Contracts sometimes include a ‘force majeure’ clause which allows a party to be excused from its contractual obligations in the event of a 'force majeure event(s)'. These are usually exceptional events or unexpected circumstances outside of a contracting party’s reasonable control which prevents it from performing its contractual obligations.
Under Hong Kong law, ‘force majeure’ applies only if such a clause had been included in a contract. The term ‘force majeure’ has to be expressly defined (often by setting out a list of ‘force majeure’ events) to take effect. ‘Force majeure’ events are also not to be confused with ‘Acts of God’, which are natural hazards occurring outside of human control. An epidemic or a pandemic is highly unlikely to be regarded as an ‘Act of God’. Parties therefore need to specific express it in their contracts and the protection afforded by the clause will depend on the precise drafting.
Even if epidemics or pandemics of a general description are covered as ‘force majeure’ events, the affected party still has to prove (depending on the precise drafting of the contract) that:
it has been ‘prevented’ from performing the obligations under the contract in that the ‘force majeure’ event has rendered it legally or physically impossible to perform; or that it has been ‘hindered’ or ‘delayed’ from performing the obligations under the contract such that the performance was made substantially more onerous. Factors such as a rise in expenses or changes in economic or market circumstances affecting the profitability of a contract or the ease with which the parties' obligations can be performed are generally not regarded as a ‘force majeure’ event;
its non-performance or default was solely caused by the ‘force majeure’ event or circumstances beyond its control but not through the fault or negligence of the affected party; and
there were no reasonable steps that one could have taken to avoid or mitigate the event or its consequences.
Finally, businesses should also bear in mind the consequences of invoking a ‘force majeure’ clause. Depending on the actual wording, most ‘force majeure’ clauses only suspend performance of the affected party's obligations to perform for so long as the relevant event subsists with an extension of time to perform, whereas others may provide for variation of terms or termination of contract.
In the absence of a ‘force majeure’ clause applicable to the epidemic or pandemic, are there alternative clauses that businesses may rely on to absolve themselves of the liability?
The principle of ‘frustration’ may be relevant when a significant change of circumstances renders the performance of a contract radically different from the obligations originally undertaken. Such a change in circumstances must be due to an external event or change of situation that occurs through no fault of the affected party. It is worth noting that the threshold for ‘frustration’ is even higher than that of ‘force majeure’.
To qualify as a ‘frustrating’ event, it would have to be of ‘catastrophic character’ and it must be a legal or physical restraint and not merely an economic one. Generally, a ‘frustrating’ event is one which:
- occurs after the contract has been formed;
- is so fundamental that it strikes at the root of the contract and far beyond what was contemplated by the parties when they entered the contract;
- renders further performance impossible, illegal or makes it radically different from that contemplated by the parties at the time of signing the contract.
The changes in economic conditions (e.g. spiked labour or transportation costs) is generally insufficient to frustrate a contract as it may have been unexpected, but not entirely unforeseen.
In terms of the parties' contractual obligations under a lease agreement, case law in Hong Kong says that the affected party needs to prove that the ‘frustrating’ event is expected to last at least for a long period of the unexpired term of
the lease. For example, the closure order made by the Hong Kong authorities in response to the SARS epidemic lasted for only 10 days out of a two-year lease and was not considered capable of ‘frustrating’ the lease.
If a contract has been ‘frustrated’, the parties are excused from their future obligations. However, the doctrine of ‘frustration’ does not rescind the contract nor restore the parties to their respective pre-contract positions.
In light of the current circumstances, companies and businesses should now:
- review all contracts in which ‘force majeure’ or ‘frustration’ may be a factor and assess the requirements and consequences of establishing the relevant rule to excuse or mitigate performance;
- comply with the notice formalities (and ensure notification procedure is fully complied with);
- stay in close contact with the other contracting party regarding the impact of the outbreak (preferably on a ‘without prejudice’ basis);
- explore alternatives to mitigate the effect of the ‘force majeure’ event (failure to take steps in mitigation may undermine a party’s ability to rely on the ‘force majeure’ clause);
- keep a good record of documentation i.e. proof of delays or cancellation of transportation, customs declarations or a ‘force majeure’ certificate issued by the China Council for the Promotion of International Trade ("CCPIT");
- ensure that tax returns are filed on a timely basis to avoid penalties and keep a record of the additional expenditure in response to the pandemic for any tax relief calculation;
- review existing insurance policies to find out what you are covered for. For example, corporate travel insurance may not cover trip cancellations if the company or the employee cancels for fear of infection or disruption; labour intensive work and work that requires the transport of goods over long distances is particularly vulnerable to disruption; and
- if entering into new contracts, consider the needs to include circumstances such as ‘epidemic’, ‘pandemic’, ‘disease’ or ‘Public Health Emergency of International Concern’, as well as more general events such as ‘strikes’, ‘circumstances beyond the parties' control’ and ‘travel ban’ as ‘force majeure’ events to cover government actions that are likely to occur after the outbreak.
Please click here for a comprehensive guide on the Legal Implications for Businesses in Hong Kong and China from the coronavirus outbreak.