How The Coronavirus May Affect Your Supply Chain's Health

By Bing Wang, Matthew Levy and Li Yan
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Law360 (February 14, 2020, 3:36 PM EST) --
Bing Wang
Matthew Levy
Li Yan
The recent coronavirus outbreak not only poses potential human health concerns but also raises new risks for companies engaged in trade with China. The outbreak has prompted all levels of the Chinese government to take preventive measures to curb its spread, including extending the Lunar New Year holiday, quarantining Wuhan city and blockading highways and local roads.

These measures have prevented many Chinese manufacturing and logistics companies from delivering products to their buyers as work suspensions, unavailability of raw materials and shipment delays ensue. This may create legal issues concerning whether delays in performance or nonperformance constitute breaches of contract or are excusable force majeure events.

Does Your Contract Have a Force Majeure Provision?

U.S. companies contracting with Chinese suppliers should take this opportunity to review their supply contracts, particularly the force majeure clauses. Special attention should be paid to the list of events deemed to constitute a force majeure event to see whether a health epidemic may be covered.

References to "acts of God," "acts of government" or other circumstances beyond the parties' reasonable control all may provide the Chinese supplier with an argument to delay performance and/or avoid a claim for breach. The coronavirus outbreak may include both a naturally occurring component (the virus itself) and a government action component (such as the quarantines and other measures to contain the outbreak).

If the contract is governed by Chinese law and is silent on force majeure, the provisions of the People's Republic of China, Contract Law and the General Provisions of the Civil Law will govern. Under those laws, force majeure is defined as "any objective circumstances which are unforeseeable, unavoidable and insurmountable."

It can be argued that the coronavirus is novel (notwithstanding the outbreak of SARS in 2003), there is no current treatment for it, and the prevention and control measures must rely on large-scale government-led action. Therefore, the coronavirus likely meets the definition of force majeure under PRC law as an unforeseeable, unavoidable and insurmountable event.

Following the SARS crisis in 2003, the Supreme People's Court of China issued a judicial interpretation stating that disputes arising from the failure or inability to perform contracts due directly to administrative measures taken by the government to prevent the SARS epidemic, or otherwise due to the impact of the SARS epidemic, are subject to the force majeure provisions of the PRC Contract Law Articles 117 and 118.

To date, the Supreme People's Court has not issued any judicial interpretation to address whether the coronavirus epidemic constitutes a force majeure event that would relieve suppliers from partial or full performance of their supply contracts. However, on Feb. 10, the spokesperson of the Legislative Affairs Commission of the Standing Committee of the National People's Congress, China's legislature, expressed the opinion that the coronavirus epidemic should be treated as a force majeure event because it is unforeseeable, unavoidable and insurmountable.

According to the PRC Contract Law, a party affected by a force majeure event is exempt from partial or full performance of the contract, unless otherwise provided by law. Some scholars view the interpretation of the Legislative Affairs Commission as an academic interpretation rather than a legislative interpretation because the Legislative Affairs Commission, as a subcommittee of the Standing Committee, has no direct legislative authority.

However, this statement is likely to have an influence on the courts. If the Standing Committee must provide a legislative interpretation of a provision of law, it will rely on the Legislative Affairs Commission to draft it.

Change of Circumstances Versus Force Majeure

In judicial practice, most of the PRC courts adjudicated SARS as constituting a force majeure event, while some determined SARS constituted a change of circumstances, and others rejected the application of force majeure. Under Chinese law, a change of circumstances is defined as any major change in circumstances that is unforeseeable, is not a business risk and is not caused by a force majeure event that occurs after the formation of a contract.

The legal implication of a change of circumstances is that the continued performance of the contract would be unfair to the affected party, or the affected party would not be able to realize the benefit of the contract due to the change. In such case, if a party files a request for the modification or rescission of the contract with the People's Court, the People's Court will decide whether to modify or rescind the contract based on the principle of fairness and in light of the actual facts of the case.

The key difference between a force majeure event and a change of circumstances is that the parties may terminate the contract under a force majeure event, and the party which is unable to perform can be partially or wholly exempted from ensuing liability. On the other hand, if a change of circumstances applies, the affected party may file a request to the People's Court for the modification or rescission of the contract, and the court has the discretion to decide whether to modify or rescind the contract as a result.

In short, the specific language of the force majeure clause may play a critical role in the ability of a party to be excused from performance. If the matter is referred to a Chinese court, other factors may be considered, such as the causal relationship between the outbreak of the coronavirus, the quarantine measures imposed by the government, and the failure or inability of a party to perform its contractual obligations.

Next Steps for Affected Companies

Under Chinese law, the party unable to perform due to a force majeure event has the obligation to timely notify the other party so as to mitigate losses, and the affected party must provide evidence of the force majeure event within a reasonable time. The China Council for The Promotion of International Trade is the agency responsible for issuing force majeure certificates to companies impacted by the coronavirus epidemic. These certificates are generally recognized by more than 200 countries and governments, including the United States.

As the coronavirus situation evolves, U.S. buyers and their Chinese suppliers should communicate to assess the potential impacts of the quarantine measures and to determine how to resolve any resulting supply issues. If contractual supply commitments cannot be met, the supplier has the obligation to mitigate losses and to perform the contract as soon as the force majeure event terminates.

U.S. companies should begin looking at their supply chains now to determine whether any suppliers have facilities in China or in other countries which may be impacted by the coronavirus outbreak. If so, those companies should begin considering contingency plans for a possible prolonged epidemic.

Bing Wang and Matthew Levy are partners and Li Yan is a legal consultant at Faegre Drinker Biddle & Reath LLP.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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