The Pandemic’s Contractual Dilema: Pacta Sunt Servanda vs. Rebus Sic Stantibus

The outbreak of COVID-19 has risen important legal considerations with respect to contractual performance. In the middle of the pandemic, parties are facing a complex legal dilemma of contract law: to honor the pacta sunt servanda principle or invoke the rebus sic stantibus clause to be excused performance of an obligation. This post explores the balance between these two legal maxims vis a vis the COVID-19 pandemic.

In most civil and common law jurisdictions, the pacta sunt servanda principle has been widely recognized as an international law rule. It stands for the stability of contractual relations. In a nutshell, pacta sunt servanda dictates that agreements which are legally binding must be performed. This principle plays a pivotal role in contract law because it entitles parties to rely on the performance of obligations undertaken by the other party. However, the pacta sunt servanda also admits exceptions. The rebus sic stantibus principle is one of them. This doctrine allows parties to free themselves from the binding force of a contract. In brief, rebus sic stantibus is based on the assumption that the continued performance of a contract is always subject to the existence of the circumstances which existed at the time of contracting. Hence, if the circumstances change in time, then a party might be excused performance of a contractual obligation. This doctrine stands for flexibility in light of unforeseeable events and constitutes an “escape clause” to the pacta sunt servanda.

In most legal systems, the COVID-19 pandemic may be classified as a force majeure event because it is an irresistible and unforeseeable situation which makes impossible (or more onerous) the performance of a contractual obligation. It is worth noting that COVID-19 per se is not a force majeure event, but certain governments’ response are (e.g. circulation restrictions, curfew, etc.). Typically, force majeure events serve as a valid justification for a party’s contractual non-performance. However, courts and arbitral tribunals all over the world tend to be reluctant to accepting force majeure as a valid defense. Judges and arbitratorstend to favor the pacta sunt servanda principle. Only if a party is able to proof certain conditions (e.g. irresistibility, unforeseeability, externality and causation) then their contractual non-performance may be excused.

There is a relevant difference between the impossibility (force majeure) and the difficulty (hardship) of performing a contractual obligation. In the first case, a party can simply not honor an obligation because of an external event which makes it impossible (e.g. an airline’s contract of carriage due to travel restrictions). In the second case, a party may be able to perform but under an excessive burden or cost (e.g. a construction contract which requires hiring more workforce because of labor restriction). In both cases, the intention of the party is to find an exception to the pacta sunt servanda.

For instance, in a construction contract, the contractor may reason that the pandemic has increased the market’s price of the materials and demands hiring a larger number of employees to continue with the project. All these aspects are covered by the hardship exception because they make the performance of the obligations more onerous. The key aspect here is that the contractor is acting in good faith. Due to the change of circumstances and the contractual disequilibrium, the contractor may be entitled to request a judge or an arbitrator to modify the terms of the contract. This entails a reconsideration of the pacta sunt servanda and the acceptance of an exception in the form of the hardship doctrine.

In conclusion, the rebus sic stantibus should not be understood as a violation of the pacta sunt servanda principle, but as a guarantee of the obligation of a party not to enrichen itself at the expense of the other due to unforeseeable events. In light of this, the pandemic will require courts and arbitrators to decide on a case-by case basis how to properly balance the pacta sunt servanda and rebus sic stantibus principles.

Disclaimer: This document is informative and does not, and is not intended to, constitute legal advice.