By Jierong Yang, Edward Lebow and Liza Mark

Law360 (May 7, 2020, 5:48 PM EDT) --

Jierong Yang

Edward Lebow

Liza Mark

Although there is no law or regulation in the People's Republic of China that explicitly parallels the U.S. Defense Production Act of 1950, as an economy with many remaining elements of state control, there are ample administrative measures, regulations and judicial precedents in China allowing the government to overrule outstanding production plans and contracts by mandating, controlling, allocating and prioritizing production of critical supplies.

Thus, during the global COVID-19 pandemic, if a company is thinking of entering into contracts with Chinese manufacturers, government action is an additional risk that it needs to consider.

On March 18, President Donald Trump issued an executive order declaring that "health and medical resources needed to respond to the spread of COVID-19, including personal protective equipment and ventilators" met the criteria set forth in the DPA to permit the use of the powers granted by the DPA.[1] On March 23, President Trump took an initial step under the DPA by issuing an executive order authorizing the attorney general to investigate and prosecute hoarding of personal protection equipment and related price-gouging.[2]

On March 24, the administration went further, with the administrator of the Federal Emergency Management Agency announcing that the agency would start using its DPA powers to procure about 60,000 test kits and began inserting DPA-specific language into its contracts for 500 million masks.[3]

Essentially, under the DPA, the U.S. federal government is authorized to force a U.S. manufacturer to prioritize government contracts ahead of existing contracts for supporting the government's COVID-19 response and to allocate materials, services and facilities in such a manner as to prioritize these contracts or orders over other contracts and orders. Companies that are required under the DPA to produce government orders in priority are protected from liability for failing to meet prior deadlines. The government's authority under the DPA is typically implemented through the Defense Priorities and Allocations System.[4]

China doesn't have any law like the DPA that overtly requires companies to prioritize the government's contracts ahead of existing commercial contracts. However, the Chinese government often uses administrative means to control epidemic prevention product manufacturing, which can have effects similar to the DPA.

For example, during the COVID-19 crisis in early 2020, the Chinese central government issued multiple notices (1) requiring local governments to take charge of manufacturing epidemic prevention materials; and (2) requiring manufacturers to obey the centralized arrangement:

• On Jan. 28, the People's Republic of China Central Committee issued the "Notice on Strengthening the Party's Leadership and Providing Strong Political Guarantee for Winning the Outbreak Prevention and Control Battle" — which states that party committees (party groups) at all levels should strengthen management and obey the central government's orders.

• On Jan. 29, the General Office of the State Council of the People's Republic of China issued the "Urgent Notice on Coordinating and the Resumption of Production of Epidemic Prevention and Control Key Material Production Enterprises," which (1) mandates that the State Council of the People's Republic of China shall have the right to centrally manage and allocate "key materials" for epidemic prevention and control and (2) the State Council (or local government equivalent) shall send material security officers to such material production enterprises to ensure the centralized management and allocation of such epidemic key materials.

• On Feb. 28, the National Development and Reform Commission of the People's Republic of China issued the "Notice on Doing a Good Job in the Management of the List of Material Production Enterprise," requiring the local NDRC branch to make a list of and to supervise the material production enterprise. If an enterprise manufactures key material for epidemic prevention and control, such manufactures will register with the local NDRC branch and will be supervised by NDRC.[5] Such enterprises will manufacture preferentially the government's contracts and enjoy state preferential policy treatment, e.g., tax, bank loan.

While there are no penalty rules established in these notices, these administrative pronouncements are regarded as mandatory.[6]

Government action has long been recognized under Chinese law as a potential objective event that could justify a "force majeure" defense to avoid contractual liabilities for nonperformance of a contract or give rise to the right to terminate a contract.

Article 180 of the People's Republic of China General Provisions of Civil Law states:


Article 94 of the Contract Law of the People's Republic of China states: "The parties may terminate a contract if (i) force majeure frustrated the purpose of the contract;"

Article 117 of the Contract Law also states that:


Please note that "force majeure" has not been clearly defined under Chinese law, and case law interpreting the factors that would be necessary to support a finding of force majeure defense is limited and sometimes contradictory. A full discussion of the legal concept of force majeure under Chinese law is beyond the scope of this article.

However, we can refer to how similar questions were interpreted during the SARS epidemic in 2003 — the Supreme People's Court of China provided that the administrative measures taken by the government and relevant departments to prevent and treat the 2003 SARS epidemic that caused parties to the contract to be unable to perform their contract shall be deemed to be "force majeure" or "force majeure events" under Article 117 and Article 118 of the Contract Law respectively.

In addition, the Supreme People's Court of China issued on April 16 its "Guiding Opinions on Several Issues Concerning the Proper Hearing of Civil Cases Involving the COVID-19 Epidemic," whereby it clearly specifies that both the COVID-19 pandemic and the government prevention and control measures in response to the pandemic can be considered "force majeure" or "force majeure events" and if such measures directly cause the delay or frustration of a contract, Chinese courts are to deal with such disputes under the provisions of Article 180 of the Civil Law and Articles 117 and 118 of the Contract Law.

China may not have an overt law similar to the DPA where the government can claim priority for the manufacturing of certain critical materials during times of emergencies. However, it can easily achieve (and has achieved) the same results by administrative means. Counterparties contracting with Chinese manufacturers would do well to consider the following:

• Commercially, is there a risk that the Chinese manufacturers may be ordered by the government to produce certain goods? Is the Chinese manufacturer a material production enterprise? If the counterparty is deemed to be a material production enterprise, consider the commercial terms that may limit your exposure to the risk (e.g., adjust payment terms).

• How should you draft the force majeure clause in your contract? Consider the definition of "force majeure" under Chinese law and whether acknowledgements within the contract would help or hinder the establishment of certain factors under such definitions.

• Governing law and dispute resolution provisions applicable to your contract will affect how the force majeure clause will be interpreted. The force majeure defense is also interpreted differently among different people's courts in China. Do you want your contract to be governed under Chinese law? If yes, where do you want your contract to be formed? If governed under laws other than Chinese law, is that practical under the commercial circumstances and what is the definition of force majeure under that governing law regime?

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Jierong Yang is an associate, Edward M. Lebow is counsel and Liza L.S. Mark is a partner at Haynes and Boone 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.

[1] Executive Order on Prioritizing and Allocating Health and Medical Resources to Respond to the Spread of COVID-19 (Executive Order 13909 of Mar. 18, 2020), https://www.federalregister.gov/documents/2020/03/23/2020-06161/prioritizing-and-allocating-health-and-medical-resources-to-respond-to-the-spread-of-covid-19.

[2] See 50 U.S.C. § 4512; see also Executive Order on Preventing Hoarding of Health and Medical Resources to Respond to the Spread of COVID-19, Mar. 23, 2020, https://www.whitehouse.gov/presidential-actions/executive-order-preventing-hoarding-health-medical-resources-respond-spread-covid-19/.

[3] Rebecca Ballhaus & Andrew Restuccia, Administration to Use Defense Production Act for First Time in Coronavirus Pandemic, Wall St. J., Mar. 24, 2020, https://www.wsj.com/articles/administration-to-use-defense-production-act-for-first-time-in-coronavirus-pandemic-11585058618?mod=djemalertNEWS.

[4] PART 700 - Defense Priorities and Allocations System (Feb. 1, 2020), https://www.govinfo.gov/content/pkg/CFR-2020-title15-vol2/xml/CFR-2020-title15-vol2-part700.xml.

[5] The list of the Key Material refers to the Letter on the Specific Scope of the Key Material《关于提供疫情防控重点保障物资具体范围的函》 issued by NDRC on Feb.18, 2020.

[6] Jinan is accelerating the organization to increase market supply! Daily output of medical and daily masks is 61,500, and the daily output of disinfectant is 10.45 tons (济南正加快组织增加市场供应！医用、日用口罩日产量6.15万消毒液日产量10.45吨); Feb. 06, 2020 – where the Information Office of Jinan Municipal People's Government acknowledged in their news conference that their epidemic prevention materials production is under the centralized control of the State Council. https://feng.ifeng.com/c/7tqK06xVHeN.

[7] (最高法院：关于在防治传染性非典型肺炎期间依法做好人民法院相关审判执行工作的通知（法[2003]72号）

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