The World Health Organization (WHO) declared the outbreak of COVID-19 as a Public Health Emergency of international concern on January 30, 2020. On March 11, the WHO declared COVID-19 as a pandemic. On March 30, the Mexican Health Department declared the pandemic to be a nationwide Public Health Emergency caused by a Force Majeure. The following day, the entire country was essentially put on lockdown, save certain essential activities and industries. Construction (not among the list of essential activities) came to a halt across the country, and hotels, resorts, restaurants, bars, shopping malls, beauty salons, gyms, and all but a shortlist of businesses deemed essential, shuttered. Likewise, the US government has restricted border crossings to essential travel only and airlines canceled approximately 95% if international flights to and from Mexico. Only recently, has Mexico begun to partially re-open, although the virus remains rampant in the country, especially in Mexico City.
As the number of cases rose and governments took further action to contain the spread of the virus, businesses across Mexico and the globe have been disrupted and transactions halted.
Lease agreements and real estate contracts have been an area particularly impacted by the pandemic and governmental restrictions.
This has raised the question, what are the rights and obligations of the parties to a contract that has been impacted by the pandemic and/or governmental action in response to it?
Can a commercial lessee legally stop paying rent if the government ordered the business shut down? What if the entire mall is shut down, thereby making it physically impossible for the lessee to access the locale? What if the government order, such as the one in Baja California sur, says citizens can be arrested if they leave their homes to do anything other than essential activities? Does that mean the lessee, who is legally prohibited from leaving his or her home to use the locale, can say the performance (I.e., the obligation to pay rent) is excused? What if the restaurant is allowed to remain open but only for takeout? While performance is not impossible, is it impracticable? Has the purpose of the lease be frustrated?
Lease Possible Scenarios
As mentioned above, on March 30, the Mexican Health Department declared the pandemic to be a nationwide Public Health Emergency caused by a Force Majeure, dividing commercial activities into essential and nonessential, and forcing the latter to shut down.
Furthermore, some local governments such as Baja California Sur, have restricted freedom of movement, implying that citizens can be arrested if they leave their homes to do anything other than essential activities. The mentioned decrees give place to three different scenarios:
- You run a commercial business considered as an essential activity, then you are free to use the rented property normally and you are expected to be able to comply with your payment obligations.
- You run a commercial business considered as an essential activity, but due to the circumstances you are not allowed to exploit the property as stated in the agreement terms, i.e. restaurants that still working but only in a home delivery basis, you might wonder if you are entitled to request a drop in your payment obligations.
- You run a commercial business considered as a nonessential activity, the current situation represents a legal, and in some States as BCS even a physical inability to use the rented property, henceforth you are looking for a way to be released from your payment obligations.
Identify your problems and options
The first issue is to review the clauses contained in the contract with special attention to whether it contains an express force majeure provision or it adopted the “unforeseeability theory” (in Spanish, teoría de la improvisión; or in Latin, Rebuc sic stantibus). The charts below explain the scope and differences of each one.
It is defined as an extraordinary event beyond the control of the parties, impossible to predict or when predictable, impossible to avoid that physically prevents the obligor from fulfilling its obligations.
It is not considered as a reason to terminate a contact but as an exclusion of liability.
- An extraordinary event beyond the control of the parties.
- Physical prevention of the obligor from fulfilling its obligations. Not being enough that it turns to be harder, more expensive, or unequal. Exclusion of liability of the party in default.
It is commonly included in the wording of the contract.
Even if not contained, parties can appeal to it since it appears in the federal and all local Civil Codes.
The parties are free to develop and wide the Force Majeure concept to include specific situations.
It implies that the stipulations of the contracts can be modified in the event of substantial alterations to the conditions and circumstances under which they were first agreed upon, making it more expensive for one party to comply.
It allows the parties to modify their obligations or terminate the contract in case the circumstances change.
- The unpredictability of an extraordinary event
- Increase of burdensome for one party
- Right of such party to request the restoration of balance
It is rarely contained in the wording of the contract.
It does not appear in the Federal Code and cannot be invoked unless it is expressly contained in the State Civil Code.
Mexico City, Guerrero and Quintana Roo Codes do contain this clause, BCS does not.
As illustrated in the flowchart below, once the problem constitutes physical impossibility, force majeure might apply notwithstanding the lack of an express contractual provision or if the scope of the provision does not contemplate the specific force majeure circumstance. The important question is if the circumstances at hand (I.e., inability or impracticability of performance due to COVID-19 or the resulting governmental orders shutting down the economy) amount to force majeure, the answer to which requires the application of the following 3-part test to identify a force majeure event:
- Is it an extraordinary event beyond the control of the parties?
- Is it impossible to avoid it?
- Is it physically preventing the obligor from fulfilling its obligations? Not being enough that it turns to be harder, more expensive, or unequal.
On the other hand, when an obligor has a monetary impossibility to comply due to a change in the circumstances that existed when the contract was executed, some particular states adopted the “unforseeability theory” (in Spanish, teoria de la imprevision; or in Latin, Rebuc sic stantibus) to their civil codes or contract law jurisprudence. Indeed, for common law lawyers, the teoria de la imprevision is akin to the doctrines of frustration of purpose and impracticability of performance due to unforeseen circumstances. We will further analyze the specific requirements and limitations of this doctrine below.
- The March 30 decree, published by Mexican Health Department counts for an extraordinary event beyond the control of the parties
- Such decree is binding for all citizens, so impossible for the parties to avoid
- Physically impossible for tenants to benefit from the property in the terms stated in the commercial lease
The tenant might indeed be capable to access to the rented property but not to achieve the purpose of the contract. Furthermore, for the lessee of rustic land, the federal code entitles the tenant to request a drop in the rent because of the loss of half of the proceeds due to a force majeure. Meaning that code recognizes the economic end of the commercial contracts.
Regarding any other sort of contract different than lease, even if there is not a special treatment stated by the law, the party facing physical prevention to comply is in the possibility to default her obligations without the burden of penalty payment, as long as all the requirements for the Force Majeure clause are met.
- Within the first 30 days after the extraordinary event appears, the affected party has the right to request the modification of the contract indicating her reasons to do so.
a. This request per se does not allow the party to default her obligations
2. After the reception of the request, the parties have 30 days to agree.
3. In the absence of such an agreement, the affected party has the right to bring the case before a judge, within the first 30 days.
a. If the judge determines that the clause applies to the specific matter, the decision on either terminate the contract or modify its terms is on the defendant
b. The modifications, either agreed or impost by the judge, cannot apply to obligations due to date before to the emergence of such an extraordinary event.
- In a broad sense, if your contract, any sort of civil contract, belongs to the jurisdiction of Mexico City, Quintana Roo, or Guerrero 5 you can invoke this clause.
- This article does not apply for commercial contracts.
- Real Estate agreements, such as leases and purchase and sale agreement, are considered civil contracts with an exception:
o For sale and purchase agreements where a seller is a person dedicated to the sale of real estate, such a contract will be deemed to have a “mixed nature”, being considered as a commercial contract for the seller, while seemed like a civil contract for the buyer.
NOW , WHAT IF THE CONTRACT DOES NOT BELONG TO SAID JURISDICTIONS, AS IS THE CASE OF BCS?
At this point is important to acknowledge that the sources for the Mexican Legal System are the following, in such order:
- The exact wording of the law,
- The interpretation of the law,
- Doctrine (legal principles, including the clauses mentioned herein)
Henceforth, the affected party coming from a state that does not contain the Rebuc sic stantibus article is entitled to demand her rights before a judge, notwithstanding that Mexican judges have shown reluctance to its applicability.
• Try to pacifically negotiate with your counterparty
• Explore alternative ways to perform
• If performance was impossible or delayed, keep documentary records
Rosen Law will continue to monitor the provisions issued by the Mexican Federal Government and updating any legal implications due to COVID-19 emergency.
1 See art. 2111 for the Federal Civil Code, art. 2111 for Mexico City Civil Code, art. 2335 for BCS Civil Code, art. 2712 for QR Civil Code and art. 2397 for Guerrero Civil Code
3 See art. 378 of Quintana Roo Civil Code
4 See art. 2012 of Guerrero Civil Code
By Daniela Velázquez