15 May 2020
Introduction
Just when Chinese people were ready to celebrate the Spring Festival of the year 2020, the outbreak of novel coronavirus (later named COVID-19) spoiled the party. The outbreak has been a global concern that has greatly affected both inbound and outbound business in China. The virus, and especially the policies and measures adopted to prevent its further spread, have led to problems in the performance of various obligations.
But does COVID-19 amount to a force majeure event that allows contract parties to suspend performance obligations under a contract?
COVID-19 Outbreak and Force Majeure
Generally speaking, force majeure is an unforeseeable, unavoidable and insurmountable event, which includes natural disasters, government actions, or social anomalies. The outbreak could not have been foreseen and its emergence and development are outside the control of any individual parties. So from this perspective, the outbreak of COVID-19 embraces the main characteristics of a force majeure event.
Moreover, drawing a parallel with the SARS outbreak in 2003 is also illustrative. At the time, the Supreme People’s Court confirmed that the SARS epidemic could be a force majeure event; and afterwards, many court judgments confirmed the application of force majeure clauses to the SARS situation. The present outbreak is even broader in scope and has a much deeper impact, and so it is logical to expect the same approach.
In fact, some high courts, such as the Zhejiang Province High People’s Court and the Guangxi Province High People’s Court, have already released guidance documents to deal with circumstances caused by COVID-19, confirming that this epidemic could be a force majeure event. The Shanghai High People’s Court has offered the same response when asked during a press conference.
Conditions to a Force Majeure Argument
However, even if the current outbreak could be deemed a force majeure event, this does not mean that every contractual party can simply rely on this argument to avoid a contractual obligation. Other conditions must be fulfilled as well.
If a contract already contains a force majeure clause, this clause may establish which conditions must be fulfilled for the COVID-19 virus to trigger the rule of force majeure. For contracts that do not have the force majeure clause, Articles 117 and 118 of the PRC Contract Law provide some general criteria. As per the guidance documents issued by local high courts and precedent cases over the SARS epidemic, the following aspects should be considered to determine whether the rule of force majeure applies:
- The contract should have been established before the date on which local government announced the virus to be a major public health emergency in this region (the date differs per location, for Beijing, Shanghai and many other cities the date is 24 January 2020), and the obligator is not late in the performance of the obligation before the performance is affected by the force majeure event.
- Is the causal relationship between virus and the inability of one of the parties to perform its obligations strong enough? There may be other causes that could frustrate the argument, commercial risk in particular. For example, increase of material price, reduced demand, shortage of labor will likely be deemed commercial risks that should have been taken into account when the parties enter into the contract rather than force majeure event, unless they are directly attributed to the virus outbreak.
- Is it really impossible to perform contractual obligations? There may of example be an alternative (even if more expensive) means of performance, such as delivery. Especially when a party raises force majeure to terminate a contract, it should be objectively impossible to perform the contractual obligations.
If the contract clause includes procedures, then these should be followed. If not then reference can be made to Article 118 of PRC Contract Law:
- The obligator should notify the counterparty in a timely manner so as to mitigate the loss that occurs to the counterparty.
- The obligator should provide evidence to prove that it is unable to perform the contractual obligation within a reasonable period.
On the matter of evidence, companies involved in international trade could try to obtain a force majeure certificate issued by the China Council for the Promotion of International Trade (CCPIT). The CCPIT certificate will confirm the occurrence of the force majeure event in a specific location and within a specific period and it is widely recognized by governmental departments, Customs, trade associations and enterprises in more than 200 countries and regions. However, the CCPIT certificate will not make any reference to the particular contract, the inability of performance or the causation between the force majeure event and the inability of contractual performance, so the burden remains on the claimant to prove that the situation meets all conditions of force majeure, if the case finally ends up in court.
Once a party successfully establishes the argument of force majeure, whether liability should be exempted wholly or partially and how the two parties should share the costs occurred, should be determined based on the principle of fairness, provided the contract is silent on the same.
Material Change of Circumstances
The legal consequences of a force majeure event include termination of contract and exemption of contractual liability, but do not include alteration of contract. So when a party wishes to alter the contract, or the factor that influences the contractual performance is not or only indirectly related to a force majeure event, the party may instead consider an argument based on a material change of circumstance, a principle that has been adopted in the Interpretation of the Supreme People’s Court on Several Issues Concerning Application of the “Contract Law of PRC” (2) of 2009. A contractual party may thus try to argue that the COVID-19 creates a change of circumstances which is so fundamental that it would be unjust for the parties to continue performing the obligations; or that it frustrates the purpose of the contract altogether. According to guidance documents of several high courts, if the government policies and measures to block the spread of COVID-19 cause or are expected to cause price increase remarkably beyond ordinary market price fluctuations, then COVID-19 could be deemed as the cause for a material change of circumstance.
Where a material change of circumstance is established, the contractual obligations of the parties should be altered or terminated based on the principle of fairness. Unlike the rule of force majeure, the rule of material change of circumstance could only be implemented through a ruling of competent court or arbitral institute, so it is more preferable to invoke the rule of force majeure than the rule of material change of circumstance.
Defenses to Force Majeure
If a party claims that it is unable to perform the contractual obligations because of the COVID-19 outbreak and invokes force majeure, then the counterpart should consider:
- Is there sufficient evidence to prove that the COVID-19 outbreak is the only and direct cause to the inability to perform contractual obligations, and is there no alternative means to performance?
- Was the party already late in performing those obligations when the virus outbreaks?
- Was the notice delivered in a timely manner, and were losses suffered due to a delayed notice?
If other causes contributed to the non-performance, or there were alternative means to perform the contractual obligations (e.g. different means of delivery), then the COVID-19 outbreak should not be deemed a force majeure event that prevents the performance of the particular contract. Either way, losses caused by delayed notice should also be compensated.
Conclusion
This COVID-19 outbreak has a wide impact on the performance of contractual obligations. Similar to the SARS outbreak in 2003, the COVID-19 outbreak could be deemed a force majeure event and may therefore trigger claims of force majeure, which could lead to a suspension of obligations, relieve a party of liability for non-performance, and even result in termination of a contract. However, whether there is a force majeure event should be decided on a case-by-case basis with reference to the contract clause and principles adopted under Chinese law. In any case, force majeure should not be used as a blanket approach to mitigate risks, evade obligations and minimize liabilities.
For further information, please contact:
Maarten Roos, Managing Director, R&P China Lawyers
