10 Q&As on Contract Performance for FIEs in Context of COVID-19
By Eagle Yang, Yvonne Wen and James Li
As the outbreak of COVID-19 pandemic early this year, there are 215 countries, areas or territories around the world that have reported more than 3.6 million confirmed cases according to the data disclosed by the World Health Organization on May 8, 2020. Even though the COVID-19 has been effectively controlled in China till now, it is, however, super majority of companies, including foreign invested enterprises (the “FIE” or “FIEs”), that have encountered, inter alia, serious difficulties in production and business operation due to the impact of COVID-19. How to effectively manage and mitigate the legal risks in contract performance is one of the most concerned issues for the FIEs. In order to provide helpful advice for the FIEs, hereby we summarize the variety issues on contract performance into 10 questions based on the actual needs thereof, and corresponding legal advice has been provided in form of answer, in hope to provide helpful reference to the FIEs.
1. Does the COVID-19 pandemic constitute force majeure? Answer : The COVID-19 pandemic constitutes the force majeure. However, the specific impact of the COVID-19 pandemic on contract performance should be determined by specific circumstances, such as the nature of the contract, the parties’ expectations, the performance of contract and the degree of impact of the COVID-19 pandemic on the performance of contract.According to paragraph 180 (2) of the General Principles of the Civil Law and paragraph 117 (2) of the Contract Law, and the opinion made by the spokesperson of the Legal Work Committee of the National People's Congress, force majeure shall mean an objective event which is unforeseeable, unavoidable and insurmountable. In order to protect public health, Chinese government has adopted corresponding pandemic prevention and control measures, resulting in the nonperformance of the contract, which shall fall into the event unforeseeable, unavoidable and insurmountable and should be regarded as force majeure. The specific impact of the pandemic on contract performance should, however, be determined by such factors as the nature of the contract, the parties’ expectations, the contract performance, and the degree of impact of the pandemic on contract performance. 2. Can the parties terminate the contract on the ground of force majeure? How liabilities would be borne by the parties?
2.1 Legal analysis on the termination of the contract on the ground of force majeureWhether or not the contract can be terminated depends on, inter alia, the nature of the contract, actual performance of the contract, the causal relationship between the pandemic situation and the non-performance of the contract, and the specific degree of impact on the contract in the development of the pandemic, on the basis of the principles of fairness and good faith.According to paragraph 94 (1) of the Contract Law, where the force majeure results in failure to achieve the purpose of the contract, the parties can terminate the contract. However, it is relatively difficult to do so for the reason that the court's review standards for invoking force majeure to cancel the contract are generally stricter. Under normal circumstances, it can be dealt with, as the case may be, pursuant to the following circumstances:(1) Where the pandemic has no or little impact on the performance of the contract, and the contract can still be performed, the party should continue to perform the contract. Where a party requests to terminate the contract on the ground that the pandemic constitutes force majeure, the request shall be dismissed.(2) Where the pandemic has a significant impact on the performance of the contract. Where continued performance of the contract is obviously unfair to one party and the purpose of the contract cannot be achieved. The party can terminate the contract in accordance with Article 26 of Interpretation II of the Supreme People's Court on Several Issues Concerning the Application of the Contract Law, the court shall make decisions in accordance with the principle of fairness and the actual situation of the case.(3) Where the contract cannot be performed and the purpose of the contract cannot be fulfilled as a result of the impact of the pandemic or the administrative measures taken by the government and relevant authorities to prevent and control the pandemic, the court shall support the claim to terminate the contract.2.2 Legal analysis on how to bear liabilities for contract termination due to force majeureThe liabilities may be decided, as the case may be, on contract termination as a result of force majeure as following,(1) According to Article 117 of the Contract Law, where the breach of contract is caused by force majeure, the breaching party will be exempted from liabilities, except otherwise provided by law. In addition, where a force majeure occurs after the party’s delayed performance, the liability cannot be exempted.(2) For the losses that have been caused in the performance of the contract, where there is no clear provision by law, the amount of compensation is usually determined based on the fault of each party, the principle of fairness, and other factors concerned considered by the court.For example, where a party claims to reduce or exempt liabilities, the court shall comprehensively consider, inter alia, the causal relationship, degree of fault, whether the party has performed the notification obligation, and whether it has adopted reasonable measures to avoid the expansion of losses based on the principles of fairness and good faith, to reasonably decide whether the liabilities should be reduced or exempted as well as the sharing of losses under provisions of Articles 117 and 118 of the Contract Law.(3) According to Articles 118 and 119 of the Contract Law, a party intending to terminate the contract shall notify the other party in a timely manner to reduce the possible losses may be caused to the other party. Where the other party takes no appropriate measures to prevent losses from expansion after it has received the notification, no compensation shall be claimed for the extended losses. 3. Where a party claims to reduce or exempt liabilities on the ground that the COVID-19 pandemic falls into force majeure, what conditions shall be satisfied?
Answer : (1) Where the contract is able to continue to be performed, the following conditions shall be met,
(i) There is a causal relationship between the pandemic and the delayed performance;
(ii) The party suffered force majeure has notified and adduced evidence of proof in a timely manner; and,(iii) The party suffered force majeure has taken reasonable actions to avoid loss expansion.According to Article 117 (1) and Article 118 of the Contract Law, where the contract cannot be performed due to force majeure, part or all of the liabilities shall be exempted, except otherwise provided by law. Where a force majeure occurs after the party delays its performance, the liabilities cannot be exempted. Where one party is unable to perform the contract as a result of force majeure, it shall notify the other party in time to mitigate possible losses may be caused to the other party and shall produce proof within a reasonable period.(2) Where the pandemic disenables the contract to be performed or the contract ’s purpose is unachievable, and the breaching party claims to reduce or exempt liabilities, the court may decide, inter alia, reduce or exempt of liabilities or share losses between the parties, by taking all factors into consideration, such as the causality between the pandemic and the failure of performance, whether the breaching party has fulfilled the notification obligation, whether reasonable actions have taken to avoid loss expansion, in accordance with the Articles 117 and 118 of the Contract Law. 4. What notification and proof measures should the parties take regarding force majeure?
Answer : The contract shall be performed according to the agreement where there are specific provisions in relation to the notification and proof measures as provided in the contract, in the absence of provisions, which shall be performed according to Article 118 of the Contract Law. The party intending to file a performance defense with force majeure shall at least perform the obligations of notification, force majeure, causality, and proof of its impact on performance.Article 118 of the Contract Law stipulates, where a party cannot perform the contract due to force majeure, it shall notify the other party in time to mitigate possible losses may be caused to the other party and shall produce evidence of proof within a reasonable period. It is generally required the party to notify the occurrence of the pandemic and its possible impact on the contract. Where the party has some specific reasons for obstructing performance, including government restrictions on traffic, factories being required to suspend business, etc., the party also need to notify the counterparty in time after the occurrence thereof.The notification shall firstly be served by the means as provided in the contract. In the absence of provision on notification means in the contract, other reasonable methods as the party thinks fit, such as electronic and postage delivery may be adopted.As for the proof of obligation, it generally refers to the proof of the occurrence of force majeure, e.g. official documents issued by the Chinese government or by other authoritative agency with high credibility, the proof of failure performance and the causal relationship between the force majeure event and failure performance.
5. Does the seller have to be liable for breach of contract due to the delay caused by the pandemic?
Answer : It shall be determined by taking such factors into account as the impact of the pandemic, whether there are any delays in performance, etc.According to Article 117 (1) of the Contract Law, where the contract cannot be performed due to force majeure, part or all of the liabilities shall be exempted under the impact of the force majeure, except as otherwise provided by law. Where the force majeure occurs after the party has delayed the performance, it cannot be exempted from liabilities. "Article 118 of the Contract Law stipulates that where a party cannot perform the contract due to force majeure, it shall notify the other party in time to mitigate possible losses to the other party and shall produce proof within a reasonable period.Therefore, whether the party shall be liable for the breach of contract, the following factors should be considered,(1) The degree of causality between the pandemic and the delayed supply, it is usually the pandemic is the direct cause that results in failure to supply goods, in which circumstances the seller may be partially or entirely exempted from liabilities for breach of the contract;(2) The seller has served a notice to the buyer in relation to the failure supply and reasons therefor, and provided the corresponding supporting documents;(3) The failure supply of goods was caused by the pandemic rather than by delayed performance of the seller.Where the above conditions are met, the seller may usually be not liable for the breach of contract.
6. What should the seller do where the buyer refuses to accept the goods due to the delayed delivery of the goods affected by pandemic prevention and control?
Answer : Where there is an agreement on this respect in the contract, the agreement shall prevail. In the absence of such an agreement, it may depends on whether the contract can continue to be performed or not. Subject to Article 94 of the Contract Law, where the pandemic results the purpose of the contract in unachievable, the buyer may, by virtue of force majeure, terminate the contract without bearing liabilities for breach of the contract.Where the contract can still continue to be performed, the delayed performance does not affect the realization of the contract’s purpose, it is only a matter of time or manner of implementation. Under this scenario, the seller may not terminate the contract on the ground of force majeure, but it may , by virtue of the principle of fairness or substantial change of the circumstances, claim to mitigate or exempt liabilities for delayed fulfilment as a result of the impact of the pandemic. 7. During the pandemic, where the lessee fails to pay the rent overdue which meets the termination condition as stipulated in the contract, can the lessor terminate the contract thereby?
Answer : The lessor may terminate the contract from a theoretical perspective, but it is, as a matter of practice, not advised to do so. According to Article 93 of the Contract Law, the parties may terminate the contract when the conditions for the termination of the contract are fulfilled. Therefore, when the lessee fails to pay the rent overdue and conditions for termination of the contract have been satisfied, the lessor can terminate the contract thereby.
However, during the pandemic, where a large number of contracts are to be terminated as result of the pandemic, which will inevitably affect social stability, the court may reasonably restrict the termination of lease contract on principles of honesty, credibility, fairness and social protection in judicial practice. Where the degree of breach of contract is small, which may not affect the realization of the contract purpose, the court may not support the claim for the termination of the lease contract.
8. Can the lessee request extension of the lease period and reduction or exemption of the rent due to the inability to use the leased premise or venue caused by the COVID-19 pandemic? Answer : It may be different depends on different situations. Take Chongqing for example, Twenty Policies and Measures for Supporting Small and Medium-sized Enterprises to Cope with the Difficulties in the Context of COVID-19 Pandemic promulgated by Chongqing Municipal People ’s Government stipulates that during the period of COVID-19 pandemic, the small and medium-sized enterprises renting state-owned premises may be entitled to exemption of rent 1-3 months.For renting non-state-owned premises by companies or individuals, the main legal basis for rent reduction or exemption is the force majeure or substantial change of circumstances, the decisions made by the courts may be different as the merits of case may be in judicial practice, some courts may support the claims for reduction or exemption, some courts, however, may not so decide.
According to the special interpretation made by Chongqing High Court, where the lessee cannot use the leased premise due to the implementation of isolation measures or other emergency measures, or requirements to shut down specific business sites adopted by the government, which results the leased premise in unable to be used normally due to the COVID-19 pandemic, the lessee may negotiate with the lessor to extend the lease term or reduce the rents. Where a lawsuit have to be brought as the parties cannot reach a consensus, the court may decide whether to extend the lease term or reduce the rents upon principle of fairness and the actual merits of the case.
9. How to deal with the residual value of house decoration after the lease contract would be terminated due to the COVID-19 pandemic?
Answer : It may be determined upon whether the decorations have obtained consent from the lessor.
According to Article 223 of the Contract Law, the lessee may improve the leased property or add other accessories with the consent of the lessor. Where the lessee improves or adds other accessories without the consent of the lessor, the lessor may request the lessee to restore it to be the original state or compensate for the losses suffered therefrom.
Where the lessor agreed the decoration by lessee, it shall follow the agreement of contract; where there is no agreement has been entered into and the attached decorations have not been formed, which can be demolished by the lessee through negotiation between the parties, or the lessor may reserve the decorations and attachments. Where the attachments have been formed, the decoration items shall be shared by the parties in accordance with the principle of fairness based on the residual value of the decorations within the remaining lease period.
Where the lessor did not agree the decorations by the lessee, the lessee shall be entitled to compensation for the residual value of the decorations and the bear the decoration costs at his own expenses. Where the lessor requires the lessee to restore it to be the original state or compensate the losses, the lessee shall dismantle, restore the original state, or bear the corresponding compensation.
10. Can the hotel claim for rent reduction or exemption due to the COVI-19 pandemic?
Answer : The hotel may be entitled to claim for reduction or exemption of rent on the ground of force majeure or substantial change of circumstance.
Based on Article 180 of the General Rules of Civil Law, Article 117 of the Contract Law and the national pandemic prevention and control regulations and rules, where the hotel cannot be operated due to pandemic prevention and control, it should be treated as force majeure. The hotel operators may claim for rent exemption or reduction. In addition, according to Article 26 of the Interpretation of the Contract Law, after the contract has been entered into, an objective circumstance occurs major changes that the parties cannot foresee, which fall outside force majeure and commercial risks, where the continuing performance of contract is obviously unfair to the parties or it may render the purpose of the contract unachievable. Under such circumstance, any party requests the court to change or rescind the contract, the court shall decide whether to change or rescind the contract in accordance with the principle of fairness and the actual circumstances of the case. Thus, where the government did not take controlling measures against the hotel during the pandemic, and the hotel suffers significant reduction of income as a result of the COVID-19, generally, the court may not regard it as the force majeure, in this circumstance the application of the principle of substantial change of circumstances may be practical, and may request the court to decide the case according to the principle of fairness.
Taking Chongqing for example, subject to the Twenty Policy Measures on Supporting Small and Medium-sized Enterprises to cope with the COVID-19 Pandemic by Chongqing Municipal Government, during the period of pandemic, the small and medium-sized enterprises will be exempted from rent for 1 to 3 months. Large-scale commercial buildings, shopping malls, and market operators are encouraged to moderately reduce rents during the period of pandemic for small and medium-sized enterprises as the lessees, and governments in districts and counties may grant appropriate financial subsidies to the renting enterprises that have adopted rent reduction and exemption measures.
Should you have any further question thereabout or need any further advice, please feel free to contact Eagle Yang or James Li.
Eagle YANG
Email: eagleyang@zhhlaw.com
Tel: +86 23 6701 8088
Mobile: +86 182 0309 3176
Yvonne WEN
Email: yvonne@zhhlaw.com
Tel: +86 23 6371 6888
Mobile: +86 186 0236 5111
James LI
Email： james.li@zhhlaw.com
Tel： +86 23 6701 8088
Mobile：+86 158 0233 2710