Be careful when you terminate a contract

In the current economic climate, there is growing interest in whether a contract can be cancelled, if one party is no longer able to fulfil its obligations due to financial difficulties.

A basic principle of contract law is that the contracting parties must perform their obligations with good faith and in a manner consistent with the contract. However, subject to this basic principle, a party to a contract that is subject to UAE law, can seek to end the contract in one of three ways:

1. it is declared null and void by a court
2. it is cancelled, terminated or rescinded
3. performance becomes oppressive or impossible.
4. Void contract

Article 210 of the Civil Code defines a void contract as follows:

“A void contract is one which is unlawful in its essence and form i.e. lacking the elements of a contract, or defective in its subject matter or purpose or form as laid down by the law, and is not capable of being rectified by consent.”

Accordingly, whether or not a contract is void is generally decided by the court. Either party to a contract may seek to have the contract declared void, either by bringing a claim before the competent court, or as a defence to a claim by the other party.

Also, a court may rule on its own motion that a contract is void. An example of this is the judgment passed by the Dubai Court of First Instance on 19 March 2009 in case no. 39/2009 in which the Court held the contract for sale of a property was void under Article 3 of Dubai Law 13 of 2008, under which a sale or other disposition that transfers or restricts title or any ancillary right is void if it is not recorded in the Register.

Cancelling a contract

Article 267 of the Civil Code provides that valid contracts are binding on the parties and no party can withdraw from, change or rescind the contract, unless by agreement or by an order of the court. So on what basis can a party to a contract obtain a court order for the cancellation of a contract? The Civil Code deals with this question in Articles 272 and 273.

Under Article 272, if one party to a contract does not do what it is obliged to do under the contract (the obligor), the other party may, after giving notice to the obligor, require the contract to be performed (specific performance) or cancelled. The court may order the obligor to perform the contract immediately or may defer performance to a specified date. The court may also order that the contract be cancelled and compensation paid if appropriate.

It is important to note that the court should order specific performance whenever possible.

In a recent case where Hadef & Partners acted for the seller of a property, the purchaser claimed cancellation of the contract and the refund of the advance payment. The Dubai Court rejected the case and accordingly the purchaser lost the advance payment he had made. The defence raised in this case was that the plaintiff was the defaulting party according to the terms of the contract as he had an obligation to redeem an existing mortgage over the property, which he failed to do. Our client’s obligation was only to transfer the title of the property into the purchaser’s name, which he showed the Court he was willing and able to do. In this case, the Court also made reference to the concept of good faith, as mentioned in Article 246 of the Civil Code. This implies a general duty to act reasonably and honestly and decently. Article 247, regarding reciprocity of breach of contract, may also be a relevant factor.

Oppressive or impossible to perform

Another consideration is the concept of exceptional circumstances of a public nature which render the performance of a contractual obligation unreasonably oppressive for one party. In such a case the oppressed party can approach the court with a claim to reduce the oppressive obligation to a reasonable level, in accordance with the provisions of Article 249 of the Civil Code. It is not possible to exclude the court’s power to vary the terms of a contract on this basis.

Surprisingly perhaps, this is a provision of the Civil Code that is not often relied upon by either party in litigation.

It is also possible for an event of force majeure to be a good ground for the suspension or termination of contractual obligations, as provided by Article 273 of the Civil Code. There is no definition of force majeure in the Civil Code, but it is generally accepted in the UAE to be limited to events that are unforeseeable, notably natural disasters such as earthquakes and floods and may extend to wars and civil unrest, depending on the circumstances.

An Egyptian court ruled the 1967 war between Israel and Egypt which closed the Suez Canal was not an event of force majeure on the grounds that it was well known at the time the contract was entered into that the state of war would soon be declared.

Although an economic recession may in itself be foreseeable and incapable of being a force majeure event, unless contractually agreed otherwise, there could be consequences flowing from an economic event which themselves could be considered to be unforeseeable force majeure, for example an inability to make a funds transfer on a payment date due to a particular bank or system collapsing.

Concluding thoughts

It is highly unlikely that the courts in the UAE would consider the global financial crisis to be an exceptional circumstance or an event of force majeure. Rather, it would be considered as a foreseeable economic risk which a contracting party should have factored in and addressed at the analysis and contract negotiation stage. However, all cases will also depend on the facts and other background.

Authors:

Omar Al Shaikh,

Michael Dark,