What to do when your company has been affected by Covid-19
Source: https://www.ft.com/content/d8b7ce82-5276-11ea-8841-482eed0038b1
With the Covid-19 epidemic spreading all over the People’s Republic of China (PRC), Chinese authorities have ordered a “city lock-down” to limit further contamination. This has prevented companies from performing their contractual obligations – such as factory operation and deliveries – and has left them wondering if they are permitted to escape their obligations of payment or penalty fees without legal liability. This note explores if companies would be able to rely on legal mechanisms such as force majeure or hardship clauses to mitigate liabilities caused by the failure to perform contractual obligations.
Force majeure
A "force majeure" clause (French for "superior force") is a contract provision that relieves the parties from performing their contractual obligations when certain circumstances beyond their control arise, making performance inadvisable, commercially impracticable, illegal, or impossible. Due to the nature of it being a contractual term, the clause would only apply if the contract provides for it. However, it is a statutory factor under PRC’s legal framework that, even with the lack of expression in contract, the principle behind a force majeure clause could still apply. This can be seen through Article 18o of PRC’s General Principles of the Civil Law, where it states that “No Civil Liability is borne in case of failure to perform civil duties due to force majeure, unless otherwise provided by law.” The ability of enforcing the force majeure principle albeit with a lack of contractual expression can also be seen in Article 117 of Contract Law of PRC: “A party who is unable to perform a contract due to force majeure is exempted from liability in part or in whole in light of the impact of the event of force majeure, except otherwise provided by law.”
It is important to note that both the aforementioned laws define force majeure as unforeseeable, unavoidable and unconquerable objective situations, and in practice, PRC law adopted common law mechanisms so that many contracts now include expressions such as “beyond the reasonable control of the parties”, followed by a list of events, e.g., war, famine, strike, act of God, earthquake, terrorism, riot, etc. It could safely be argued that the epidemic that has caused lock-downs nationally and has disrupted the course of business globally can be deemed as a situation in which the principle of force majeure would apply.
It, therefore, seems that whether or not the contract in question contains a force majeure clause, the principle shall always apply for the contractual relationships that have been directly affected by Covid-19. But, Article 118 of the Contract law provides corresponding notice and proof of force majeure: “If a party is unable to perform the contract due to force majeure, it shall promptly notify the other party to mitigate the loss that may be caused to the other party and shall provide it within a reasonable period prove”, and article 119 stipulates that parties shall take the appropriate measures to prevent unnecessary losses.
Hardship
A hardship clause in a contract is one that is intended to cover cases in which unforeseen events occur that fundamentally alter the equilibrium of a contract, therefore resulting in an excessive burden being placed on one of the parties involved. Article 26, Interpretation II of the Supreme People’s Court of Several Issues Concerning the Application of the Contract Law states: “Where any major change which is unforeseeable, is not a business risk, occurs after the formation of a contract, and if the continuous performance of the contract is obviously unfair to the other party or cannot realize the purposes of the contract, a party may file a request for the modification or rescission of the contract with the people’s court and the people’s court shall decide whether to modify or rescind the contract under the principle of fairness and in light of the actualities of the case.”
In judicial practice, application of this kind of clause is very strict and issued a notice that it shall only be applied when the continuous performance is obviously unfair to a party of the contract, and it shall be submitted to the higher people’s court for approval, or to the Supreme Court when necessary.
Force Majeure v Hardship Clause
The stark difference between the initiation of the two clauses lies in the event that can trigger it. While natural disasters and political social events that render performance impossible instigate force majeure, generally unexpected events such as sharp changes in the socio-economic situation, soaring prices, severe currency depreciation, and changes in national policies that disadvantage one party instigates hardship.
Covid-19 v SARS
Though China’s economy was at a different stage of development to what it is now, it may be useful to refer to how courts handled companies affected by the SARS outbreak in the early 2000s. The Supreme People’s Court issued a notice in 2003, providing that “disputes arising from administrative measures taken by the government and relevant departments to prevent the SARS epidemic directly resulting in the contract being unable to be performed, or due to the impact of the SARS epidemic causing the parties to the contract to fail to perform at all”, the force majeure clause shall apply.
Albeit China’s tendency to retain information and delay in reporting the facts of both of the outbreaks, it is irrefutable that it has taken extraordinary measures to attempt to contain the virus – as Vox notes – “on a scale that’s never been done,” even with SARS. With stricter restrictions on public places like quarantining more than 50 million people in the city of Wuhan and boosting its surveillance technology capabilities through drones and QR codes, it appears to be conclusive that these measures are more likely to impact contractual performances.
It is therefore likely that companies will be able to fall back on force majeure if they are unable to fulfill their contractual obligations.
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