Contract Performance in the Time of Coronavirus: Perspectives from Mainland China and Hong Kong

The coronavirus outbreak has severely hindered business activities in mainland China, with ripple effects throughout Asia and beyond. As a result of the outbreak, companies in mainland China, Hong Kong, and other places in Asia may find it difficult or impossible to perform commercial contracts. What legal recourse do companies have? And is the answer different under Chinese law than under Hong Kong law? We briefly address these questions below. Under both Chinese and Hong Kong contract law, a well-drafted force majeure clause often provides the best support for a party seeking to avoid liability, but remedies may also be available in accordance with underlying contract law doctrine. In any case, the availability of a remedy will typically depend on the nature of the contract and the particular impacts on contract performance of the outbreak and of government measures taken in response to the outbreak.

Chinese Law

The starting place for considering the impact of the coronavirus outbreak on the performance of a commercial contract under Chinese law is the language of the contract itself. For example, if the contract has a specific provision (such as an express force majeure clause) written in a way that captures the outbreak and its effects, then the terms of the contract typically will inform any available remedy and procedural steps necessary to invoke that remedy. Assuming the contract does not contain a provision that addresses the outbreak, two Chinese law doctrines may nevertheless be relevant: force majeure and changed circumstances.

Force Majeure

Chinese law defines force majeure as a circumstance that is objectively unforeseeable, unavoidable, and insurmountable. If a party is unable to perform a contractual obligation because of a force majeure event, that party generally will be partially or fully exempted from contractual liability in proportion to the circumstances of the force majeure. China’s Contract Law also allows either the defaulting or the innocent party to rescind (“Jie Chu”) the commercial contract if the force majeure renders the purpose of the contract unachievable.

Depending on the nature of the contract and the disruption, the outbreak may qualify as a force majeure event that limits the liability of a defaulting party. A party seeking to invoke force majeure on the basis of the outbreak must prove that the outbreak was unforeseeable, unavoidable, and insurmountable and also that the circumstances of the outbreak rendered the party unable to properly perform the contract. This will require a fact-specific showing in the particular circumstances of the contract at issue. In addition, the party seeking to invoke force majeure also needs to (a) promptly notify the other party of its inability to perform and (b) furnish evidence proving the force majeure.

Useful guidance in evaluating the applicability of force majeure to the coronavirus outbreak is a notice of the Supreme People’s Court (SPC) issued in 2003 in relation to the SARS epidemic, which confirmed that force majeure would apply where the SARS epidemic or government measures adopted to combat it rendered a contract unable to be performed. It is not unreasonable to expect similar SPC guidance in response to the current outbreak, but even without that formal guidance, force majeure may be a useful doctrine for defaulting parties in appropriate circumstances. In any event, parties should monitor SPC notices for relevant guidance on important rules relating to contract performance during the coronavirus outbreak. Parties may also be able to obtain proof of the existence of force majeure from sources such as the China Council for the Promotion of International Trade (CCPIT) (See here).

Changed Circumstance

If the coronavirus outbreak does not qualify as a force majeure event in the circumstances of a particular contract, a defaulting party may nevertheless consider invoking the “changed circumstance” doctrine. Chinese practitioners generally trace the changed circumstance doctrine (“Qing Shi Bian Geng”) to an SPC interpretation of the Contract Law issued in 2009. Under that interpretation, a contractual party impacted by “changed circumstance” can petition a people’s court to modify or rescind a contract. The interpretation permits application of the doctrine where, after a contract is concluded, there is a material and objective change of circumstance that: (a) was unforeseeable at the time of contracting; (b) was not caused by force majeure; and (c) is not a commercial risk assumed by the parties. A qualifying “changed circumstance” must either render the performance of the contract obviously unfair to the party invoking the doctrine or render the contract’s purpose unachievable. Notably, the changed circumstance doctrine does not require a party to be completely unable to perform; it applies where an event makes it obviously “unfair” for a party to perform. The principle of fairness is the touchstone of the doctrine, and courts apply the doctrine with the principle of fairness firmly in mind, considering the facts of each individual case.

Invoking the changed circumstance doctrine is procedurally more cumbersome than invoking force majeure because it requires a court petition to modify or rescind the contract at issue. The SPC also has instructed lower courts to apply this doctrine cautiously. Nevertheless, it may provide affected parties a means to limit liability in connection with contracts impacted by the coronavirus outbreak. Regardless, parties should consider notifying their contractual counterparties of difficulties arising from the coronavirus outbreak so that the counterparties are given the opportunity to mitigate losses. Companies expecting performance from their contractual counterparties can also require the counterparty to give comfort or undertake that the counterparty will perform despite the coronavirus outbreak. If the counterparty already is in default, the innocent party – as required by the PRC Contract Law – must adopt appropriate measures to prevent its losses from increasing.  

Hong Kong Law

Hong Kong law also affords contractual and doctrinal protections that may apply to help limit liability in connection with commercial contracts impacted by the coronavirus outbreak. Under Hong Kong law, force majeure only will apply if the parties include a force majeure clause in their contract, but the common law doctrine of frustration may afford some relief even absent a specific contract provision.

Force Majeure

Parties often include a force majeure clause in their Hong Kong law-governed commercial contracts to set out the consequences if an unforeseen event occurs. This type of clause can help allocate risk when an unforeseen event adversely affects the ability of one or both parties to perform contractual obligations on time or at all.

In practice, force majeure clauses vary greatly depending on how they are drafted. Although not all use the words “force majeure”, relevant clauses typically contain three main features:

1. a definition of certain events as “force majeure events” or events “beyond the reasonable control of a party”, typically with a non-exhaustive list of examples of events covered by the clause;
2. reporting obligations or formalities that a party invoking the clause must follow; and
3. the consequences of the occurrence of a force majeure event, such as extension of time for performance of obligations or parties are no longer required to perform its obligations.

Some force majeure clauses may even specify which party is to retain the benefit of monies paid or work done under the contract upon the occurrence of the force majeure event.

Whether circumstances arising out of the coronavirus outbreak will qualify as a force majeure event in connection with any particular contract will depend heavily on how its force majeure clause is drafted. A party wishing to rely on a force majeure clause generally will have to prove that: (a) the event is covered by the force majeure clause as drafted; (b) it has been prevented, hindered, or delayed from performing the contract by reason of that event (a rise in costs or expense usually does not suffice); (c) its non-performance was due to circumstances beyond its control; and (d) there were no reasonable steps that it could have taken to avoid or mitigate the event or its consequences.

Whether the coronavirus outbreak qualifies as a force majeure event ultimately will depend on the construction of the contractual clause at issue. Some clauses may make it reasonably clear if they specifically identify “disease”, “epidemic”, or “quarantine” as force majeure events. Other clauses may include more general events such as “acts of God”, “acts of government”, “strikes”, or “circumstances beyond the parties’ control”. The current outbreak could be a combination of more than one factor, the disease/epidemic itself and the government/public actions that ensue. Affected parties should carefully review the force majeure clauses in their contracts to determine whether they may apply.

Frustration

If a contract does not include a force majeure clause, the common law doctrine of frustration nevertheless could be relevant. This doctrine operates to discharge a contract where an event occurs after the formation of the contract that makes performance of the contract physically or commercially impossible, or radically different from that envisaged by the contract.

The test for frustration requires an event that so significantly changes the outstanding contractual rights/obligations from what the parties reasonably contemplated at the time of contracting that it would be unjust to hold the parties to their initial bargain in the new circumstances. The doctrine, however, has a very narrow scope: a contract will not be frustrated if it has a relevant force majeure clause, if performance has become merely more onerous or expensive, or if the impossibility of performance is the fault of either of the parties. Hong Kong law is clear that frustration may not be invoked merely to get out of a bad commercial bargain or if the parties have foreseen the relevant event. The party invoking the doctrine bears the burden of proving frustration under these strict standards. Typical examples of frustrating events may include the destruction of the subject matter of the contract, personal incapacity of a party, if the contract becomes illegal to perform, or if a contract is deprived of its commercial purpose.

Unfortunately, there is very limited case law in Hong Kong or the United Kingdom that specifically addresses whether and how an epidemic could frustrate commercial contracts. One case from the SARS epidemic, however, illustrates the narrowness of the doctrine. In Li Ching Wing v. Xuan Yi Xiong [2004] 1 HKLRD 754, a tenant subjected to a SARS-related 10-day isolation order 13 months into a 24-month lease sought to invoke frustration to discharge a lease. The court rejected the tenant’s effort to rely on the frustration doctrine, primarily because the isolation order was only for a short duration in the context of the lease at issue. This ruling demonstrates the difficulty that a party may have in successfully invoking the frustration doctrine to discharge a commercial contract.

Parties affected by the coronavirus outbreak must carefully consider the general principles underlying the frustration doctrine to see whether it may be helpful in the context of their commercial agreements. Application of the doctrine ultimately will depend on the obligations arising from and subject matter of the contract itself and how these have been affected by the coronavirus outbreak.

As further explained in the Terms / Notices linked below, the information provided herein does not constitute legal advice.  Any information concerning the People’s Republic of China (“PRC”) is not intended and shall not be deemed to constitute an opinion, determination on, or certification in respect of the application of PRC law. We are not licensed to practice PRC law.