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Article: March 2020: Managing the Growing Fallout from the Coronavirus— Contractual Non-Performance Defenses Around the World

Business Litigation Reports

By almost any measure, the novel coronavirus pandemic appears poised to eclipse anything the global markets have ever seen in terms of business disruption.  Countries, states, localities, and entire industries have come to a standstill in an effort to prevent the spread of COVID-19.  Stock markets have turned wildly volatile and have erased trillions of dollars in value.  Even as China appears to have gained some control over the virus, reports indicate that its industries face severe challenges ahead.  As of the time of this publication, the Chinese government already has issued thousands of force majeure certificates and high-profile businesses like CNOOC, Total, and Shell have declared force majeure events regarding receipt of natural gas shipments.  Global production lines have been shut down or throttled and material and labor shortages are further disrupting contracts around the world.  Law firms are inundated with questions from clients struggling with never-anticipated difficulties that may prevent them from fulfilling their contractual obligations.  

Although the COVID-19 pandemic appears to be charting new ground, this article reviews the traditional approaches taken by courts when presented with unforeseen events that render contractual performance difficult or impossible.  Despite differences across jurisdictions, courts facing these difficult circumstances typically evaluate whether contractual performance can be excused under three broad legal doctrines: (1) impossibility (common law force majeure); (2) hardship (impracticability); or (3) contractually defined supervening events (i.e., “force majeure” or “vis major” contractual clauses).  This article explains how each of these doctrines has been applied under various civil law and common law regimes.

I. Impossibility Defenses

The term force majeure (force major, equivalent to vis major in Latin) is a French term that was incorporated into the original Napoleonic Civil Code.  Today, in both civil law and common law systems, force majeure is a defense to a breach of contract action that excuses a party from its contractual obligations because performance has been rendered impossible.  The following discussion addresses how various code-based and common law jurisdictions address and evaluate force majeure and similar impossibility defenses.

French Law.  In the French civil code, force majeure is defined as a contractual excuse when unforeseen events prevent performance.  Specifically, Article 1218 of the French Civil Code provides:

In contractual matters, there is force majeure where an event beyond the control of the obligor, which could not reasonably have been foreseen at the time of the conclusion of the contract and whose effects could not be avoided by appropriate measures, prevents performance of his obligation by the obligor.

If the prevention is temporary, performance of the obligation is suspended unless the delay which results justifies termination of the contract.  If the prevention is permanent, the contract is terminated by operation of law and the parties are discharged from their obligations ...

When interpreting Article 1218, French courts have rarely found that an epidemic event is sufficient to invoke a force majeure defense.  For example, in 1998, a French court held (CA Paris, Sept. 25, 1998, 1996/08159) that a minor plague epidemic did not constitute force majeure because a preventive treatment was available.  The same court, however, held that the 2013 Ebola epidemic could constitute force majeure (CA Paris, Mar. 17, 2016, 15/04263), but only if non-performance was a direct result of the epidemic.  And a separate French court held that a chikungunya virus epidemic in the French Caribbean did not constitute force majeure because the disease was widely known and non-lethal (CA Basse-Terre, Dec. 17, 2018, n°17/00739).  

The current pandemic, however, appears to be readily distinguishable from the epidemics at issue in these cases.  Unlike the plague or chikungunya, the coronavirus is new, fast spreading, potentially lethal, and has no known cure.  For those reasons, the French government already has declared the coronavirus outbreak a force majeure event for government contracts.  

German Law.  Section 275 of the German Civil Code codifies force majeure principles and  states: “A claim for performance is excluded to the extent that performance is impossible for the obligor or for any other person.”  

Under German law, a force majeure event only excuses performance of contractual obligations where circumstances beyond the parties’ control have permanently rendered performance impossible.  Temporary impediments to contractual performance, which could be removed prior to the deadline for performance, do not excuse a party from performing its obligations.  German courts scrutinize the facts of each case to determine if an unexpected event has permanently rendered performance impossible. 

Chinese Law.  Under Chinese law, force majeure principles have been recognized and codified under the term bu ke kangli in the General Principles of Civil Law and Contract Law.  The main Contract Law provisions are:

Article 117

If a contract cannot be fulfilled due to force majeure, the obligations may be exempted in whole or in part depending on the impact of the force majeure, unless laws provide otherwise.  If the force majeure occurs after a delayed fulfillment, the obligations of the party concerned may not be exempted.

Force majeure as used herein means objective situations which cannot be foreseen, avoided or overcome.

 

Article 118

Either party that is unable to fulfill the contract due to force majeure shall notify the other party in time in order to reduce losses possibly inflicted to the other party, and shall provide evidence thereof within a reasonable period of time.

The SARS epidemic that began in 2002 presented Chinese courts with myriad bu ke kangli claims.  Courts in Beijing and Guangdong instructed trial courts to apply the bu ke kangli doctrine to epidemic-related disruptions when: (1) the parties entered the disputed contract before the epidemic arose (such that it was unforeseeable); and (2) the epidemic’s supervening effects did not occur after an inexcusable delay in contractual performance.  In 2003, the Chinese Supreme Court instructed lower courts to apply the bu ke kangli doctrine any time a party is unable perform its contractual obligations due to measures adopted by the government to address an epidemic.  

On February 7, 2020, the Fangshan District Court in Beijing issued a release recommending that courts follow the Chinese Supreme Court’s 2003 guidance when evaluating contracts affected by the coronavirus pandemic.  The District Court noted, however, that non-performance caused by negligence on the part of the non-performing party should not be excused.

UN Convention on Contracts.  The United States, China, and 91 other countries have adopted the United Nation’s Convention on Contracts for the International Sale of Goods (CISG).  The CISG commonly is the default law governing contracts with Chinese parties concerning the international sale of goods, and it contains what is widely recognized as an impossibility defense.  Specifically, Article 79 of the CISG states in relevant part:

(1) A party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.

* * * 

(3) The exemption provided by this article has effect for the period during which the impediment exists.

(4) The party who fails to perform must give notice to the other party of the impediment and its effect on his ability to perform.  If the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, he is liable for damages resulting from such non-receipt.

The protections available under Article 79 of the CISG are generally considered to be equivalent to force majeure under French law.  When litigating under a CISG provision, however, the forum in which a matter is tried will be a factor because a particular jurisdiction may be influenced by the peculiarities of its local law and norms.

U.S. Common Law.  In U.S. courts, the term “force majeure” typically refers to an express contractual provision rather than a common law defense.  The common law doctrine of impossibility, however, may excuse performance when performance has been rendered impossible by an unforeseeable event.  

The impossibility doctrine under U.S. law traces its roots to the English case of Taylor v. Caldwell.  In Taylor, a fire destroyed a music hall, which made it impossible for a musician to fulfill his contractual obligations to perform.  The music hall likewise could not fulfill its obligation to supply a venue for the musician’s performance.  The Queen’s Bench appellate court held that both parties were excused from performance because the fire rendered all future performance impossible.  

U.S. courts have applied similar principles to excuse performance of contractual obligations when intervening, unexpected events make performance impossible.  For example, in Kel Kim Corp. v. Cent. Markets, Inc., 70 N.Y.2d 900 (1987), New York’s Court of Appeals held:

Impossibility excuses a party’s performance only when the destruction of the subject matter of the contract or the means of performance makes performance objectively impossible.  Moreover, the impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against in the contract.

Courts in the U.S. have taken a restrictive view on the impossibility defense.  For instance, in United States v. Gen. Douglas MacArthur Senior Vill., 508 F.2d 377 (2d Cir. 1974), the Second Circuit held that “[d]ischarge under this doctrine has been limited to instances where a virtually cataclysmic, wholly unforeseeable event renders the contract valueless to one party.”  Courts also look at how the parties allocated risk in their contracts; if the risk of impossibility was allocated on the face of the contract, courts are unlikely to excuse performance based on the common law doctrine of impossibility.  

English Common Law.  In England, the impossibility defense falls squarely under the doctrine of frustration of purpose (which is discussed below).  Like in the U.S., the doctrine is strictly construed by English courts, which tend to look closely at the issue of allocation of risk under the parties’ contract and whether the entire value of the contract to the party seeking relief has been negated.

Other East Asian Law.  Like French, German, and Chinese law, the civil law-based systems of Japan, South Korea, and Taiwan also provide for codified impossibility doctrines.  The common law jurisdictions of Hong Kong and Singapore, however, follow the English lead excusing performance based on impossibility or frustration of purpose, but strictly applying those doctrines.

II. Hardship Defenses

Even where contract performance is not impossible, courts may excuse performance or alter a party’s contractual obligations when extreme circumstances render performance unforeseeably difficult.  The discussion below provides an overview of the circumstances in which courts in various jurisdictions might excuse performance or reform contractual obligations based on a claim of hardship.

French Law.  In 2016, amendments to the French Civil Code codified a hardship defense under French Law.  Article 1195 to the French Civil Code now states:

If a change of circumstances that was unforeseeable at the time of the conclusion of the contract renders performance excessively onerous for a party who had not accepted the risk of such a change, that party may ask the other contracting party to renegotiate the contract.  The first party must continue to perform his obligations during renegotiation.

In the case of refusal or the failure of renegotiations, the parties may agree to terminate the contract from the date and on the conditions which they determine, or by a common agreement ask the court to set about its adaptation.  In the absence of an agreement within a reasonable time, the court may, on the request of a party, revise the contract or put an end to it, from a date and subject to such conditions as it shall determine.

There is little case law interpreting this provision and it remains to be seen how French courts might apply it to a pandemic.  Given the massive disruption caused by the COVID-19 pandemic, it would be reasonable for French courts to seriously consider whether Article 1195 excuses contractual performance where the coronavirus pandemic has made contractual performance particularly onerous.  The hardship doctrine could be useful when the conditions for the force majeure doctrine under the French Civil code are not satisfied.  For instance, a party that has the ability to perform its obligations despite the massive disruption caused by the pandemic (hence negating force majeure), may ask a court to reform the terms of an agreement if performance becomes “excessively” more expensive or difficult than anticipated at the time of contracting.  Still, given the lack of precedent, how the French courts will rule in any particular case is difficult to predict.

German Law.  Germany’s hardship doctrine, which dates back to the period of hyperinflation between the two world wars, is codified in Section 313 of the German Civil Code.  Section 313 states: 

(1) If circumstances which became the basis of a contract have significantly changed since the contract was entered into and if the parties would not have entered into the contract or would have entered into it with different contents if they had foreseen this change, adaptation of the contract may be demanded to the extent that, taking account of all the circumstances of the specific case, in particular the contractual or statutory distribution of risk, one of the parties cannot reasonably be expected to uphold the contract without alteration.

(2) It is equivalent to a change of circumstances if material conceptions that have become the basis of the contract are found to be incorrect.

(3) If adaptation of the contract is not possible or one party cannot reasonably be expected to accept it, the disadvantaged party may revoke the contract.  In the case of continuing obligations, the right to terminate takes the place of the right to revoke.

Like the doctrine reflected in the French Civil Code, courts apply Germany’s hardship doctrine to reform a contract to account for a newfound hardship that was not anticipated at the time of contracting.

Chinese Law.  In 2009, the Chinese Supreme Court (acting in a quasi-legislative capacity)  adopted a hardship doctrine under the term qingshi biangeng.  The qingshi biangeng doctrine provides:

After formation of a contract, if an objective situation occurs that the parties could not foresee at the time of contracting, and that is a major change which is not force majeure and does not qualify as a commercial risk, rendering continued performance of the contract manifestly unfair to one party or rendering its purpose unattainable, upon a request by a party to vary or terminate the contract, a court should confirm whether to vary or terminate the contract, in accordance with principles of fairness and taking into account the actual circumstances of the case.

Since the COVID-19 outbreak, lower courts in China, such as the Heilongjiang province court system, have issued guidance indicating that qinshi biangeng, like bu ke kangli, should be available for reformation or rescission of contracts affected by the pandemic.  The court’s guidance, however, also indicated that these doctrines should be applied only to unforeseeable events, which means, as a general matter, they will not be available for contracts executed after the current crisis became known.  

CISG.  Although practitioners generally agree that the CISG does not provide a contractual hardship defense, some courts and tribunals have applied Article 79 (related to impossibility) in hardship circumstances.  Whether a particular tribunal will apply Article 79 to mere hardship depends on the tribunal that is presiding over the particular case.

U.S. Law.  The U.S. common law doctrine related to hardship is often called impracticability or frustration of purpose, and it again traces its roots to an English case, Krell v. Henry, 2 KB 740 (1903).  In Krell, a tenant rented a premises overlooking the route for the coronation procession of King Edward VII.  King Edward VII became ill and the procession was cancelled.  The court held that the tenant was excused from his duty to pay rent because he could no longer receive his bargained-for benefit (a view of the coronation procession).  

The principles underlying that decision are now reflected in Section 261 of the Restatement (Second) of Contracts and Article 2 of the Uniform Commercial Code (UCC), which has been adopted in nearly identical form by all U.S. states to govern contracts relating to the sale of goods.  

Section 615(b) of the UCC provides that delayed delivery is excused when “performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made. . . .”  Section 615 does not, however, extend to conditions or events that reasonably should have been anticipated by the parties at the time of contracting.  For example, Comment 4 to UCC § 615 references Ford & Sons Ltd. v. Henry Leetham & Sons Ltd, 21 Com. Cas. 55 (1915), another English case, which held that routine changes in market prices are not a cognizable contractual hardship.  On the other hand, a severe shortage of necessary materials caused by an unforeseeable, extreme event may create a hardship excuse.  The outcome of any hardship defense will depend on the specific language of the contract at issue.  For instance, in N. Indiana Pub. Serv. Co. v. Carbon Cty. Coal Co., 799 F.2d 265, 267 (7th Cir. 1986), the Seventh Circuit held that the presence of a price floor and absence of a price ceiling in the parties’ contract meant that the risk of price escalation had been passed on to the buyer, regardless of potential hardship caused by changes in market conditions.

A similar doctrine, frustration of purpose, may excuse performance where an unforeseeable event renders the mutually understood purpose of the contract worthless to one contracting party.  The doctrine of frustration of purpose is embodied in Section 265 of the Restatement (Second) of Contracts, which states:  

Where, after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary.

Courts applying Section 265 hold that when an unforeseeable event “makes one party’s performance virtually worthless to the other, frustrating his purpose in making the contract,” performance may be excused.  See, e.g., PPF Safeguard v. BCR Safeguard Holding, 85 A.D.3d 506, 508 (N.Y. App. Div. 1st Dep’t 2011 (citing Restatement (Second) of Contracts § 265 comment a)).  

The Restatement further indicates that the frustrated purpose has to be the sine qua non of the contract, as understood by both parties at the time of contracting.  For example, in Rembrandt Enterprises, Inc. v. Dahmes Stainless, Inc., No. 5:15-CV-4248-LTS-KEM, 2017 WL 3929308 (N.D. Iowa Sept. 7, 2017), a large-scale farming enterprise sought to be excused from a contract to purchase a USD 9 million industrial egg dryer, which was part of its plans for an expansion of its operations.  The farming enterprise canceled its expansion plans after the Avian flu forced it to cull half of its chickens and caused it to lose a lucrative contract to supply eggs to Kellogg.  The purchaser sought to avoid its obligations, and the district court found that a force majeure clause in the parties’ contract was not triggered because performance was not impossible.  The court nonetheless allowed the case to proceed to trial on the issue of frustration of purpose, finding sufficient evidence to show that both parties might have understood the purpose of the contract was to support the purchaser’s expansion of operations to meet demand from the anticipated Kellogg orders.  

English Law.  Under English law, hardship alone is not an excuse for performance, but frustration of purpose has been recognized as far back as Krell v. Henry (1903).  The House of Lords Appellate Committee’s decision in National Carriers Ltd v. Panalpina (Northern) Ltd., 1 AC 675 (1981), formulated the doctrine as follows:

Frustration of a contract takes place when there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances; in such case the law declares both parties to be discharged from further performance.

National Carriers involved a 10-year lease for a warehouse, which was interrupted by a government closure of the road leading to the warehouse that lasted for 20 months.   Despite the severe interruption, the court held that the doctrine of frustration of purpose was not triggered because the road would be re-opened three years prior to expiration of the lease.  And unlike the relief available under French and German law to address hardship claims, the frustration of purpose doctrine under English law is not available to rewrite a contract to account for a temporary change in circumstances.  Indeed, the reluctance of English courts to excuse contractual duties was explained recently by the English High Court in Canary Wharf (BP4) T1 Ltd. v. European Medicines Agency (2019) EWHC 335 (Ch):  “[S]ince the effect of frustration is to kill the contract and discharge the parties from further liability under it, …[it] must not be lightly invoked and must be kept within very narrow limits.”

Other East Asian Law.  Hardship doctrines similar to those in the German Civil Code are available in the civil law systems of Japan, South Korea, and Taiwan.  Hong Kong and Singapore, however, follow English law that hardship alone is not sufficient to excuse nonperformance.  

III. Supervening Event Clauses

It is commonplace for contracts to contain express “force majeure” or “vis major” clauses.  These clauses typically list events including acts of God, terrorist attacks, inclement weather, union strikes, riots, and wars which can excuse or modify contractual obligations.  Some contracts also contain a separate hardship clause, which is often called a “material adverse change” or “material adverse effect” clause, which likewise can change a party’s obligations or release a party from obligations it has not yet performed.  

Courts in different jurisdictions take different approaches to the interpretation of express force majeure clauses.  U.S. and English courts, for example, are reluctant to offer broad interpretations of force majeure provisions.  In England, under the leading case of British Electrical and Associated Industries (Cardiff) Ltd v. Patley Pressings Ltd. (1953) 1 WLR. 280, a generic force majeure clause—which referred only to a “force majeure event”—was held to be void for uncertainty.  Another English court recently held in Maritime Inc. v. Limbungan Makmur SDN BHD (2019) EWCA Civ 1102 that a force majeure clause will apply only where a defined force majeure event was the sole cause of a party’s non-performance.  U.S. courts also are reluctant to extend a force majeure clause to situations not specifically identified in a contract.  For example, the New York Court of Appeals held in Kel Kim Corp. that “[o]rdinarily, only if the force majeure clause specifically includes the event that actually prevents a party’s performance will that party be excused.”  

Depending on the governing body of law, parties should also be aware that an express contract clause may supplant rights of recourse that otherwise would be available.  For instance, in France, the force majeure regime in Article 1218 of the Civil Code can be contractually amended, and therefore restrictive lists of qualifying events in force majeure clauses might narrow the scope of relief available.  The same result could occur under English law when the contract addresses the consequences of a supervening event through a force majeure clause.  Under such circumstances, a party may not be able to pursue recourse to the doctrine of frustration.

IV. Conclusion

Given the widespread, unexpected, and still uncertain economic impact of the COVID-19 pandemic, commercial disputes are inevitable.  Whether a business anticipates disruptions caused by the crisis or is already experiencing them, it should take stock of its potential legal options, both under governing law and the terms of the specific contracts that are affected.  Specifically, businesses should consider taking the following actions:

  • Examine each affected contract’s governing law and forum selection clauses, or determine the body of law that might be applicable and where litigation can be filed.  The controlling law and forum may shape whether and in what form a defense to non-performance is available, and also may shape how the express terms of a supervening event clause will be construed.
  • Review the specifics of any supervening event clauses in the affected contract, especially to see if they include epidemic or pandemic events or, alternatively, a generic definition or some other term that could arguably cover the event.  It also is advisable to review any contractual provisions with respect to notices that may be required to trigger such a clause.
  • Review insurance contracts to determine whether there is coverage for force majeure events.  

 

Going forward, businesses also should consider the following:

  • When drafting new contracts where performance could be interrupted by the effects of an epidemic, consider specifying the contract’s purpose in recitals or elsewhere.  Express identification of the contract’s purpose can later be used by a court or tribunal to determine whether the purpose of the contract has been frustrated.  
  • Tailor force majeure or material adverse change clauses to account for the COVID-19 pandemic and potential follow-on effects.  For material adverse change clauses, consider whether price adjustment mechanisms or adjustment to performance deadlines are appropriate.