Menu

Articles

Analysis on Handling of Contractual Dispute in COVID-19 Epidemic By David Wang, April Yan, Tobey Yan 2020-02-25

 

At the beginning of 2020 Chinese lunar new year, many enterprises in People’s Republic of China (“PRC”) are suffering severe difficulties in performing their contracts due to the outbreak of novel coronavirus. Various legal issues have been triggered, such as whether the contracts can be changed or terminated due to the outbreak of novel coronavirus.According to what we’ve learned from our clients, two main issues are their top concerns: (1) How to allocate the losses already caused between the parties? (2) What measures can be taken in order to mitigate such losses?

 

In responding to these questions, this article aims to analyze the relevant PRC laws, regulations and referential court cases, hoping to provide some guidance to the enterprises suffering from the economic downturn. 

 

 

 
 
 

I. Impact: 

Difficulties Encountered by

Enterprise

 

To prevent the wide spread of novel coronavirus outbreak in the PRC, the Chinese government has taken extensive measures to curb the virus at the start of the 2020 Chinese lunar new year.

 

Wuhan, the city at the epicenter of the novel coronavirus outbreak, has been locked down since January 23, 2020. In other cities, comprehensive and rigorous measures have also been taken, such as extension of the Spring Festival Holiday, shutting down of factories and restrictions on travel.  Enterprises are not allowed to resume work before February 9, 2020 in most provinces, except those enterprises which are involved in epidemic prevention and control activities, or in the industries which are essential to the operation of the cities, such as supermarkets.

 

With the continuous escalation of epidemic prevention and control measures against the novel coronavirus outbreak, enterprises in the PRC are facing severe difficulties in their daily business and operation.  Contractual breaches may appear constantly, such as failure to fulfill orders, deliver goods or complete construction projects timely, which will lead to a series of contractual disputes.

 

On January 31, 2020, the World Health Organization declared the novel coronavirus outbreak as a Public Health Emergency of International Concern, or PHEIC, triggering more global reactions to prevent the spread of the virus, such as cancellation of international flights, which will definitely lead to more international trade disputes.

 

 
 
 

Ⅱ. Nature: 

Change of Circumstances

 or Force Majeure?

 

The Notice of the Supreme People's Court on Seriously Implementing the Spirit of the Third Meeting of Central Committee for Comprehensive Law-based Governance and Effectively Conduct the Trial and Execution Work during the Prevention and Control Period of Novel Coronavirus Pneumonia (in Chinese,《最高人民法院关于认真贯彻落实中央全面依法治国委员会第三次会议精神切实做好防控新型冠状病毒感染肺炎疫情期间审判执行工作的通知》) has been issued to properly handle relevant contractual disputes arising out of the novel coronavirus outbreak.  Furthermore, many high people's courts and intermediate people’s courts in local provinces and cities have also issued relevant notices or opinions on handling of contractual disputes.  The core legal issues are whether the contracts can be changed or terminated, and how to allocate the losses incurred thereto.

 

A contract, if not seriously affected by the novel coronavirus outbreak, shall of course continue to be valid and binding.  The parties concerned shall abide by the spirit of the contract and continue to perform the obligations thereunder in a flexible manner.  However, if a contracting party faces serious difficulties to perform a contract, or the contract purpose thereof is unable to be achieved, can the said party resort to the principle of Change of Circumstances or Force Majeure?

 

First, let’s see the definitions of Force Majeure and Change of Circumstances under PRC law.  Force Majeure means a situation which, from an objective view, is unforeseeable, unavoidable and is not able to be overcome[1].  Change of Circumstances shall refer to any significant change in the objective environment taken place after the formation of a contract, which could not have been foreseen by the contracting parties at the time of entering into the contract, while not belonging to any commercial risk, and not caused by any Force Majeure event, rendering the continual performance of the contract manifestly unfair to the relevant party or making it impossible to achieve the goal of the contract.[2]

 

Both Force Majeure and Change of Circumstances are based on unforeseen objective event, but there are some differences in the application of these two principles.  Pursuant to Article 94(1) of the PRC Contract Law, the parties may dissolve the contract in case the objectives of the contract cannot be achieved due to Force Majeure.  As provided in the first paragraph of Article 117 of the PRC Contract Law, where it is not possible to perform a contract due to Force Majeure, then depending on the extent of the Force Majeure, the performing party shall be partially or wholly exempted from liability, unless the law provides otherwise.  

 

As to Change of Circumstances, according to Article 26 of the Interpretation of the Supreme People's Court on Several Issues Concerning Application of the "PRC Contract Law " (2)[the “Judicial Interpretation of PRC Contract Law (2)”],if a party to a contract petitions the court to modify or terminate the contract,the court shall decide whether the contract shall be modified or terminated according to the principle of fairness on a case-by-case basis.  Therefore, the possible outcomes and liability assumptions resulted from Force Majeure and Change of Circumstances are different.

 

点击图片可查看大图

 

Theoretically speaking, the differences between Force Majeure and Change of Circumstances are as follows: (a) the contractual obligation is impossible to be completed upon occurrence of a Force Majeure event, while it can still be carried out under Change of Circumstances although it is extremely difficult and will cause apparent unfairness to the performing party; (b) part or all of the liabilities will be statutorily exempted upon occurrence of Force Majeure; while upon Change of Circumstances, the contracting parties are entitled to request the court to change or terminate the contract, and the court has the discretion to decide it; (c) the legal consequence takes effect immediately in case of Force Majeure, while under Change of Circumstances, the court shall, based on the principle of fairness, determine whether to change or terminate the contract case by case; and (d) Change of Circumstances is to address whether a contract shall continue to be performed from the perspective of contract validity, while Force Majeure is to resolve the question of liability assumption from the perspective of contract breach.

 

In terms of the application, Professor Cui Jianyuan from Tsinghua University School of Law is of the view that, “the principle of Change of Circumstances shall not be applied if a Force Majeure event does not affect the contract performance; if a Force Majeure event makes a contract unfulfillable, ... the contract shall be terminated under the PRC Contract Law, thus the principle of Change of Circumstances shall not be applied either; only when the Force Majeure event has made the performance of contract rather difficult (but not impossible), and the performance (if continued) will be obviously unfair to the performing party, the principle of Change of Circumstances shall become applicable.”[3]

 

Therefore, contractual disputes arising out of the novel coronavirus outbreak shall be handled on a case-by-case basis, taking full account of the actual circumstances, so as to confirm whether a contract shall be further performed, changed or terminated.

 

 
 
 

Ⅲ. Liabilities: 

Different Loss Allocation Principles 

Shall be Applied

 

1.Self-assumption of Risk for Business Strategy Adjustment

 

As mentioned above, a contract shall continue to be performed if the novel coronavirus outbreak does not constitute a substantial obstacle thereto.  However, in practice some enterprises may adjust their business strategies on their own.  For instance, considering that the number of customers in hotels and restaurants may drop sharply, some hotels or restaurants may decide to shut down events without government order.  Under such circumstance, the principle of Change of Circumstances or Force Majeure may not be applied. 

 

For example, in the Case (2007) Gui Min Si Zhong Zi No. 1, the appellant (plaintiff of the first trial) leased a building from the respondent (defendant of the first trial) for hotel business.  In early 2003, due to the sudden occurrence of SARS, the business of hotels was greatly affected.  The hotel operated by the plaintiff has been closed ever since, and the plaintiff suffered huge economic losses as a result.  The court of the second instance ruled that, although the occurrence of SARS had certain impact on the hotel industry, it would not inevitably lead to the impossibility to achieve the appellant's purpose to operate hotel business.  Instead, it was the appellant's own business strategy to cease the hotel business.  Therefore, the SARS outbreak was not a substantial obstacle to the performance of the lease contract entered into by and between the parties.  Thus, the principle of Change of Circumstances shall not be applied thereto.

 

As provided in the Implementation Opinions on Regulating Civil Legal Disputes Related to the Novel Coronavirus Pneumonia Outbreak (Trial) (in Chinese,《关于规范涉新冠肺炎疫情相关民事法律纠纷的实施意见(试行)》; the “Zhejiang Opinions”) issued by the First Civil Court of Zhejiang High People’s Court [the Zhe Gao Fa Min Yi (2020) No. 1], if the contract can be performed during the epidemic outbreak, it is encouraged to perform continually; if the parties claim to terminate the contract, it shall be rejected generally.  If one party can perform the contract but refuses to do so, the other party may require it to assume the corresponding liabilities for breach of contract in accordance with relevant provisions of the PRC Contract Law.

 

In PRC judicial practice, it is important to distinguish Change of Circumstances from a mere business risk.   To apply the principle of Change of Circumstances, the following conditions shall be satisfied: (a) there is a significant change in the objective environment and such objective environment was replied upon when the contract was concluded; (b) such change was unforeseeable to the contracting parties when the contract was concluded; (c) such change, which is not caused by a Force Majeure event, shall not be attributable to the contracting parties; (d) such change occurred after the contract was concluded but before the performance is completed; and (e) such change will make the performance of the original contract substantially unfair, or make it impossible to achieve the contract purpose.[4]

 

It’s worth noting that, the PRC courts are very prudent in applying the principle of Change of Circumstances.  If, in light of the special circumstances of a case, it is indeed necessary to apply such principle in an individual case, such case shall be reviewed by the high people's court (at provincial level), and, where necessary, shall be further reported to the Supreme People's Court for review.[5]

 

2. Liabilities Shall be Fairly Allocated under Change of Circumstances

 

If the novel coronavirus outbreak leads to extreme difficulties in contract performance, though not absolutely impossible, the principle of Change of Circumstances may be applicable.  In particular, if the government policies issued for epidemic prevention and control purpose have a material impact on the contract performance, the principle can be applied.  

 

The Case (2015) Min Ti Zi No. 39 heard by the Supreme People's Court of PRC can be a reference.  In this case, Z Company and X Company signed a contract stipulating that Z Company shall be responsible for constructing X Company's boiler flue and gas desulfurization project.  After that, the parties began to perform the contractual obligations thereunder.  However, in December 2011, X Company terminated the contract unilaterally and attributed the reason of termination to the change of government policy (i.e. according to a written government policy, the local government ordered enterprises to dismantle gas boilers in order to prevent air pollution).  Z Company sued X Company for reimbursement of the losses arising from its non-performance of the contract.  The Supreme People's Court of PRC held that "although it’s not clearly provided in the PRC Contract Law and relevant judicial interpretations that government policy change belongs to Change of Circumstances, if the government policy change does result in a party’s inability to continue the contract performance or impossibility to achieve the contract purpose, it is certainly a significant change of objective situation beyond the will of the contracting parties.  Therefore, the situation in this case should be deemed as Change of Circumstances as provided in Article 26 of the Judicial Interpretation of PRC Contract Law (2). "

 

According to the principle of Change of Circumstances, the parties concerned may petition the court to modify or terminate the contract.  But the next question is how to allocate the losses/liabilities after the contract is modified or terminated.  The Supreme People's Court of PRC stated in the above-mentioned Case (2015) Min Ti Zi No. 39 that "the provision of Article 26 of the Judicial Interpretation of PRC Contract Law (2) does not merely solve the question of whether the contract shall be changed or terminated.  If one party or both parties to the contract have performed or partially performed the contract, the issue of how to allocate the losses incurred thereof must be resolved, no matter through the parties' negotiation or court ruling.  In the event a lawsuit is initiated, the court shall reasonably allocate the liabilities in accordance with the principle of fairness. "

 

In general, the court shall give more weight to protect the non-defaulting party.  Furthermore, the principle of Change of Circumstances shall not be applied simply to relieve debtors from obligations and let creditors bear adverse consequences, but to fairly and reasonably adjust the interest relations between both parties, with a full consideration of balance of interests.  During the litigation proceeding, the court shall actively direct the parties concerned to re-negotiate and revise the contract; if re-negotiation fails, the court shall try to resolve disputes through mediation.[6]

 

During the SARS outbreak, the Supreme People's Court of PRC issued the “Notice of the Supreme People's Court on Proper Trial and Enforcement by the People's Courts According to the Law during the Period of Prevention and Treatment of Infectious Severe Acute Respiratory Syndrome” (hereinafter, “Circular (2003) No. 72”), which clearly stipulates that: "If the continued performance of the original contract will have substantial impact on the rights and interests of one party due to the SARS outbreak, the contract dispute may be handled in accordance with the specific circumstances and apply the principle of fairness.”  This provision is actually an affirmation that courts may apply the principle of Change of Circumstances to handle contractual disputes arising from the SARS outbreak.

 

For example, in the Case (2018) Lu 06 Min Zhong No. 268 the court held that “the SARS outbreak was an unpredictable disaster.  The hotel rented by the appellant Li Peiyan was closed, which caused huge economic losses to him.  The members of residents’ committee signed and confirmed that the loss thereof exceeded the scope of market risks.  It’s appropriate for the court in the first instance to apply the principle of Change of Circumstances to reduce or exempt part of the rent.”  Different from the aforementioned Case (2007) Gui Min Si Zhong Zi No. 1, in this case there existed a government policy.  The Laizhou Public Security Bureau issued a notice providing that, from April 2003 to October 2003, hotels other than Laizhou Hotel and Commercial Building were not allowed to host guests, which had a substantial impact on the appellant's business operation. 

 

As also provided in the Zhejiang Opinions, if one party requests the people's court to change or terminate the contract because the epidemic outbreak makes the continual performance of the contract obviously unfair to the said party or the contract purpose unachievable, the people's court shall deal with relevant situations in accordance with the principle of fairness, pursuant to relevant provisions including the Judicial Interpretation of PRC Contract Law (2).  This is also confirmed in the relevant notices and opinions issued by the high people’s courts in Hubei, Shanghai, Shandong, Jiangsu, Fujian, Guizhou and etc. 

 

3. Liabilities Shall be Statutorily Exempted under Force Majeure

 

In the worst scenario, a contract cannot be carried out at all due to the novel coronavirus break.  For example, poultry breeding enterprises are unable to conduct any business due to government restrictions on market trading of live poultry.  Manufacturing enterprises are unable to fulfill the purchase orders due to compulsory shut down of factories.  Transportation companies are unable to deliver goods due to compulsory traffic control.  Under these circumstances, the enterprises concerned may request to terminate the contracts based on the reason that the purpose of the contracts cannot be achieved due to Force Majeure.  As also provided in the aforementioned Circular (2003) No. 72 promulgated during the SARS period, for any non-performance of contract due to administrative measures taken by the government to prevent the SARS outbreak, or any dispute arising directly from the SARS outbreak which resulted in the contracting party’s complete failure to perform the contract, the disputes shall be solved by referring to Article 117 and Article 118 of the PRC Contract Law. 

 

As discussed, liability can be statutorily exempted under Force Majeure.  Contractual parties concerned may claim for liability exemption in all or in part, such as exemption from paying any contractual penalty caused by delay of construction period, as illustrated in the below case.  In the Case (2014) Qing Min Yi Zhong Zi No. 1069, the Qingdao Intermediate People’s Court ruled that, “the influence of the 2003 SARS outbreak as a Force Majeure on the construction period mentioned in the first instance trial is a factor that cannot be ignored.  Therefore, if Y Company fails to prove T Company’s default in providing operators or construction equipment which might cause delay in the construction period, its claim for imposing penalty on T Company for delaying the construction period shall not be supported."

 

In the Zhejiang Opinions, it’s also mentioned that, if due to the administrative measures taken by government and relevant departments to prevent and control the epidemic outbreak, the contract is unable to be performed; or where the impact of the epidemic outbreak makes the contract totally unfulfillable, and the contractual parties claim to reduce or exempt their own legal liabilities, the relevant contractual disputes shall be dealt with according to Article 117 and Article 118 of the PRC Contract Law.  Such opinion is also consistent with the relevant notices and opinions issued by the high people’s courts in Shandong, Sichuan, Heilongjiang, Hubei, Chongqing, Shanghai, Jiangxi, Inner Mongolia, Xinjiang, Fujian, Jiangsu and Guizhou.

 

In addition, if any particular laws, regulations and juridical interpretations governing certain industries have provisions on Force Majeure, these provisions can be directly resorted to by enterprises in such industries, for example:  

 

(1)Tourism Industry.  The PRC has suspended all group tours since January 25, 2020.  Pursuant to Article 13 of the Provisions of the Supreme People's Court on Several Issues Concerning the Application of Law in Hearing Cases of Tourism-related Disputes, “where the performance of the tour contract becomes impossible due to objective reasons which cannot be attributed to the tour operator or tourism supporting service provider (including Force Majeure), and the tour operator and tourist request to terminate the tour contract, the court shall support such request.  If the tour operator or tourist requests the court to hold the other party responsible for breach of contract, the court shall not support such request.  Where the tourist requires the tour operator to refund the costs and expenses which have not been actually incurred, the court shall support such request.”   

 

(2)Railway and Waterway Transportation Industry.  In the event that any loss, shortage, deterioration or contamination of the goods is caused due to Force Majeure, the carrier in railway or waterway transportation industry shall be exempted from the liability for compensation, in accordance with Article 18 of the Implementing Rules on Contracts for Carriage of Goods by Railway and Article 21 of the Implementing Rules on Contracts for Carriage of Goods by Water Transport.

 

 
 
 

Ⅳ. Suggestions: 

Measures That Can be Taken 

by Enterprises

 

Predictably, as the novel coronavirus outbreak continues, a wide range of enterprises will encounter difficulties in contract performance.  In order to contain the losses, we suggest these enterprises taking the following measures timely:

 

1.Sort out relevant facts in relation to performance of the contractual obligations and confirm whether it’s feasible to claim Change of Circumstances or Force Majeure so as to reduce losses.  First, confirm whether the contract was signed before the novel coronavirus outbreak.  If yes, the principles may be applicable.  Secondly, confirm whether there is any government policy which affects the contract performance.  If yes, it would be much easier to resort to the said two principles.  Thirdly, confirm if there is any delay in the contract performance before the novel coronavirus outbreak.  If Force Majeure occurs after a party has already been late in performing an obligation, the said party will not be excused from liability.

 

2.Notify the counterparty immediately.  Pursuant to Article 118 of the PRC Contract Law, where one of the parties is unable to perform the contract due to Force Majeure, the said party shall immediately notify the other party in order to reduce the potential losses sustained by the other party, which is also applicable under Change of Circumstances.

 

3.Prepare relevant evidence.  As provided in 118 of the PRC Contract Law, the party encountering Force Majeure shall also provide evidence within a reasonable time.  On January 30, 2020, China Council for Promotion of International Trade released a notice on issuance of Force Majeure evidence regarding the novel coronavirus outbreak.  Those enterprises that cannot perform international trading contracts or cannot fulfill the contractual obligations within certain time constraints may apply for the proof on Force Majeure from such Council.

 

4.Negotiate with the counter party to modify or terminate the contract.  On January 28, 2020, Wanda Group made an announcement, according to which merchants in Wanda Plaza all over the country will be exempted from paying rents incurred from January 24 to February 25, 2020.  As a reference, other enterprises under housing lease contracts may also communicate with the landlords to negotiate whether it is possible to reduce the rents during the novel coronavirus outbreak period.

 

At the meantime, government authorities have also formulated relevant supportive policies in order to help enterprise to survive, such as reduction of tax, cutting down of interest rates, provision of subsidies, exemption, reduction or deferred payment of social securities and housing provident fund.  With the joint endeavor of all sectors of the society, we believe we will win the fight against the novel coronavirus outbreak ultimately.

 

[注] 

[1] See Paragraph 1 of Article 180 of the General Rules of the PRC Civil Law, and Paragraph 2 of Article 117 of the PRC Contract Law.

[2] See Article 26 of the Interpretation of the Supreme People's Court on Several Issues Concerning Application of the PRC Contract Law (2).

[3] Jianyuan Cui, the “Contract Law”, Peking University Press, the first version in June 2012, page 115. 

[4] Please refer to the Case (2016) Zui Gao Fa Min Zhong No. 224 and the Case (2017) Zui Gao Fa Min Shen No. 3380.

[5] See the Notice Concerning Right Application of the Interpretation of Several Issues on the PRC Contract Law (II) to Serve the Overall Work of the Party and the State (Fa [2009] No. 165).

[6] See the Guiding Opinions on Several Issues Concerning the Trial of Cases on Disputes over Civil and Commercial Contracts under the Current Situation (Fa Fa [2009] No. 40).

 

本文在中文版上有所更新,原中文版请见《疫情防控引发的合同履行困难如何定性与处理?》