COVID-19 Legal Series (2): How to Minimize Losses From Force Majeure Declarations

Article 180 of the CL Provisions, Article 153 of the CL Principles and Article 117 of the Contract Law define force majeure as any objective circumstances which are unforeseeable, unavoidable and insurmountable. In the context of the COVID-19 outbreak, a force majeure claim may be triggered by the occurrence of the outbreak itself, the government actions or decisions to contain the outbreak, or a combination of both. For example, the spokesman for the Legislative Affairs Commission of the National People's Congress Standing Committee has publicly stated that where a party is unable to perform a contract due to government prevention and control measures regarding COVID-19, such circumstance constitutes an "unforeseeable, unavoidable and insurmountable force majeure event".

The specific force majeure language in the contract also matters in terms of the degree of burden to establish such fact.  For example, if "epidemic" or a similar term such as "global health emergency", "pandemic" or "plague" is explicitly listed in the contract as a force majeure event, then the affected party has a stronger position from which to invoke the force majeure clause. Nevertheless, in the absence of such specific reference, the catch-all clause or reference to broad criteria will provide possible room for such interpretation.

In any case, the mere establishment of COVID-19 as a force majeure event for the affected party will not automatically entitle the declarant to be relieved from its contractual obligations. The counterparty should examine additional factors and assess its options, as illustrated below.

…businesses are advised to engage in discussions with affected counterparties to gain early visibility of the extent of likely disruption to their operations

4 .  Maintain earlier and continued communication

Article 118 of the Contract Law requires that a party which is unable to perform the contract due to force majeure must promptly notify the other party so as to reduce the potential losses sustained by the other party. If a specific notice requirement is provided in the contract, the counterparty should assess whether the affected party has provided its notice pursuant to the notice requirements. Where the counterparty is not able to receive, or fails to timely receive, the force majeure notice, such counterparty could use this as a factor in disputing the claimed relief. Failure or delay in giving notices will likely make the affected party liable for any resulting undue increase of losses, but this generally would not fully preclude the affected party from relying on invocation of the force majeure clause.

To more proactively manage any impact, businesses are advised to engage in discussions with affected counterparties to gain early visibility of the extent of likely disruption to their operations. For example, they may request an affected counterparty to submit a detailed written statement, and provide as much information as possible about the specific claims, the timing and expected duration of the event, the precise ambit of the impact, relevant proof and proposed mitigating measures. Companies should also make sure that an affected counterparty agrees to provide timely notification of any changes to the situation.

However, counterparties to force majeure notices should also be careful not to inadvertently make any goodwill offers or gestures that will later jeopardize their contractual or legal protections which they did not intend to waive.

5 .  Request for supporting evidence and examination of causality

Article 118 of the Contract Law provides that the party making a force majeure claim must also provide evidence of the event within a reasonable time limit. This evidence may include documents issued by government bodies or authorized institutions relating to the event and affected contract performance. One of the functions of the CCPIT as stated in its Charter is to issue force majeure certificates; as noted above, the CCPIT has already issued thousands of such certificates for businesses that are struggling to perform their international trade contracts due to the COVID-19 outbreak since it published the guidance for application of such certificates on Jan. 30, 2020 (and issued the first certificate only two days later). However, the CCPIT's force majeure certificate only serves as a proof of objective facts such as delay in resumption of work, traffic control or difficulty in dispatch of personnel, and the certificate itself is not a legal instrument relieving or reducing a party's contractual obligations.

A counterparty to a force majeure notice should also carefully scrutinize the direct causal link between the claims and supportive evidence provided to assess the claimed extent of the force majeure event and whether the relief claimed (relief of contract performance or termination of contract) goes beyond the effect of such event. In PRC judicial practice, factors considered to be in connection with force majeure relief include the nature of the contract, the characteristics of the business in which the parties engage, the local work resumption arrangements where the party is located, the time of execution of the contract, and the duration of the contract, and findings and judgments will be made on a case-by-case basis.

It should be noted in particular that a claim for contract termination would be subject to stricter review in judicial practice. In addition to evidence on the extent of the effect and the causality between the outbreak and the failure to perform the entire contract, the court will examine whether the purpose of the contract has been fundamentally frustrated. Relevant judgments rendered on contract disputes related to the 2003 SARS outbreak may provide helpful reference. In practice, the Chinese courts are rather cautious in upholding a party's claim to terminate a contract due to a force majeure event, and again their assessment will be made on a case-by-case basis, taking into consideration various factors and specific situations.

A party invoking force majeure is generally required to take appropriate mitigating measures

6 .  Request for mitigation measures

A party invoking force majeure is generally required to take appropriate mitigating measures. Therefore, a party receiving notice of force majeure should request the affected party to provide evidence that it has made the required effort to prevent or mitigate the effects of the force majeure event. If the party invoking force majeure fails to do so, the counterparty could then dispute at least part of the force majeure relief claimed and claim damages resulting from such failure.

7 .  Evaluate possible legal consequences

If a force majeure event is validly established, the legal consequences under the CL Provisions, the CL Principles and the Contract Law include partial or entire relief of contract performance to the extent of the effect of the force majeure event, and ultimately termination of the contract should the conditions for termination be fulfilled. For a party facing a force majeure claim, it is advisable to assess the specific claims and how they would impact its operations. If continued performance of the contract is preferred, it is essential to consult with the affected party in a timely manner to minimize the extent of the effect and actively explore alternatives, and ensure that the affected party continues to perform the part of the contract which is not affected. If termination of the contract is desired by the recipient of a claim, it should also start to gather evidence in light of possibly shifted burden of proof.

8 .  Application of "change of circumstances" principle

A party affected by the COVID-19 outbreak might also resort to the so-called "change of circumstances" principle available under the PRC legal regime. Such principle usually applies to situations such as an abrupt surge in the cost of raw materials, labor, logistics, financial crisis or other significant social and economic changes which make performance so onerous as to render it unfair. During the 2003 SARS outbreak, judicial rules provided that relevant cases should be handled based on the principle of fairness, which is akin to the "change of circumstances" principle, and court judgments rendered during that time could be of some relevance.

In 2009, the Supreme People's Court issued a judicial interpretation to the Contract Law, Article 26 of which specifically stipulates that the court may rely on the "change of circumstances" principle in adjudicating a claim for modification of termination of contract on grounds of fairness or frustration of contract purpose. However, in practice, the court is quite cautious in applying this principle and it is not common for courts to grant such relief. In the face of such claims, companies are advised to further raise its vigilance level in dealing with such claimants.

As force majeure or "change of circumstances" cases are often context specific, to properly manage the effects of COVID-19 on their commercial contracts and overall business operations, recipients of force majeure or "change of circumstances" notices should seek professional advice on the legal ramifications on their contractual positions, as well as appropriate options in light of their business objectives. Meanwhile, companies which have not yet received such notices should carry out a risk-based review of their operations and contracts as soon as possible.