08 April 2020
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Contracts: no exemption from the primary obligation or default interest in extraordinary circumstances

Lately, lawyers and businesses have widely exploited the concept of force majeure. A large number of foreign and domestic legal experts have tendered explanations of this legal institute. In light of the lengthy wrangling on this topic, we believe additional clarification is called for.

This should not be a theoretical discussion about whether or not the pandemic and ensuing measures are force majeure because without getting into the nitty-gritty of each and every case there is no one answer fits all. The Contracts and Torts Act is clear when it comes to grounds for exemption from contractual liability for damages. It is up to lawyers to scour the act (and even case law) for answers rather than get into the game of naming specific phenomena. At this juncture, we will analyze in detail one of the grounds significant for current events.


Force majeure is not some magic phrase that exempts contracting parties from liability. None of the grounds for exemption from contractual liability for damages allows contracting parties to dispense with the principal obligation. What does that really mean?


With the exception of obligations where the time limit is an essential element, in which case contracts are terminated by virtue of the law at the time of default (which is followed by restitution and compensation) unless the creditor states that it still requires performance, other types of principal obligations will exist after the default. Debtors who have genuinely not been able to meet their obligations when they fall due as a result of the circumstances stipulated by law will only be able to dispense with the obligation to compensate (any) damages. However, they will have to perform the principal contractual obligation subsequently unless they can prove insolvency (in the case of pecuniary obligations) or if they are completely unable to perform it, which is a different institute. Therefore, at this moment the important question is if someone is really unable to discharge the obligation due to the current circumstances, namely, who can prove it. An obligation does not vanish simply because of a shift in the moment of fulfillment, while other costs may also accumulate.


The Contracts and Torts Act explicitly stipulates that a debtor is in default when it fails to fulfill an obligation within the set time limit. Default in Serbian law is, therefore, objectified, which means that the debtor will be in default as soon as it is late in discharging an obligation, whether at fault or not and irrespective of exceptional circumstances. When a debtor fails to or is late with the performance of an obligation, the creditor is entitled to claim for damages caused as a consequence. This takes us to the “famed” Contracts and Torts Act article that is being quoted extensively these days and which we flagged even before the state of emergency was imposed. A debtor shall be exempt from liability for damages if it proves it was unable to discharge its obligation or that it was in default owing to circumstances which arose after the conclusion of the contract that it could not prevent, remedy or avoid (Art. 263).


We interrupt the discussion around whether or not this provision is a definition of force majeure, or whether the pandemic and measures accompanying it are force majeure or not – to bring you the position of the Supreme Court of Cassation. Circumstances arising after the conclusion of the contract, that exclude liability for damages for non-performance of the obligation, do not have to be of a force majeure character and it is sufficient that the debtor was unable to prevent, remedy or avoid them (Judgment of the Supreme Court of Cassation, Prev. 173/2011 dated 12 February 2012).


Therefore, the burden of proving performance incapacity rests with the debtor. It will have to prove that it really could not discharge the obligation. If a debtor succeeds in doing so, it will be exempt from liability for (any) damages, regardless of whether the contract contains a so-called force majeure clause or similar clause because the law itself affords the debtor protection which is also, as we have seen, the position of case law. However, if at a later stage the debtor is able to and where it serves the purpose of the contract when circumstances change, it will have to discharge the obligation, unless the other party terminates the contract. So, the question here is not whether the pandemic is a circumstance that cannot be remedied, prevented or avoided. Even emergency measures cannot be avoided or remedied, from the parties’ point of view. The question here is whether, due to circumstances that undoubtedly exist, the debtor is indeed unable to perform the obligation. If it fails to prove its case, when the extraordinary circumstances end it will certainly have to pay damages and discharge the obligation if that still serves the purpose of the contract and if it is possible. This is particularly noteworthy where pecuniary obligation debtors are concerned because unless they become insolvent they will have to fulfill their obligations and they have no recourse to an exemption from additional compensation in the form of default interest.


Featured – pecuniary obligations debtors


While debtors cling to their magic phrase – force majeure, creditors of pecuniary obligations have their own – default interest. In their case, however, these is a truly magical phrase in the sense that default interest is a clear-cut institute that is activated at a moment unambiguously set down in law.


The debtor in default on a pecuniary obligation shall owe, in addition to the principal obligation, default interest at the rate determined by the law. This provision is imperative. Parties cannot agree that default interest will not accrue if the debtor is default (Judgment of the Commercial Court of Appeal, Pž. 5627/2013 (1)), but on the other hand parties could waive their claim in that respect.


Another express provision of law states that a creditor is entitled to default interest, regardless of whether it has suffered any damage due to default by the debtor. If it has suffered damage and if the damage is higher the amount of default interest, it is entitled to claim for the difference up to the amount of full damage.


The most important aspect in extraordinary circumstances such as those we find ourselves in now is that debtors are not exempt from default interest even if they are in default due to circumstances which occurred after the conclusion of the contract, which could not be avoided, remedied or prevented. In support of that assertion is the wording of the provision governing the moment when default interest becomes payable. Default interest is payable from the moment of default, and as we have already explained, fault or exceptional circumstances do not excuse default. However, case law also upholds this interpretation. A debtor in default on a pecuniary obligation cannot be exempt from the obligation to pay statutory default interest to the creditor by adducing to the provision of Art. 263 of the Contracts and Torts Act (cited above), because by operation of law it owes the creditor default interest at the statutory rate even where it settles arrears (Ruling of the High Commercial Court, Pž. 3569/2006).


Let’s imagine that a creditor has rendered its services and that the customer/client (debtor of a pecuniary obligation), a mere two weeks after the state of emergency is declared, refuses to pay. The debtor e.g. a company will have to pay the contracted fee sooner or later and definitely default interest, while it can’t be ruled out that it wouldn’t have to compensate any damages suffered by the creditor. There is a chance that that in order to maintain liquidity companies may now refuse to fulfill previous obligations to their creditors that fall due during the state of emergency. Substantive time limits continue to run. Default interest also continues to accrue because, as we have seen, exceptional circumstances don’t affect that obligation. In the case of default, debtors are still required to fulfill their obligations if they are solvent and to pay default interest. If they prove that, due to exceptional circumstances, they were prevented from fulfilling their obligation (which is unlikely considering that pecuniary obligations are performed by a simple transfer of funds from one current account to another, especially given the wholesale use of e-banking), they will only be able to dispense with the obligation to pay the difference between damages and default interest if there are any.


Thanks to the magic phrase of creditors to pecuniary obligations –default interest, taking advantage of the fact that enforcement (save for some exceptions) has been suspended, will prove detrimental to the debtors themselves.


That said, we wrap this text up with a mention about debtors who adhere to the principle of good faith. We reiterate that debtors of non-pecuniary liabilities are protected by the Contracts and Torts Act and the case law of the Supreme Court of Cassation. If they were indeed prevented from fulfilling their obligations due to the new circumstances, and proved so, they could be exempt from the obligation to pay compensation regardless of the existence of an appropriate contractual clause. We do not claim that there is no court that could take a different approach when interpreting this legal conundrum, but we believe our position is substantiated and has merit.


Please also note that some contractors, such as carriers and warehouse operators, fall under a special regime when it comes to liability for damages. For advice in that regard, feel free to contact us.


For more information, please contact us via covid19@geciclaw.com.