In Shanghai, the citywide lockdown from 1 April has continued into May and more cities are experiencing epidemic control and prevention measures. As a result, companies may face difficulties rendering contractual obligations, for example inability to continue manufacturing goods or performing services under terms agreed in commercial contracts signed before the lockdown. Under such cases, the circumstances in which the contracts were originally signed under have significantly changed and invoking force majeure could be used.
What is Force Majeure?
A force majeure clause exempts one or both parties from liability or obligation since an extraordinary event. Examples include war, strike, crime, or “Act of God” prevents one or more parties from fulfilling their obligations under the signed contract. Epidemic measures enacted to contain COVID-19 (such as lockdown) which directly restricts companies from performing contractual obligations may constitute as a force majeure. Mainly, due to that the original terms can no-longer be performed. For instance, as the citywide lockdown in Shanghai continues, manufacturers are unable to resume work. Therefore the party cannot fulfil their contractual obligations, and such manufacturers may invoke the force majeure clause.
Invoking Force Majeure During or After Lockdown
The legal basis for force majeure is provisioned under The Civil Code of the People’s Republic of China
Articles 180, 563 and 590.
Article 180
A person who is unable to perform his civil-law obligations due to force majeure bears no civil liability, unless otherwise provided by law. “Force majeure” means objective conditions which are unforeseeable, unavoidable, and insurmountable
Article 563
The parties may rescind the contract under any of the following circumstances:
(1) the purpose of a contract is not able to be achieved due to force majeure;
Article 590
Where a party is unable to perform the contract due to force majeure, he shall be exempted from liability in whole or in part according to the impact of the force majeure, unless otherwise provided by law. The party unable to perform the contract due to force majeure shall promptly notify the other party to mitigate the losses that may be caused to the other party, and shall provide proof of the force majeure within a reasonable period of time. Where the force majeure occurs after a party’s delay in performance, such party’s default liability shall not be exempted
Under such provisions, companies invoking force majeure are not wholly exempted from contractual obligations. Rather companies are required to prove that the lockdown measures directly impacted their contractual terms. For example, a manufacturer could not deliver the goods as agreed within the contract since the factory was lockdown. Therefore, the manufacturer could be exempted from such obligation and breach of contractual term.
In conclusion, affected companies can be exempted from for the breach of contract in part or in whole. This is based according to the influence of the force majeure – such as an epidemic measure.
Terminating Contracts under Force Majeure
Contracts can only be terminated if the fundamental purpose of the contract cannot be achieved due to force majeure. Namely, where the contract cannot be performed or cannot be performed in accordance with the agreed terms defined in the contract.
The Circular of the Supreme People’s Court on Issuing the Guiding Opinions (II) on Several Issues concerning the Proper Trial of Civil Cases Related to the COVID-19 Epidemic According to the Law (“the guiding opinions of the Supreme Court (II)) provides further guidance on contract termination.
If the epidemic situation or epidemic prevention and control measures cause the parties to fail to perform the sales contract within the agreed time limit or the performance cost will be increased, and the continued performance does not affect the realization of the purpose of the contract, if either party request to terminate the contract, the people’s court will not support.
The continued performance of the contract has been adversely affected by the epidemic measures, the force majeure affects the purpose of the contract. Under such circumstance, the contract cannot be terminated. Instead, both parties to the contract shall still perform their contractual obligations in accordance with the agreement. And with the principle of good faith.
The affected party in such instance may apply the change of circumstance to renegotiate the contractual terms. This can be applied if the epidemic situation or prevention and control measures significantly increased the following:
- the performance costs of labor;
- raw materials and logistics; or
- significantly reduced the price of products.
Change of circumstances
The Civil Code of the People’s Republic of China revised in 2020 includes epidemic in the change of circumstances. Specifically, parties to a contract adversely affected by the epidemic may renegotiate the conditions for the performance of the contract. If the negotiation fails within a reasonable period of time, each party may request the people’s court or arbitration institution to change or terminate the contract.
The Civil Code stipulates parties to renegotiate new terms in the first instance. Parties shall continue to perform according to the negotiated terms. However, if the negotiation fails each party may request the people’s court or arbitration institution to change. Alternatively, the party may apply to terminate the contract by applying to the principle of fairness.
Where the people’s court or arbitration institution decides to change the contract, the party shall continue to perform the contract according to the changed conditions based on the agreement of the parties or the effective judgment document.
Case Study
Epidemic prevention and control measures directly restricted the delivery of goods within the agreed time limit defined in the contract. Parties failed to negotiate new terms and the seller requested the people’s court to change the conditions of performance time limit. The people’s court changed the performance time limit according to the principle of fairness in combination with the actual situation of the case.
Consequently, companies should note that invoking force majeure clause for lockdown measures can be complex. It requires proof that the force majeure directly impacted contractual obligations. Under certain circumstances, the party is exempted from the breach of contract. However, the performance of the contract shall continue. Terminating contracts under force majeure should demonstrate the purpose of the contract is affected by the force majeure. Otherwise the people’s court may not support such case. Companies may utilise the change of circumstances to renegotiate more suitable terms. This can be done by applying to the people’s court to change or terminate the contract.
Contact Us
If you would like more information about invoking force majeure, send us an email at talktous@horizons-advisory.com. A Horizons professional contact you.