Under PRC law, the impact of the COVID-19 pandemic on contract performance involves two regimes: force majeure and rebus sic stantibus (change of circumstances).
Force majeure. According to the Contract Law, force majeure has two main legal consequences for the performance of the contract, namely, the exemption from liability for breach of contract, and the termination of contract.
If parties invoke the force majeure clause to exonerate themselves from liability for failure to perform the contract, the following conditions should be met: (1) the pandemic and its prevention and control measures constitute force majeure; (2) there is a causal relationship between the pandemic, and its prevention and control measures, and the party’s failure to perform the contract; and (3) the party has no fault in the performance of the contract affected by the pandemic and its prevention and control measures.
It should be noted that the pandemic and the government’s prevention and control measures have the characteristics of force majeure, but whether it constitutes force majeure in a case needs to be analyzed in conjunction with the parties’ expectations and the stage of development of the pandemic. To decide whether it has the legal effect of force majeure, it is necessary to analyze the pandemic situation in combination with the case situation, and whether the pandemic and its prevention and control measures have rendered the contract impossible to perform.
If the performance of the contract is affected by the pandemic, and the parties demand termination of a contract, they must satisfy the condition of force majeure rendering the purpose of the contract impossible to achieve, in addition to the above-mentioned conditions of invoking force majeure to claim an exemption from liability.
Doctrine of change of circumstances. According to article 26 of Interpretation II of the Supreme People’s Court on Several Issues concerning the Application of the Contract Law of the People’s Republic of China, applicable requirements of change of circumstances include: (1) a significant change in the underlying conditions of the contract after its formation; (2) such a significant change could not have been foreseen at the time the parties entered into the contract; (3) the significant change is not force majeure and is not a commercial risk; and (4) the continued performance of the contract is manifestly unfair to one of the parties, or fails to achieve its purpose.
Each of these elements should be judged on its own merits. If the pandemic, and its prevention and control measures, constitute a change of circumstances for the performance of a particular contract, the parties may request the court or arbitration body to change or terminate the contract.
Under English law, the impact of the pandemic on contract performance is manifested at two levels: first, the contractual content expressly agreed by the parties is applied (usually force majeure clauses); and second, in the absence of an agreement, the regime of the frustration of contract is considered.
Force majeure clause. There is no concept and regime of force majeure in English law itself. The analysis of the impact of the pandemic on contract performance based on the force majeure clause cannot be generalized. It should be specifically analyzed in the context of the agreement on the impediments to contract performance, the impact of the impediments on contract performance, the duty to give notice, the consequences of the occurrence of force majeure, etc.
Frustration of contract. Frustration of contract refers to the occurrence of unexpected events or accidents in the course of the performance of the contract that could not have been reasonably foreseen by the parties at the time of the conclusion of the contract, which frustrates the purpose of the contract and exempts the parties from liability for failure to perform their contractual obligations.
The judicial responses of English law have always been to support, rather than negate, the validity of contracts, and it is therefore extremely difficult to claim the frustration of contract under English law. Unless the pandemic directly results in circumstances such as the loss of the contract subject, or an export embargo, which are sufficient to render the contract impossible to perform at all, it will be difficult for parties to reduce their liabilities and losses through the frustration of contract regime.
Advice to international traders
When dealing with the impact of the pandemic, companies should not be too quick to rely on force majeure, change of circumstances and other regimes to refuse to perform the contract, or even ask for its rescission, but instead should do a comprehensive analysis and thorough planning.
(1) Review the contractual agreements and legal regulations. If the parties have agreed on the definition, legal consequences, and allocation of responsibility, among others, of force majeure and change of circumstances, the agreement of the parties shall generally take precedence. If there is no such agreement in the contract, or the agreement is unclear, attention should be paid to foreign laws and international conventions that may apply to the contract to clarify the rights and obligations of the company itself in the context of extraterritorial law.
(2) Pay attention to the control measures adopted by relevant countries or regions. Companies should pay close attention to the latest control measures in the countries or regions that concern the contract performance, and make preparations in advance to minimize the impact on the performance of the concluded contract. Appropriate arrangements should be made in advance for the contract to be concluded, taking full account of the possible impact of the relevant control measures on the performance of the contract.
(3) Notify the other party in a timely manner and conduct communication and consultation. A party affected by the pandemic and experiencing difficulties in contract performance should promptly notify the other party of the resulting difficulties in contract performance, in accordance with the contractual agreement or the law, to mitigate the losses that may be caused to the other party and to prevent its liability for increasing losses.
(4) Make every effort to maintain the performance of the contract and take appropriate and timely mitigating measures to prevent the increase of losses. The seller should actively resolve the performance difficulties and make every effort to maintain performance. At the same time, either party should take appropriate mitigation measures in a timely manner to prevent losses from increasing, and to avoid increasing its liability after the occurrence of, or when it becomes aware of, difficulties in the performance of contracts affected by the pandemic.
(5) Pay attention to fixing and collecting evidence to prepare for potential lawsuits. The contracting parties should pay attention to fixing and collecting evidence of the pandemic, of the prevention and control measures, and the evidence that caused (or are insufficient to cause) the difficulties in the performance of the contract, as well as evidence from communication and consultation between the parties. In particular, if the party affected by the pandemic sends a notice or request for renegotiation to the other party, attention should be paid to fixing and collecting the content of the notice or request, and the process of sending and receiving.
(6) Pay close attention to newly released policies to mitigate legal risks. At present, various government departments and agencies at central and local levels have introduced several measures to support companies affected by the pandemic in various ways, and companies should pay attention to the use of policies to facilitate the risk reduction of breach of contract.
(7) New contracts should be concluded with attention to assessing the impact of the pandemic and making agreements. If supplementary agreements or new contracts are to be concluded after the outbreak of COVID-19, they should fully assess the possible impact of the pandemic and its prevention and control measures on the performance of the contract – taking into account the actual situation of the industry, the region and the transaction itself – and make clear agreements on the allocation of relevant risks and responsibilities in the contract. When drafting contract terms, model reference texts of relevant institutions and industries can be referred to, avoiding omission of terms on risks, to strive for maximizing contract benefits.
Mary Zhu is a senior partner and head of arbitration practice, and Guo Youning is an associate at TianTong Law Firm. This article is solicited and recommended by CIETAC.
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