China Lawyer: How to Deal with the Impacts of Coronavirus on Your Contracts
All of us are now experiencing a global disaster - coronavirus (also known as COVID-19), and seeing its impacts especially on global manufacturing, cross-border supply chains, capital flows, etc. You might have an existing contractual arrangement with a Chinese supplier now, and what you worry about most happened - the Chinese supplier regretted to tell you that it may delay performance or terminate the contract because of COVID-19; or it asserted that the outbreak constitutes a force majeure event or gives rise to another legal basis excusing non-performance under commercial contracts.
But one of the most important questions is whether this outbreak counts as a force majeure event or makes other doctrines available which allow the other party to cancel the contract. Given the international trade and commerce which may be severely impacted, this issue is becoming a billion-dollar question. Therefore, we need to consider the appropriate allocation of risk and consequences of the current and further business deterioration resulting from the COVID-19 outbreak. As we all know, COVID-19 will pass one day, but the damages for non-performance of contract caused thereby will be left here. Our firm is advising clients on numerous legal issues relating to the outbreak, such as proposals to settle contractual disputes in the face of assertion of force majeure or any legal excuse by the other party. However, the impact of the virus on a particular business and under a particular contract will be fact-specific, and it is important for both parties to review the relevant agreements together with other material agreements to ascertain all rights and obligations. We suggest that the contracting parties impacted by the virus outbreak should now promptly analyze their rights and obligations under the contract by taking following steps:
Identifying key provisions of material contracts that may be affected by the recent outbreak (e.g., force majeure clause);Identifying notice requirements that have been or may be triggered;Considering whether there are alternative means to perform contractual obligations or proactive steps that can be taken in anticipation of the potential future effects of the outbreak in order to minimize the loss;Analyzing the potential consequences of a breach and/or default;Managing communications with the counterparty (e.g., inquiring about the official factory worker return days and allowing it to perform its obligations within a given reasonable period); andUnderstanding local regulatory actions and restrictions, and monitoring new edicts in real time to determine whether they require the company to take steps or make decisions that may affect the contract (e.g., searching and verifying the resumption date online).Also, we provide below a summary of potentially applicable legal principles such as force majeure and frustration with regard to the current outbreak. Both force majeure and frustration relief can have profound impacts, so we recommend that the exercise of these rights should be carefully assessed.
The force majeure clause is normally included in a contract, which can relieve a party from its obligations to perform the contract in certain extreme circumstances. In our case, whether the COVID-19 outbreak and the resultant restrictions are covered must be analyzed under the terms of the agreement, and the governing law of the contract. The impact and natural effect of a force majeure clause will vary from contract to contract. Some operate to suspend obligations during the period of the applicable event whereas some give rise to a right to terminate and some may relieve the non-performing party of liability to perform its obligations under the contract. APPLICATION As for the current COVID-19, China Council for the Promotion of International Trade (‘CCPIT’), accredited with China’s Ministry of Commerce, announced on 30 January 2020 that Chinese entities may apply for force majeure certificates for disputes with foreign trading partners arising from the virus. To apply for the certificate, companies must provide legitimate documents such as proof of delays or cancellation of transportation to the agency. However, as the CCPIT warns, claims of force majeure are not a trump card for getting out of an unwanted deal. Instead, whether a contracting party may rely on such a certificate (as proof of a force majeure) would remain dependent on an analysis of the relevant facts and wording of the force majeure clause and also whether the certification is recognized by the counterparty to the contract (and the jurisdiction in which the contract is formed). This is to mean that the Chinese supplier cannot take it for granted that it is entitled not to perform the contract without compensating for any loss you suffer therefor by presenting you only such a certificate. REQUIREMENT FOR PROOF Even where a party is able to show that the current situation is a force majeure event within the force majeure provision in the relevant contract, the party seeking to rely on this clause to excuse its non-performance must still prove the following:
It was prevented, hindered or delayed from performing its obligations due to the virus;Its non-performance was due to circumstances beyond its control; andThere were no reasonable steps that it could have taken to avoid or mitigate the event or its consequences.Generally, this is to mean that such a clause can be relied upon only if all reasonable steps had been taken by a party to mitigate the effect of the event. Further, whether COVID-19 really creates an “unforeseeable” and “insurmountable” impediment for the execution of a contract and therefore count as force majeure can be construed differently in the context of the rest of the relevant clauses and the contract as a whole. The party seeking to rely on force majeure will need to gather the necessary evidence if it wishes to declare force majeure. The required evidence will be fact-specific and will depend on the contract and the prevailing circumstances, generally including but not limit to emails, notices, telegrams relevant to the force majeure event. In conclusion, whether the COVID-19 outbreak and/or the resulting restrictions are covered by a force majeure clause in a contract will depend on the wording of the scope of the clause, the steps taken by the party seeking to rely on the clause (e.g., whether it promptly sent you a notice for delayed performance/non-performance), and whether the outbreak constitutes a foreseeable contingency.
Doctrine of Frustration
Where a contract does not contain a force majeure clause, or where a force majeure clause does not cover the relevant circumstance, parties may wish to consider whether the doctrine of frustration applies. This applies when an event occurs which is the fault of neither of the contracting parties but which makes it impossible for a party under the agreement to fulfill a fundamental obligation or transform the obligation into a completely different obligation. REQUIREMENT FOR PROOF The threshold for relying on frustration is higher than standard force majeure clause and it is difficult to prove. It requires impossibility of performance caused by an unforeseen event significantly altering the contractual obligations of a party outside of what could reasonably have been contemplated at the time the contract was executed. For example, delays caused by measures taken due to the COVID-19 outbreak, will not in principle amount to frustration. Likewise, a frustrating event that may be “self-induced” (e.g. performance made impossible by one’s own choice), will not qualify as a frustrating event. CONSEQUENCES If a contract is frustrated, then the contract may be automatically discharged, relieving the parties from complying with future obligations.
In order to assess the impact of the coronavirus outbreak on a particular business and its contractual relationships, a fact-specific analysis is required. If your counterparty assert the said two principles to you, you should first undertake a review of the rights and obligations under the contract to ensure whether the notice requirements and any other duties to mitigate the impact of the outbreak have been fully complied by the other party, and to determine whether the factual situation allows it to declare such a force majeure or frustration. If you are in doubt, please feel free to contact us.