How are your contracts affected by the coronavirus?

Categories: Business In China, Legal Updates | By Wendy Zhang

Local businesses, as well as global companies with significant footprints in China, have temporarily suspended their production, logistics, international service, and other aspects of their operations as they grapple with the widespread disruption brought on by the novel coronavirus 2019 (nCOV-19) outbreak that has derailed commerce in China. This has also spurred companies to review their rights and obligations under the contracts, particularly whether they can declare “force majeure” to exempt them from contractual obligations!

In this article, we will take a look at the applicability of force majeure in contract disputes in China.

What is force majeure?

According to Article 153 of the “General Principles of The Civil Law of The People’s Republic of China” and Article 117 of the “Contract Law of The People’s Republic of China,” force majeure clauses are contractual clauses which alter parties’ contractual obligations and absolve them from penalties when an unforeseeable, unavoidable and insurmountable event prevents one or all of them from fulfilling those obligations. These circumstances could include anything from natural disasters (fire, earthquake, flood, hurricane, drought) to contrived events (wars, terrorism, strikes, riots, government orders).

Currently, as the country seeks to contain the novel coronavirus 2019, it has implemented city-wide lockdowns and large-scale quarantines that have effectively curbed the movements of millions. Daily activities are under epidemic control, and those even suspected to be the carriers of the virus are quarantined. Clearly, this situation has hurt businesses as operations of factories and facilities came to a near-standstill. That is why, around February 2020, provisional authorities continuously announced that coronavirus in China constitutes force majeure. This means that civil liability shall not be borne for failure to perform a contract if it is caused by the coronavirus epidemic.

When should force majeure be applied?

Though the novel coronavirus 2019 could be regarded as force majeure, it does not mean that force majeure could be applied to the contract execution during coronavirus unconditionally. Only when the obligation under the contract is obstructed and cannot be fulfilled by the force majeure can relevant rules be applied. For example, due to the close management, quarantine treatment, government instructions, or other coronavirus-related issues, ownership of land cannot be transferred, or goods cannot be delivered, service obligations cannot be continued or have to be cancelled,  periods are forced to be delayed, etc. In these cases, force majeure could be used to exempt certain liabilities.

Coronavirus is a global pandemic and has spread to all parts of the world, and almost all sectors are affected. For example, the film and television industry has been suspended because shootings and transportation were stopped. Large manufacturing industries have been interrupted because of material supply (or lack thereof). Therefore, various types of contracts could claim coronavirus as force majeure to avoid relevant liability. Because of interruption, the statutory period and prescribed period for litigation may be interrupted. It is accepted that the relevant period is postponed accordingly. But for the situation that the presence of concerned parties is refused for fear of being infected could not be allowed.

What is the consequence of applying force majeure?

According to Article 117 of the “Contract Law of The People’s Republic of China,” non-performance by a party shall be partially or wholly excused from breach liability if it is not possible to perform a contract due to force majeure. According to Article 94 of the “Contract Law of The People’s Republic of China,” the parties may terminate the agreement if the adverse impact of the force majeure is severe enough so that the contract purposes are not able to be fulfilled.

Besides, pursuant to the  Judicial Guidance of Civil Dispute during Coronavirus issued by the supreme court of Jiangsu Province, except for the situation that contract couldn’t be performed because the contract purpose is beyond the reach due to the impact of coronavirus, the claims of terminate contract are difficult to find the support from the court.

Here’s an example: Earlier this year, the contending parties of a ride-hailing-related dispute reached a reconciliation agreement under the mediation of Haishu Court in Ningbo. In the dispute, the claimant (driver) requested to terminate the contract as he was not able to continue the taxi service due to the city being locked down during the novel coronavirus epidemic. Under the mediation of the court, both parties finally agreed that the plaintiff (rental company) is to reduce the rent during the lockdown period, and once the claimant returns to work, the agreement is to be continued. Apparently, in this case, though the outbreak affected taxi service, it does not mean that the contract could not be executed within the contractual period. It is unfair to the rental company if the driver terminates the contract with coronavirus as the pretext. Therefore, the rules of force majeure are not accepted to be the excuse for the party to terminate the agreement. If the contract proves to be implementable after the coronavirus, generally, the contract will not be terminated.

How to invoke force majeure?

When a force majeure clause triggers and the implementation of a contractual obligation is interrupted by either party and the said party requests to be exempt from the related liability, some necessary measures must be taken, and basic principles must be followed. According to Article 118 of the “Contract Law of The People’s Republic of China,” if one of the parties is unable to perform its obligation under the agreement due to force majeure, the said party shall immediately notify the other party to reduce the potential losses sustained by the other party, and the said party shall also provide evidence of the force majeure within a reasonable time. In the case of the current coronavirus epidemic, the evidence could be medical certificates, official orders, quarantine certificates, etc. If there is no relevant evidence, it may not be identified as force majeure.

Furthermore, in the light of the interpretation of Luohu Court in Shenzhen, the principle of good faith and the principle of equity are also to be applied in the identification of a force majeure event. For example, commercial entertainment properties such as cinemas and theatres may not be able to perform their obligations subject to the property lease agreement due to an official lockdown – that shall be deemed as force majeure. On the other hand, if apartments, hotels, or restaurants fail to perform their obligations under the agreement, it may be deemed as a commercial risk, not a force majeure. Therefore, generally speaking, they are not allowed to claim rental deduction under the coronavirus epidemic.

Is there any exception when force majeure is inapplicable?

Rules of force majeure are applicable for only those suffering in unexpected adverse situations – and not for those who saw it coming. So, in order to avoid the abuse of this clause, situations, where its use is absolutely inapplicable, have been exempted from being considered a force majeure event. For example, force majeure only temporarily prevents performing parties from the liabilities for overdue fulfillment. However, pursuant to the “Contract Law of The People’s Republic of China”, if the delayed performance has already occurred before the force majeure event, the above liability exemption will not apply.

In addition to that, pursuant to the “Contract Law of the People’s Republic of China,” even if there would be a force majeure event, if a party fails to perform their obligations under the contract, they shall not be exempt from any liability. For example, if a business enters into an agreement with its consumers during the novel coronavirus outbreak and fails to fulfill its obligations with excuses including difficulty to secure raw supplies, no courier services, lack of a workforce or an epidemic management plan, etc., they cannot request to be exempted from the relevant liability because, after the outbreak, these obstacles were not “unforeseen.” It could be even worse for the business owner who can foresee all the obstacles following the epidemic, but still enters into an agreement with consumers and collects deposits for his/her services in advance because their behaviour may be regarded as a fraud and may even result in criminal liability. In other words, force majeure is not applicable for contracts entered during or after it.

Final Notes

Force majeure could be applied in various contracts affected by the novel coronavirus 2019 outbreak. Such rules are essential for the affected parties to prevent commercial loss relevantly. For agreement with a large number of subjects, there may be a large amount of damages being avoided. However, whether it is acceptable to claim liability exemption shall be subject to circumstances that alter individual cases. And when it comes to triggering the clause, the parties shall comply with relevant laws and regulations. Otherwise, there may be criminal liabilities rather than benefits caused by invoking force majeure.

Wendy Zhang* received her bachelor’s degree from Sichuan University and master’s degree in Fudan University in Shanghai. Majored in international law, Ms. Zhang is experienced with and practiced in international investment law, corporate law, international financial trust law, international IP law, maritime law commercial and litigation, having practiced as an in-house lawyer for several firms, including a Chinese Red Flag Firm prior to joining this Firm..  She is a registered and licensed lawyer in China has advised a number of enterprises concerning litigation, equity transferring, labor and employment and related fields.  She has also designed risk management structures for an online Fintech company as well as a domestic bank, advised pharmaceutical companies, served as legal consultant to several foreign companies on their pre-IPO restructuring, advised Russian companies on their structure for investment in China, advised domestic companies on their trademark anti-infringement strategies, etc. The companies Mr. Zhang has advised include Chinese state-owned companies, Russian companies, American Companies, and German Companies. During her professional career, Ms. Zhang has developed a deep understanding of red-chip structures, equity investment structures both at home and abroad, especially structures involving Cayman companies, BVI companies and Mauritius companies.  Furthermore, she is also capable of advising finance and tax structure globally.  Ms. Zhang speaks and writes Chinese (native) and English.
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