Coronavirus in China: Applicability of Force Majeure in Contract Disputes

February 4, 2020 Posted by China Briefing Reading Time: 7 minutes

By Vivian Mao, Dezan Shira & Associates

The spread of the coronavirus in China these past few weeks has caused the World Health Organization (WHO) to announce the situation as a Public Health Emergency of International Concern (PHEIC). Many enterprises in China (including foreign invested entities) may be heavily affected in the production, logistics, international service, and other aspects of their operations, which may result in delays or failure to fulfill contractual obligations. Under such a situation, should the affected enterprises take liabilities for breach of contract? Is delayed performance or contract termination allowed?

In this article, we look at the situation according to Chinese laws and similar cases and suggest what measures should be taken to deal with these contractual issues.

Definition of force majeure

Firstly, we need to analyze whether the new coronavirus outbreak should be identified as “force majeure”. How is force majeure defined internationally? How is force majeure stipulated under China laws? How should force majeure clauses be designed in contracts?

In terms of force majeure, Article 7.1.7 of the “Principles of International Commercial Contracts” stipulates the following:

(1) Non-performance by a party is excused if that party proves that the non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of conclusion of the contract or to have avoided or overcome it or its consequences.

(2) When the impediment is only temporary, the excuse shall have effect for such period as is reasonable having regard to the effect of the impediment on the performance of the contract.

(3) The party who fails to perform must give notice to the other party of the impediment and its effect on its ability to perform. If the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, it is liable for damages resulting from such non receipt.

(4) Nothing in this article prevents a party from exercising a right to terminate the contract or to withhold performance or request interest on money due.

Similarly, in China’s legal system, both 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” define force majeure as being unforeseeable, unavoidable, and insurmountable objective conditions. They are also the key characteristics based on which China’s arbitration courts identify “force majeure”.

The legal consequences of force majeure are stipulated in the above mentioned two laws as well. Civil liability shall not be borne for failure to perform a contract or damage to a third party if it is caused by force majeure, except as otherwise provided by law (Article 107 of “General Principles of The Civil Law of The People’s Republic of China”).

The parties may terminate a contract if force majeure has frustrated the purpose of the contract (Article 94 of the “Contract Law of The People’s Republic of China”).

Where it is not possible to perform a contract due to force majeure, then, depending on the extent of the force majeure, the performing party shall be partially or wholly excused from liability, except where laws provide otherwise. Where force majeure occurs after a party has already been late in performing an obligation, the said party will not be excused from liability (Article 117 of the “Contract Law of The People’s Republic of China”).

Where one of the parties is unable to perform the contract due to force majeure, the said party shall immediately notify the other party in order 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 (Article 118 of the “Contract Law of The People’s Republic of China”).

After one of the parties has breached the contract, the other party shall take appropriate measures to prevent any increase in the losses sustained; where the other party fails to take appropriate measures, and this leads to an increase in the losses sustained, the other party may not demand compensation for these additional losses. Any reasonable expenses paid by a party to prevent increased losses shall be borne by the breaching party (Article 119 of the “Contract Law of The People’s Republic of China”).

Based on international practice, force majeure usually includes natural disasters (fire, earthquake, flood, hurricane, drought) and contrived events (wars, terrorism, strikes, riots, government orders). The contracting parties can agree on and detail the situations and events of force majeure in the contracts.

Force majeure and the coronavirus

Taking the coronavirus outbreak as an example, if such specific circumstances as epidemic diseases and plagues have been included in the force majeure clauses under executed contracts, the situation can easily be identified as force majeure. Even if epidemic diseases or plagues are not listed in force majeure clauses, arbitration courts are still likely to judge that the event falls into force majeure, in accordance with the above mentioned characteristics of force majeure, and take full consideration of the epidemic duration, the detailed provisions in contracts, and scope of government order, etc.

In the most similar situation (SARS, 2003), the Chinese courts and arbitration bodies judged this kind of epidemic as force majeure in many cases at that time. The Supreme People’s Court issued a notification. In event that the non-fulfillment of contract results from SARS or the prevention measures taken by the government, the related contract disputes should be dealt with according to the provisions of force majeure. However, also in some “SARS” cases, some courts did not support the application of force majeure, because the government’s acts were deemed to have only partially affected the business activities of the breaching parties and did not directly or radically trigger the non-fulfillment.

Force majeure – extent of liabilities

A frequently raised question is whether the liabilities for breach of contract will be exempted as the coronavirus outbreak constitutes force majeure.

Force majeure events do not necessarily exempt the whole liabilities for breach of contract. The liability exemption should be dealt with differently depending on the extent of force majeure and the difficulties imposed on the performing parties. If it is impossible for the performing parties to execute contracts due to force majeure, the contract should be terminated and the liabilities for breach of contract should be exempted.

If the contracts can only be partially performed due to force majeure, the parties can amend the contract terms and partially exempt the liabilities for breach of contract.

In this case, force majeure only temporarily prevents performing parties from performing the contracts, the other parties can plan for the delayed fulfillment by performing parties, and the performing parties should be excused from 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.

There are additional notifications and regulations regarding coronavirus prevention and control recently published by relevant administrative departments or local governments. For example, the China Banking and Insurance Regulatory Commission released the “Notice on Enhancing the Cooperation of Prevention and Control over Coronavirus Outbreak within Banking and Insurance Industries” (Yin Bao Jian Ban Fa [2020] 10), which clearly states “for those temporarily lost incomes due to the outbreak, the preferential loan policies shall apply, and shall flexibly adjust the repayment arrangement of personal loans such as housing mortgage and credit cards”, and “it is not allowed to withdraw, cut off or suppress the loans against the industries largely affected by the outbreak, like wholesale and retail, accommodation and catering, logistic transportation, culture and tourism, or those enterprises temporarily trapped but with promising future”.

How to handle potential force majeure claims?

What measures should be taken by both contractual parties after the occurrence of force majeure?

In the face of the contract performance obstacles caused by the coronavirus outbreak, we suggest that suppliers should take the following measures:

(1) Assess the impact on the contract performance, and determine whether the provisions in terms of force majeure are applicable and whether to terminate or change contracts;

(2) Take immediate and effective measures to prevent the increase in the losses; and

(3) Obtain the certificate of force majeure.

In China, the China Council for the Promotion of International Trade (CCPIT) is the competent organization to issue the certificate of force majeure.

For those who delay or fail to perform the international trade contracts due to the coronavirus outbreak, the China Council for the Promotion of International Trade (CCPIT) created an online certification platform (see here) on January 30, 2020 for proof of facts related to force majeure.

The following supporting materials should be submitted by enterprises online:

Certificates/announcements issued by the local governments or institutions;
Notices/certificates on delay or cancellation of sea, land or air transportation;
Export sales contracts, cargo booking agreements, freight forwarding agreements, customs declarations, etc.; and
Other related materials.

Other actions when claiming force majeure:

(4) Send written notices to buyers / service receivers as soon as possible, to confirm the facts and propose appropriate solutions; and

(5) Proactively negotiate with buyers / service receivers and prepare for potential litigation.

Meanwhile, the following measures should be taken by buyers / service receivers:

(1) Check with suppliers whether their production and operation have been affected by the coronavirus outbreak, and whether the contract performance will be affected, to be prepared in advance in case that buyers need to purchase from other channels or slow down their own production and operation accordingly;

(2) In the event that buyers / service receivers have foreseen that it is impossible to fulfill the contracts due to the coronavirus outbreak, buyers / service receivers can also take the initiative to send notices on contract termination to suppliers; and

(3) If the situation results in buyers / service receivers’ failure in receiving goods or services, or making payment, buyers / service receivers should send notices to suppliers as soon as possible.

Please check with your China consultants concerning these issues, or email our firm’s legal counsel at legal@dezshira.com with any questions concerning China trade contracts.

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Vivian Mao is in-house legal counsel at Dezan Shira & Associates Shanghai and is a partner of the firm. She has a law degree in International Economic Law from East China University of Political Science and Law, holds the Certificate of Lawyer’s Qualification, and is a member of International Bar Association.