On 11/03/2020 the World Health Organization declared the COVID-19 disease pandemic, while on the same day the Croatian Minister of Health issued a Decision declaring the COVID-19 disease (the so-called “coronavirus”) epidemic in the entire Republic of Croatia.
The Civil Protection Headquarters of the Republic of Croatia (hereinafter: the Headquarters) adopted, on 19/03/2020. , a Decision on Measures to Limit Social Gatherings, Work in Commerce, Services and Organising Sports and Cultural Events (hereinafter: the Decision on Anti-Epidemic Measures), which, inter alia, ordered the avoidance of close personal contact and the suspension of work in trade activities.
After only a few days, and taking into account the consequences of the devastating earthquake that hit Zagreb early in the morning, on 22/03/2020, the Headquarters issued, on 23/03/2020, a Decision on Prohibition of Leaving the Place of Residence and Permanent Stay in the Republic of Croatia. This decision effectively prevented internal migrations in the Republic of Croatia that are not indispensable for the supply chain or prevention of the spread of the disease.
Given the spread of COVID-19 so far, more severe anti-epidemic measures in the Republic of Croatia can be expected in the upcoming period.
In such circumstances, it is impossible to maintain business activities at the usual level, and for businesses it is much more difficult to meet their obligations. This is especially true of the obligations arising from the lease of office space, which become questionable, especially given that office space is generally no longer used, and the work is conducted from home.
The question arises as to whether rent and other lease obligations must continue to be paid in such extraordinary circumstances and what options are available to businesses in their effort to reduce costs and mitigate the effects of the crisis.
Below are the answers to these questions that can be found in the provisions of the relevant regulations in force in the Republic of Croatia on 23/03/2020.
It should be noted that the application of these provisions depends on the circumstances of each individual case, so it is necessary to consider in each individual case all the circumstances of the case, and in particular what is stipulated under the lease agreement, since the parties are, in general, free to regulate their relationship differently from what is prescribed by law.
Are rents and other lease obligations payable in the coronavirus era?
The lease relations are governed by the Sale and Lease of Commercial Premises Act (Official Gazette 125/2011, 64/2015, 112/2018; hereinafter referred to as the SALCOPA) and, on the basis of the provision of Article 1, paragraph 5 of the SALCOPA, the lease relations that are not regulated under this act the general regulations of the obligations law apply, which is the Obligations Act (Official Gazette 35/2005, 41/2008, 125/2011, 78/2015, 29/2018; hereinafter: OBLIGA).
In principle, the Croatian legal system is based on the rule that contractual obligations must be fulfilled in a timely and complete manner (lat. “pacta sunt servanda”). However, at the same time, the legal framework provides for certain exceptions to this rule in the case of extraordinary circumstances, such as the COVID-19 pandemic.
Specifically, although the SALCOPA does not specifically regulate how exceptional circumstances such as the situation caused by the COVID-19 pandemic affect the payment of rent and other obligations, the lessee has the possibility to invoke certain provisions of the OBLIGA to reduce its obligations or to cause termination of the contract; depending on whether the fulfilment of his obligations has become excessively difficult, or whether the fulfilment of his obligations has become impossible in whole or in part.
In case the fulfilment of the obligations of the lessee did not become impossible, but became excessively difficult:
Thus, the provision of Article 369 (1) of OBLIGA provides that if, due to extraordinary circumstances arising after the conclusion of the contract, which could not have been foreseen at the time of the conclusion of the contract, the fulfilment of the obligation for one contracting party would become excessively difficult or cause it to incur an excessively heavy loss, the lessee may require from the lessor that the contract be modified or even terminated.
This is the so-called “clause of altered circumstances” (lat. “clausula rebus sic stantibus”) that can only be applied to liabilities that have not yet matured; meaning only to future rents and other obligations and it cannot be invoked by a lessee who entered into a lease after the COVID-19 pandemic, 19; when he could already have considered the circumstances of the pandemic or could have avoided or overcome them.
In addition, the right to terminate or amend the contract is allowed only when there is a substantial and serious loss or significant and hard difficulty in fulfilment of obligations, and in no way does it apply to a loss of a smaller extent or to a minor level of difficulty in fulfilment.
Therefore, whether the prerequisites for the application of the provision under Article 369 (1) of the OBLIGA have been met should be determined on a case-by-case basis and considering all the lessee’s circumstances. This provision could not be applied to businesses whose operations have not been significantly affected by the anti-epidemic measures and suffer losses to a lesser extent or suffer lesser extent of difficulties in fulfilment of their obligations, respectively.
Consequently, it is clear from the legal formulation itself that in the case of the COVID-19 pandemic, this provision can be applied to the largest number of lessees since the largest number of SMEs are significantly affected by anti-epidemic measures and their operations are significantly impeded. Affected lessees, depending on their circumstances, may ask the lessor to modify or even terminate the lease.
However, it also needs to be noted that the risks involved in invoking this provision are greater. This primarily so because several years may pass before the Court renders a decision in the matter and during this time the contract would be fully effective and the lessee would still be obliged to continue to pay the full amount of the rent and other obligations for the entire duration of the contract. The lessee could petition the court for an interim measure under which the lessee would be freed from paying the lease fees and other obligations during the litigation. However, in order to do this, the lessee would need to make probable the exsistence of his claim as well as the irreparability of the threatening damages due to the continuance of payment of the obligation under the lease contract, or other prerequisites prescribed under the Execution Act, respectively.
Also, the requested termination can be prevented by the lessor by offering or agreeing to amend the relevant provisions of the contract fairly.
In the event that the lessor accepts the proposed contract amendments or termination, the respective annex to the contract or the termination of the contract should be executed, under which the contractual parties may regulate all the terms of the further contractual relationship (eg. reduced rent, exemption from payment of rent during the pandemic, exemption from payment of the costs during the pandemic, postponement of payment of obligations, etc.) or all the consequences of the termination of the contract (e.g. notice period, amount of rent during the termination period, manner and time of handover of business premises, etc.).
It is our opinion that invoking the altered circumstances and submitting a written request to the lessor that the lease agreement should be appropriately amended (or terminated) is, in any case, the first step that each lessee can make towards the lessor in order to establish the lessor’s initial position in the newly arisen situation. Namely, what are the business interests and intentions of the lessor, what are the possibilities of the lessor to release the lessee from the payment of the rent and/or other lease obligations for the time being, under what conditions it would be acceptable for the lessor to continue or terminate the lease, etc.
In the formal letter that the lessee drafts for the lessor, the lessee can also refer to the basic principles of contractual relations: the obligation to cooperate in the fulfilment of obligations, the prohibition of the abuse of rights, the prohibition of causing harm, etc. Also, if the contract is to be amended, it can be emphasised that if the contract is not properly amended, this could only jeopardise the lessees business and thus the future payment of any amount of the rent; since the circumstances in which the lessee’s fulfilment of the obligations would become impossible in whole or in part might occur.
In case the lessee becomes completely unable to fulfil the lease obligations:
The provision of Article 343 of OBLIGA provides that the debtor shall be released from a liability for damage if he proves that he could not fulfil his obligation, or that he was late in fulfilling his obligation due to external, extraordinary and unforeseeable circumstances arising after the conclusion of the contract which he could not prevent, eliminate or avoid (the so-called “force majeure”).
The consequences of not being able to fulfil the obligations by one contractual party in a bilateral contract, such as a lease agreement, are regulated under Article 373 (1) of the OBLIGA, by which then the obligation of the other contracting party (i.e. the lessor) is then extinguished; whereas the party that has fulfilled its obligation may require repayment under the rules of restitution of what has been acquired without a basis.
According to the legal view taken in the legal theory, and in jurisprudence of the Supreme Court of the Republic of Croatia, the contract in this case ceases to exist by the virtue of law. This means that the contract is terminated by the mere inability to fulfil obligations due to force majeure, so the lessor would not be able to claim rent and other obligations under the contract from that point onwards.
In other words, if the lessee invokes the total impossibility of fulfilment of the obligations due to force majeure and the termination of the lease contract in accordance with the provision of Article 373 (1) of the OBLIGA, his obligation to pay the rent and other obligations under the lease contract would maturing after the impossibility of fulfilment has occurred due to force majeure would be extinguished.
However, as with the altered circumstances clause, the lessee must not be in arrears, that is, his obligations under the lease contract must not be due before the impossibility of fulfilment due to force majeure has occurred.
Although the assessment of the occurrence of circumstances of the impossibility to fulfil obligations due to force majeure depends on a case-by-case basis, regarding the COVID-19 pandemic it could be argued that the above could apply to all obligations maturing after 11/03/2020, given that on this date a COVID-19 pandemic has been declared worldwide, together with an epidemic in the Republic of Croatia.
However, this largely depends on the business activities that a particular lessee performs and its business circumstances at the time of the adoption of certain anti-epidemic measures, as well as the impact of those anti-epidemic measures on the lessee’s business, and it is more likely that the inability to fulfil obligations due to the COVID-19 pandemic occurred later, after the pandemic had already left significant negative effects on the lessee’s business, i.e. after a month or two after the regular business operations have been discontinued.
Also, the lessee should be prepared and immediately invite the lessor to take the business premises back into his possession, in order to avoid possible lessors demands for the use of the business premises without a legal basis.
It should be noted that in a possible dispute, the lessee would have to prove that it was impossible for him to fulfil the obligations arising from the lease, and the occurrence of force majeure in relation to him. In other words, if the decision on anti-epidemic measures, as well as the subsequent decisions of the Headquarters aimed at combating the epidemic, did not significantly affect the business of the business entity and if, even in the circumstances of the pandemic, it was objectively not prevented from fulfilling its obligations, the lessee would hardly justify the failure to fulfil its obligations by invoking force majeure.
In conclusion, this legal route is appropriate for those business entities that, at the time of the COVID-19 pandemic, did not have any reserves to pay for the lease costs or had exhausted them in the meantime, which made it impossible for them to fulfil these obligations; whereas they may continue to operate in another manner (by working from home, etc.) and renting office space is not necessary for them to continue working.
In doing so, they should suspend work in the leased premises as soon as possible, informing the lessor as soon as possible and inviting him to take back the premises.
In case the lessee has become partially unable to fulfill the lease obligations:
The provision of Article 373 (2) ZOO provides for the consequences of the partial inability to fulfil the obligations of the lessee. If the lessee can only partially meet his obligations under the lease agreement, the provision gives the lessor the right to terminate the contract if the partial fulfilment does not meet his needs. Otherwise, the contract remains in effect and the lessor has the right to demand only a proportionate reduction of his obligations.
In this case, the lessee would also have to prove that fulfilment of the obligation partially became impossible due to force majeure. On the other hand, if the lessor wishes to terminate the contract, he would have to prove that partial fulfilment does not meet his needs.
Also, if the lessor would accept partial fulfilment without terminating the contract or retaining that right (e.g. receiving part of the lease fee and not informing the lessee that he reserves the right to terminate the contract), he would only have the right to demand that his obligation be reduced proportionately. In other words, in that case, the lessor could request, for example, to limit the number of leased premises given the reduced rent received and the like.
This legal path is appropriate for those lessees in respect of whom there has been an objective inability to fulfil the obligations under the lease agreement in part of those obligations, and who need at least part of the business premises they had leased under the lease agreement with the same lessor to continue to operate; whether it be multiple separate business premises in different locations, or business premises that can be appropriately separated and further leased in the same location.
In this case too, it should be determined whether all of the lessee’s circumstances justify the partial fulfilment of obligations and at what exact moment these circumstances have emerged; making the fulfilment of the obligations partially impossible due to the COVID-19 pandemic.
What are the possible consequences of not paying the lease fee and other obligations under a lease agreement?
Pursuant to Article 26, Paragraph 1, Item 2 of the SALCOPA, the Lessor may terminate the lease at any time, regardless of the contractual or legal provisions on the duration of the lease, if the lessee fails to pay the due lease fee within fifteen days upon reception of the lessor’s written notice to do so. Furthermore, a lease agreement for business premises executed for a fixed or indefinite period of time may be terminated by any contracting party at any time, if the other contracting party fails to fulfil its obligations established by the contract or the SALCOPA.
Therefore, by not paying the rent and other obligations arising from the lease agreement, the lessee is exposed to the possible termination of the lease agreement, the enforcement of claims in arrears under the lease and the eviction from the leased premises.
In order to determine what exactly are the consequences of the termination of the lease agreement, what obligations and to what extent are they still charging the lessee and what are the deadlines for possible eviction from the premises, it is necessary to first examine the provisions of the lease itself, and then the relevant provisions of the SALCOPA and the OBLIGA.
It should be briefly pointed out that Article 20 of the SALCOPA prescribes the obligation of the lessee to, after termination of the lease, hand over the premises to the lessor in the condition in which he received it (unless otherwise agreed); whereas the termination deadline, pursuant to the provision under Article 24 of the SALCOPA is 30 days from the date of receipt of the termination notice upon the expiration of which the lease agreement ends.
In other words, in the event that nothing else has been agreed upon, the lessee is obliged to hand over the premises to the lessor in the condition in which he received it within 30 days from the day on which the lessor informed him of the cancellation.
Can the issuance of measures and/or amendments to the regulations by the state authorities be expected in order to facilitate the business activities of business entities leasing office space in the wake of the COVID-19 pandemic?
The Government of the Republic of Croatia has so far taken some measures; namely:
- on 17/03/2020 the Decision of the Government of the Republic of Croatia on Deferral of Payment of Rent, Fees for Long-Term Lease, Fees for Long-Term Lease for Ponds, Concession Fees and Compensation for Temporary Use for Agricultural Land Owned by the Republic of Croatia, under which the lessees and users of said lands and ponds owned by the Republic of Croatia obligations to pay the agreed rent or usage fee for 2020 have been deferred for three months; starting from 01/03/2020;
- on 18/03/2020 a Decision of the Ministry of State Property on Deferral of Payment of Rent and Usage Fees for Business Premises, Commercial Buildings, Hotels and Other Tourist Accommodation Facilities has been adopted, under which the obligations to pay the agreed rent or usage fee for 2020 to lessees and users of the said facilities owned by the Republic of Croatia has been deferred for three months; starting from 01/03/2020.
Also, certain units of local and regional self-government (such as the City of Zagreb) have enacted measures in order to relieve the businessmen of paying rents and/or utility fees and other costs, or delaying their payment.
Whether there will be further amendments in legislation and/or additional measures to make it easier to bear the costs of rent and other lease obligations can only be speculated, so it is opportune to follow the websites of local and regional self-government and other state authorities for the latest information.
Businesses whose business is significantly affected by the circumstances surrounding the COVID-19 pandemic and may find it difficult or impossible to settle their lease obligations, depending on their circumstances and the impact of extraordinary circumstances on their business, may:
- propose to the lessor the conclusion of an appropriate annex to the lease agreement, which would appropriately amend the lease provisions to take account of the reduced needs of the tenant and the extraordinary circumstances affecting his business; or
- propose to the lessor the execution of a contractual termination of the lease agreement, which would regulate all the consequences of termination of the lease agreement, including the possible duration of the termination period, payment of rents for the duration of the termination period, etc .; or
- inform the lessor that extraordinary circumstances have arisen which make further fulfillment of the obligations under the lease contract impossible for the lessee and invite the lessor to take possession of the premises without delay; or
- inform the lessor that extraordinary circumstances have arisen which make further fulfillment of the obligations under the lease contract partially impossible for the lessee and continue to pay the reduced amount of the lease and other obligations under the lease agreement, and possibly invite the lessor to take over part of the premises that the lessee no longer uses into possession.
For any additional information regarding the measures taken by the Government of the Republic of Croatia, current news, anti-epidemic measures and relevant facts, we suggest visiting the website: https://www.koronavirus.hr/.