Coronavirus: force majeure and your supply chain

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.

Onshore Supply Chain

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 does not necessarily result in automatic termination of a supply contract. Only when the purpose of the supply contract is frustrated by force majeure, the right to terminate may arise under Art. 97 of the PRC Contract Law;
• contractual liabilities of the party affected by force majeure may be exempted partially or completely, which however will not apply if there was already default in contractual performance (e.g. delay in delivery) before occurrence of force majeure;
• claiming force majeure shall follow procedural requirements. Art. 118 of the PRC Contract Law stipulates that the affected party shall give a notice to the other party in time so as to reduce the losses that may be caused to the other party and provide evidence within a reasonable time limit. Where necessary, one may already consider obtaining official evidence from agencies like CCPIT which is now offering a certificate of proof tailored for Coronaviruses.

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.

Cross-border Supply Chain

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.

To-dos

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

• evaluating potential supply chain risks on business side to see where the exposure stands (i.e. supply side or distribution side or both);
• reviewing your supply contracts with your Chinese supplier and/or customer to assess your legal position and prepare your strategy for a potentially contentious scenario (termination or suspension). If you are on supply side, already start now to get a certificate of proof including other evidence;
• properly managing and documenting your communication with your suppliers and/or customers, particularly paying attention to any contractual and statutory procedural requirements including deadlines under the concerned jurisdiction;
• bearing in mind other statutory obligations which might apply like “fair and reasonable” allocation of received stock among customers.

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.