February 05, 2020

How the Coronavirus May Impact Your Commercial Health and Contracts

The recent coronavirus outbreak not only poses potential human health concerns but also raises new risks for companies engaged in trade with China. The outbreak has prompted all levels of the Chinese government to take preventive measures to curb its spread, including extending the Lunar New Year holiday, quarantining Wuhan city, and blockading highways and local roads. These measures have prevented many Chinese manufacturing and logistics companies from delivering products to their buyers as work suspensions, unavailability of raw materials and shipment delays interfere. This may spur legal issues concerning whether delays in performance or non-performance constitute breaches of contract or are excusable force majeure events.

Does Your Contract Have a Force Majeure Provision?

Companies contracting with Chinese suppliers should take this opportunity to review their supply contracts, particularly the force majeure clauses. Special attention should be paid to the list of events deemed to constitute a force majeure event to see whether a health epidemic may be covered. References to “acts of God,” “acts of government” or other circumstances beyond the parties’ reasonable control all may provide the Chinese supplier with an argument to delay performance and/or avoid a claim for breach. The coronavirus outbreak may be viewed to include both a naturally occurring component (the virus itself) and a government action component (such as the quarantines and other measures to contain the outbreak).

If contractual supply commitments cannot be met, the supplier has the obligation to mitigate losses and perform the contract as soon as the force majeure event terminates.

If the contract is silent on force majeure and is governed by Chinese law, the provisions of the PRC Contract Law and the General Provisions of the Civil Law will govern. Under those laws, force majeure is defined to mean “any objective circumstances which are unforeseeable, unavoidable and insurmountable.” It can be argued that the coronavirus is novel (notwithstanding the outbreak of SARS in 2003), there is no specific treatment for such virus, and its prevention and control must rely on large-scale government-led action. Therefore it likely meets the definition of force majeure as an unforeseeable, unavoidable and insurmountable event.

To date, China has not issued any judicial interpretation to address the issue of whether the coronavirus epidemic constitutes a force majeure event that will relieve suppliers from partial or full performance of supply contracts. In the judicial interpretation issued by the Supreme People’s Court during the SARS crisis in 2003, the Court stated that disputes arising from the failure or inability to perform the contract due directly to the administrative measures taken by the government to prevent the SARS epidemic, or otherwise due to the impact of the SARS epidemic, are subject to the force majeure provisions of the PRC Contract Law (Articles 117 and 118).

Change of Circumstances Versus Force Majeure

In judicial practice, most of the courts adjudicated “SARS” as constituting a force majeure event, while some determined “SARS” constituted a “change of circumstances” and others rejected it as a force majeure event. Under Chinese law, a “change of circumstances” is defined as a situation where any major change that is unforeseeable, is not a business risk and is not caused by a force majeure event occurs after the formation of a contract. The legal implication of a “change of circumstances” is that the continued performance of the contract would be unfair to the affected party, or the affected party cannot realize the benefit of the contract. In such case, if a party files a request for the modification or rescission of the contract with the people's court, the people's court will decide whether to modify or rescind the contract based on the principle of fairness and in light of the actual situation of the case.

The key difference between force majeure and a “change of circumstances” is that the parties may terminate the contract under a force majeure event, and the party who is unable to perform can be partially or wholly exempted from ensuing liability. On the other hand, if a change of circumstances applies, the affected party may file a request to the People’s Court for the modification or rescission of the contract, and the court may decide whether to modify or rescind the contract as a result.

In short, the specific language of the force majeure clause may play a critical role in the ability of a party to be excused from performance. If the matter is referred to a Chinese court, other factors may be considered, such as the causal relationship between the outbreak of the coronavirus, the quarantine measures imposed by the government, and the failure or inability of a party to perform the contract.

Next Steps for Affected Companies

Under Chinese law, the party affected by a force majeure event has the obligation to timely notify the other party so as to mitigate losses, and the affected party must provide evidence of the force majeure event within a reasonable time. The China Council for The Promotion of International Trade (CCPIT) is the agency responsible for issuing force majeure certificates to companies struggling to cope with the impact of the coronavirus epidemic. These certificates are generally recognized by more than 200 countries and governments, including the United States.

As the coronavirus situation evolves, buyers and their Chinese suppliers should communicate with one another to assess the potential impacts of the quarantine measures and to determine how to resolve any supply issues. If contractual supply commitments cannot be met, the supplier has the obligation to mitigate losses and perform the contract as soon as the force majeure event terminates. U.S. companies should begin looking at their supply chains now to determine whether any suppliers have facilities in China or elsewhere that may be impacted by the coronavirus outbreak, and if so, they should begin considering contingency plans for a possible prolonged epidemic.

As the number of cases around the world grows, Faegre Drinker’s Coronavirus Resource Center provides information to help you understand and assess the legal, regulatory and commercial implications of COVID-19.
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