The outbreak of the COVID-19 virus and its rapid spread forced governments to impose strict limitations on freedom of movement and economic activities. Many businesses had to either completely suspend or significantly reduce their activities, which naturally aggravated the performance of contracts, at least for one of the parties, and significantly affected contractual relationships. Unfortunately, the effects of the pandemic did not spare the financial markets and existing financing agreements, as the performance of contractual obligations became a burden to many borrowers.
Due to the impact of the COVID-19 crisis on existing financing agreements, at least three important questions arose:
The answers to these questions lie within general Lithuanian contract law, but it should be analysed in a new light.
Lithuania’s Financial Institutions Adopted a Moratorium on Payments to Provide Borrowers with Payment Relief
Since the beginning of the COVID-19 crisis it became apparent that, under such circumstances, the performance of contractual obligations will become a burden to many businesses and the majority of them will eventually find themselves in a breach or a potential breach of financing agreements. Therefore, it was not the right time for lenders to demonstrate a rigid approach towards borrowers’ performance of financial covenants. For this reason, in the turmoil of an economic downturn, various public and private entities sought effective measures to mitigate the outcomes of the pandemic on the financial market, amongst others, by providing payment relief of some form to borrowers suffering as a result of the pandemic.
On 17 April 2020 the Association of Lithuanian Banks announced a Temporary Moratorium for Private Obligors, followed by a Temporary Payment Moratorium for Legal Entities on 23 April 2020 (the Moratoriums), concluded in accordance with the guidelines of the European Banking Association on legislative and non-legislative moratoria on loan repayments applied in the light of COVID-19. The Moratoriums aimed to reduce the negative impact of the pandemic on Lithuanian businesses and households. They were signed by several credit institutions, and their adoption was supported by the national supervisory institution of financial markets, the Bank of Lithuania. Under the Moratoriums, signatory Lithuanian credit institutions have undertaken to change repayment schedules under financing agreements in accordance with the terms of the Moratoriums, by deferring loan repayments upon the request of borrowers for up to six months, or up to 12 months for mortgage loans. However, the Moratoriums only apply to financing agreements concluded before the announcement of quarantine, and can only be resorted to by those borrowers that meet certain criteria.
Borrowers may request the deferral of loan repayments under the Moratoriums in the following circumstances:
Additional criteria must be met by legal entities, as follows:
The adoption of the Moratoriums indeed reduced the burden of the performance of financing agreements for many borrowers and thus temporarily set aside a necessity to look for resolutions of arising conflicts in the general contract law. However, the application of the Moratoriums is limited, and upon their expiry parties will be forced to look for answers to the same aforementioned questions.
Three Concepts of Lithuania’s Contract Law are Relevant in the Context of COVID-19
The main legal concepts in Lithuanian contract law that may be utilised to deal with contractual disruptions caused by the COVID-19 crisis are force majeure, modification of contracts upon a fundamental change of circumstances (so-called hardship) and unilateral termination of the contract. The application of relevant legal instruments is based on the evaluation of subjective circumstances, so there is no one-size-fits-all solution, and a decision on whether the legal instrument may be invoked varies in every case. Nonetheless, some guidelines on how specific circumstances relevant to the performance of financing agreements may be assessed during the COVID-19 crisis can be provided under the general contract law and relevant case law.
The Non-performance of Contractual Obligations may be Excused under Force Majeure
In order to invoke force majeure, the impediment must meet conditions established in the Civil Code
The concept of force majeure is established in Art. 6.212 of the Lithuanian Civil Code (the Civil Code), and coincides with the concept as established in Art. 7.1.7 of the UNIDROIT Principles of Commercial Contracts (the UNIDROIT principles). Thus, when analysing the application of force majeure during the COVID-19 crisis, the analysis of the application of the UNIDROIT principles provided in the Note of the UNIDROIT Secretariat on the UNIDROIT principles of international commercial contracts and the COVID-19 health crisis (the UNIDROIT note on COVID-19) will also be taken into account.
In cases of force majeure, a party is excused non-performance if it can prove that said non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract in order to have avoided or overcome it or its consequences. Thus, a party wishing to invoke force majeure in order to be exonerated from paying damages for non-performance and/or to suspend performance must prove that the impediment meets the conditions established in the Civil Code, which are analysed below.
Can the COVID-19 pandemic or measures adopted to contain COVID-19 be considered a force majeure circumstance?
The main question is whether COVID-19 and/or the measures adopted to contain it may be considered a sufficient impediment of the performance of financing agreements to invoke force majeure. One may argue that the COVID-19 pandemic itself might satisfy the necessary criteria to be considered a force majeure circumstance. Another view is that the adopted containment measures, such as quarantine, should be considered as having a sufficient causal link to entitle an obligor to resort to force majeure. There is also an opposition to both such views, stating that neither of the two circumstances impact the ability to make payments, so should not be considered as force majeure.
Resolution No. 840 confirming the Rules on Exemption from Civil Liability Under Force Majeure Circumstances adopted by the Government of the Republic of Lithuania on 18 July 1996 establishes that lawful or unlawful actions of state authorities may be considered an impediment to the performance of contractual obligations. Moreover, Art 6.253(3) of the Civil Code foresees that lawful government actions may be an independent ground to exempt the party from civil liability. The same position is also expressed in the UNIDROIT note on COVID-19, which states that certain containment measures imposed by public authorities and causing the temporary suspension of a party’s activities are considered to indirectly impede the performance of the contract and thus may be considered a circumstance of force majeure.
In our view, borrowers would have a better chance arguing that the imposition of containment measures such as quarantine amounts to force majeure rather than the pandemic itself, and this line of argumentation is analysed further below.
Causal link between containment measures and borrower’s non-performance is necessary to invoke force majeure
Similar attempts have already been seen in Lithuanian courts during the 2008-2010 economic crisis (the 2008-2010 Crisis). Since there is no case law analysing the performance of contracts under the circumstances of COVID-19, the rulings relating to the performance of financing agreements under circumstances of the 2008-2010 Crisis may provide useful guidance in the context of the pandemic.
When analysing the circumstances of the 2008-2010 Crisis, Lithuanian courts decided that the circumstances of an economic crisis itself cannot be considered force majeure circumstances that would universally exonerate obligors from the outcomes of the non-performance of contractual obligations. The courts ruled that only certain circumstances of the 2008-2010 Crisis that related to the party’s activity and objectively made performance of a specific contract impossible can be considered a force majeure circumstance. The same position is expressed in the UNIDROIT note on COVID-19, where it is indicated that the circumstance must be external and objective in order to consider the impediment a force majeure circumstance – ie, not just a subjective problem of a borrower.
In the context of the current economic downturn, borrowers must prove the existence of a causal link between the containment measures adopted by the government and any difficulties with the execution of payments experienced by the borrower. The UNIDROIT note on COVID-19 also indicates that a direct or indirect causal link between the containment measures adopted and non-performance of the contract must be proved in order to invoke force majeure. Moreover, the UNIDROIT note on COVID-19 emphasises that a mandatory nature of imposed restrictions is essential in order to consider it a force majeure circumstance; mere recommendations or the imposition of limitations on activities may not always be considered a relevant impediment. Therefore, borrowers whose activities were suspended due to the imposed quarantine may have a better argument trying to rely on force majeure and, respectively, excuse the non-performance of their obligations under financing agreements.
When force majeure is invoked, lenders can protect their interests under Art. 6.212(1) of the Civil Code, indicating that the force majeure does not occur in cases inter alia when the party does not have sufficient funds to perform contractual obligations (it is noteworthy that this provision is provided in Lithuanian national legislation and does not derive from the UNIDROIT principles). However, under Lithuanian case law, if a borrower seeks to be excused for non-performance of obligations under force majeure, it must prove that there is a causal link between the specific circumstances related to the crisis and the borrower’s inability to objectively perform the contract to the lender. In particular, this reasoning of the courts, at least in theory, creates a ground to argue that an exemption from civil liability under force majeure would also be possible when the borrower does not have sufficient funds to perform contractual obligations, if it is proved that such insufficiency of funds was caused namely by circumstances of force majeure.
Application of force majeure is not absolute: lenders can still protect their interests
The Civil Code also establishes another safeguard that can be used by lenders, with Art. 6.212(4) foreseeing that force majeure circumstances do not deprive the other party of a right to terminate the contract or suspend the execution of a contract, or to require the payment of interest for the suspended amounts. The same position is also upheld in the UNIDROIT note on COVID-19. All in all, numerous remedies available to the lenders demonstrate that the effect of force majeure is not absolute.
Upon a Fundamental Change of Circumstances, Borrowers may Request Modification of Existing Financing Agreement
The change of circumstances must meet the criteria established in the Civil Code to entitle a borrower to request modification of an agreement
The circumstances of an economic downturn impel borrowers to look for legal instruments that enable them to modify existing long-term financing agreements in order to avoid defaults and the consequent termination of contracts. Art 6.204 of the Civil Code entitles an aggrieved party to request another party to modify an existing contract where the performance of the contract was obstructed since it became more onerous for the aggrieved party. The concept established in the Civil Code is based on the concept of hardship established in Arts. 6.2.2 and 6.2.3 of the UNIDROIT principles. Thus, the UNIDROIT note on COVID-19 is also relevant for the analysis of this legal instrument.
The COVID-19 crisis itself should not always be a ground to request modification of the contract
While the concept of the modification of a contract upon a change of circumstances was not designed for situations when both parties are experiencing difficulties, it is likely that there will be many attempts to invoke it during the COVID-19 pandemic.
On one hand, in decisions adopted in the aftermath of the 2008-2010 Crisis, Lithuanian courts held that the setting of an economic crisis itself does not indicate that the equilibrium of the contract has been fundamentally altered, and that circumstances to invoke Art. 6.204 and to modify the contract occurred.
On the other hand, in previous decisions the courts have admitted that in some cases the impact of the economic crisis on the equilibrium of contractual obligations may be observed. In particular, the economic crisis may be considered a sufficient ground to modify financing agreements if it fundamentally alters the equilibrium of contractual obligations. For example, after the 2018-2010 Crisis, a credit market significantly changed, interest rates increased and debt servicing costs increased. According to the Lithuanian courts, such circumstances may be considered an obstruction of the performance of the financing agreement, partly excusing the borrower for the non-performance of contractual obligations. The same position is also indicated in the UNIDROIT note on COVID-19, stating that the hardship and a request to modify the contract upon a change of circumstances may under specific circumstances of the pandemic be invoked in cases when the performance was aggravated due to the increased costs of performance.
The change of circumstances does not automatically allow a borrower to suspend the performance of the contract
Obstruction of performance itself does not permit a borrower to unilaterally suspend the performance of obligations. A borrower that is unable to duly perform the agreement due to the obstructed performance of the contract should immediately after the occurrence of obstructions make a request to its lender for modification of the contract. A borrower who requested to modify the financing agreement must prove that it is possible to restore the equilibrium of contractual obligations and that a borrower will be able to continue performing the contract thereafter. However, if a borrower does not perform the contract properly after the request for modification or after the modification of the contract, a lender is not deterred from using other available remedies to protect its rights and interests.
A lender may deny a request to modify the contract, or request additional security
When renegotiating the relevant conditions of the financing agreement, a lender may request a borrower to provide additional security. Such demand should not by itself be considered unfair or contradictory to the principle of co-operation.
According to Lithuanian case law, a lender is not considered to be in breach of the principle of co-operation when denying a borrower’s request for modification of the contract in the following circumstances:
Upon failure to agree amicably on modification of the contract, each party is entitled to turn to the court
If the parties fail to agree on the modification of the contract within a reasonable period of time, any party is entitled to bring an action before the court requesting it to decide on the financing agreement (ie, to modify its conditions) or to terminate the agreement. The latter is unlikely to be applicable to financing agreements in reliance on Art. 6.204 of the Civil Code because, as a result of termination, a borrower would be placed at an even more disadvantageous situation than if continuing the agreement on its current terms. However, as discussed below, termination of the financing agreements is still possible as a lender’s remedy.
In Certain Cases a Lender may Terminate a Financing Agreement
In the context of the COVID-19 crisis, when a borrower requests modification of a contract, a lender may still legitimately terminate a financing agreement when a borrower breached it (eg, if a borrower is in payment default or in breach of financial and non-financial covenants, etc).
Modification of the contract prevails over termination of the contract
Under Lithuanian case law, concurrence between modification and termination of a contract should be resolved in favour of modification, unless after the modification the execution of a contract would still be too onerous for one of the parties and the lender would lose its interest in performance and in a result of the contract. Therefore, when a request is made to modify the conditions of the contract under Art. 6.204 of the Civil Code, it should first be decided whether all conditions necessary for the application of this article exist; only in their absence can the court decide to terminate the contract.
Grounds and procedure of termination established in the contract prevail over the provisions of the Civil Code
When analysing the grounds to terminate a financing agreement, the provisions of the contract itself should be considered at first. The contract may be unilaterally terminated on the grounds established in the contract, in which case a termination of the contract should be initiated and executed exclusively according to the conditions and procedure established in the contract. If the financing agreement is sufficiently vague regarding applicable events of default and causes of termination, then the financing agreement may still be terminated in accordance with the provisions of Art. 6.217 of the Civil Code upon proving that the borrower committed a fundamental breach of contract.
Clauses of Existing and Future Financing Agreements Should be Tailored in Accordance with the Circumstances of the COVID-19 Crisis
Since the future and the development of the COVID-19 virus are uncertain, and there are projections of the insurgence of new waves of the pandemic, it is important to consider tailoring existing or future financing agreements in light of COVID-19. The UNIDROIT note on COVID-19 suggests the establishment of more specific clauses or the modification of existing clauses, in a way that they would be more detailed or would deviate from the general rules that are established in general contract law in a manner facilitating or specifying the invocation of relevant legal instruments.