11 February 2020
Being the world’s largest manufacturing base, the current outbreak of the Coronaviruses in China is having a substantial impact on global supply chain business. Most business operations in China are not supposed to resume before February 9, 2020. This does not necessarily mean your supplier or your China operation will immediately be back on track as of February 10, 2020, since epidemic preventive measures including traveling restrictions as adopted by the Chinese government may prevent people from getting back to work as usual. Besides local employment issues to be looked into (see our earlier newsletter at Chinese Employment Law Issues in Dealing with Coronavirus Infections), another hot topic discussed these days is whether or not one may use force majeure to improve a company’s position in the supply chain business. Companies which are already affected or may be affected should already start to proactively look into this issue to better manage and mitigate risks.
You first need to check your local supply contract, e.g. between your China subsidiary and its Chinese supplier or its China customer. Such a contract will be governed by Chinese law and, if well drafted, will usually include a force majeure clause outlining what exact events (e.g. epidemic situation like SARS outbreak or similar) shall qualify as force majeure. In the absence of such a clause or clear definition, one will need to refer to statutory laws to assess the issue. Key criteria under PRC Contract Law to evaluate the establishment of a force majeure event are “unforeseeable, unavoidable and insurmountable” (Art. 117, 118). According to a notice issued by the Supreme People’s Court on June 11, 2003 (No. 72), failure to perform a contract including contract frustration due to administrative measures taken by government to prevent “SARS” shall be properly handled according to Art. 117 and 118 of the PRC Contract Law (i.e. force majeure).Therefore, one could reasonably assume that the current Coronaviruses outbreak including the respective governmental preventive measures will very likely also be taken as force majeure.
To resort to a force majeure clause, there are few issues to be noted:
Force majeure is certainly not the only issue you may encounter in a supply chain dispute. Other concepts under Chinese law like “contract frustration”, “foreseeable breach”, “fairness principle” may all come into play. How to best manage a case will require careful review of your supply chain contracts and related facts.
If your supply arrangement crosses the border (e.g. between your European affiliate and a Chinese supplier), things will get more complicated. A more relevant scenario in reality could be that you will be breaching your contract towards your European customers since your Chinese supplier is not able to deliver due to the virus outbreak in China. Whether or not you can use force majeure to defend and mitigate your risks will need to be examined under the concerned jurisdiction. Here we take German law as an example.
German law recognizes force majeure generally only if explicitly addressed under a supply contract. More often used in such a case could be the alternative concept “frustration of contract” which is close to force majeure. It allows adapting the contract to changed circumstances, provided: (i) circumstances have changed decisively after conclusion of the contract. (ii) these circumstances have not become part of the contract (test: If the parties had foreseen the change, they would not have concluded the contract or would have concluded it with a different content). (iii) the adherence to the unchanged contract must be unreasonable for one party, taking into account all circumstances of the individual case, in particular the contractual or legal distribution of risk. If such exceptional circumstances exist, the concept allows the contract to be adjusted – or, if an adjustment is impossible or unreasonable, even to terminate the contract.
Different from PRC law under which breach of contract by a third party cannot be used as an argument to exempt one’s liability for breach of contact, German law requires fault (i.e. negligence or wilful intent) to establish legal liabilities for breach of contract. Since the existence of fault will be presumed by law, you will need to prove that the breach has occurred without your fault (i.e. neither your own nor that of your vicarious agents). Whether or not you can successfully rely on the “no fault” argument depends on the individual case, including your supply contract itself. To withstand the test in court, such an argument should best be backed up by further argumentation, especially that (i) you were not able to procure the goods elsewhere and (ii) that the lack of supply was not foreseeable by you. In this context, you may also need to consider asking your Chinese supplier to provide evidence like the CCPIT proving certificate mentioned above.
The above are just a quick glance at some typical legal issues which could arise out of your supply chain arrangement as impacted upon by the Coronaviruses outbreak in China. It is certainly not meant to be exhaustive and each single case will be different. Nevertheless, taking precautionary measures as early as possible is highly recommended for all companies which have a supply tie with China. These may include
If you need a hand, do not hesitate to talk to a specialist from Taylor Wessing where we have legal experts familiar with all these issues in both China and Europe who are easily available.