China – Special Series Regarding The Legal Impact Of The COVID-19 Epidemic On The Real Estate Industry – Topic One – The Impact Of The COVID-19 Epidemic On The Sale Of Commodity Housing.

20 March, 2020

 

Editor's Note: This is an overview of the Special Series regarding the Legal Impact of the COVID-19 Epidemic on the Real Estate Industry

 

1. Background of the Special Series 

 

In January, 2020, an outbreak of pneumonia caused by a new type of coronavirus, the 2019 Novel Coronavirus Disease Epidemic (hereinafter referred to as the “COVID-19” or “COVID-19 Epidemic”),   spread like wildfire throughout China. Within a short period of time, various administrative measures were introduced by local governments requiring housing construction projects to postpone the resumption of work or the start of new housing construction. Commercial sales centers have been closed and some cities have even been locked down in order to control the spread of the COVID-19. As people reduce their spending and consumption, the income of hotels, shops, restaurants, and other commercial places has dropped sharply, creating a heavy rental burden for these companies. To reduce the effect of the COVID-19 Epidemic, some property management companies have blocked off their neighborhoods to restrict the entry and access of people into the areas. 

 

The COVID-19 Epidemic has had a significant influence on the real estate industry, especially on the sale of real estate, construction, housing rental, and real estate management.  

 

2. Composition of the Special Series

 

This Special Series consists of four topics:

 

• Impact of the COVID-19 Epidemic on the Sales of Commodity housing

• Impact of the COVID-19 Epidemic on the performance of construction contracts

• Impact of the COVID-19 Epidemic on the performance of leasing contacts

• Impact of the COVID-19 Epidemic on property management 

 

We will add other relevant topics to respond to people’s concerns if the impact of the COVID-19 Epidemic increases.

 

3. Purpose of the Special Series

 

It is our hope that these articles will be useful for real estate development companies, housing rental companies, and property management companies who have suffered from the COVID-19 Epidemic.

 

Editors: Ms. Yu Xueping and Mr. Li Haifu

 

Main Text

 

1. Whether a Developer is liable for breach of contract if it cannot deliver a house on time due to the COVID-19 Epidemic

 

Due to the COVID-19 Epidemic, the national government has extended the Spring Festival Holiday this year to last until February 3, 2020. Following this national policy, many provinces and cities have also adopted regulations regarding the delay in the resumption of work.  In Beijing, regulations were adopted to require all housing and municipal infrastructure projects in the city to resume construction only after February 9, 2020. Meanwhile, in Shanghai, Chongqing, Guangdong, Fujian, Yunnan, Zhejiang, Jiangsu, Jilin, Hebei, Henan, Heilongjiang, Guizhou, Shandong, Hubei, Jiangxi, Anhui, and Inner Mongolia, companies that do not carry out activities involving important national welfare and people's livelihoods are only required to resume work after February 9, 2020. On the other hand, Tianjin has required companies to stop all construction projects until further notice.

 

As the amount of confirmed cases has continued to increase, many districts have implemented stricter measures to limit population movement, even to the extent of blocking off certain communities or villages.   

 

Under the circumstances mentioned above, mainly due to the delay in the resumption of construction work, many developers have found difficulties in delivering houses on schedule. Thus, it is worth to discuss whether the developer can claim an exemption from liability for the breach of contract arising from a delayed delivery due to the COVID-19 Epidemic.  

 

(1) Situation I: The time of delivery agreed in the contract is later than the start of the outbreak of the COVID-19 Epidemic and the adoption of relevant controlling measures

 

(i) If there is a valid agreement, the parties shall perform the contract as agreed 

 

In practice, many developers see epidemics, major public health events, universal epidemic diseases, governmental policies and decrees relating to construction as force majeure events, or at least situations where developers are specifically entitled to postpone the time of delivery as agreed upon in their sales contracts.  

 

Thus, based on the principle of autonomy of will, sellers and purchasers can enjoy and undertake the rights and obligations to postpone the time of delivery as agreed upon in their contracts if it is valid.

 

(ii) If there is no valid agreement, developers can apply for a force majeure or use the principle of change of circumstances. However, the legal consequences and outcome of such a declaration will be determined on a case-by-case basis 

 

A. Force majeure

 

According to Article 117 of the Contract Law of the People's Republic of China (hereinafter referred to as “the Contract Law”) and Article 180 of the General Rules of Civil Law of the People’s Republic of China (“the General Rules”), force majeure is defined as situations that are objectively seen to be unforeseeable, unavoidable and unconquerable. No civil liability will be borne in the case of failure to perform civil duties due to force majeure.

 

According to these regulations, developers should be able to claim for an exemption from liability for the breach of contract due to the COVID-19 Epidemic if it satisfies these three tests: it has to be unforeseeable, unavoidable and unconquerable. There must also be a causal relationship between the delayed delivery of the house and the COVID-19 Epidemic. Thus, to determine the applicability of the principle of force majeure and the legal consequences of applying it for a specific case, the following factors should be taken into consideration:

 

(a) Time of execution of the sales contract 

 

As the COVID-19 Epidemic developed in phases, developers would satisfy the ‘unforeseeable’1 test only if the developer, based on the technology at the time, could not foresee the influence of the COVID-19 Epidemic when it entered into the sales contract.

 

Although the Wuhan Municipal Health Commission (“WMHC”) had made the Announcement of the Current Situation of the Pneumonia Epidemic in Wuhan2 on 31 December 2019, the WMHC had also stated that there had been no obvious signs that the disease could be transmitted from human to human, meaning that further spread could be prevented and controlled. Therefore, the announcement did not draw people’s attention to the COVID-19 Epidemic and the public remained unaware of it. This changed on January 20, 2020 when the media reported that Academician Zhong Nanshan had confirmed that the novel coronavirus could be transmitted from human to human, which resulted in more and more people understanding and being aware of it. Therefore, it can be concluded that the COVID-19 Epidemic was unforeseeable for developers that entered into sales contracts before January 20, 2020.

 

Since January 20, 2020, national and local governments started to adopt various policies to control the COVID-19 Epidemic, including the initiation of first or second-level public health emergency responses, traffic control measures, extension of the Spring Festival Holiday, delays in the resumption of work and so on. These control policies were adopted at different times in different districts, with varying levels of policy enforcement across provinces and cities. Moreover, these policies were implemented during the Spring Festival Holiday. Therefore, not all developers are taken to have foreseen the influence of the COVID-19 Epidemic on the delivery of houses after January 20, 2020. The specific policies and the time that such policies were adopted should be taken into consideration before deciding whether this issue was foreseeable for a certain case.  

 

One example would be in Shenyang Xinzhongcheng Real Estate Development Co., Ltd. (“Xinzhongcheng”) v. Sun Xiuyan (No. of Judicial Documents: [2005] Shen Civil [2] Housing Final No.799). In this case, the Shenyang Intermediate People's Court pointed out that although the Severe Acute Respiratory Syndrome (“SARS”) epidemic broke out during the spring and summer of 2003, Xinzhongcheng should have foreseen that the SARS epidemic would affect their construction project when it entered into their Agreement with Sun Xiuyan on June 21, 2003.  Regardless, Xinzhongcheng agreed to deliver the house to Sun Xiuyan before the end of September 2003 in the Agreement. Xinzhongcheng also believed that construction was almost completed at the beginning of September 2003, with only inspection and acceptance left.  Moreover, a Sales Contract for Commodity Housing was entered between Xinzhongcheng and Sun Xiuyan on September 28, 2003, where both parties agreed that the house should be delivered to the buyer before September 30, 2003.  Here, the Court ruled that these facts showed that the SARS epidemic did not have an adverse influence on the delivery of the house, meaning that Xinzhongcheng’s was not exempted from liability for breach of contract for delayed delivery due to the SARS outbreak. As a result, the Court rejected the appeal of Xinzhongcheng.

 

In the series of cases in which Xinzhongcheng was involved, the Shenyang Intermediate People's Court emphasized the importance of the time of execution of a contract in determining whether a situation was foreseeable or not.

 

(b) Whether the COVID-19 Epidemic has caused local governments where commodity housing is located to adopt policies that result in a delay of construction  

 

The COVID-19 Epidemic itself does not inevitably lead to the delay of delivery. On the other hand, the government in places where commodity houses are located have adopted policies that may result in delay of construction such as measures that limit the purchase of construction materials, traffic control measures, population movement control measures or measures that cause delays in construction. Therefore, there may be a causal relationship between the COVID-19 Epidemic and the delay of delivery due to local governments’ policies.

 

In Sanya Changyuan Property Development Co., Ltd. (“Changyuan”) v. Yin Wenmin (No. of Judicial Documents: [2005] Sanya Civil [1] Final No.79), the Sanya Intermediate People's Court ruled that the SARS epidemic was unforeseeable, unavoidable, and unconquerable given the sanitary, medical and technical conditions at that time. This resulted in the adoption of necessary governmental policies that banned the employment of migrant workers from outside the island.  Changyuan had entered into construction contracts with several construction companies before the adoption of the above restraining order.  Considering the outbreak of the SARS throughout the country at that time, the local government took action to strictly control the migration of the people. Since construction workers of the project were mainly migrant workers from outside of the island, the control of migration of workers gave rise to a delay in the Changyuan’s construction. The Court thus believed that the SARS epidemic gave rise to a local government policy that had constituted a force majeure obstructing the timely completion of the project. 

 

(c) The duration of the COVID-19 Epidemic and relevant controlling measures 

 

Even though the COVID-19 Epidemic may result in the adoption of local government policies that lead to delay in construction, the controlling policies are only enforced for a limited time and so the developer cannot postpone the date of delivery indefinitely. 

 

Currently, several provinces and cities have prohibited companies from resuming work before February 10, 2020.  Compared with the original last day of the Spring Festival Holiday (i.e. January 30, 2020), there has been a delay of 10 days (if work is resumed on February 10, 2020).  If subsequent policies still limit the migration of people, the delay in construction is expected to be longer. 

 

We should also note that the COVID-19 Epidemic broke out during the Spring Festival. During this time, construction workers will usually return to their hometown and will often extend their holiday so that they only resume work a few days after the Spring Festival Holidays officially ends – this is a common practice even in times where there was no COVID-19 Epidemic.  This may have an influence on the judge’s decision on the extent to which the COVID-19 Epidemic affects the delivery of houses. 

 

In Xia Guihau v. Qionghai Hongxin Real Estate Development Co., Ltd Mengcheng Branch, the Court emphasized that according to the document (Meng Jian [2010] No.63) and the explanation letter of the Center for Disease Control and Prevention of Mengcheng County, there was an epidemic that lasted from August 14, 2010, to October 9, 2010. The epidemic lasting for 57 days, causing a closure of the defendant’s canteen on the construction land as well as the suspension of construction for 48 days. As the suspended duration coincided with two rainy days, suspension of construction due to the epidemic practically lasted for 46 days.  Therefore, although the epidemic lasted for 57 days, the suspended duration due to the epidemic was only 46 days. The Court thus allowed for an extension of the construction period based on the actual suspended duration due to the epidemic rather than the duration of the epidemic itself. 

 

(d) Whether the delayed delivery results from the COVID-19 Epidemic and relevant controlling measures

 

The COVID-19 Epidemic and relevant controlling measures can only serve as an excuse for the exemption from liability for delayed delivery when they actually result in the delayed delivery, i.e. when there is a causal relationship between the COVID-19 Epidemic and relevant controlling measures with the delay in delivery. 

 

In Mr. Cai v. Wenzhou City Construction Co., Ltd., the Court rejected the defendant’s claim that it failed to deliver on schedule due to the influence of SARS as the defendant failed to prove that there was a suspension of and delay in construction due to SARS.     

 

(e) Whether the developer has notified the buyer in time and provided relevant evidence 

 

According to the Contract Law, if one of the parties is unable to perform the contract due to force majeure, the said party shall immediately notify the other party in order to reduce the potential losses suffered by the other party. The said party should also provide evidence of the force majeure within a reasonable time. 

 

The obligation to notify is especially important in the sale and purchase of commodity housing as the purchaser is more likely to arrange matters relating to acceptance, furnishing, and decoration on purchase of the house. Thus, any delay in the delivery of the house will seriously affect the performance of other contracts entered into by the purchaser.  The developer will be responsible for any additional losses on failure to notify the purchaser in time. 

 

B. Change of circumstances

 

According to Article 26 of the Interpretation of the Supreme People’s Court on Issues Concerning the Application of the Contract Law of the People's Republic of China (II), the People's Court shall rule in accordance with the principle of justice to determine whether a contract should be modified or terminated in the case of a change of circumstance. This will be done by taking into account the actual circumstances to determine objectively if there was anything significant that took place after the formation of a contract, which could not have been foreseen by the relevant parties at the time of entering into the contract. The change also cannot constitute any commercial risk occasioned by any force majeure. Moreover, the change must render the continual performance of the contract manifestly unfair to the relevant party or render it impossible to realize the goal of the contract.

 

In Huaibei Mining (Group) Co., Ltd.v.New Sun Group Limited, the Supreme People’s Court ruled that the principle of change of circumstances can only apply when the following tests are satisfied: (i) there is a change of circumstances, that is, the objective environment on which the contract depends has changed; (ii) the change is unforeseeable for the parties when entering into the contract; (iii) the change of circumstances is not a result of fault or negligence of the parties, meaning that the change of circumstances results from incidents other than force majeure; (iv) the change of circumstances occurs after the conclusion and before the fulfillment of the contract; and (v) continual performance of the contract becomes manifestly unfair or it becomes impossible to realize the goal of the contract due to the change of circumstances.

 

According to the above explanation of the Supreme People’s Court, the elements for the application of force majeure and the principle of change of circumstances are quite similar.  We believe that it is more logical for a developer to claim an application for the principle of change of circumstances rather than force majeure if the developer intends to amend the contract proactively. This is because the application of the principle of change of circumstances may lead to a change of contract, while the application of force majeure would usually lead to a reduction or exemption of legal obligations.

 

However, the difference between the legal consequences of the application of force majeure and the application of the principle of change of circumstances is not as significant as described in the regulation.  In practice, a litigant that claims for a reduction or exemption of legal obligations based on force majeure might result in a change of contract even though the contract is not amended proactively or directly.     

 

(2) Situation II: The time of delivery agreed in the contract is earlier than the outbreak of the COVID-19 Epidemic and relevant controlling measures

 

According to Article 117 of the Contract Law, if force majeure occurs after a party has already been late in performing an obligation, the said party will not be exempted from liability. 

 

The delayed delivery is not a result of the COVID-19 Epidemic if the time of delivery agreed upon in the contract is earlier than the outbreak of the COVID-19 Epidemic and relevant administrative measures.  Based on the principle of fairness under the Contract Law, the liability of the developer for breach of contract cannot be exempted due to the COVID-19 Epidemic. 

 

2. Whether the Buyer shall undertake the liability for breach of contract if he/she cannot pay the consideration on schedule due to his/her failure to obtain a mortgage on time as a result of the COVID-19 Epidemic

 

Firstly, it should be determined whether the date agreed in the contract on which the buyer shall pay the consideration by a mortgage is earlier than the outbreak of the COVID-19 Epidemic. If earlier, the buyer should bear the liability for breach of contract as agreed upon in the contract.

 

Secondly, if the date agreed upon in the contract on which the buyer shall pay the consideration by a mortgage is later than the outbreak of COVID-19 Epidemic, it should then be determined whether there is a special agreement in respect of failing to obtain a mortgage on time.  If not, it should be further decided whether force majeure or the principle of change of circumstances can apply.  Special attention should be paid to whether the handling and granting of a mortgage is affected by the COVID-19 Epidemic or whether there is any objective difficulty for the buyer to handle the mortgage. These can include the suspension of business and mortgage approvals by banks, postponement of mortgage approvals, suspension or postponement of loan grants under the government’s orders, or the quarantine of the buyer.  Other matters to keep in mind are similar to the analysis in Part 1 of this article.  

 

Particularly, the objectiveness of the situation and the causal relationship are quite important for the application of force majeure and the principle of change of circumstances.  Force majeure and the principle of change of circumstances cannot apply if the buyer fails to obtain a mortgage on time just because he/she is afraid of getting infected and refuses to handle the mortgage outside his/her home. This situation must be distinguished from the legitimate reasons for suspension or postponement of the mortgage bank’s business or the quarantine of the buyer.

 

3. Whether the developer and purchaser should be liable for breach of contract if  they fail to enter into the sales contract for commodity housing or pay a deposit as agreed upon in the commodity housing reservation contract due to the COVID-19 Epidemic

 

In practice, before signing a formal sales contract for commodity housing, developers and purchasers will usually sign a “subscription letter”, “reservation letter” and a “letter of intent” (hereinafter jointly referred to as “commodity housing reservation contract”). Under this commodity housing reservation contract, the parties agree that they would sign a formal sales contract for commodity housing (“formal sales contract”) after a certain period of time or after certain conditions are met. This contract also usually stipulates that the purchaser should pay a certain amount for a deposit or a similar payment to the developer.

 

(1) Liability of the developer and purchaser for breach of contract for failing to sign a sales contract for commodity housing as agreed upon in the commodity housing reservation contract

 

(i)  Subject to the contract’s stipulation (if any)

 

The developer and purchaser should abide by the commodity housing reservation contract if the contract is valid and if there is a special stipulation in this regard, based on the principle of autonomy of will. 

 

(ii) If there is no special stipulation in this regard, both the developer and purchaser are unlikely to be liable for a breach of contract and they are entitled to terminate the commodity housing reservation contract

 

In accordance with Article 4 of the Interpretation of the Supreme People's Court on Several Issues Concerning the Application of Law in the Hearing of Cases Regarding Disputes over Contracts of House Transaction (Fa Shi [2003]No.7) (hereinafter referred to as “Commodity Housing Judicial Interpretation”), where a seller collects earnest money from a buyer through subscriptions, orders or reservations as a security deposit to conclude a sale of the house, if the contract fails to be concluded due to the fault of either party, the deposit shall be handled according to the provisions on deposits prescribed by law. If the failure to conclude the sale of the house is not caused by either party, the seller shall return the deposit to the buyer. A developer should return the deposit to the purchaser if the developer and purchaser fail to enter into a sales contract for commodity housing due to the COVID-19 Epidemic, as it is not regarded as a result “caused by either party ”3as stipulated in the aforementioned article.

 

In judicial practice, courts generally hold that the commodity housing reservation contract can be terminated and either party is not liable for breach of contract if the failure to conclude the formal sales contract is not caused by either party.  In Dai Xuefei v. Huaxin Company, a case published in the Supreme People’s Court’s 118th Gazette, the Suzhou Intermediate People’s Court held that the commodity housing reservation contract should be terminated and the deposit should be returned. This is if after signing the commodity housing reservation contract, the formal sales contract cannot be concluded due to reasons not caused by either party and these reasons do not breach the commodity housing reservation contract. This was followed in Yang Zhaoming v. Guizhou Province Chongqing Longyou Real Estate Development Co., Ltd. Zhenyuan Subsidiary, Xiang Xingming v. Sichuan Dongxu Investment Co., Ltd., and Chu Cong v.Beijing Rundi Real Estate Co., Ltd., where the Courts supported the parties’ claims to terminate the commodity housing reservation contract and demand the developer return the deposit. 

 

(2) Liability of the purchaser for breach of contract for failing to pay the agreed amount

 

(i) Subject to contract’s stipulation (if any)

 

As mentioned above, the developer and purchaser should respect the sales contract for commodity housing if the contract is valid and if there is a special stipulation in this regard.

 

(ii) If there is no special stipulation in this regard, the purchaser cannot usually argue for force majeure. However, the purchaser may invoke the principle of change of circumstances to claim to change or terminate the commodity housing reservation contract although there is uncertainty as to whether such a claim would be supported by the court

 

Commodity housing reservation contracts usually require the purchaser to pay an amount of money (such as a deposit). Such contractual obligations often take the form of monetary payments. The COVID-19 Epidemic would not be seen as directly causing the purchaser to fail to perform such an obligation as it may only have a certain effect on the purchaser’s ability to perform such an obligation. This is because there is no direct causal relationship between such an effect and the failure to make payment. Therefore, an event like the COVID-19 Epidemic would not ordinarily lead to the failure of the purchaser to perform such pecuniary obligations. Neither can the COVID-19 Epidemic be used as an exemption for the purchaser's failure to pay the agreed amount.

 

Several courts have held the same view in judicial practice. For example, in Wang Ting v. Agricultural Bank of China, Guangdong Branch Sales Department, the Guangzhou Intermediate People’s Court held the view that SARS should not be regarded as an excuse for the appellant’s breach of contract because SARS, Avian Flu or municipal construction may only affect the macroeconomic operating environment of construction. It would not cause any direct and inevitable effect on the performance of the loan agreement in such a case. Thus, the appellant's claim for relief from civil liability on the basis of force majeure did not comply with the provisions of Article 117 of the Contract Law.

 

In the case where a purchaser cannot invoke force majeure to use the COVID-19 Epidemic to exempt him/herself from liability, the purchaser may invoke the principle of change of circumstances in order to change or terminate the commodity housing reservation contract. Under paragraph 3, Article 3 of the Notice of the Supreme People’s Court on Trial and Enforcement of the People’s Court During the Prevention and Control of SARS (Fa [2003] No.72), disputes can be resolved in accordance with the specific situation and the principle of fairness if performance in accordance with the original contract would have a significant impact on the rights and interests of the parties due to SARS. Since SARS and the COVID-19 Epidemic are similar, the principle aforementioned in the case involving SARS should be similarly applied to cases concerning the COVID-19 Epidemic.

 

It should be noted that the prerequisite for applying the principle of change of circumstances is that continuous performance of the contract would be obviously unfair to one party or that continuous performance of the contract would not achieve the purpose of the contract. However, given the COVID-19 Epidemic, whether it is obviously unfair to require purchasers to pay money in accordance with the commodity housing reservation contract is at the court’s discretion in each case.

 

4. Suggestions  

 

In the current situation, both developers and purchasers should pay attention to the following issues：

 

(1) Pay attention to the following clauses in commodity housing reservation contracts and sales contracts: (a) timing for fulfilling contractual obligations, such as timing for signing a formal sales contract, timing for payment, timing for delivery of a house, etc.; (b) liability for delay in the performance of contractual obligations, especially whether there is a special stipulation for the failure to obtain loans in a timely manner, and under what circumstances delivery can be deferred, etc. (c) specific circumstances constituting force majeure and application of force majeure clauses.

 

(2) Notify the other party about the impact caused by the COVID-19 Epidemic on the performance of commodity housing reservation contracts and sales contracts; keep in touch with the other party, and retain relevant evidence of communication.

 

(3) Retain relevant evidence affecting contract performance, such as relevant notices issued by the government (e.g. notices prohibiting traffic, traffic restrictions, restrictions on the movement of people, orders for the closure of sales offices and other public places, companies prohibitions from returning to work before a certain period, etc.), notifications of banks' suspension of processing loan applications, diagnosis reports, hospitalization vouchers, vouchers related to quarantine, etc.

 

(4) Retain relevant evidence about measures taken to avoid expanding losses, such as communication documents showing active communication with the contractor to resume work, and evidence indicating active applications for loans.