17 Mar 2020

Business advice: Effects of COVID-19 on Contractual Performance in China

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. This alert by MSI Chinese member firm DaHui Lawyers 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: A seller may argue that the COVID-19 outbreak excuses it from a contractual obligation to deliver certain goods. A contractor may seek exemption from liability for abandoning or delaying a construction project. 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 existing contractual provision on force majeure may take precedence over default PRC law. An affected party must promptly provide, to its counterparty, notice and proof of the force majeure event, including details specific to the party and the health situation at the party’s place of business. Force majeure relief should be presumed not available in certain circumstances, e.g.,
  • when the contract was concluded after the COVID-19 outbreak;
  • when performance was delayed, or not carried out at all, before the outbreak; or
  • the obligation/liability to be exempted is purely a monetary one.
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: What governing law and dispute resolution mechanism(s) does the contract provide? Does the contract have a force majeure or similar provision? What are the terms? When was the contract entered into and when did the issue in performance arise? If a party cannot or may not be able to timely perform a contractual obligation:
  • what affects may non-performance have on the relationship with counterparties (upstream and downstream);
  • which obligations in particular are affected and to what extent are they affected by the outbreak, the government response or some other aspect of the situation; to what extent can the non-performance be avoided, the impediment(s) overcome or the consequences mitigated;
  • would insurance cover potential liability for non-performance; and
  • when should notice be given and what should it specify?
What evidence is available relating to the effects of the force majeure to the non-performance? (Has a “force majeure certificate” been obtained from the CCPIT?) If a counterparty cannot or may not be able to timely perform a contractual obligation:
  • has the counterparty provided the requisite notice and evidence regarding the force majeure;
  • how strong is not only a claim for breach of contract but also the ability to recover from the counterparty?
  • what roll-on effects will non-performance cause and can they be avoided;
  • would insurance cover potential liability for non-performance; and
  • what, if anything, should be communicated (in response) to the counterparty?
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.

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