The coronavirus epidemic, force majeure and hardship

The outbreak of the coronavirus epidemic in China, along with numbers of governmental restrictions on travelling, returning to work, opening of business etc. are causing enormous concerns to enterprises operating in China. Not only the SMEs but also large-scale enterprises may face unexpected and very heavy financial burdens during this difficult period not yet seeing its end. Under PRC laws, what are the legal tools at disposal of the struggling enterprises to mitigate their burdens and risks?

  1. FORCE MEJEURE

Force majeure is defined by the PRC Contract Law (1999) as any objective circumstance which is unforeseeable, unavoidable and insurmountable (Art. 117). The same Art. 117 provides that “A party who was 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.” Hence, the legal function of this tool is to exempt the impacted contractual party from assuming contractual liabilities.

Whether the coronavirus epidemic constitutes a force majeure? This question can be partly answered by comparison with the 2003 SARS epidemic.

Shortly after the control over SARS epidemic, on June 11th, 2003, the Supreme People's Court issued the "Notice on Well Performing the Trial and Enforcement of People's Courts According to Law during the Prevention and Control of Infectious Atypical Pneumonia" (Fa [2003] No. 72, abolished in 2013, “Notice No. 72”). Part III of the Notice No. 72 provided: disputes on contractual performance, which, if following the original contract, due to the epidemic, has a significant impact on the rights and interests of one of the parties, can be dealt with in accordance with the specific situation and the principle of fairness. Should it be impossible to perform the contract directly due to administrative measures taken by the governmental authorities to prevent the SARS epidemic or due to the impact of the SARS epidemic, the provisions of Art 117 and 118 of the Contract Law should apply.

Notice No. 72 seemed only to advocate the application of force majeure in case of impossibility of performance of the contract. Contracts that could be performed, even though the economic balance between the parties was materially disturbed due to the epidemic, were to be adjusted according to the principle of fairness, and therefore, the epidemic as such is not absolutely regarded as force majeure.

  1. HARDSHIP

The legal doctrine of rebus sic stantibus had not been codified in PRC laws until 2009 when the Supreme People's Court issued the Interpretation II of the of Several Issues concerning the Application of the Contract Law of the People's Republic of China (“Interpretation II”). This might explain why, back to 2003, Notice No. 72 did not mention the application of hardship, but only used the principle of fairness.

Article 26 of the Interpretation II provides that parties can modify or terminate a contract where: 1) a substantial change of circumstances occurs after the contract is concluded; 2) the change of circumstances is unforeseeable when the contract is concluded; 3) the change of circumstances is not caused by force majeure; 4) the change of circumstances is not a commercial or business risk; and 5) it is obviously unfair to a party, or the purpose of the contract would be frustrated if the parties continued to perform the contract.

The attempt to totally differentiate hardship from force majeure events above was criticized academically and often disrespected by the courts. In numbers of cases, the courts supported the application of hardship even though the change of circumstances was caused by a typical force majeure event, such as a natural disaster.

Regardless of the unclarity in definition of hardship in PRC laws, rich precedents exist where a party to a long-term contract was granted adjustment of contract due to the outbreak of SARS epidemic.

  1. DIFFERENT PROCEDURES AND LEGAL CONSEQUENCES

A party relying on force majeure is required to follow certain procedures under PRC laws (Art. 94, 96, 118):

  1. it shall timely notify the other party so as to mitigate the loss that may be caused to the other party;
  2. it shall provide proof of force majeure within a reasonable time;
  3. in the event force majeure frustrated the purpose of the contract, a party may terminate the contract by serving a notice to the other party. The contract is terminated when the notice reaches the other party.

On February 2nd, 2020, CCPIT (China Council for the Promotion of International Trade) issued its first certificate to a Zhejiang auto parts manufacturing enterprise, a supplier of Peugeot, certifying that the production cannot be timely resumed due to the governmental restriction.

Hardship, however, does not grant the contractual parties with much liberty. When claiming on the basis of hardship, a party needs to file a request for the modification or termination of the contract with the court. The court shall decide whether to modify or terminate the contract under the principle of fairness and in light of the facts of the case (Art. 26 of the Interpretation II).

Considering the overlap of force majeure and hardship, parties to a contract may face the difficulty of choosing the correct procedures to go through. It could well happen that a party sends out a notice claiming for termination of a contract due to the coronavirus epidemic as force majeure while the other party believes it is a hardship situation and therefore rejects such termination on notice. Procedurally, such a dispute can only be solved through the court proceedings.

  1. TYPICAL CONTRACTUAL RELATIONSHIP—LEASE AND SALE OF GOODS

Finally, to put the doctrines into practice and analyze two typical contracts.

  1. Long-term lease

In a broad sense, a lease contract may include contracts of leasing office or operational premises, and also contracting operation contracts. Business operators, leasing the premises, equipment, assets to operate and make profits, especially those lessees of shops, boutiques, and restaurants are heavily hit by the governmental restrictions and bans of resuming work.

Numbers of cases relating to the SARS epidemic show that adjustment of the rental claimed by lessees based on hardship (either the epidemic as such or the governmental bans) was often supported by the court. Nevertheless, termination of a long-term lease may be rejected by the court, since the contract purpose is not fully frustrated (for instance case: Guangxi Zhuang Autonomous Region Higher People's Court 2007 Guimin Siwanzi No. 1).

  1. Sales contract

Numbers of local governmental bans on resumption of production until Feb 9th, 2020 are resulting in delay in production and delivery and hence a breach of sales contracts. Under both international sales laws, such as CISG, UNIDROIT Principles of International Commercial Contracts, and PRC laws, governmental orders, restrictions, bans related to the epidemic may constitute a force majeure event impeding the timely performance of the contract.

Following the PRC laws, as introduced above, the party impacted by force majeure shall notify the other party on time. The impacted party may be exempted from the performance during the period of force majeure (in the current case until Feb 9th, 2020, or even longer, depending on the development of the epidemic) and the liability of breach, i.e. the delay in delivery. If the time of delivery is of essential to the buyer and therefore the purpose of contract is frustrated, the buyer may terminate the sales contract. But the seller impacted by the force majeure should not be held liable.

Should CISG be the applicable law, Art. 79 of CISG provides the similar solution in terms of notification and exemption of liabilities.

Finally, it should be noted that contracts carefully negotiated by the parties often contain force majeure and/or hardship clauses. Should these clauses contain specific agreements, such agreements precede the laws. It is therefore always advisable for the parties to anticipate and include more events as force majeure or hardship events in order to prevent unexpected risks.

Partner, ADAMAS – Attorneys-at-Law