Force Majeure Plus – The Use of Force Majeure Provisions in China during Covid-19

The COVID-19 virus was identified in Wuhan last year and it is believed that virus might have originated there in either November or early December. However, issues did not really arise until well into January 2020. At the beginning of the Chinese New Year (which was 25 January 2020), businesses were operating as normal. International flights were running without interruption and businesses were planning to resume as usual after the holiday period.

It was during Chinese New Year that problems really started and the PRC government took swift action by locking down Wuhan. Similar measures were also adopted in other provinces around the PRC. Among other things, the Chinese New Year holiday was extended so as to prevent the usual mass movement of people and other measures were introduced by various cities around China. It was at this time that businesses started to be impacted – as whole populations were either encouraged or ordered to remain at home. Schools and businesses were closed. Restrictions on movement were slowly introduced and quarantine measures were imposed on travellers.

During the period, businesses started evaluating their contractual obligations and considering if they could rely on the Force Majeure clauses in their contracts in the context of their ongoing obligations and those of their business partners.

Force Majeure in China

Force majeure provisions are by their nature, negotiated without any knowledge of the precise circumstances in which they will apply. Such provisions will ordinarily provide relief from obligations based on events or circumstances beyond the control of the party claiming force majeure. Clearly, many companies have been reviewing such provisions recently given the disruptions caused by the COVID-19 pandemic.

Force majeure, in Article 117 of the PRC Contract Law, refers to “the objective circumstances that are unforeseeable, unavoidable and insurmountable”. Almost all force majeure contractual provisions will specifically refer to events broadly within this definition subject to an express duty to mitigate. The COVID-19 outbreak was obviously not foreseeable and in many cases parties can do little to mitigate circumstances, particularly during periods of closure as mandated by the government. However the position may not always be clear-cut and parties must be careful when considering how force majeure provisions apply.

Basis of a Claim

There are particular features relevant in the PRC that should be noted.

1. As in many jurisdictions, a party seeking force majeure relief may wish to rely on ‘epidemic’ as one of the circumstances specified in a force majeure provision or perhaps the general definition of force majeure as being an event or circumstance beyond the control of the party claiming it.
2. Alternatively, a party claiming force majeure may also rely on government directives, policy statements and local regulations which have either ordered businesses to close or encouraged changes in the way business is conducted.
3. Although force majeure relief is usually applied to obligations that cannot be performed (such as an obligation to deliver something or provide a service), a payment obligation usually would not fall into this category, although some government directives and policy statements provide additional scope to address the financial consequences of COVID-19.

These issues will be particularly important where one party disputes another’s rights to claim force majeure at all, the period during which force majeure relief is available and may also impact on precisely what sort of relief or variation to contractual obligations is available.

Differing Circumstances

Clearly government directives issued by major cities such as Beijing and Shanghai have either required or encouraged companies to ask their employees to remain at home or in some cases shut down businesses for various periods of time. Differing requirements may provide room for argument as to the way in which force majeure provisions apply, particularly where government makes a recommendation only rather than a rules that must be strictly followed. There have been differences between the various directives issued, often depending on the severity of the virus at a particular time.

The date that such directives are issued may also be a factor relevant in disputes about the validity of force majeure claims. Some periods prior to or immediately after a period covered by a government directive may limit the ability for a party to claim force majeure or otherwise make it more open to question.

The other variable is the nature of business being conducted. In some cases government directives are focused on particular business areas (such as visitor attractions, cinemas and other services industries involving the gathering of members of the public in one place). For example, Shanghai has issued emergency measures to close entertainment and visitor attractions. At the same time, the environment in other sectors has evolved. For example, many restaurants closed voluntarily in the beginning, leaving a small number open. A period then followed where many restaurants started to serve takeaway food only or closed completely.

SARS Experience

Separately, parties may find themselves in circumstances with no, or an inadequate, force majeure provision. However, there may be scope to argue for flexibility and request good-faith negotiations with a view to an adjustment of payment obligations. This issue was examined during the SARS (Severe Acute Respiratory Syndrome) outbreak in 2003, when the Supreme People’s Court issued a notice (SARS Notice) on 11 June of that year addressing, among other things, the application of the principle of fairness in contractual disputes during the SARS outbreak. Although this Notice is no longer effective, it is indicative of the approach that might be expected during the present COVID-19 period.

The SARS Notice said a force majeure could treated as having been established if (i) a failure to perform was directly caused by administrative measures taken by government to prevent the SARS epidemic; or (ii) it is fundamentally impossible for a party to perform its obligations due to the SARS epidemic. The general requirement was that the parties act in a fair and reasonable manner including in respect of the variation of obligations and (significantly) requests for financial adjustments – although the precise arrangements to be made were to be considered on a case-by-case basis, with no hard rules but simply an expectation that the parties adopt a fair approach. Clearly the way the SARS Notice was applied was subject to contractual arrangements and all other circumstances but with a direction to the courts to adopt the principle of fairness in deciding disputes.

2020 Supreme People’s Court Guidance

On the 16 April 2020 the Supreme People’s Court issued a new guidance opinion which made some important points and in addition confirmed that force majeure should be available during the COVID-19 pandemic. Some important statements were also made as to how force majeure provisions should be applied.

Among other things, the Supreme People’s Court has provided guidance regarding the obligations on any party claiming force majeure to mitigate their losses and to mitigate the effects of non-performance on the other parties involved. The requirement of give notice promptly following the occurrence of an event of force majeure was also stressed.

Alongside these confirmatory statements however, important guidance has now been given indicating that where a party’s performance is affected but not necessarily prevented and “only causes difficulties in the performance of the contract”, the parties may nevertheless seek renegotiation. This is significant and appears to go beyond the scope of ordinary force majeure in that the guidance refers to adjustment of financial obligations and contract variations to deal with the changed circumstances caused by COVID-19. The guidance appears to follow the general approach taken in 2003 during SARS that stressed the requirement for parties to show flexibility and fairness.

New Government Directives

In the context of discussions regarding contract performance now taking place, parties may wish to embark on good-faith discussions taking heed of the new Supreme Court Guidance and perhaps also referring to the SARS experience as an example of how similar issues have been addressed in the past.

Furthermore, additional guidance has been given. For example, a spokesperson for the Legislative Affairs Commission of the National People’s Congress Standing Committee is reported to have stated on 10 February 2020 that if parties are unable to perform their contractual obligations due to the government measures relating to COVID-19, they should be allowed to claim force majeure reliefs in accordance with the PRC Contract law. The First Civil Division of Higher People’s Court of Zhejiang Province is also reported to have stated on the same day that in disputes force majeure relief and the principle of “fairness” should be adopted (being very similar to the SARS approach discussed above).

One should also note that the Beijing and Shanghai governments both issued notices granting special support for small and medium size businesses for rent relief.

• In particular, the Beijing notice, issued on 5 February 2020, stated that a landlord that is a state-owned enterprise should grant a two-month rent exemption for a manufacturing premises and a 50% reduction for office leases (subject to certain criteria). It also encouraged private landlords to grant rent relief to tenants. Certain financial incentives appear to be available to landlords offering such rent relief arrangements.
• A Shanghai municipal government notice on 7 February 2020 also appeared to indicate that of February and March 2020 rent could be potentially exempted where the landlord is a state-owned enterprise and encourage private operators of large office buildings, malls and industrial parks to grant rent relief to tenants.

Some of these policy statements may be very general and the recent Supreme Court Guidance is by its nature a very high level indication of the approach that is expected. However taken collectively this is a body of opinion that appears to be consistent. Overall, this indicates that in the event of a dispute, the courts are likely to be sympathetic to those more severely impacted by the COVID-19, while facilitating negotiation and keeping contracts alive. Perhaps more importantly, such policy statements can be used in negotiations to encourage cooperation and compromise.

Although the COVID-19 crisis in the PRC has moved into a recovery and control phase and businesses are now open, the legal issues discussed above are more important than ever, especially considering the ongoing problems faced globally which are causing further issues to some China-related contracts. Discussions will continue in the months ahead as businesses attempt to re-set contractual relationships and issues of liability will inevitably arise. As the financial impact of the crisis continues to bite, the issues discussed above are likely to continue to be relevant to many business relationships.