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16 Mar 2020
In the wake of the COVID-19 outbreak and governmental responses, concepts such as “force majeure” have become commonplace in connection with the (non-)performance of contracts. The People’s Republic of China (“PRC”) is a focal point for such contractual issues, including because of its position in global supply chains and because of the complexity of its legal framework for force majeure. Most notably, the Chinese government’s extensive involvement in handling both the health and the economic effects of the outbreak is unprecedented outside and even inside China. This alert aims at highlighting certain fundamental and certain novel aspects of the PRC framework that in present circumstances have been or may be deployed in disruptions of contractual performance and suggesting some considerations in handling them.
The Basics of Force Majeure in the PRC
Force majeure in the general sense of an unforeseen circumstance preventing contractual performance is a well-known legal concept around the world, but its codification in the PRC contrasts with looser frameworks in other jurisdictions. Thus, as a starting point, while some jurisdictions may excuse a party’s performance of a contract on the basis of force majeure only if and to the extent the contract contains an express provision for it, all contracts subject to China’s jurisdiction effectively contain such a provision by operation of law. Specifically, according to Article 117 of the Contract Law of the PRC, barring certain exceptions, any party may be exempted from liability for, and to the extent of, an inability to perform a contractual obligation due to circumstances that were objectively unforeseeable, unavoidable and insurmountable. Basic examples of force majeure relief include the following:
However, the existence of a force majeure event will not automatically, under PRC law, exempt a party of its obligation to perform a contract. First, an express force majeure provision in a contract can at least to a certain extent modify or prevail over the application of Article 117 of the Contract Law of the PRC. Second, to the extent Article 117 does apply, it has preconditions, including that the triggering event be “unforeseeable”, “unavoidable” and “insurmountable”. Third, Article 118 of the same law requires the party claiming force majeure to timely notify its counterparty and provide proof of the force majeure event within a reasonable time. Fourth, a valid force majeure will exempt performance/liability only to the extent it has caused a party’s inability to perform.
The Novel Coronavirus / Force Majeure in the PRC and Beyond
China’s government in recent weeks has been taking steps to clarify its framework for force majeure, on the one hand seemingly strengthening the basis for a party to claim the exemption while on the other hand possibly reinforcing some of its limitations. As an initial matter, the China Council for the Promotion of International Trade (“CCPIT”), an organization with ties to the government, has reportedly issued thousands of so-called “force majeure certificates” to companies claiming inability, under the current situation, to perform contracts (worth hundreds of billions of RMB). The particulars and effectiveness of these certificates, reminiscent of certificates issued during and after the SARS outbreak in 2003, are far from certain, despite the CCPIT’s assertions that they would apply to support invocation of force majeure even in jurisdictions other than the PRC. While they would not satisfy all the conditions for force majeure exemption under PRC law, they may be taken into consideration by PRC courts, e.g., going towards the proof of force majeure an affected party is required to provide under Article 118 of the Contract Law of the PRC.
More significantly, a spokesperson for the Legislative Affairs Commission of the PRC National People’s Congress Standing Committee stated that the virus outbreak and the PRC government’s measures in response to the outbreak should be deemed force majeure under PRC law. The Higher People’s Courts in most provinces and municipalities have also issued special guidelines in this respect. In addition to reiterating the basics of force majeure as described above and repeating that the outbreak and government response constitute force majeure, they reinforce some further avenues for relief, e.g., suspension of a statute of limitations if a relevant claim cannot be made in a timely manner because of the present situation.
At the same time, the Legislative Affairs Commission and Higher People’s Courts have not only indicated that the basic framework for force majeure still applies but have also reinforced its limitations. Major points of note include the following:
An additional way in which the PRC appears to be balancing competing interests and concerns is in its treatment of potential contract terminations both per force majeure and per the separate though related concept of “change of situation”. In short, although Article 94 of the Contract Law of the PRC permits a party to terminate a contract when performance is prevented by force majeure, PRC courts are indicating they will not only closely scrutinize the basis for termination (e.g., the causal link between the outbreak and government response and the parties inability to perform) but also may seek to avoid termination by encouraging parties to negotiate, by supporting a delay in performance, and even by modifying the contract. This last mechanism has long been provided for when a party argues a “change of situation” renders the contract obviously unfair or unduly burdensome for it. As an example, payment terms under contracts for the lease of hotel property, ships or aircrafts may be reduced upon a showing of a significant drop in customer bookings as a result of COVID-19.
Evaluating and Managing Exposure
Parties who face actual or potential non-performance may wish to consider the following, inter alia:
All the above would best be considered in light of the efforts the PRC has been making to support its economy, both from domestic and foreign angles, of the growing global effects of COVID-19 and of the likelihood the situation will significantly evolve in the coming weeks and maybe months.