1 April, 2020
This alert covers the following governing laws: English, PRC, New York, Australian, Hong Kong, Singaporean and South African
Since the COVID-19 coronavirus was first reported in Wuhan, China, in December last year, countries around the world have sought to impose travel bans, quarantine citizens and isolate the infected in an attempt to stop the spread of the new virus. The outbreak has developed into a global threat and on 30 January 2020, the World Health Organization declared that the outbreak constituted a public health emergency of international concern.
Worldwide, the full impact of the outbreak and the resulting emergency measures on international trade remains to be seen but our clients have reported substantial business and operational disruptions, including closures of workplaces and ports, disruptions to supply and distribution channels, shortage of labor and weakened regional demand.
Given the unexpected nature of the outbreak, attention has focused on the prospect that parties to affected commercial contracts may invoke force majeure provisions in those contracts in order to excuse delay or non-performance.
This alert discusses force majeure and the coronavirus from the perspective of PRC law and several of the more frequently adopted common law systems governing international commercial contracts, focusing on the main differences in the latter.1 We also outline several alternative remedies that may apply depending on the governing law of the relevant contracts.
Affected contracts
Numerous force majeure claims involving a Chinese buyer or supplier have already been reported in the world media2 and it seems likely that claims with a wider ambit will follow as the ripple effects of the outbreak spread globally.
Any contract with a specific force majeure clause may be the subject of a claim. Contracts governed by a civil law framework which grants force majeure remedies, whether or not they are written into the contract, may also be the subject of the claim. This includes the PRC.
Force majeure claims are particularly relevant for contracts with a long-term or ongoing supply and in the following markets:
- Commodity contracts (including iron ore, coal and copper);
- LNG contracts;
- Ship building contracts;
- Supply contracts for textiles, foodstuffs and mechanical equipment;
- Contracts for electrical equipment and electronic components;
- Medical equipment manufacturing contracts.
The effect of the outbreak on suppliers is perhaps most obvious. With emergency measures impacting on goods, workers and logistics, many suppliers appear unable to fulfil their
contracts within the prescribed time or at all. But invoking force majeure may also be of interest to buyers, either because taking delivery under the contract has been impacted or due to disruptions in downstream markets.
The PRC government has acted on force majeure specifically, with the quasi-governmental China Council for the Promotion of International Trade (CCPIT) announcing on 30 January that it would offer “force majeure certificates” to help companies deal with disputes with foreign trading partners arising from government control measures. To date, it has been reported3 that thousands of certificates have been issued purporting to shield Chinese companies against liabilities for non-performance. We discuss the effects of these certificates on contracts with different governing laws below.
What is force majeure?
The concept of force majeure (FM) derives from French civil law and has been carried across to several other civil law jurisdictions. It's also of wide application in common law jurisdictions and is frequently used in commercial contracts governed by such common law systems because of the limited remedies otherwise available to the parties when the contract becomes impossible, difficult or onerous to perform due to events outside the affected party's control.
Whether the source of FM rights is legislation or the terms of the contract, FM regimes typically operate by excusing non-performance by a party of its contractual obligations where non-performance is caused by a defined FM event.
Determining whether an event is a FM event normally involves applying the objective test found in the relevant law or written in the contract. However, most FM regimes are "open" or inclusive in the sense that the event does not need to be specifically listed as a FM event, provided it meets the requirements of the objective test.
Civil and contractual FM regimes often differ in practise. Contractual FM can be, in scope and remedies, either wider or narrower than the more inflexible civil law schemes, depending on the bargaining power of the parties at the time the contract was entered into and how that translated into the drafting of the particular contract.
For example, many contractual FM provisions will include a list of examples of FM events. Generally it will be easier to bring a FM claim if the event is listed (although typically the other requirements of the objective test must still be met). While epidemics are uncommon in modern times, recent memory includes SARS, Ebola and various severe flu outbreaks. Epidemics arise frequently enough though that the parties may have specifically included "epidemic" or "pandemic" as listed FM events or they may be subsumed within more general terms such as "disease" or "illness". Similarly, emergency measures to address or contain an outbreak may be listed or covered under general terms such as "government action," "government order," "national or regional emergency" or "quarantine."
It's also common, particularly in certain markets, to include in contractual FM a (potentially long) list of excluded FM events. Depending on the drafting, if the event, or potentially one of multiple events, causing the non-performance is excluded, FM remedies may be precluded. Both buyers and suppliers will often use this type of drafting to allocate risk to the affected party of events which are outside their control and might otherwise technically meet the definition of a FM event but are generally seen as attendant risks of doing business in that market, such as economic downturns and other financial hardships.
Below we consider FM under PRC law, the most likely applicable civil law jurisdiction and from the common law perspective.
PRC law perspective
FM exists as a doctrine under Article 180 of the General Rules on the Civil Law and Articles 117 and 118 of the PRC Contract Law. The regime applies automatically to commercial contracts governed by PRC law where the contract contains no FM provisions.
Test/Causation
A FM event is an objective event or situation which is (1) unforeseeable (at the time of entering into the contract), (2) unavoidable in terms of occurrence or impact and (3) impossible to overcome.4
There must be a causal link between the FM event and the affected party's failure to perform (i.e., the affected party must establish that the FM event must have caused the non-performance). It's not necessarily required that the FM event must be the direct cause immediately resulting in the non-performance. If there are too many steps between the FM event and the non-performance it will be difficult for the affected party to satisfy causation.
Requirements for claim
The affected party must notify the counterparty of the FM event promptly or in a timely manner stating their claim for an exemption of liability and providing proof of the existence of the FM event and the impact of the event on the affected party's non-performance. There remains some uncertainty under PRC law as to whether such notice must be given before non-performance actually materialises. Accordingly, it's advisable to do this where possible.
Where such prompt or timely notice is not given the affected party may become liable for losses suffered by the counterparty which could have been avoided had such notice been given.
Mitigation
The affected party's obligation to mitigate the effects of the FM event has been expressed as a "best efforts" obligation implied under the third limb of the above test. If the affected party fails to utilise its best efforts to overcome the impact of the FM event on its non-performance it may not invoke FM.
Exemptions
Under the Contract Law, FM does not apply (1) where the contract is entered into after the FM event, (2) to non-performance of monetary payment obligations; or (3) if the FM event occurs after the affected party delays performance.
Remedies
FM remedies under the Contract Law are (1) the affected party is excused from civil liability, including damages, in relation to its non-performance (or delay); and (2) either party may terminate the contract where the essential purpose of the contract cannot be realised as a result of the event of FM.
While not expressed in the Contract Law, decisions of the PRC courts in the wake of the 2003 SARS outbreak demonstrate a willingness by the courts to also grant modification of the contract terms, though under a different doctrine – see alternate remedies below.
"Force Majeure" Certificates
These have been issued by the CCPIT to numerous Chinese companies in relation to the coronavirus outbreak as above. Typically, to obtain such a certificate, the affected party must provide the CCPIT with documents evidencing the occurrence of the relevant event. Typically, CCPIT issued certificates will only certify the occurrence of the event, which may qualify as an FM event under general circumstances but would usually refrain from certifying it as an FM event.
The purpose of these certificates is to facilitate the invoking of FM remedies where the contract requires the provision of such a certificate issued by a relevant government authority as a prerequisite to the bringing of the FM claim. Such certificates will not be binding on PRC courts either as to the existence of the relevant FM event or the effect of the event on the affected party's non-performance.
So are they of any practical use where not required by a contract? Perhaps only to add a level of authenticity when accompanying FM claims submitted to foreign counterparties.
Certainly we do not recommend relying on them alone as a virtual shield against liability as implied in several media reports.
Common law perspective
FM is a creation of the contract in common law jurisdictions. Where the contract is governed by a common law system the relevant courts will generally recognise the parties' freedom to agree wide or narrow FM relief. Generally, FM provisions are interpreted by focusing on the actual language used with the result that each particular case rests on its own contractual language and set of facts. Another complication is that the term "force majeure" is also sometimes used to refer to other provisions frequently applying to exceptional supervening events such as "hardship" clauses and those creating a framework for making amendments to the contract for material changes in circumstances.5
Test/Causation
What constitutes an FM event and the precise objective test depends on the specific wording of the provision. As noted above, the definition of FM is generally inclusive but some clauses are exhaustive instead. If the contract provides that a FM event must "prevent" performance, the affected party must generally demonstrate that its performance has become legally or physically impossible and not merely more difficult or more expensive. By contrast, if the provision refers to the event "hindering" or delaying" performance then the threshold will generally be lower and FM may be satisfied if performance remains possible but has become substantially more onerous.
While common law systems generally take a consistent approach, variations (some subtle) persist and it's important to approach interpretation of each FM provision with regard to the corresponding case law.
Until fairly recently, English courts applied a test of unforeseeability to FM events and while there is authority that this is no longer the case, other common law courts may still impose such a requirement. Hong Kong and Singapore courts have tended to follow the English courts' approach. Conversely, English courts have found that the affected party must also generally have been "ready, willing and able" to perform the contract but for the FM event. English courts have also tended to take a dim view of claims that a change in economic or market circumstances affecting the profitability of a contract may be a FM event.
Certain New York courts have tended to interpret FM provisions narrowly, reflecting the terms of the agreement and the intent of the parties, though there is also authority that "known practices within the industry" is important, particularly in specialist industries like oil and gas. This may, depending on the drafting, place additional emphasis on the specific list of FM events as a whole as a New York court might decline relief if an unlisted event is not of the same kind or nature. Some New York courts have interpreted FM provisions even more narrowly by requiring that the event be listed and that the event be unforeseeable, although authorities to the later proposition appear mixed.
Requirements for claim
FM provisions commonly contain a notification requirement, which can operate as a "condition precedent" precluding relief if the relevant notice is not given in the necessary timeframe. Such provisions are generally enforceable, and so complying fully with all notice requirements will be important for parties seeking to declare FM.
Mitigation
FM provisions commonly requires the claiming party to show that is has taken all reasonable endeavors to avoid or mitigate the event and its effects (a highly fact sensitive enquiry).
Exemptions
These are a matter of drafting and can doom an otherwise valid claim.
In some markets, it's common practise to exclude changes in the relevant market or demand. This can increase the challenge for a buyer who wishes to claim FM but cannot show it was unable to accept delivery of the supply, particularly if it has taken advantage of falling prices and already sourced the supply from elsewhere.
Remedies
These are a matter of drafting and need to be sufficiently certain to be enforceable. Typically, the affected party is excused from relevant non-performance while the FM event (or its effects) persist. Again, depending on the drafting, this can take effect as an extension of time or general suspension of the affected party's obligations.
If non-performance caused by the FM event is prolonged (or permanent) then the drafting may provide for termination of the contract with the financial consequences for the parties set out in the provision. Where such termination right is mutual, the affected party may need to consider carefully whether to invoke FM at all, especially if preserving the economic benefit of the contract is more valuable than losing the contract.
Long-term supply contracts may provide for more complex scenarios, with some contracts requiring supplies to be made at a later date to maintain total quantities while others effectively cancel the affected supply (leaving the supplier with the headache of a quantity it may be unable to sell in circumstances where prices have fallen).
Alternate remedies to FM
Aside from the typical FM provisions outlined above, the affected party may have alternate remedies, depending on the governing law of the contract.
Some examples:
- For English law contracts, the affected party might claim relief under the doctrine of frustration, which permits parties to cease performing contractual obligations where it becomes impossible to do so in circumstances entirely beyond the remit of the parties. While frustration tends to have limited application and is even more difficult to establish where the contract does contain FM provisions, this could be a potential avenue for relief where emergency measures have made the supply permanently unavailable or the necessary skilled labor to perform a contract became unavailable due to travel restrictions or illness.
- For PRC law contracts, the doctrine of "change of circumstances [situation]" may apply where a FM remedy is not available.6 The doctrine operates where (1) there is an unforeseeable and material adverse change to the fundamental assumptions upon which the parties relied when they entered into the contract, (2) the change is outside the sphere of regular commercial risks, and (3) such change would make continued performance of the contract on its original terms egregiously inequitable to the affected party. While the judicial process is more complex than for a FM claim, the affected party may apply for the contract to either be terminated or modified (something not generally available for a FM claim based on the civil law).
Recommended actions
If, whether as buyer or supplier, you have entered into commercial contracts that have or may be affected by the outbreak, we recommend the following actions:
- Review each contract carefully, with particular regard to the governing law and FM provisions, including any time bars or other procedural requirements.
- Form a preliminary view on whether any FM provision is "open" or exhaustive in relation to the list of FM events and whether the outbreak and/or resulting government crisis measures are covered/excluded.
- If you may need to invoke a claim, consider your obligation to mitigate the effect on non-performance and what steps you can take. Starting a mindful dialogue with the counterparty may be an important part of the process.
- Consider any potential flow on effects from the invoking of a claim such as termination of the contract.
Aside from your legal position, there are generally going to be several other important matters of concern:
- For a counterparty who receives a FM claim they do not think is valid, there is the issue of enforcement of the contract, particularly if it does not provide for international arbitration.
- There are the reputational risks and potential damage to long-term supply relationships with foreign buyers and suppliers. Even where there is no legal basis for FM relief, parties who receive FM claims may wish to be flexible about amending or restructuring (e.g. by postponing deliveries) the contract to accommodate the affected party.
- Declaring FM or receiving a FM claim may impact on insurance arrangements.
- Buyers who are part of a chain of supply contracts may themselves need to declare FM in response to a supplier's declaration in order to avoid being in breach. Each contract in the chain may of course be on different terms or subject to entirely different governing laws and this can create substantial challenges for the buyer, especially where their downstream contract has less favourable (or no) FM provisions. There may also be separate time bars or other procedural requirements as above.
Clearly if you are entering into new contracts during this period you should consider the FM provisions with particular care.
Conclusion
With the full impact of the coronavirus likely to play out for some months yet and the potential for the outbreak to spread into new regions, this is an issue seemingly becoming more important by the week.
If you would like to discuss any of the issues raised in this alert please contact us. Further news, regional law perspectives and other information can be viewed at Baker McKenzie's Coronavirus Resource Center.
For further information, please contact:
Milton W. M. Cheng, Partner, Baker & McKenzie
milton.cheng@bakermckenzie.com
1 This alert covers commercial contracts governed by the following common law legal systems: New York law, English law, Australian law, Singapore law and Hong Kong law.
2 https://www.ft.com/content/e3d6b116-4975-11ea-aeb3-955839e06441; https://www.wsj.com/articles/coronavirus-toll-on-shipping-reaches-350-million-a-week-11581366671; https://www.reuters.com/article/us-china-health-lng-prices/free-falling-lng-prices-wreak-havoc-on-trade-amid-coronavirus-fears-idUSKBN2010P9
3 https://www.chinadaily.com.cn/a/202002/17/WS5e4a38eaa31012821727818d.html
4 不能预见、不能避免、不能克服的客观情况（事件）
5 These are also sometimes referred to as Material Adverse Effect (MAE) clauses in certain jurisdictions.
6 Some commentators have argued that the remedies are reconcilable particularly following Supreme People's Court decisions in relation to the 2003 SARS outbreak.
