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Covid-19 in the fashion and retail chain: impacts on contracts and solutions

Covid-19 in the fashion and retail chain: impacts on contracts and solutions

3/27/2020

Considered one of the most powerful global industries, fashion brings together particularities that make it one of the most economically vulnerable sectors affected by the Covid-19 pandemic. 

 The fashion industry is heavily dependent on contracts signed with companies based in countries that are at the epicenter of the pandemic, such as China and Italy, in addition to other important countries such as the United States, France, England and Japan, true catwalks and showcases of what the world will consume next season. 

 In addition, products are usually manufactured and marketed according to seasonality, originality and trends, particularly in the fast fashion industry, which business model has been established and widely adopted by major retail chains in the last decade. The success of this business model occurs precisely in the rapid and continuous production of parts and supply in physical stores and online collections, weekly or even daily.  

 Covid-19 has hit the fashion industry hard, from design and conception to offering products on racks at the point of sale. 

 Faced with an unprecedented scenario, with determinations of social isolation, quarantine and suspension of activities of factories, shopping malls and commerce, cancellation of events, conferences, fairs, trips, significant reduction in the flow of international trade and canceled imports, the global losses projected for the year 2020 is in the tens of billions, with the sharp drop in consumption. [1] 

 It is true that the preservation of public health and containment of the expansion of the virus through the measures of social isolation recommended by the World Health Organization are fundamental at this moment for the containment of the pandemic and are being observed by many countries and by the agents of the industry. 

 

Global chain and emergency packages 

 

However, it is important to keep in mind that the production chain of the fashion and retail industry contains links that are being impacted on a global scale. It is likely that, even after the reopening of shopping malls and commerce as a whole, it still takes time for factories to start producing again and stores to be adequately supplied. In the same way, consumers will need extra breath to recover from the spiral caused by the pandemic and return to the pace of consumption as before. Not to mention the economic uncertainties that follow into recession and the prospect of deceleration, which was already outlined in the main reports and specialized indicators for the fashion sector [2]. 

 Unfortunately, there is no prospect of normalizing activities and consumption in the near future.

 Therefore, it is essential that the Government and agents discuss emergency packages that include, for example, the temporary suspension of taxes and collection of interest; financial aid, access to low-cost credit and through simplified or expeditious procedures, measures that make it possible to preserve employment and support for self-employed workers who are also part of the fashion economy. Specifically in a sector of activities as globalized as that of fashion, it is also necessary to analyze the easing of tariff and non-tariff barriers in facing the effects of Covid-19, as well as alternatives for supplying the domestic market. 

 Given the evolution of the pandemic in different regions of the globe until it reached Brazil, concrete legal questions arise and are felt by companies in Brazil. These are issues that result from the modification of the material conditions for the execution of current contracts and the interrelationship between agents, such as, for example, in the different and successive links in the chain – supply, import, distribution, logistics, purchase and sale, franchises. 

 

Application of unforeseeable circumstances or force majeure 

 

In Brazil, it is questioned whether Covid-19 can be invoked as force majeure as an exclusion of liability. The Brazilian Civil Code establishes, in its article 393: 

 Art. 393. The debtor is not liable for damages resulting from unforeseeable circumstances or force majeure, if expressly not responsible for them. 

 Single paragraph. The unforeseeable circumstances or force majeure occurs in the necessary fact, the effects of which it was not possible to avoid or prevent. 

 In a quick analysis and, taking the State of São Paulo as an example, we have the following normative context in relation to the confrontation of COVID-19, which reinforces the inevitability of the event and the impediment in achieving the obligation assumed and not fulfilled by force of the pandemic (for example, in the case of stoppage of industrial activity, closure of shopping centers and commerce, among others): 

 

  1. Federal Law no 13,979 / 20, which provided for measures to deal with the aforementioned emergency, included quarantine (art. 2, II), which covers the “restriction of activities […] in order to avoid possible contamination or spread of the coronavirus ”; 
  2. the decree, by the National Congress, of a state of public calamity (Legislative Decree nº 06/2020); 
  3. Decree No. 10,282 / 2020, which determines public services and essential activities that need to remain operational and accessible, including to support the population in combating Covid-19; 
  4. Decree nº 64.879 / 20, which recognizes the state of public calamity resulting from the COVID-19 pandemic in the State of São Paulo and which suspends activities of a non-essential nature in the respective areas; 

 

It is important to note, however, that the exclusion of liability based on the occurrence of unforeseeable circumstances or force majeure must be analyzed on a case-by-case basis, considering the particularities of the contract and the context of its execution. In addition, it should be noted whether there is some formal requirement to be met based on the contract – for example, minimum notice. 

 It is also necessary to take into account the effect of the declaration of the occurrence of a case or force majeure, which may be the suspension of the obligation and exclusion of liability for the duration of the pandemic or, in the limit, depending on the contract and the unfulfilled obligation. , the termination and termination of the contract may result. 

 There is also a risk that the other party will not consider the occurrence of a force majeure event and, in this case, determine compliance with the obligation, under penalty of default of the contract. This aspect could have serious consequences, particularly the early maturity of the debt, the triggering of a crossdefault, a fine, termination of the contract, etc., which would also affect other stakeholders. 

 In the globalized supply chain of the fashion industry and the consequent signing of international contracts, the possibility of resorting to unforeseeable circumstances and force majeure will depend on the legislation applicable to each contract. In addition, the multiplicity of players and links along this chain may give rise to the application of different national laws, where different results can be observed [3]. The companies, therefore, will have to analyze the specific situations and the hypothesis of force majeure according to the law applicable to the contract. 

 

Contract review 

 In Brazil, other alternatives can be invoked to regulate situations of contractual imbalance, as provided for in the Brazilian Civil Code, in article 317 (maintenance of the contractual balance determined in court) and in articles 478 and 479 (excessive burden). In the face of extraordinary and unpredictable events, the termination or revision of the contract can occur if the obligation of one of the parties becomes excessively burdensome, with extreme advantage for the other. The contract can be canceled or the obligations originally foreseen can be changed through judicial intervention. 

 Brazilian jurisprudence has been strict, in business contracts, regarding the characterization of the requirements indicated above. In this context, several claims of excessive burdens were denied due to inflationary peaks or abrupt devaluation of the currency, given the understanding that such circumstances are predictable in our economy. 

 Our courts have granted the contractual review only in extreme cases, in which the breach of the financial-economic balance of the contract or a substantial change in the original economic bases is demonstrated. Under the Economic Freedom Act, this aspect was reinforced, with the inclusion of an express provision in the Civil Code that “the contractual review will only occur in an exceptional and limited manner”. 

 Obviously, Brazilian courts have never faced the challenge of removing penalties or revising contractual clauses on the scale that the Covid-19 pandemic indicates. This is an absolutely unprecedented factual situation. On the other hand, the application of force majeure institutes or excessive costs will depend on the analysis of each contract, as well as the consideration of the underlying circumstances for the possible reallocation of risks. 

 In this respect, the particularities of the fashion industry are extremely relevant to the disentangling of the issues that today arise with closed malls, paralyzed factories, lack of inputs for production, suspension and retention of goods in transit, threatened jobs, delays and suspension of payments, precipitous and abrupt drop in consumption, difficulties in paying royalties for licenses of IP rights, especially trademarks, in licensing and franchise agreements, and so on. A detailed analysis of the entire sector will be necessary, so that all implications of the production, distribution and sales chain are considered. The moment will demand a lot of attention from economic agents, lawyers and judges. 

 

Mediation is the solution 

 

Ideally, however, the sector itself will have full incentives and conditions to seek out-of-court solutions. Among them, mediations between the different players in this market stand out, often represented by the competent associations and their respective advisors. Mediation strategies facilitate interlocution between parties, minimize the judicialization of issues, prevent the flow of mass litigation to the already overwhelmed Judiciary and reestablish commercial relations. This interaction involves, for example: 

 

  1. the renegotiation of existing contracts 
  2. shortage and adaptation of contract execution schedules and deadlines for payment of suppliers and contractors 
  3. measures for preservation and gradual stock dilution 
  4. reprogramming of retail, logistics / transportation activities and scheduling shipments to customers 

 

Regardless of the theory of supervening impeding facts that may be applied, it is worth remembering the necessary application of the institute of objective good faith, also expressly provided for in the Civil Code. In this sense, shopping malls, retailers, franchises and other economic agents in the fashion industry should always act with transparency and keep the communication channels open, with interaction efforts proportional to their respective economic sizes. It is recommended that large companies and associations keep crisis committees active until economic activities are normalized. Franchisors, on the other hand, must pay attention to the fiduciary character before franchisees, so that they cannot be subsequently sued also for failure to comply with loyalty and good faith duties, in addition to the issues raised above. 

 Although challenging, it is possible to affirm, based on the consistent development of the sector in the last decades, that the business solution pointed out here is perfectly feasible, considering the maturity and sophistication of the fashion industry in Brazil. 

 L.O. Baptista Advogados is available to guide players in the field in facing the challenges imposed by the Covid-19 pandemic. 

 

[1]https://www.businessoffashion.com/articles/news-analysis/luxury-braces-for-43-billion-in-losses-as-coronavirus-panic-goes-global
[2]Ver, por exemplo,McKinsey Global Fashion Index (MGFI); available  here.
[3]Specific exceptions are also contemplated in the case of contracts governed by the CISG, in light of the provisions of, for example, Article 79 of the Convention, in force in Brazil under Decree no. 8327/2014.

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