It is now more than seven years since the Belt and Road Initiative (BRI) was announced by President Xi Jinping in 2013, and the Novel Coronavirus (COVID-19) that originated in Wuhan is putting the resilience of the BRI's Silk Road Economic Belt and the 21st Century Maritime Silk Road to the test.
The city of Wuhan is a key transport and trade hub in China, with rail connections to many trading partners, including Russia, Poland and the Czech Republic. The outbreak of COVID-19 has dealt a heavy blow to the Chinese economy. Other countries participating in BRI have also started to feel the impact of the virus on their supply chains and production lines.
With various governments imposing travel restrictions and compulsory quarantine measures on Chinese visitors, the progress of cross-border projects, such as those involving the China-Pakistan Economic Corridor, will inevitably be delayed. COVID-19 has also brought the US $6 billion Indonesian high-speed railway project to a temporary halt.
Difficulties are exacerbated by the fact that many workers had returned home for Chinese New Year holiday before the unexpected outbreak. The healthcare system in many African countries participating in BRI, such as Kenya and Ethiopia, is also a cause of concern because they are less prepared than more developed nations for an epidemic of this kind.
The sourcing of construction materials and machinery for international projects has been severely disrupted because the Chinese New Year holiday has been extended and major cities locked down. In addition, some factories that are hoping to reopen cannot do so without permission from the relevant authorities. Some of those that have re-opened are operating at reduced capacity.
This article examines how the common law doctrines of force majeure and frustration may operate in commercial contracts in this difficult situation.
Force Majeure (FM)
Parties are advised to check if their contracts contain a FM clause. The clause is usually present in large-scale, complex commercial contracts. Depending on how it is drafted, a FM clause can function to suspend contractual obligations, grant extension of time or allow renegotiation of certain terms. It may also grant parties a right to terminate the contract in case of long-lasting / extreme FM events. At the very least, it gives immunity from potential liability for non-performance.
If the contract contains a FM clause, the question arises of whether it is wide enough to cover the outbreak of COVID-19.
If wording is included that refers to quarantine, disease or epidemics, then the position is clear. However, in the absence of such words, the fact that the Chinese government has directed closure of businesses until further notice and that various travel restrictions are in force may enable parties to rely on "acts of government" to invoke the FM clause. If the wording is more general, the argument will be more difficult to make but it is likely that wording such as "events beyond a party's control" will still allow an FM clause to be invoked.
Some FM clauses require that the event under the FM clause is unforeseeable. There might be room for argument on this point given the emergence in recent years of other new viruses such as SARS, H1N1 and MERS. However, compared with these previous occurrences, the present epidemic appears already to be much more serious: it has caused a large number of infections, has led to many casualties, and has required government-ordered lockdowns on an unprecedented scale. The WHO's declaration that it amounts to a public health emergency of international concern may help invoking FM.
Apart from showing that an event has occurred that was envisaged by the FM clause, the party seeking to rely on it is likely to have other contractual requirements to satisfy. Typical requirements will require the party invoking the clause to show that:
- it was prevented, hindered or delayed from performing its obligations (not only that the performance of any obligations has become more costly / time-consuming than anticipated);
- the FM event was beyond its control;
- it has taken all reasonable steps to prevent the occurrence of the FM event; and
- it has complied with all other contractual provisions (e.g. notice provisions, duty to mitigate).
Further, parties should substantiate their claim by collating as much evidence as possible on the effects of COVID-19 and the burden it has placed on them in terms of time and costs.
To shield enterprises from breach of contract claims, China Counsel for the Promotion of International Trade has issued FM certificates absolving Chinese companies from liability for the non-performance or defective/late performance of contracts. In fact, some foreign suppliers have already rejected these certificates and insisted that contracts be performed. The evidential weight that will be attached to these certificates by international courts or arbitral institutions outside China remains to be seen.
Under common law, parties may rely upon the doctrine of frustration. The effect of frustration is less flexible and will bring the contract to a premature end. That may not be the wish of the parties.
To invoke the doctrine of frustration successfully, parties need to show that an event which is not the fault of either party occurred which either renders:
- performance of the contract radically different from what they had bargained for; or
- the contractual obligations impossible to perform, either physically or commercially.
Given the extreme effect of the doctrine, leaving little leeway for parties to renegotiate their deal, it has only been invoked successfully in a limited number of cases.
A contract may be frustrated on the ground that the cost or the time required for completion is out of all proportion to what was contemplated under the contract, viewed from an ordinary commercial competitive standpoint. This will be determined with reference to the nature of the obligations, the time required for performance, and the costs of performance.
It is questionable whether the months-long suspension of factories and the temporary absence of staff have the effect of rendering the parties' obligations radically different from what was originally contemplated or impossible to perform. However, if the situation continues or worsens, there may be more scope to rely on an argument of frustration.
The effects of COVID-19 on international businesses are still unfolding. Disputes will arise concerning the interpretation of an FM provision, the value of the FM certificates, and the application of the doctrine of frustration, as well as level of damages that should be awarded for non-performance or late performance. The outbreak highlights the importance of including well-drafted dispute resolution clauses in contracts, tailored to disputes involving several countries with different legal, political and economic systems. In our view, these types of disputes are best dealt with through international arbitration. This ensures a high degree of neutrality, gives parties the right to select arbitrators with relevant experience and expertise, and allows proceedings to be dealt with confidentially and privately. It also results in an award that is generally final and cannot be appealed.
Our experience extends to all the world's arbitral major centres and rules. We have a global network covering six continents. We are well placed to support you every step in all of your needs associated with the Belt Road Initiative. For further information, please do not hesitate to reach out to Mun Yeow, based in our Hong Kong Office, or Jon Howes, based in our Singapore Office, who can help protect your businesses better in light of COVID-19 and its potential consequences.