Following the rapid spread of the novel coronavirus ("COVID-19") that was first reported in Wuhan, China at the end of 2019, the World Health Organization declared COVID-19 to be a pandemic on March 11, 2020.
In this note, we consider how force majeure provisions in commercial contracts and the related common law doctrine of frustration may be engaged in the context of the COVID-19 outbreak. While this analysis focuses primarily on the position under English law, we have included a PRC law perspective because of the significant impact COVID-19 has had on business in China. We also suggest steps that parties may take to safeguard their positions in view of the evolving situation.
Force Majeure Provisions
A force majeure event refers to the occurrence of an event which is outside the reasonable control of a party and which prevents that party from performing its obligations under a contract. English common law has no general concept of force majeure (save for the limited doctrine of contractual frustration, which is addressed below). A party's ability to claim relief for a force majeure event therefore depends upon the terms of the contract, and the force majeure provision in particular. Force majeure provisions are express terms and will not ordinarily be implied into contracts governed by English law.
A party affected by such an event of force majeure will typically be relieved from performing the obligation affected for the duration and to the extent affected and may be entitled to compensation.
As with all matters dependent upon the terms of the contract, each force majeure provision must necessarily be considered on its precise terms and in its specific context. There are nonetheless some features common to most force majeure provisions, which we consider below.
Events Capable of Constituting Force Majeure
The "test" for force majeure usually requires the satisfaction of three distinct criteria:
- the event must be beyond the reasonable control of the affected party;
- the affected party's ability to perform its obligations under the contract must have been prevented, impeded or hindered by the event; and
- the affected party must have taken all reasonable steps to seek to avoid or mitigate the event or its consequences.
These criteria will be considered in turn.
It is common to see force majeure events split into two categories which set out a specific list of events which are deemed to be events of force majeure: political force majeure, which deal with risks related to changes in the political or legal environments and non-political force majeure (or natural force majeure), which deal with physical risks that might impact a business or a project. These different categories often provide different remedies—an extension of time and increased costs (for cases of political force majeure) or an extension of the time for completion and relief from termination (for cases of natural force majeure).
Many contractual provisions set out a specific list of force majeure events which are deemed to be events of force majeure beyond the control of the parties, such as "pandemics," "epidemics" or "diseases." A specific reference to a "pandemic" will make it easier to bring a force majeure claim but will still require the other criteria for a force majeure test to be satisfied.
However, if the provision does not include language to that effect, then it will be necessary to consider whether COVID-19, or its impact on a business or a project, is captured by a different concept, such as an "Act of God," "action by government" or a catch-all provision. Most force majeure provisions contain "catch-all" language in respect of events which are "outside the reasonable control of the party affected". It seems fairly clear that a pandemic such as COVID-19 would qualify as force majeure under such a provision.
It is important to bear in mind however that the relevant force majeure event need not be COVID-19 itself. It is the consequences of COVID-19 and its impact upon the ability of the affected party to fulfil its contractual obligations that will be relevant.
The second criterion will be affected by the degree of impairment of the affected party's ability to perform its contractual obligations required to trigger the operation of the force majeure provision. A force majeure provision typically relieves a party from what would otherwise be a breach of contract—i.e. its failure to perform an obligation due to the effects of the event of force majeure in question. The party must establish the causal link between the event and its inability to perform. A provision that requires a party to be "prevented" by the force majeure event from performing its obligations will likely be more difficult to rely upon than one which only requires the party to be "impeded" or "hindered" in the performance of its obligations.
A highly likely scenario with COVID-19 would be the inability to perform a contract due to having to self-isolate an office or a team due to the outbreak of COVID-19 at the workplace. Under many force majeure clauses, this would likely have the necessary impact and causal link to qualify as a force majeure event, subject to the party affected having taken all reasonable measures. A disruption that merely impacts the profitability of a contract may not be sufficient for a force majeure claim unless there is express contractual provision for such a situation. Nor would an economic downturn or other general adverse business conditions likely be sufficient, even if it could clearly be shown that a key trigger for the downturn was COVID-19.
Duty to Mitigate
Finally, a party seeking to rely upon a force majeure provision will usually have to show that it has taken reasonable steps to avoid or mitigate the event and its consequence, and that there are no alternate means for performing under the contract. What constitutes a reasonable mitigation measure is fact-specific and depends upon the nature and subject matter of the contract in question.
For example, a supplier could consider using alternative manufacturing lines in a different location, or a project owner could seek alternative suppliers. However, the reasonableness of a mitigation measure will be considered in light of any additional burdens and costs that the party incurs, as well as availability of alternative manufacturing lines and suppliers at that time and the overall impact of any delays that a mitigation measure could have upon the project schedule.
Given the continued impact that the spread of COVID-19 is having upon global businesses, it is possible that there may be fewer mitigation measures available to parties than in other potential events of force majeure. However, it will be important for employers to follow all relevant official guidelines and to consider all reasonable measures to contain or limit the spread of the virus in the work place so as to allow contractual performance to continue. Short-term measures such as home-working may be necessary.
Typically, the affected party's right to relief for force majeure under the contract will be conditional upon the issuance of a notice by it to the other party, supported by the required evidence. The contract may additionally require the notice to state the anticipated consequences and duration of the force majeure event. Some contracts, especially construction contracts, include a "time-bar" clause that requires notice to be provided within a specified period from when the affected party first became aware of the force majeure event, failure of which will result in a loss of entitlement to claim.
Unlike a one-off event such as natural disaster, which is usually limited in time and confined to a particular geographical locale, the COVID-19 outbreak has been dynamic and has been characterized by its ability to proliferate rapidly and unexpectedly across multiple countries and geographical regions. Parties have therefore adopted the approach of issuing "protective" or "rolling" force majeure notices that take into account the developing impact that the COVID-19 outbreak has upon the performance of their obligations under the contract.
Consequences of Force Majeure Claims
The consequences for the parties where a valid force majeure event has occurred will depend on the nature of the affected party's obligations under the contract, as well as the consequences and remedies expressly contemplated by the force majeure provision.
Contractual remedies for force majeure typically include an extension of time to perform those obligations or suspension of contractual performance for the duration of the force majeure event. If the force majeure event extends over a longer period, some provisions may entitle the parties to terminate the contract.
Doctrine of Frustration
In the absence of an express force majeure provision within an English law contract, parties may be able to rely upon the doctrine of frustration. By contrast, the doctrine of frustration is not available if the contract contains an express force majeure provision, since the provision will be regarded as the agreed allocation of risk between the parties.
The doctrine of frustration will apply if:
- the underlying event is not the fault of any party to the contract;
- the event or circumstance occurs after the formation of the contract and was not foreseen by the parties; and
- it becomes physically or commercially impossible to fulfil the contract, or transforms the obligation to perform into a radically different obligation from that undertaken initially.
The doctrine of frustration results in the contract automatically coming to an end. The parties to the contract will no longer be bound to perform their future obligations. Because of the dramatic consequences contractual frustration, the threshold for proving frustration is much higher than that for most force majeure provisions, since it must be shown that the obligations impacted by the event or circumstance are fundamental to the contract.
Some contracts may also contain a "change in law" provision, which addresses circumstances where there has been a change in law that makes it impossible for the party to perform its contractual obligations. As a result, parties may incur increased costs to reimburse the affected parties, and in some cases, the right to terminate the contact. Given the continued global spread of the outbreak, it is possible that laws may be passed in order to contain the spread of the virus, but which also prevent that party from performing its contractual obligations (eg, travel restrictions or nationwide quarantine and self-isolation measures, as recently implemented across Italy). A party's entitlement to remedies will depend upon the scope of a "change in law" provision.
Force Majeure Under PRC Law
In addition to the position under English law, we briefly consider the position under PRC law in view of the impact of the COVID-19 outbreak in China.
Under PRC General Provisions of the Civil Law (promulgated in March 2017), force majeure is generally recognized as an excuse for not performing civil obligations. If a contract does not include a force majeure provision, it will be implied. If a contract includes a force majeure provision, a party can rely on the force majeure provision or resort to the protection offered by the general law if the scope of the contractual remedy is considered to be limited. To be eligible for force majeure protection under PRC law, the affected party must demonstrate that the relevant situation is unforeseeable, unavoidable and cannot be overcome, and also that it is the cause of the affected party's inability to perform its obligations.
The China Council for The Promotion of International Trade has been issuing force majeure certificates to companies that claim they are unable to meet their contractual obligations to protect them from potential breach of contract claims by counterparties. These certificates would not automatically satisfy the "test" for force majeure for a contract governed by English, PRC or another law; these certificates would at best provide evidentiary support for the affected party's force majeure claim, but the specific requirements of the force majeure provision must still be satisfied.
We understand that there is pressure on the China International Trade Commission to stop issuing force majeure certificates for companies as the Chinese Government is keen to revive the economy as soon as possible. State-owned enterprises have been instructed to resume operations and recall all employees back to work. While these orders may be resisted in some instances, it is widely thought that without governmental support, there will likely be fewer force majeure claims made by Chinese companies.
Practical Suggestions for Clients
In order to be prepared for different scenarios as the situation continues to unfold, we recommend that clients consider taking the following proactive steps.
- Review your contract to determine whether the contract includes
a force majeure provision and, if so:
- Carefully review the definition of force majeure in that contract to determine whether there is any express event incorporating events such as COVID-19 and, if not, whether the general language is sufficient to include COVID-19 and its consequences. If in doubt, it may be helpful to seek legal advice early in the process.
- Consider those aspects of the relevant contract that you are not able to perform and satisfy yourself that the inability to perform is due to the consequences (direct or indirect) of COVID-19 and not a different reason.
- Consider and review what steps you are taking as a business to avoid or at least reduce so far as possible the effects of COVID-19 upon your work force and your ability to continue to perform contracts. It will be important to be able to show that you have taken all reasonable measures and followed all official guidance. Remote working and other steps such as adopting a "clean" team structure may be helpful in this regard.
- Consider whether there are any notice requirements to trigger entitlement to relief, including what type of supporting documents must be provided and whether there is any time limit for that notice to be issued.
- Consider what the consequences of a successful claim for force majeure are.
- Review the financing or other related documents to determine whether there are any notice provisions that must be complied with in relation to anticipated or actual force majeure claims.
- Determine whether insurances, such as business interruption insurance or force majeure insurance, may cover any of the expected losses.
Parties Receiving Notices of Force Majeure
- A party receiving a notice of force majeure should carefully
examine the claim to determine:
- if it is consistent with the scope of protection conferred by the force majeure provision;
- if the process for giving notice has been complied with; and
- whether the relevant supporting documentation or information has been provided.
- A party involved in back-to-back contracts or a network of interrelated contracts will need to take a strategic approach, taking into account the overall impact of the claim for force majeure on its obligations under the related contracts.
- A party embedded within a chain of contracts is involved must also consider whether to issue protective notices of force majeure under the linked contracts as a protective measure.
- Where different laws govern back-to-back contracts, the
differing interpretations of force majeure under those laws
requires careful consideration.
- For example, an affected subcontractor under a PRC governed law supply contract may have a valid claim under that contract, while the contractor, with an English law governed commercial arrangement with the owner, may not.
Parties Making Claims of Force Majeure
- A party affected by the COVID-19 outbreak should take steps to record and document the steps it is taking to prevent or mitigate the impact of the COVID-19 outbreak on its ability to perform its obligations under the contract.
- A party looking to make a force majeure claim should consider
carefully how the force majeure event is framed, and the
consequences that are said to flow from that event.
- For example, a party could claim that the COVID-19 outbreak constitutes the force majeure event, or it could rely upon a supervening government regulation or a disruption in its supply chain or the supply of labor.
- A party should only make a force majeure claim with care, because a wrongful claim could have serious consequences, including amounting to a breach of contract or a repudiation of the contract. In such circumstances, the other party may be entitled to claim damages or to terminate the contract.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.