As the fall-out from the detection and spread of the coronavirus continues, the quarantine restrictions in China, together with airlines suspending and reducing flights to and from China and the closure of ports, indicate disruption to import and export of products including soybean, electronics and textiles amongst others.Notwithstanding the appalling human cost of coronavirus, severe disruptions to both inbound and outbound shipments, which has impeded countless supply chains and may result in companies being unable to fulfil their contractual obligations all of which is likely to have a stark financial impact for both Chinese manufacturers and suppliers and UK and European customers and distributors. Given that the World Health Organisation (WHO) has declared this a global health emergency, one consideration is whether these events and circumstances faced by the affected parties can fall within the operation of a force majeure clause so as to delay or absolve the liabilities of the affected contracting parties or whether there are other applicable rights.
Most English law supply contracts will contain a force majeure clause, which is a clause that relieves a party from its obligations to perform the contract in certain extreme circumstances. Although the term 'force majeure' is commonly used, it has no recognised meaning in English law and so whether the coronavirus outbreak and the resultant restrictions are covered will be determined by the wording of the specific term of the agreement.
The direct impact of the coronavirus for supply chains means that factory worker return days are postponed until at least 10 February and transportation within China has been disrupted or in some cases, stopped altogether, requiring export businesses to attempt to use different ports to export goods to the US, UK and Europe, causing severe delays in many cases.
On Thursday 30 January, the China Council for the Promotion of International Trade released a statement confirming that China was offering force majeure certificates to local companies unable to fulfil their international contractual obligations due to the coronavirus outbreak. To apply for the certificate, companies must provide legitimate documents such as proof of delays or cancellation of transportation to the agency.
The impact and natural effect of a force majeure clause will vary from contract to contract. Some operate to suspend obligations during the period of the applicable event whereas some give rise to a right to terminate and some may relieve the non-performing party of liability to perform its obligations under the contract.
A force majeure clause usually requires the defaulting party to show that it used its reasonable endeavours to prevent, or at least mitigate, the effects of the force majeure. Generally, this is to mean that such clauses can be relied upon only if all reasonable steps had been taken by a party to mitigate the effect of the event. The shortage of component materials may have an impact on pricing now and in future months, the scarcity of such parts may well drive prices upwards if demand remains stable. Contracts should be reviewed to ensure that protection against price rises is included or whether they otherwise need to agree new terms or 'flex' other parts of their supply chains to ensure adequate provision of stock at a commercially sensible price.
The outbreak of an epidemic may not be seen as an unforeseeable event given the outbreaks of various strains of flu in recent years. However, the unprecedented scale of the restrictions enforced together with their swift implementation, could differentiate the coronavirus outbreak from other epidemics. The recognition by the WHO of the severity of the outbreak and separately, by the Chinese authorities that its implications constitute a force majeure event is likely to assist the party seeking relief to rely on the force majeure clause.
If there is no force majeure clause in the relevant agreement, unfortunately the law will not automatically provide one. However, the affected party may be able to rely on the doctrine of frustration. This applies when an event occurs which is the fault of neither of the contractual parties but which makes it impossible for a party under the agreement to fulfil a fundamental obligation or transforms the obligation into a completely different obligation. It should be noted that the threshold for relying on this is higher than standard force majeure clauses, which will not necessarily just relate to 'fundamental' contractual provisions. If a contract is frustrated then the contract may be automatically discharged, relieving the parties from complying with future obligations.
Apart from the impact on supply chains, there is likely to be a knock-in effect for UK retailers particularly those in the luxury sector of the market, many of whom will be relying on the positive effect of Chinese tourists to the UK boosting sales after an indifferent peak period. Due to extensive prohibition on flights to and from China, this shopping boon is unlikely to materialise. Markets have recognised this impact already and share prices of most large luxury fashion houses are down in the aftermath of the outbreak.
Whether the coronavirus outbreak and/or the resulting restrictions are covered by a force majeure clause in a trade agreement will depend on the wording of the scope of the clause, the steps taken by the party seeking to rely on the clause, and whether the outbreak constitutes a foreseeable contingency. Contractual parties will need to consider the wording of such clauses carefully before relying on them and similarly counterparties may want to challenge any such reliance, it should be borne in mind that the party claiming relief will bear the burden of proof regarding the event and its effect on the contractual obligations. Importantly, contractual parties should review their trade agreements to ensure full compliance with notice requirements and any duties to mitigate the impact of the force majeure event, often relief under a force majeure provision is not available for the impact of avoidable events or those that could have been reasonably mitigated.
For support on this issue or international supply contracts generally, please contact James Corlett or your usual Fieldfisher contact in our UK or China offices.