Revisiting fund contracts in the context of PRC Civil Code

On 28 May 2020, the National People’s Congress of China approved the nation’s first civil code (Civil Code), in response to generations of efforts of China’s legislators to enact comprehensive legislation on civil rights and duties.

The Civil Code is a codification of civil laws that regulate property and personal rights, including laws on property, contracts, marriage, rights of personality, and torts, and its importance lies in different aspects. To the general public, it affects their lives in the most direct and intimate manner. To businesses and societies at large, the Civil Code reduces the inconsistencies between the standalone civil statutes enacted over the years, and would also settle some of the novel legal issues that have since arisen.

The significance of the Civil Code doubtlessly warrants reconsideration and reassessment of some key aspects of the private fund practice. As such, we will launch a mini-series to discuss some key clauses of a private fund contract in the context of the Civil Code, and will cover the force majeure clause in this article.

The Civil Code does not directly alter the substantive provisions in relation to force majeure, even though topics surrounding such point has gained increasing attention amid the COVID-19 pandemic.

Force Majeure

Under the Civil Code, force majeure events are defined as the “objective situations that are unforeseeable, unavoidable and unsurmountable”. The code further prescribes that “if a contract cannot be performed due to a force majeure event, liabilities may be exempted in whole or in part depending on the impact of the force majeure event, unless otherwise prescribed by law.”

As one could easily imagine, the somewhat ambiguous definition has led to the constant debate on whether certain events fall within the scope of a force majeure event or not. In such case, the court would adjudicate whether a force majeure event occurs either on a case by case basis or in the form of a judicial interpretation. For instance, in 2003, shortly after the SARS outbreak, the Supreme Court of China issued a judicial interpretation specifying that, in case that a contract could not be performed due to the SARS outbreak or any administrative measures adopted against SARS, such situation would be considered a force majeure event (and there is no such juridical interpretation recognising Covid-19 as force majeure).

It is worth noting that PRC laws generally respect the mutual agreements between the parties to a contract and will refer to the specific terms of the contract. Therefore, an adequately documented interpretation of force majeure event will prevail over the Civil Code’s default position. This means that the force majeure clause, despite being a boilerplate clause and constantly overlooked by parties when negotiating contracts, deserves more attention than it usually does.

Specifically to private fund managers, we would suggest that the drafting of a force majeure clause should factor in the following considerations:

1. What constitutes a force majeure event:

The first step is to include a definition that enumerates, usually non-exhaustively, events that parties consider as force majeure events. Examples that parties will often put include 1) natural disasters such as earthquakes, typhoons, floods, fires, and epidemics; 2) social events such as governmental actions, strikes, wars and riots; and 3) technology issues such as power failures, communications failures and abnormal accidents in technology systems.

In the private fund context, those who provide service are more likely to cite the force majeure clause to limit its contractual liabilities for non-performance than those who receive the service. As such, when negotiating the fund contract and various other service provider contracts, funds/investors may wish to limit the scope of the listed force majeure events. One way to do it is to, instead of making a general reference to natural disasters, include only natural disasters that are equal to or above a certain level – for instance, earthquakes above a certain magnitude scale.

2 .In order to rely upon the force majeure clause, what the
non-performing party needs to do. Typical items include:

• to notify the other party of the force majeure event as soon as
  possible;

• to provide certifying documents within a reasonable period evidencing
  the event constitutes a force majeure event, including but not
  limited to its non-ability to perform as resulted by such force
  majeure event; and

• to work with other parties to minimise the potential damage,
  including resuming the performance of the contract once the force
  majeure event ends.

3. Specifying the time needed for either party to terminate the contract
if applicable.

Being able to terminate the contract within a clearly construed
timeline serves a very important role in providing certainty to all
parties in the time of uncertainty.

Covid-19 specifics

In practice, whether the coronavirus makes a party unable to perform its obligations or renders the purpose of contract impossible to achieve will of course turn on the facts of each case, but as a preliminary observation, it would be generally difficult for asset managers and service providers to rely on the coronavirus to claim relief given the nature of fund contracts and service provider agreements unless the contract specifically stipulates otherwise. In other words, in most cases, coronavirus may make the performance of a fund contract or service provider contract more difficult, but not impossible.