By Katharine Wheatcroft and Duncan Burrell
As the so-called COVID-19 virus continues to spread in China and this week also in Italy, Iran and Korea, with almost 80,000 confirmed cases and over 2,000 dead as of late February, the world’s second largest economy is struggling to get back to work, and other economies are feeling the effects.
Within the trade sphere, worker shortages, transport disruption and heavy government restrictions have meant that many of the corporations that drive China’s economy, the world’s largest importer of raw materials, are starting to review their international supply and demand contracts.
As a result, there seem to be increasing examples of Chinese firms seeking to rely on force majeure clauses incorporated into their contractual agreements to seek to delay, postpone, suspend or even cancel their contractual obligations. Chinese copper importers have already invoked force majeure to cancel purchase contracts and Chinese LNG importers have sought to follow suit. There are also reported delays in the soybean and palm oil shipments into China. Exports have been affected with factories seeking to postpone deliveries under supply contracts. The Chinese Government has stated that it will offer force majeure certificates to Chinese companies struggling to cope with the impact of the virus on their overseas business.
There has also been discussion about whether Chinese banks themselves may refuse to pay a letter of credit in reliance upon the express inclusion of force majeure in the UCP 600 (Article 36). For example, it is alleged that there have been instances of couriers refusing to deliver corresponding documents to an issuing bank located in Wuhan.
By way of a reminder force majeure clauses are supposed to be specifically enacted when events occur that are outside of a party’s reasonable control and which inhibit that party from fulfilling their duties and obligations under a contract.
Force majeure clauses are not standardised and are often incorporated with insufficient thought being given as to whether they are appropriate for the contract in question and what the consequences of their enforcement might be. Such clauses also often tend not to mention diseases or pandemics, though they often refer to "acts of government," which appears to be what is being relied upon by those triggering them for COVID-19.
English case law indicates that, in contracts where English law applies, simply inserting the words force majeure into your contract is not enough, and some attempt must be made to set out the kinds of circumstances the parties wish to constitute such an event. It is also important to note the difference between contractual frustration (for example where an obligation has become more costly or time-consuming) and a genuine force majeure event, which makes it effectively impossible for a party to perform its contractual duties. Thought also needs to be given to what the result is of declaring a force majeure event – avoidance of liability? Suspension or termination of the contract?
It should be noted however, that other jurisdictions interpret the doctrine of force majeure very differently to English law. Civil law jurisdictions, such as China, often do not distinguish between frustration and force majeure, leaving what is or is not a force majeure event a matter of interpretation.
In relation to letters of credit, the force majeure clause in UCP 600 is only applicable where the relevant banks’ own commercial operations are being affected by the force majeure event, and not where problems are experienced by the obligors themselves within the supply chain. The ICC in China issued a circular to its member banks on 5th February calling on them to do their best to ensure the continued timely processing of international trade finance business despite COVID-19. Correspondent banks may only invoke force majeure as a cause to refuse to pay if they can justify how their own operations are being affected by COVID-19, for example perhaps the delivery issues to Wuhan or Hubei Province, but these should affect only a small minority of cases.
Action Points
Companies should review their Chinese (and other) supply and demand contracts with a focus on:
- What law governs the contract?
- Does it have a force majeure clause?
- Does the force majeure clause set out a list of the kinds of scenarios where it would be triggered, and does this include epidemics/pandemics?
- Does it specify what the outcomes of triggering it will be?
Any response to a claim of force majeure should be carefully considered based on the specific wording of the relevant contract and the potential consequences of accepting such a claim. Rejecting a claim, however, may well prove hard in the face of the Chinese Government’s support for domestic corporations. This may widen to other countries depending on the impact of COVID-19. There is likely to be a need for negotiation between the respective parties, which may see acceptance of delays or additional costs to avoid termination of contracts.
