Coronavirus – impact on business contracts

Everyone will be aware of the concerns facing individuals in regions impacted by the coronavirus. With government restrictions, and other related impact on movement, there will inevitably be interruptions to business contracts. When such interruptions occur parties will need carefully to examine their contractual rights and obligations. For Hong Kong, PRC and English law governed contracts, this will require consideration of the force majeure clause (if any) contained in the contract as well as business continuity / disaster recovery obligations.

What is a force majeure clause?

Most Hong Kong, PRC and English law supply contracts will contain a force majeure clause, which is a clause that relieves a party from its obligations to perform the contract in certain extreme circumstances.

Although the term "force majeure" is very commonly used, in Hong Kong and English law it has no recognised meaning in terms of the precise circumstances it covers, and so whether the coronavirus outbreak and / or the resulting Government restrictions are covered will be determined by the wording of the specific contract term.

Many Hong Kong and English law contracts define what constitutes a force majeure event by reference to events “beyond the reasonable control of a party” and contain a non-exhaustive list of the type of events covered. Parties will need to consider the wording of such clauses carefully before relying on them and similarly counterparties may want to challenge any such reliance.

Under PRC law, "force majeure" is a statutory right. Article 117 of the PRC Contract Law defines force majeure as “any objective circumstances which are unforeseeable, unavoidable and insurmountable”. Given the nature of the coronavirus, it may well constitute a force majeure event under PRC law, depending on the nature of the contractual relationship concerned.

How to benefit from a force majeure clause

Under Hong Kong law and English law, to be able to benefit from the force majeure clause, parties will need to check:

• whether the type of hindrance is covered by the clause, i.e. does it apply in cases of delay or only where performance is impossible? A clause which refers only to performance being prevented presents a higher hurdle to get over than a clause that refers to performance being impeded, hindered or delayed;
• what the notification requirements are. Notice of the occurrence of a force majeure event should not just be served on operational contacts but also in accordance with the contractual notice requirements (to avoid any dispute about proper service);
• whether there are any other obligations that a party is required to comply with in order to rely on the force majeure clause. For example, a force majeure clause may require specified mitigating measures to be implemented by a party while the force majeure event is ongoing; and
• how the clause interacts with contractual business continuity and disaster recovery provisions that apply separately to the agreed force majeure regime. For example, could the impact of the event have been mitigated by implementing the agreed business continuity / disaster recovery plan? It is often the case that force majeure relief is not available for the impact of events that could have been avoided or mitigated through the proper operation of a business continuity and / or disaster recovery plan.

Under PRC law, in addition to the contractual considerations stated above, the parties also need to be aware of the statutory requirements which require the party claiming relief to give timely notice and provide relevant supporting documents, and the other party to take necessary steps to mitigate the losses.

Note that under all three laws – Hong Kong, PRC and English, it is the party claiming relief under the force majeure clause who has the burden of proving that the event has occurred and that it prevents or hinders their performance.

What does relying on a force majeure clause mean?

Under all three laws, the impact of a party relying on a force majeure clause will depend on the wording of the contract. It may lead to:

• the affected party being entitled to suspend their obligations and avoid liability for any failure to perform their obligations or delay in performing those obligations;
• enhanced contract governance measures (such as extra reporting) or remediation measures (such as “step-in” rights);
• termination by either the unaffected party or either party. This is usually after the force majeure event has persisted for a stated period of time; and
• exit or handover assistance if the contract is terminated in whole or part and if such assistance is required by the contract.

In addition, PRC law provides statutory exemption and termination rights where there is a force majeure event (subject to certain conditions being met):

• statutory exemption: a party who is unable to perform a contract due to force majeure is exempted from liability in part or in full based on the impact of the event of force majeure (Article 117 of PRC Contract Law); and
• statutory termination: The parties to a contract may terminate the contract the purpose of contract is impossible to achieve due to an event of force majeure (Article 94.1 of PRC Contract law).

What if there is no force majeure clause?

In Hong Kong and English law governed contracts without a force majeure clause, the doctrine of frustration may assist. Frustration applies where something, which is the fault of neither party, happens after the formation of the contract which:

• under Hong Kong law: so significantly changes the nature of the outstanding contractual rights and obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the contract in the new circumstances; and
• under English law: makes it physically or commercially impossible for a party to fulfil a fundamental obligation of the contract; or which transforms the fundamental obligation to be performed into a radically different obligation.

Where frustration does apply, the contract is automatically discharged, meaning neither party has to comply with future obligations.

While this may sound more appealing than seeking to rely on the force majeure clause, the standard for establishing frustration is a high one, and the supervening event must very significantly change the nature of the outstanding obligations. It is also worth noting that counterparties may have a claim in restitution or under statute for the return of any amounts paid prior to the frustration.

In PRC law governed contracts without a force majeure clause, the statutory force majeure clause will apply. The doctrine of “changes of circumstances” may also avail the parties. This doctrine applies where “any major change which is unforeseeable, is not a business risk and is not caused by a force majeure occurs after the formation of a contract, if the continuous performance of the contract is obviously unfair to the other party or cannot realize the purposes of the contract...”

Where the doctrine of “changes of circumstances” applies, the Court has discretion to decide whether to modify or rescind the contract.

Conclusion

Businesses who are part of a supply chain impacted by the existence of the coronavirus should carefully consider whether they, or the other party, can rely on a force majeure clause. That will depend upon the governing law of the contract and the wording of the clause in question.