The unfolding coronavirus outbreak has devastated the economy of Hong Kong. It was reported that the average daily number of visiting tourists decreased to 3,000 in Mid February 2020 from 200,000 in Mid February 2019. Domestic demand has also seen a dramatic drop as Hong Kongers worry about the risk of infection in public places and an impending economic recession.
As the coronavirus strikes their business and operations, a lot of companies attempt to seek relief in contractual terms to alleviate the pressure. For example, in early February 2020, the China Council for the Promotion of International Trade (CCPIT) announced that companies affected by the coronavirus outbreak could apply to the CCPIT for “proof of facts” relating to force majeure if they were unable to perform international trade contracts on schedule or at all.
In one of the world’s most expensive commercial property markets, it is not surprising that the possibility of invoking force majeure clauses has grabbed the attention of many businesses amidst an environment of difficulties and uncertainties.
WHAT IS A FORCE MAJEURE CLAUSE?
It is common for commercial contracts to include a force majeure clause to deal with certain events (usually out of the control of the parties) that may significantly disrupt the parties’ ability to perform their contractual obligations. In the case of such unforeseen events outside the party’s control, the party may rely on the force majeure clause to excuse itself from performing the contract.
WHO CAN RELY ON THE FORCE MAJEURE CLAUSE?
In order to rely on a force majeure clause, the party seeking to rely must satisfy the following requirements:
- First of all, the party must ensure that there is a force majeure clause in the contract. Without an express clause, parties may not imply a force majeure clause into the contract. It must be noted that some contracts may incorporate a force majeure clause without putting it under the term “force majeure”. To identify whether there is an equivalent clause in the contract, the party may look for the following characteristics:
- Definition of triggering events, such as “events beyond the reasonable control of a party”, together with a non-exhaustive list of events which fall into such definition, e.g. war, Acts of God;
- Formalities that the party must follow after a triggering event occurs; and
- The consequences of the triggering event occurring; usual consequences include an extension of time or full/partial discharge of the contractual obligation.
- Parties wishing to rely on a force majeure clause must ascertain the scope of the clause and show that the current event falls within the definition of force majeure events.
- Third, the party must show that the force majeure event is beyond its control and that it has unforeseeably prevented or delayed its performance of the contractual obligation. A causal link between the force majeure event and the party’s failure to perform the contract is essential. A tenant may not invoke the force majeure clause if it could not fulfil its contractual obligation anyway even without the triggering event.
- The party must demonstrate that it has taken all reasonable steps to mitigate the impact of the force majeure event.
- The party must show that it has complied with the relevant notice formalities stated in the force majeure clause. As there is usually a time limit for notice to be given, parties are strongly advised to proceed in a timely manner. In relation to whether local tenants may rely on the force majeure clause in their tenancy agreements, while the impact of the novel coronavirus outbreak is certainly unforeseeable and significant, whether such event constitutes a force majeure event still depends on construction of such clause. It would be straightforward if the clause expressly covers events such as “epidemic”, “disease”, or “quarantine”. The current situation in Hong Kong is likely to be a combined result of both the coronavirus and government decisions (e.g. quarantine, immigration control, etc.). Tenants who intend to invoke the force majeure clause should review it with prudence. Legal assistance should be sought, where necessary, to ensure the parties’ interests are protected.
The major hurdle appears to lie in the third requirement above. Tenants’ primary contractual obligation under the tenancy agreements would be to pay rent in accordance with the terms. While the economic downturn caused by the coronavirus outside may have severely affected revenue and made rental payment a heavy burden for the business, it does not necessarily relieve tenants of the obligation to continue paying rent. This is contrary to strikes, for example, which prevent the companies from providing services or typhoons which make punctual cargo delivery impossible. It is an established principle that the force majeure clause does not release a party from a bad bargain or a contract simply because it becomes difficult for a party to perform its obligations after signing.
Therefore, in the absence of extreme incidents (e.g. government-ordered shutdown of the premises for quarantine purpose for a significant period of time), it is unlikely that tenants can invoke the force majeure clause to excuse themselves from performing the tenancy agreement.
THE COMMON LAW PRINCIPLE OF FRUSTRATION AS AN ALTERNATIVE?
If it is not possible to rely on the force majeure clause, the frustration doctrine under common law may provide some relief for tenants. Pursuant to this doctrine, a contract may be discharged “when something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract or transforms the obligation to perform into a radically different obligation from that undertaken at the moment of the entry into the contract”.
However, this doctrine is riddled with hurdles, such as a narrow scope. The common causes of frustration include (i) physical destruction of the subject matter of the contract, (ii) cancellation of an expected event; and (iii) delay attributable to the fault of neither party. Typically, hardship or financial loss and a difference in expense between the expected and actual performance of contract have been held to be insufficient to give rise to the frustration of contracts. Therefore, a contract will not be discharged on the ground of frustration simply because it turns out to be more difficult to perform.
From the very limited case law on whether an epidemic would frustrate a contract in Hong Kong, one example is Li Ching Wing v. Xuan Yi Xiong  1 HKLRD 754 (a case from the SARS epidemic). In that case, the tenant entered into a tenancy agreement with the landlord to rent domestic premises for a fixed term of two years beginning August 2002. After several months, there was an outbreak of SARS and the tenant was subject to a 10-day isolation order. The tenant sought to terminate the tenancy agreement and argued that the agreement was discharged by frustration due to the unforeseen SARS epidemic. It was held by the District Court that the circumstances were not sufficient to invoke frustration; the tenant in question was not entitled to treat the contract as discharged as the outbreak of SARS did not significantly change the nature of the tenancy agreement and given the short length of isolation period in the 2-year lease. This case illustrates the difficulty of getting a commercial contract discharged on the ground of frustration in case of an epidemic.
The application of the doctrine ultimately depends on the obligations arising from the contract and how these have been affected by the coronavirus outbreak. It would be prudent to seek legal opinion on the matter.
CONSEQUENCES OF BREACH OF TENANCY AGREEMENT
If the tenant defaults in paying rent but is unable to successfully invoke a force majeure clause or to persuade the landlord that there has been frustration so as to discharge a contract, it would amount to a wrongful repudiation of the tenancy agreement and the landlord would be entitled to claim for accrued rent and damages for the wrongful repudiation. Hong Kong case law shows that unless there is an express provision in the force majeure clause or an extreme situation e.g. a very long isolation order which covers a substantial period of the lease, it is unlikely that tenants can rely on force majeure or frustration to discharge the tenancy agreement.
More importantly, tenants should bear in mind that the compensation to be paid to the landlord after the wrongful termination of the tenancy agreement is not limited to the accrued rent and the security deposit. A landlord would likely have sustained further losses including the loss of rent due to the inability to find a substitute tenant for the remainder of the term of the unexpired lease. Although a landlord has a duty to mitigate its losses, the duty is one to take reasonable steps and given market conditions under the coronavirus outbreak, it is unlikely that a landlord would be able to find a replacement tenant to take up the remainder of the unexpired lease in a short period of time. In the worst-case scenario, the tenant might end up being held liable to compensate the landlord for the outstanding rent for the remainder of the term of the unexpired lease. Therefore, attempting to terminate the agreement is a very serious matter under the current situation, especially when the unexpired lease covers a long period.
In conclusion, tenants affected by the coronavirus outbreak should carefully consider the general principles of the force majeure clause and the frustration doctrine to see whether they may be helpful in the context of terminating tenancy agreements. Tenants should seek independent legal advice given the potential substantial compensation payable to the landlord in case of wrongful repudiation of the tenancy agreement. Tenants should also consider whether the terms of any business disruption insurance policy they may have will be of assistance.