(By Wang Haichuan)Facing the coronavirus epidemic, some people are going on the extra 10-days’ holiday, while others are worrying about their contracts. For example, the Government of Shanghai requires local enterprises not resume their work before 24:00 of February 9th. Such requirement may result in a delay or failure of contract performance. This brings about a few questions. Who should be responsible for the contract breach? Can the contract be extended or terminated? What about allocation of damages arising from the contract termination.
I.The epidemic is a force majeure event
People usually think of such events as force majeure. Is the coronavirus epidemic a force majeure event? Chinese courts used to consider similar events as force majeure. The SARS epidemic in 2003 is very similar to the coronavirus epidemic this time. The Supreme Court issued the notice regarding contract disputes arising from SARS (“SARS cases”) in 2003. Accordingly, contract disputes arising from the SARS epidemic or government acts to prevent and control the SARS epidemic should be resolved according to force majeure related provisions. Actually, there are contract disputes decided by Chinese courts as caused by force majeure events.
According to the Contract Law of the People’s Republic of China, if a contract cannot be fulfilled due to a force majeure event, the liabilities may be exempted in whole or in part depending on the impact of the force majeure event. The “exemption of liabilities” means no longer needing to pay damages and be responsible for the breach of the contract, but does not mean exempting the obligation to perform the contract. For example, in case of delayed performance of a contract, the defaulting party shall pay the non-defaulting party 0.5% of the contract price as penalty for each day of delay. When the performance is delayed due to force majeure, the delaying party is entitled to refuse to pay the penalty pursuant to force majeure related provisions. After the disappearance of a force majeure event, the other party is entitled to require the delaying party to continue to perform the contract.
You may feel less worried after reading the above paragraph because anyhow you are not liable for the contract breach. However, force majeure related provisions do not apply in all cases where a force majeure event occurs. For example, the effect of the epidemic on a sales contract may be different from that on a tourism contract. For instance, a tourism contract for a trip to Wuhan is completely unable to be performed, while a computer sales contract between two Shanghai-based companies are not be affected at all. Therefore, the impact of force majeure events on the performance of contracts should be determined on a case-by-case basis by taking actual circumstances into consideration. In some SARS related cases, courts found that the SARS epidemic and restrictions imposed by the government due to the SARS epidemic only affected part of the business of the defaulting party in a way that was not serious enough to “directly” or “basically” cause the contract to be unable to be performed and therefore the force majeure event could not be a legal reason for the contract termination[L.S.2.M.K.Z.No.14 Tenancy Contract Case of Second Trial between Dalian Pengcheng Holiday Damu Co., Ltd. and Dalian Zhengdian Watches Co., Ltd.]. In summary, after the occurrence of force majeure events, factors such as the duration of the epidemic, the contents of the contract, the term of the contract and government orders should be taken into consideration to determine whether relevant force majeure provisions can be applied.
II. What should we do after a force majeure event occurs?
The exemption of liabilities in the event of force majeure doesn’t mean that the contractual parties can wait and do nothing until the disappearance of the force majeure event. The parties should do the following things about their contract after the occurrence of a force majeure event.
1. To take active and appropriate measures to reduce the extent of the damage and the adverse effect on the performance of the contract. The party failing to take prompt action is liable for additional losses arising from such failure.
2. To obtain proof of the occurrence of the force majeure event. In some contracts the affected party may be required to provide the other party with proof of the force majeure event within a certain period of time. Therefore, the affected party should be active collecting proof of the force majeure event from government agencies or other third parties.
3. To deal with other contract related issues as soon as possible, especially modification or termination of the contract. In case of modification of the contract, the parties will continue to perform the contract some time later or at a reduced contract price. In the SARS epidemic some tenants had to stop doing business and asked for cuts in rent. Courts supported their claims in equitable fashion[(2004) H.2.Z.M.2.(M) Z.Z.No.354 House Lease Contract Case between Shanghai Pipe Entertainment Co., Ltd. and Shanghai New Huangpu (Group) Co., Ltd.]. In case of termination of the contract, neither party is liable for the termination if the purpose of the contract cannot be met because of the force majeure event.
4. Any party that wants to terminate the contract needs to collect evidence of losses arising from the contract performance. After the termination, the fulfilled part of the contract should be paid for, with the rest part of the contract price not needing to be paid. The cost of preparations made for the performance of the contract made are part of losses of the parties to the contract. Courts usually award damages in an equitable fashion. In some cases, each party pay 50% damages[cf. Government’s Abstract Administrative Act Resulting in Non-Performance of a Contract Can Be Considered as a Force Majeure Event, by Li Hu, People’s Judicature, 20th issue 2009, pp.83-86; and the written judgement for the (2016) SPC.M.Z.No.220 contract case of second trial between Bai Junying and the Government of Tumd Zuoqi].
5. To send a written notice to the other party to the contract. Issuing such written notice will give you the following advantages. First, giving a clarification of measures taken to mitigate the adverse effect of the force majeure event could reduce the risk of being held liable (for further losses). Second, there are different approaches to addressing issues arising from an force majeure event (such as change or termination of the contract). Sending a written notice can give you an advantage of making a good choice for yourself. A notice usually contains:
(1) details of the force majeure event and its effect;
(2) measures taken or to be taken by you to reduce losses after its occurrence;
(3) your proposed plan to deal with other contract related issues arising therefrom (such as change or termination);
(4) your losses arising from performance of the contract and loss distribution plan (if the contract is terminated)
6. To actively negotiate with the other party and prepare for possible action. The two parties must reach a mutual agreement for the change of contract. If the parties fail to reach an agreement, an action may be brought to change the contract. When a force majeure event occurs, the possibility of contract disputes is higher. Therefore, on one hand, the parties involved should discuss and negotiate with each other actively to resolve the problems; on the other hand, they must prepare for possible litigation.
We suggest the parties affected by the epidemic of the coronavirus:
1.evaluate the impact of the epidemic on the contract performance to see whether force majeure related provisions are applicable;
2. take reasonable measures to reduce losses after the occurrence of the force majeure event;
3. obtain proof of the occurrence of force majeure event;
4. decide how to deal with issues related to the contract (change or termination);
5. collecting evidence of losses arising from the performance of the contract;
6. sending a written notice to the other party as soon as possible to fix related facts and express your opinions;
7. discuss with each other actively and prepare for possible litigation.