The coronavirus and its consequences
Legal impact on supply and production relationships
In this piece, Deloitte Germany examines the impact of COVID-19 from a legal perspective. The coronavirus epidemic poses a stress test for cross border trade relationships with China-based companies. From a legal perspective, the question inter alia circles around how epidemic-related disruptions of production and supply chains shall be handled appropriately. So-called “Force Majeure-clauses”, often being embedded in respective supply agreements, are of particular relevance in this context. A thorough analysis of the legal framework being applicable in the respective specific case is strongly advisable.
The (legal) impact of the coronavirus
Starting first from the Wuhan region, the coronavirus epidemic is in its spreading already now exceeding the 2002/2003 SARS-crisis. The consequences are dramatic. The Chinese government’s quarantine-related counter-measures have caused significant restrictions to public life in large parts of the country. In light of this, the epidemic’s economic consequences are increasingly getting into focus. The crisis affects a huge number of China-based companies, which either had to cease or move their production. European companies producing in China or purchasing goods from there see themselves confronted with supply chain disruptions.
Moreover, there are plenty legal implications arising from the epidemic such as the handling of affected employment relationships, insurance coverage of epidemic-related damages or consequences in the field of travel law. However, given the enormous volumes the Chinese-European trade has meanwhile reached, it is of highest relevance how epidemic-related disruptions may affect the legal side of existing supply and production-related relationships. Keywords being often repeated in this context are the terms “Acts of God” and “Force Majeure-clauses”. Taking a closer look could be beneficial.
What does “Force Majeure” mean?
Quite often, contracts such as e.g. supply agreements include “Force Majeure“-clauses or provisions regarding “Vis Major” or – in the Anglo-American context (namely under Common Law or US law) – clauses with respect to “acts of god”. In general, respective clauses aim at governing the consequences of cases of default in performance being related to circumstances or events, which are beyond the control of the contracting parties. The term “Force Majeure” – at least under German law – is not defined by statutory law. Typically, respective clauses provide for an abstract definition of the term being further illustrated by a number of non-exhaustive examples (e.g. natural disasters as earthquakes or flood as well as events like terrorist attacks, armed conflicts or strikes). In standard cases, legal consequence of a “Force Majeure”-event is the (at least) temporary suspension of the contracting being affected by the respective event under exclusion of damage liability obligations vis-à-vis the other party. From a formal standpoint, it is often stipulated that the party being affected by a “Force Majeure”-event shall be subject to respective notification obligations towards the other contracting party. In some cases, “Force Majeure”-clauses provide for extraordinary termination rights in favor of either one or both parties. It is furthermore important to consider that “Force Majeure”-clauses regularly also provide for obligations and requirements, which must be observed by the other contracting party not directly being affected by the respective “Force Majeure”-event. Typically, the party not being directly affected by the event (in most cases: the recipient) shall be obliged to limit its own damages using its best reasonable efforts.
“2019-nCoV” as “Force Majeure”?
By way of a detailed analysis of the specific contract clause, it has to be determined in the individual case whether the new coronavirus (in science known under the preliminary denomination “2019-nCoV”) meets the applicable definition of a relevant “Force Majeure”-event. Although commonly used standard clauses seem to imply the occurrence of a “Force Majeure”-event, it is to be checked with utmost care, which law and legal understanding shall apply in connection with the respective agreement. Depending on which law shall apply in case of an agreement, this can be of material influence on the interpretation of the respective clause and can lead to rather contrary results. It is also advisable to consider conflict of laws-related requirements in connection of a related legal assessment. For the avoidance of unintendedly non-compliant conduct, a thorough review of the specific clause is essential.
With respect to agreements being subject to the laws of China, the PRC’s Supreme Court ordered in connection with the 2002/2003 SARS-epidemic that defaults either directly relating to the epidemic or to the government’s related counter-measures, would be considered as “Force Majeure”-constellations within the understanding of the legal definition of the term “Force Majeure” under Chinese civil law.
Also with respect to the current crisis, this legal assessment seems to be applied: It is now possible to obtain, upon application, so-called “Force Majeure-certificates” from CCPIT (China Council for the Promotion of International Trade) which can be utilized as proof in court proceedings vis-à-vis contracting partners. This could turn out as rather useful for companies having production plants in place in the affected regions of China and now not being able to comply with their supply obligations due to epidemic-related production disruptions, consequently, facing damage claims from the contracting partners.
Besides, there are efforts being undertaken in China to cover the consequences of the current crisis by way of special regulation. For instance, for the financial services sector, Chinese authorities are planning the implementation of sector-specific regulations.
However, what if there is no “Force Majeure”-clause included in the respective agreement? In case the agreement is subject to German law, then statutory provisions covering the respective default constellation (such as e.g. the German civil law concepts of the temporary impossibility (vorübergehende Unmöglichkeit) or frustration of contract (Störung der Geschäftsgrundlage)) apply. Also in such scenario, a thorough legal assessment of the individual case is required in order to determine which possible options either for an adjustment or termination of the respective agreement are the most suitable, especially from an economic standpoint.
Conclusion: What next?
The present coronavirus-epidemic has – from a medical point of view – still not reached its peak. Also from an economic perspective, the full picture of the epidemic’s consequences (particularly for China’s internationally closely interwoven supply and production relationships) is not foreseeable yet.
Parties being affected by epidemic-related supply or production disruptions can benefit from a precise assessment of the underlying contractual framework. Possible “Force Majeure”-clauses should be reviewed with particular care. Even though standardized versions of respective clauses are quite often being used, generalizing statements cannot be made. Considering which law applies in respect of the specific agreement, it is to be clarified in light of the wording of the respective “Force Majeure”-clause whether the current crisis meets the contractual definition of a “Force Majeure”-event and, if so, what the legal consequences deriving from this fact are. In case no “Force Majeure”-clause was provided for, the general statutory regulations under the respectively governing law would apply. In addition, it shall be carefully considered which options are available to achieve an economic reasonable result. Either party to an agreement should evaluate and comply with the legal frame for its own conduct (“Is my conduct in compliance with the agreement?”).
For companies producing in PRC (being affected by epidemic-related production defaults) it is advisable to check whether the obtainment of a “Force Majeure-certificate” from CCPIT would be useful. This could be the case if existing supply relationships with recipients are either subject to Chinese law or provide for a China-based place of jurisdiction. Our Chinese colleagues would be more than happy to support you with the obtainment of a “Force Majeure-certificate”.
In any case, pursuing a pro-active approach in connection with the handling of the economic consequences of the coronavirus epidemic will be the better choice. To use a medical terminology: Only a careful and thorough anamnesis of the possible legal risks as well as of the potential options will reduce the risk of being unexpectedly confronted with the negative diagnosis of a court.