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March 4, 2020

What to Do When You Receive a Coronavirus-Related Force Majeure Notice

Coronavirus: Multipractice Advisory

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Updated March 16, 2020

Introduction

While China already has made considerable progress in its fight to contain the novel coronavirus disease (COVID-19), the protracted disruption to the Chinese economy is severely impacting businesses and economies around the world in ways that are only beginning to be felt and understood. In an effort to protect Chinese companies from being held responsible for such impacts, the Chinese government has been encouraging Chinese companies affected by COVID-19 to claim force majeure protection. To aid in that effort, the China Council for the Promotion of International Trade (CCPIT), a People's Republic of China (PRC) non-governmental organization with deep government roots, is reported to have issued thousands of "force majeure event certificates" to Chinese companies seeking to prove the existence of a force majeure event in relation to the COVID-19 outbreak. In this Advisory, we describe how force majeure operates under PRC law and explain the role of the CCPIT certificates (section 2); analyze the potential effect of a COVID-19 force majeure notice (which may be accompanied by a CCPIT certificate) where the governing law is English law (section 3) and New York law (section 4); provide guidance on steps to take after receiving a force majeure notice (section 5); and then offer some concluding thoughts (section 6).

Force majeure under PRC law and force majeure certificates issued by CCPIT

PRC Law permits force majeure claims. According to Articles 117 and 118 of the PRC Contract Law, the affected party is temporarily exempted from its liabilities in the event of force majeure and is required to serve notice together with evidence to the other party within a reasonable period.

The Legislative Affairs Commission of the PRC National People's Congress Standing Committee has clarified that a party that is prevented from performing its contract obligations as a result of government measures taken to contain COVID-19 should be entitled to force majeure relief under PRC law.

As of March 11, 2020, in an apparently coordinated effort with the PRC Ministry of Commerce, CCPIT and its local branches have issued 5,637 force majeure event certificates to companies affected by the COVID-19 outbreak, according to a report by China Daily. The value of the relevant contracts is approximately RMB 503.5 billion (equivalent to approximately $73.2 billion). Such certificates purport to certify the existence of a particular event that may constitute force majeure, such as a local government measure prohibiting resumption of work for a particular period of time. But even for contracts governed by PRC law and providing for dispute resolution in China, such certificates would be only one factor in the analysis. Under PRC law, whether or not a force majeure can be established—and if so the scope of relief—depends on a fact-specific analysis of the contract provision in question, the nature of the contractual obligation sought to be excused, and the extent to which the event in question (e.g., a particular government measure responding to the COVID-19 outbreak) has specifically impacted the party claiming relief. Thus even in China, the role of the CCPIT certificate is limited to providing evidence of the occurrence of a particular event, which is only one element of the force majeure analysis.

What impact would a CCPIT certificate have outside China? According to CCPIT, its force majeure event certificates are recognized by the governments, customs agencies, trade associations, and enterprises of more than 200 countries and regions. That claim notwithstanding, the usefulness of a CCPIT certificate outside of China may not be so clear or automatic, as we discuss below.

Force majeure and frustration of contract under English law

Force majeure does not have any independent, recognized meaning under English law and will not be implied into English law contracts. It may, however, be invoked if there is an express force majeure provision included in the contract. The circumstances in which a party may rely on force majeure, and the effect of such reliance, will be defined by that express provision. In order for force majeure to be available if a particular event occurs, it will therefore be imperative that the event in question falls within the scope of the force majeure clause in the contract. Thus, although a CCPIT certificate may be useful evidence of the occurrence of the event in question, the certificate itself does not prove that force majeure is available under an English law contract. The Chinese party would still need to establish that its particular circumstances fall within the ambit of the relevant contractual force majeure provision and (as discussed below) that its inability to perform the contract was in fact caused by the claimed force majeure event.

Under English Law, the specific wording of the force majeure clause is important. Force majeure clauses often contain a list of events that qualify as force majeure provided that other express conditions are satisfied. Such additional conditions may include, for example, that the event is beyond the claiming party's reasonable control and could not reasonably have been avoided by the claiming party. Such lists may either be exclusive or non-exclusive. Non-exclusive lists allow for the possibility of other, non-listed events qualifying as force majeure, depending on the nature of the events listed and the wording of the clause. In examining a contract where the listed events are part of a common category or class, the English courts may hold that non-listed events only fall within the scope of the clause if they are of the same category or class as the listed events. By contrast, where the list is exclusive, a qualifying event must fit within the scope of one of the listed items. For example, the COVID-19 outbreak in China would seem to fall squarely within the scope of the term "epidemic," but would not necessarily fit within the scope of the term "famine or plague."

There must also be an actual causal link between the non-performance and the claimed force majeure event. Thus, the inability of the Chinese party to perform must actually have been caused by the COVID-19 outbreak (or a government's response thereto), not other reasons. The party seeking to rely on the force majeure clause will have the burden of showing that its inability to perform was caused by the force majeure event. As Lord Mustill noted on behalf of the Privy Council in Hoechong Products Co. Ltd v Cargill Hong Kong Ltd, (Privy Council (Hong Kong) [1995] 1 W.L.R. 404), although a CCPIT certificate may be “useful” as evidence of “the existence of the force majeure event,” it would be “pointless” to ask CCPIT to analyze the question of causation in any particular case, since that question “would have to be looked at all over again at the stage of litigation or arbitration.”

If the force majeure clause in question requires a party to be "prevented" from performing due to the force majeure event, the party must show that performance of its obligations has been made physically or legally impossible due to the outbreak of COVID-19 or governmental measures taken in response, i.e., that there are no alternative means for performing the party's obligations. A party relying on a force majeure clause must also show that there are no reasonable steps that it could have taken to mitigate or avoid the effects of the force majeure event.

In the absence of an express force majeure clause, the defaulting party might attempt to excuse its non-performance by reference to the English doctrine of frustration of contracts and the Law Reform (Frustrated Contracts) Act 1943. The textbook formulation of this doctrine is that a contract may be discharged on the grounds of frustration when an event or circumstance arises after the formation of a contract that renders its performance physically or commercially impossible or transforms the obligation to perform into a radically different obligation than that to which the party originally agreed. However, the frustration principle is subject to a very high threshold, and proving that a contract has been frustrated is therefore very difficult.

Such difficulty notwithstanding, it should be noted that if the performance of a contract were to be rendered illegal in its entirety under PRC law (for example due to measures taken in response to the COVID-19 outbreak), and the contract was required to be performed in mainland China, this set of circumstances could potentially frustrate the contract and discharge the parties from performing their contractual obligations. This "doctrine of supervening illegality" arguably could become relevant in relation to COVID-19. Under PRC law, any entity refusing to implement preventive and control measures promulgated by the PRC health authority, leading to the spreading or to the creation of serious risk of spreading a Class A contagious disease such as COVID-19, may be subject to criminal liability; and any person directly in charge of or having responsibility for the entity may also be subject to criminal liability.

Force majeure and impossibility of performance under New York law

As a general matter, the courts of New York interpret and apply express force majeure provisions according to their terms. Conversely, when the parties' integrated agreement does not contain a force majeure provision, there is normally no basis for a force majeure defense. As discussed below, however, in exceptional circumstances New York courts have been willing to excuse non-performance on the basis of the doctrine of impossibility of performance even in the absence of a force majeure provision. Additionally, in the sale of goods context, Article 2 of the Uniform Commercial Code provides an additional potential defense known as "commercial impracticability," a concept discussed in depth in this Advisory.

Express force majeure clauses are construed narrowly under New York law. Where the clause includes an exclusive list of qualifying events, the event in question must fall within the scope of a listed item. For clauses including a non-exclusive list, the event in question must either be included on the list or must be of the same kind or nature as the expressly listed events. The same rule applies even if there is a catchall phrase at the end of the non-exclusive list, such as "and other events beyond the control of the parties."

Force majeure clauses will only excuse non-performance where the reasonable expectations of the parties have been frustrated due to circumstances beyond the parties' control. New York courts are divided as to whether the event in question must also have been unforeseeable (absent a requirement to that effect in the force majeure clause).

The doctrine of impossibility of performance may also excuse non-performance in exceptional circumstances, even in the absence of a contractual force majeure provision. This doctrine may have particular relevance for situations where governmental measures have rendered performance temporarily impossible.

In Bush v. Protravel International, Inc., the court examined whether a party could be excused from failing to cancel a travel contract in accordance with its terms where, immediately following the September 11, 2011 attacks, "New York City was in the state of virtual lockdown with travel either forbidden altogether or severely restricted" and "was on a wartime footing, dealing with wartime conditions." 746 N.Y.S.2d 790, 795, 797 (N.Y. Civ. Ct. 2002). The court held that measures taken by the State and City governments (including their declaration of a State of Emergency in the wake of 9/11) strongly supported the claim that performance of the contract had been rendered impossible for a period of time.

Likewise, actual measures taken by national, provincial and local authorities in China in the wake of the COVID-19 outbreak arguably could give rise to a viable excuse of impossibility of performance (or force majeure) if such measures in fact rendered performance impossible. This would be a fact-dependent inquiry. A CCPIT certificate could serve as evidence of the existence and scope of the government measures in question, but the affected party would still need to prove that such measures had in fact rendered performance impossible. Note also that even if the COVID-19 outbreak or the governmental measures adopted in response were deemed to have created a temporary impossibility, performance would only be excused for the period in which performance remained legally or physically impossible.

Steps to take upon receipt of a force majeure notice

If you receive a force majeure notice from a party claiming to be unable to perform its obligations under the contract due to the COVID-19 outbreak (potentially accompanied by a CCPIT certificate), you should: (a) check whether the contract has a force majeure clause; (b) identify the governing law of the contract; (c) review and analyze the exact language of the force majeure clause to see whether the claimed event indeed qualifies as a force majeure event as specified under the contract; (d) assess whether there is a causal link between the claimed force majeure event and the non-performance; (e) in the absence of a force majeure clause, consider whether performance may be excused under the doctrine of frustration of contract (English law) or impossibility of performance (New York law); (f) insist that the party claiming force majeure provide (1) evidence of the circumstances that are allegedly preventing performance, and (2) regular updates regarding its efforts to resume performance and/or mitigate the impact of non-performance; and, where appropriate (g) consider negotiating a written amendment to the contract to reflect a commercially sensible resolution.

Keep in mind that a force majeure notice may signal the beginning of a dispute that may ultimately need to be resolved through arbitration or litigation. It is therefore important to take all of the usual precautions for a dispute situation, including for example preserving all relevant records and being careful not to inadvertently make statements or promises that may later form the basis for the other party to claim that you agreed to waive or forego contractual rights. Where the parties have orally discussed a commercial resolution, be sure to send a written communication to the other party memorializing the discussions, and to insist that any amendment to the contract conform to the requirements of the contract's anti-oral modification clause (if any).

Conclusion

The COVID-19 outbreak is now a global crisis. The full extent of disruptions to global commerce flowing from the interruption of business in China in particular is yet to be seen. The sharp increase in force majeure event certificates issued by CCPIT indicates that non-Chinese parties to contracts with Chinese companies are likely to be hit by a wave of force majeure claims from their Chinese counterparties in the coming days, weeks, and months. In responding to any such notice, be sure to carefully assess the facts and evidence, the contractual provisions, and the applicable legal principles.

*Yeseung Jang contributed to this Advisory. Ms. Jang is a graduate of Stanford Law School and is employed at Arnold & Porter's Seoul office. She is not admitted to the practice of law in Korea.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.

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