Takeaways

China’s statutory laws allow contracting parties to terminate a contract or excuse their performance of certain contractual obligations upon occurrence of a force majeure event or a material adverse change event.
Interested parties should first examine the relevant clauses in their PRC Law-governed contracts. In the absence of such clauses, the parties can consider seeking relief under China’s statutory laws.
Whether the outbreak of the coronavirus falls under the legal concept of force majeure or material adverse change depends on the provisions in the contract. Whether the parties to the contract are entitled to claim for being exempted from part or all liability should be reviewed and evaluated on the basis of the actual circumstances of each case.

As the COVID-19 (coronavirus) pandemic spreads across the globe, the outbreak has severely slowed business activities in mainland China and disrupted the international business community. As a result of COVID-19, companies in mainland China as well as multinational companies doing business in China may find it difficult or impossible to fully perform commercial contracts. In this alert, we will discuss the legal recourse companies may have and the remedies available under the laws of the People’s Republic of China (PRC Laws) on the non-performance of a commercial contract.

The parties should first examine the language of the contract itself for disruption or non-performance due to the coronavirus. For example, if the contract contains a specific force majeure clause that was drafted widely enough to cover an epidemic (such as the coronavirus outbreak) and its effects, then the terms of that contract will govern and will typically include provisions for an available remedy and procedural steps necessary to invoke that remedy. If the contract does not contain a provision that addresses the outbreak, two Chinese law doctrines may nevertheless be relevant: force majeure and material adverse change. Here, we discuss the concepts of “force majeure” and “material adverse change” under the PRC Laws and how these apply to the contracts impacted by the coronavirus outbreak.

Force Majeure

Under the PRC Laws, both the General Rules of the Civil Law (民法总则 in Mandarin) and the Contract Law (合同法 in Mandarin) define “force majeure events” as unforeseeable, unavoidable and unconquerable situations, viewed objectively.

The Chinese courts can declare whether an occurrence constitutes force majeure. For example, in 2003, shortly after the SARS outbreak, the Supreme Court of China issued a Judicial Interpretation1 specifying that, in case that a contract could not be performed due to the SARS outbreak or any administrative measures adopted against SARS, such a situation was to be considered a force majeure event. As of the publication of this alert, the Supreme People’s Court of China has not formally opined on whether the current coronavirus outbreak should be considered as a force majeure event. However, courts in different provinces and municipalities have issued various guidelines and opinions during the past two months to guide trials on contractual disputes caused by the outbreak. According to those guidelines, whether the parties to the contract are entitled to claim for being exempted from part or all liability under the contract will be reviewed on a case-by-case basis, taking into consideration of the specific facts of each case. The key elements that a Chinese court may consider are (i) whether the coronavirus outbreak directly caused the failure of performance or failure to achieve the purpose of the contract; (ii) whether the contract was entered before or after the outbreak; (iii) whether the claiming party is at fault; (iv) whether the claiming party used reasonable endeavors to avoid the effects of the extreme circumstance; and (v) whether the failure results from the outbreak itself or the measures taken by the administrative governments for preventing and containing the outbreak.

Even if the court finds that force majeure has occurred, to claim the occurrence of “force majeure” event, the PRC Laws require the defaulting party to (i) timely notify the other party or parties of the force majeure event in order to minimize the potential damage and (ii) to provide certifying documents (including, but not limited to, the China Council for the Promotion of International Trade (CCPIT) notice described below) within a reasonable time period. Assuming these requirements are met, either the defaulting or the non-defaulting party may terminate the contract in question, or the non-defaulting party may waive part or all of the contract performance obligations in case of a force majeure event.

What constitutes “certifying documents?” While the PRC Laws do not provide a definition, we note that the CCPIT has been issuing force majeure certificate to help companies to claim remedies. In January 2020, CCPIT confirmed that China would offer force majeure certificates to local companies which were not able to fulfill contractual obligations because of the outbreak of the coronavirus, with the certificates serving as a means of evidencing their inability to perform the contract. Such certificates are helpful for parties asked to provide evidence of their inability to perform, so that they can invoke force majeure for nonperformance of their obligations in contracts governed by the PRC Laws. On February 2, 2020, CCPIT issued China’s first force majeure certificate based on the coronavirus to an auto parts manufacturer in Huzhou, Zhejiang Province. According to the CCPIT website, the force majeure certificate can “help enterprises minimize liability for contracts that can't be fulfilled due to the epidemic and safeguard their legitimate rights and interests.” While CCPIT claims that “force majeure certificates have been recognized by governments, customs, chambers of commerce and enterprises in more than 200 countries and regions around the world, and it is widely accepted overseas,” this type of certificate is not likely to carry much weight in an international context or in contracts governed by laws of other jurisdictions.

Material Adverse Change

Other than claiming force majeure, a party may choose to submit a motion to the PRC court petitioning modification to terms of the contract (including the termination of a contract), under Article 26 of the Supreme People’s Court of China’s Interpretation No. 2 on the Contract Law. In the motion, the petitioning party must demonstrate that there is a significant change to an underlying circumstance which is the basis for contract performance (such as a substantial change to China’s national policies, laws or exchange rate). Further, the petitioner must demonstrate that such change occurred after contract execution, and that such occurrence was unforeseeable when the contract was executed, is not caused by a force majeure event and is not a commercial risk. The court will examine the motion and the specific facts of the case using the principle of fairness in deciding whether to allow changes or termination of the contract.

It is worth noting that, in prior similar cases, the Chinese courts have applied a strict and high standard in deciding whether to allow changes to or termination of the underlying contracts. This is a difficult standard to meet, as the petitioner needs to show that the occurrence of the coronavirus or the effect of a similar epidemic was not contemplated at the time of the contract execution, and the court must be convinced that the contract obligation, if performed, would be substantially unfair to the petitioner.

Suggestions

PRC Laws generally respect the mutual agreements between the parties, and the terms of such agreements, if properly documented, should prevail. Therefore, as a starting point, the parties should consider the language in the contract, whether the force majeure clause is included, how it defined, and what procedures are provided to claim force majeure.

In the absence of such a provision, the parties may consider whether there is sufficient evidence to demonstrate a force majeure event has occurred or to petition for contract modification based on the occurrence of a material adverse change.

[1] Under the PRC Law, Judicial Interpretations are issued by Supreme Court of China, and they carry the same legal weight as Chinese laws and regulations.