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China invokes ‘force majeure’ to protect businesses — but the companies may be in for a ‘rude awakening’

Employees work on the production line of high-precision sheet aluminium at a factory of Shandong Weiqiao Pioneering Group Company Limited on November 23, 2019 in Zouping, Shandong Province of China.

Tang Ke | VCG via Getty Images

Widespread disruption brought on by the coronavirus outbreak has hammered global supply chains and spurred Chinese companies to declare “force majeure” — a provision that exempts them from contractual obligations. But experts warn there’s a high chance such a move may not work.

A force majeure event occurs when unforeseeable circumstances, such as natural catastrophes, prevent one party from fulfilling its contractual duties, absolving them from penalties.

Since late January, the Chinese government has implemented city-wide lockdowns and large-scale quarantines that effectively curbed the movements of millions in China as the country seeks to contain the COVID-19 virus. Those restrictions have hurt businesses as operations of factories and facilities came to a near-standstill.

According to the China Council for the Promotion of International Trade, a government-linked entity, China has issued 4,811 force majeure certificates as of Mar. 3 due to the epidemic. They covered contracts worth 373.7 billion Chinese yuan ($53.79 billion), state media Xinhua reported. Such certificates are issued by the government to companies that apply for them.

In a previous update, the council said applicants span across 30 industries and sectors with high applications rate include manufacturing, wholesale and retail and construction.

Force majeure may not work outside China

But Chinese entities may face a “rude awakening” when they try to claim force majeure against counterparties internationally, said Brian Perrott, a London-based partner at international law firm Holman Fenwick Willan.

PRC (People’s Republic of China) entities that have been issued the certificates face a rude awakening if they think they will allow them to get out of contracts with international parties.

Brian Perrott

partner at Holman Fenwick Willan

While such documents may help entities claiming against one another in the Chinese domestic markets, most claims will not hold up on the global stage, Perrott told CNBC in an email. “Most of these FM (force majeure) claims will not succeed,” the law firm added.

“PRC (People’s Republic of China) entities that have been issued the certificates face a rude awakening if they think they will allow them to get out of contracts with international parties,” it added.

That is because the majority of trading contracts between China and international parties are governed by English law, which only allows parties to claim force majeure if the document includes very specific clauses.

Force majeure clauses in English law contracts are usually “very lengthy and detailed, and outline exactly which events can be used to trigger FM,” said Perrott. “They will often specifically refer to epidemics, which would cover the coronavirus.”

The party claiming force majeure would then need to prove that their ability to meet the contract was “impaired” or made “impossible” by the coronavirus. “The latter, in particular, is extremely challenging to prove. Most FM claims fail,” he added.

French oil giant Total has already rejected a force majeure notice from a liquefied natural gas buyer in China, Reuters reported.

‘Catch-all’ vs explicit provisions

Such provisions are only relevant if the contracts have a force majeure clause to begin with. 

According to an analysis by legal technology provider Kira Systems, just 72% of the contracts reviewed — or 94 out of 130 — included force majeure provisions. The commercial contracts filed between Feb. 2018 and Feb. 2020 involved at least one Chinese entity.

Of the 94 contracts with the force majeure provisions, just 13 of them explicitly state that public health events — such as flu, epidemic, serious illness, plagues, disease, emergency or outbreaks — would constitute a force majeure situation, Kira Systems found. Unforeseen public health situations were not expressly included in the remaining 81 contracts.

“This data suggests a gap in contract drafting, at least from the perspective of the entities affected by the coronavirus outbreak seeking to invoke their force majeure clauses,” wrote Jennifer Tsai, the company’s legal knowledge engineering associate.

English law encourages both parties in a force majeure situation to take steps to mitigate the event and the consequences – even if those actions are outside the terms of the contract.

Brian Perrott

partner at Holman Fenwick Willan

Most of the contracts with force majeure provisions reviewed by Kira Systems also use a general “catch-all” language stating that “any other events that cannot be predicted and are unpreventable and unavoidable by the affected Party” constitute force majeure, the company said in its report. This flexibility means that companies need to consider if the outbreak constitutes an unpreventable and unpredictable force majeure event, Tsai wrote.

Of the 94 contracts that included force majeure provisions, 44% included acts of government in its definition, the Kira analysis found. 

That means that “affected parties could ostensibly cite the governmental extension of the Lunar New Year holiday, the mandated closing of businesses, and travel restrictions in Hubei province and other provinces, as ‘acts of government’ beyond their control in order to avoid incurring liability for delays in performance or failure to perform,” said Tsai.

Talk it over

Given that the coronavirus outbreak is — by most expectations — supposed to be short-lived, Perrott advises the parties in a contract to resolve the issues rather than enter a dispute.

A former vice minister at China’s Ministry of Commerce, Wei Jianguo, told CNBC in an interview on Sunday, that companies want to maintain their credibility with business partners. He added that work is picking up in areas outside Hubei, the epicenter of the coronavirus outbreak.

Wei, who is now vice chairman and deputy executive officer at Beijing-based think tank, China Center for International Economic Exchanges, said he expected the number of new force majeure certificates to fall into the double digits in the next 10 days.

Perrott advises both parties in a contract to take steps to mitigate any disruptive event due to the viral outbreak.

“English law encourages both parties in a force majeure situation to take steps to mitigate the event and the consequences – even if those actions are outside the terms of the contract,” he told CNBC.

“It’s also good sense for parties to try to resolve the matter amicably. After all, the coronavirus is nobody’s fault,” said Perrott.

— CNBC’s Evelyn Cheng contributed to this report.