties should likewise review other provisions of their contracts that may have similar effects as force majeure, albeit under different principles commonly found in commercial agreements.

Other Contractual Provisions to Consider

Depending on the nature of the transaction and the status of the implementing contracts, other provisions may likewise be triggered by the COVID-19 situation.

• Material Adverse Effect (MAE) clauses. MAE provisions in the contract, if any, may be applicable particularly for agreements that are yet to close or achieve completion. These typically involve M&A or financing agreements, where MAE clauses are intended to cover gaps in due diligence, unforeseen changes to a party’s financial situation, and even drastic market changes. MAE clauses in existing contracts may be triggered, depending on how the MAE provisions are crafted. Since MAE clauses are often vague and do not offer specific criteria, invoking an MAE clause largely depends on what is considered “material” within the context of the agreement. Under present circumstances, however, parties may already make a case for MAE, especially considering the further extension of the ECQ in the Philippines. While Philippine jurisprudence is thin on interpretations of what is material in this context, the underlying principle is that the circumstance present should be material and significant in terms of the long-term perspective of the obligation.

• Longstop Dates. Similarly, contracts yet to close or that are otherwise still subject to the completion of conditions precedent, may contain longstop dates. These conditions typically include regulatory permits or other government approvals that parties have agreed are prior requirements for the agreement to close. Non-completion of these conditions prior to the longstop date may cause the contract to automatically terminate. Thus, parties should closely monitor whether the extended ECQ may have the need to require a negotiation or extension of any longstop date, especially considering the limitation in services provided by both private and public sectors.

• Governmental Actions / Change in Law. Parties should likewise review provisions specifically governing governmental actions or changes in law and the allocation of liability between the parties that may result from such. Considering the continuous developments in the measures the government is undertaking to battle the COVID-19 situation, new issuances, regulations or orders may be covered as governmental actions or changes in law that have stipulated effects on existing contracts.

Parties with a grasp of where COVID-19 and the ECQ stand on their force majeure provisions should keep in mind other provisions in their contracts that may likewise be triggered. Having said that, the reality is that many contracts may not clearly include (or worse, expressly exclude) COVID-19 and/or ECQ situations as exempting circumstances from contractual obligations. Thus, concerned parties may need alternative legal basis to address these concerns.

Exploring Alternative Legal Principles Provided by Law

When the provisions of the contract cannot be applied to treat the COVID-19 situation and resulting ECQ as force majeure or otherwise exempt or mitigate liability for nonperformance of a contractual obligation, a party may further explore provisions in law that may provide alternative remedies.

• Legally or physically impossibility to perform the obligation. The Civil Code provides that a debtor may be released when the obligation becomes legally or physically impossible without the fault of the obligor. ^[3] Given the lack of precedent, however, it may be difficult to absolutely determine whether the ECQ in itself is sufficient to exempt contractual obligations under this principle. Nevertheless, the extended ECQ and its implementing measures imposed by the government have actually restricted numerous businesses from continuing operations. As a result of measures enforced by the government, for instance, nonessential industries have effectively shut down or, at the very least, have significantly slowed down for the time being. Thus, depending on the specific circumstances that may be established by the affected contracting party, a case for legal or physical impossibility may arguably be made. Note, however, that this law does not apply to obligations to give or deliver a thing, ^[4] which includes payment of rentals^[5] or sums of money. Rather, impossibility of performance will likely only apply to obligations to render a service.

• Fundamental Change in Circumstances. The Civil Code likewise allows a debtor to be released when the service has become so difficult as to be manifestly beyond the contemplation of the parties.^[6] Thus, a contracting party may be exempted from contractual liability if the following conditions are met: (a) the change in circumstances could not have been foreseen at the time of the execution of the contract; (b) it makes the performance of the contract extremely difficult but not impossible; (c) it must not be due to the act of any of the parties; and (d) the contract is for a future obligation to be performed. ^[7] From a practical perspective, however, relief from this legal argument may be more difficult to enforce than impossibility of performance. In this regard, the Supreme Court has not been keen on granting exemptions under this ground. Rather, relevant decisions appear to give higher credence to the security of contractual relations, a presumption that parties have assumed the risks of unfavorable developments, and that this principle should only apply in absolutely exceptional changes of circumstances.^[8]

• Unjust enrichment under applicable instances. Referring to Article 22 of the Civil Code, unjust enrichment may occur when a person unjustly retains a benefit to the loss of another, or when a person retains money or property of another against the fundamental principles of justice, equity and good conscience.[9] The enrichment by one party may have some correlative prejudice, disadvantage, or injury to the other, which may consist of non-payment of compensation for a service rendered.^[10] Considering the potential domino effect of default scenarios between different contracting vis-à-vis possible reliefs that may be granted at different liability points within a chain of contracts, a scenario open to unjust enrichment may arise. This may be further examined in a supply chain or back-to-back agreements, especially where supply costs are passed on to an ultimate consumer. Again, the applicability of this principle and the potential reliefs to be enjoyed will depend on the specific circumstances surrounding the situation.

Apart from contract provisions and existing general laws, however, it is necessary for parties to likewise monitor specific issuances by the government to continuously address the COVID-19 situation and the potential effects they may have on their contractual obligations.

Government Intervention and Effects on Contracts

As can be reasonably expected, in the country’s unprecedented fight against the ongoing pandemic, additional laws, regulations and orders will be issued and developed by the government, which may specifically affect contractual obligations. As mentioned, the Bayanihan to Heal As One Act already provides several potential remedies to continuing contractual liabilities, which include the following:

• A thirty (30)-day grace period for the payment of all loans owing to banks, quasi-banks, financing companies, lending companies, and other financial institutions, public and private, including but not limited to salary, personal, housing, and motor vehicle loans, falling due within the period of the ECQ, without incurring interests, penalties, fees, or other charges,^[11] which grace period is automatically extended with the further extension of the ECQ.^[12]

• A thirty (30)-day grace period on residential rents falling due within the period of the ECQ, without incurring interests, penalties, fees, or other charges.^[13] The Department of Trade and Industry (DTI) further explained that there will be a grace period for commercial rent paid by micro, small, and medium enterprises, which will also not incur interest, penalties, fees, and other charges. The cumulative amount of rents that are supposed to be paid during the ECQ period must be amortized equally in the six (6) months following the end of the period.[14]

Similarly, the DTI has also limited operations of commercial malls only to basic necessities,^[15] and has prohibited operations of businesses offering leisure, entertainment, and gathering of crowds confined in a specific area are prohibited from operating. Lessors and owners of these business spaces shall share the responsibility by waiving the corresponding rental fees and charges of stores that were closed during the ECQ period.^[16]

Additional guidelines are expected to be issued by the Department of Health, the Department of Transportation, the DTI, the Department of Labor and Employment, and the Department of Public Works and Highways. As the COVID-19 situation rapidly develops in the country and around the world, contracting parties should monitor corresponding enactments by the Philippine government.

Practical Steps to Take Today, and What to Anticipate for Tomorrow

All the foregoing points aim to serve as a guide to address the common concern of businesses on the effects of the COVID-19 situation on contractual obligations. Looking ahead, however, the reality is that even after the ECQ has been lifted, we will still likely feel the economic impact of COVID-19. Thus, the discussion on force majeure and alternative exempting principles may carry into applicability under financial crisis scenarios.

Precedent from the Asian Financial Crisis shows that Philippine courts are not keen on deeming an economic crisis as force majeure. ^[17] Similarly in the US, the 2008 Global Financial Crisis was generally not considered as a ground to invoke force majeure, which was found not to be a valid defense against financial hardships in itself.[18] Thus, in anticipation of what is to come in the interpretation of liabilities under a looming financial crisis, and in connection with all the foregoing points, parties may consider taking the following practical steps to try and get ahead of the situation:

• Review contracts to identify risks and exposure to liabilities that may arise from delays and/or inability to perform obligations, as well as relevant provisions that may exempt the party from any such liability.

• If already deemed necessary to claim force majeure or other contractually stipulated exemptions from liability, begin the required procedures (i.e. written notices, alternative remedies, etc.)

• Take reasonable risk management actions that may mitigate any such potential adverse effects, and may likewise serve as a badge of good faith in addressing a force majeure situation.

• Continue to monitor the developing measures enacted by the government and their corresponding effects on existing contracts.

• Notwithstanding express stipulations and applicable developments in law, we likewise encourage parties to keep in mind that the counterparts to a contract may be willing to commercially negotiate risk or liability mitigation or allocation measures. After all, the scale of the COVID-19 situation has placed many businesses in the same proverbial boat.

However, as much as force majeure / fortuitous events can affect additional contractual rights or trigger exemptions for debtors, they likewise pose a dilemma for creditors on issues of allowing justifiable delays vis-a-vis enforceability of obligations. Regardless of the nature of the contracting party, whether as debtor or creditor, businesses should examine COVID-19-related force majeure / fortuitous events as issues both on enforceability of rights and mitigation of risks. Businesses are encouraged to take proactive measures and conduct an assessment of the impact of COVID-19 on their contractual rights and/or obligations.

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[1] See Nakpil & Sons v. Court of Appeals, G.R. No. L-47851, L-47863, L-47896, (3 October 1986).

[2] Philippine Communications Satellite Corp. v. Globe Telecom, Inc., G.R. Nos. 147324 & 147334 (25 May 2004).

[3] Civil Code, Art. 1266.

[4] Development Bank of the Philippines v. Clarges Realty Corporation, G.R. No. 170060, (17 August 2016).

[5] Comglasco Corporation  v. Santos Car Check Center Corporation,G.R. No. 202989 (25 March 2015).

[6] Civil Code, Art. 1267.

[7] Tagaytay Realty Co., Inc. v. Gacutan, G.R. No. 160033, (1 July 2015).

[8] Philippine National Construction Corporation v. Court of Appeals,G.R. No. 116896 (5 May 1997).

[9] Lazo v. Spouses Villas, G.R. No. 221792 (30 January 2019).

[10] National Power Corporation v. Delta P, Inc., G.R. No. 221709, (16 October 2019).

[11] Bayanihan to Heal As One Act, Section 4(aa).

^[12] Section 3.10, Implementing Rules and Regulations of Section 4(aa) Bayanihan to Heal As One Act (Bayanihan Act),

[13] Bayanihan to Heal As One Act, Section 4(bb).

[14] DTI Memorandum Circular No. 20-12, Series of 2020.

[15] DTI Memorandum Circular No. 04, Series of 2020.

[16] Id.

[17] Mondragon Leisure and Resorts Corp. v. Court of Appeals, G.R. No. 154188 (15 June 2005).

[18] Flathead-Michigan I, LLC v. Penninsula Dev., LLC, 2011 WL 940048.