Coronavirus！How to Defend Global Auto Supply Chain

Legal Analysis: 

How Can PRC Enterprises Deal with the Impact of the Outbreak of Novel Coronavirus Pneumonia on Global Auto Components and Parts Supply Chain 

Introduction: 

The fact that Chinese components and parts manufacturers are facing suspension of production and supply chain disruptions have been gradually affecting the whole world.

The outbreak of Novel Coronavirus Pneumonia (COVID-19) has swept across China at the end of 2019 and the beginning of 2020. In order to prevent further spread of the coronavirus outbreak, the State Council has extended the Spring Festival holiday, followed by local authorities launched policies for further delaying resumption of enterprises after the holiday, which included a large number of auto components and parts manufacturers.

As we all know, China plays a significant role in global auto components and parts supply chain. Every year, Made in China components and parts are used to assemble millions of cars in automobile factories around the world. Not only Hubei is the severely affected area of the coronavirus outbreak, but also it is an important center for auto components and parts production and transportation, where lots of industrial chain supporting suppliers are based in. The headquarters or factories of large global auto enterprises, such as Honda, Nissan, GM, PSA and Renault, are also located there.

Affected by Chinese auto components and parts manufacturers’ postponed resumption of work, many world leading automakers have already announced that they have shut down some of their factories due to the disruptions of components and parts supply from China, while some have announced low stock of certain components and parts and issued a shutdown warning.

Due to the outbreak, well-known auto enterprises or multinational components and parts supply giants are searching for replacement of auto components and parts suppliers outside China, in order to mitigate the crisis of possible shutting down brought by interruption of supply. However, small and medium-sized domestic components and parts suppliers are relatively more vulnerable against risks when facing force majeure, compared to automobile OEMs. Especially for these Chinese companies exporting products to overseas, their production being suspended could directly affect the global auto industrial chain. Even the disruption of supply in terms of wiring parts could lead to shut of automakers’ factories that produce different vehicles. Moreover, as a number of auto components and parts are tailor-made for particular auto brands and car models, meaning that those automakers may hardly find new suppliers among other countries in such short time and start massive production. Once domestic suppliers are sued for breach of contract, they could face large sums of compensation that they cannot afford.

Based on the above-mentioned impact of the coronavirus outbreak on the global supply chain of auto components and parts, we will make a brief analysis and discussion on several issues regarding contract performance that Chinese enterprises may encounter in the domestic and international trade during the outbreak.

01

CITY

Whether this coronavirus outbreak could be identified as a force majeure event or change of circumstances under the PRC Contract Law?

1.1 Force majeure under the PRC law

Article 117 of Contract Law of the PRC (the “PRC Contract Law”) provided that, “party who is unable to perform a contract due to force majeure is exempted from liability in part or in whole in light of the impact of the event of force majeure, except otherwise provided by law. Where an event of force majeure occurs after the party’s delay in performance, it is not exempted from such liability. For purposes of this Law, force majeure means any objective circumstances which are unforeseeable, unavoidable and insurmountable.” And, Article 180 of the General Rules of the Civil Law of the PRC provided that, “if a party is unable to perform a contract due to an event of force majeure, it shall timely notify the other party so as to mitigate the losses that may be caused to the other party, and shall provide evidence of such event of force majeure within a reasonable period.”

We are of the view that, both parties who entered into the components and parts supply contracts/purchase orders prior to the outbreak, were unable to foresee the occurrence of such event. The socio-economic impact brought by the coronavirus outbreak has gradually become obvious. For example, because of anti-epidemic campaigns conducted by the governments, the fact that the enterprises have to delay resumption and traffic controls have negatively affected logistics, would unavoidably affect components and parts suppliers. And this would further cause in production and delivery, which is insurmountable.

In practice, although at this time there is no case to illustrate whether this coronavirus outbreak can be identified as a force majeure event, this outbreak is very similar to the outbreak of Severe Acute Respiratory Syndrome (“SARS”) in 2003. Clause 3.3.2 of Notice of the Supreme People’s Court on Properly Carrying out Relevant Trial and Enforcement Work during the Period of Prevention and Treatment of SARS【1】provided that, “Disputes arising directly from failure of performance of contracts due to administrative measures taken by the government and relevant authorities for epidemic prevention and control, or from the impossibility of performing by the contracting parties due to the impact of the coronavirus outbreak, shall be handled properly in accordance with the article 117 and article 118 of the PRC Contract Law.” After having done some legal search, it is found that, for cases involving the outbreak of SARS, the SARS outbreak could be considered a force majeure event in many specific cases【2】.

Compared with the SARS, this coronavirus outbreak spreads even wider and its transmission speed is faster which results in more serious consequences. At present, most regions of China have initiated the First-level Response Measures for the coronavirus outbreak. The National Health Commission has previously classified the COVID-19 into Category B infectious diseases and adopted measures for the prevention and control of Category A infectious diseases. The World Health Organization also declared this coronavirus outbreak as a “Public Health Emergency of International Concern (PHEIC)”. Therefore, we take the view that the coronavirus outbreak has met the standard of force majeure under the PRC law, i.e., unforeseeable, unavoidable and insurmountable.

Zang Tiewei, the spokesperson and director of the Research Office of the National People’s Congress Legal Work Committee, also represented on February 10th that the China government has adopted corresponding preventive measures in order to protect public health under the coronavirus outbreak. For the parties who are unable to perform the contract, it is a force majeure event which is unforeseeable, unavoidable and insurmountable. According to the relevant provisions of the PRC Contract Law, if the contract cannot be performed due to force majeure, according to the influence of force majeure, the liability shall be partially or wholly exempted, except as otherwise provided by law. Although the current opinion is not a formal judicial interpretation, it should indicate the standard for the identification of the nature of the outbreak in the future domestic judicial practice.

1.2 Change of circumstance under the PRC law

In addition to force majeure, during the SARS period in 2003 there were also an opinion about applying the principle of change of circumstance to handle the performance of specific contracts. Clause 3.3.1 of the above mentioned Notice of the Supreme People’s Court on Properly Carrying out Relevant Trial and Enforcement Work during the Period of Prevention and Treatment of SARS provided that, “For these contract disputes in which the performance of the original contract has a significant impact on one party’s rights and interests due to the outbreak of SARS, based on the specific circumstances, such disputes could be dealt with according to the principle of fairness.” This clause is basically consistent with the principle of changing circumstances.

In China’s current legal system, the principle of changing circumstance is provided in Article 26 of Interpretation of the Supreme People’s Court on Several Issues Concerning Application of the Contract Law of the PRC (II) (promulgated in 2009), provided that “Where any significant change in the objective environment has taken place after the formation of a contract which could not have been foreseen by the relevant parties at the time of entering into the contract, and does not belong to any commercial risk occasioned by any force majeure cause, rendering the continual performance of the contract manifestly unfair to the relevant party or rendering it impossible to realize the goal of the contract, the People’s Court shall confirm whether the contract shall be varied or discharged in accordance with the principle of justice and actual circumstance, where the party apply to a People’s Court to vary or discharge the contract.”

1.3 The application of force majeure and change of circumstances under the PRC law

We have noticed that there are many similarities between force majeure and change of circumstances. e.g., they were both unforeseeable when the contract was formed, and both have a significant impact on the performance of the contract. In general, if relevant event is insufficient to constitute force majeure but does has impact on the performance of the contract, the parties may try to invoke the change of circumstances clause. Under the background of the coronavirus outbreak, we can refer to the two scenarios provided under Clause 3.3.1 and 3.3.2 of the Notice of the Supreme People’s Court on Properly Carrying out Relevant Trial and Enforcement Work during the Period of Prevention and Treatment of SARS for better understanding and applying these two principles, i.e., (1) Any dispute arising out of either contractual party’s failure to perform the contract due to the impact of the SARS, or as a direct result administrative measures taken by the government and relevant authorities to prevent and control the SARS, shall be settled in accordance with the principle of force majeure. We understand that， in such cases, the force majeure principle shall be applied to terminate the contract and the affected parties will be excused from liabilities for breach of contract, and (2) in the contract dispute where the performance of the contract has a significant impact on the rights and interests of either party due to the SARS outbreak, the principle of fairness could be applied in accordance with the specific situation. We understand that under this scenario (2), principle of fairness will be applied to modify or terminate the contract, which is also in line with the principle of change of circumstances.

Based on the above, the applicability of force majeure and change of circumstances can be summarized as follows: (1) If the fundamental purpose of the contract cannot be achieved due to the coronavirus outbreak, relevant provisions of force majeure can be invoked to request for termination of the contract; (2) If the contract is still enforceable, but the performance will cause obvious unfair consequences, then change of circumstance (essentially, the principle of fairness) can be invoked in order to adjust the relevant contract terms. Of course, in the case where the delay in performance is caused solely by the coronavirus outbreak, the affected party can also directly invoke force majeure to request the exemption of the period of delay in delivery caused by the outbreak.

It is important to note that, in order to prevent possible abuse of the principle of change of circumstances, Supreme People’s Court in 2009 issued the Notice on the Interpretation of Several Issues Concerning the Application of the People's Republic of China (II) to Serve the Overall Work of the Party and the State, article 2 of which provided that, the people’s courts at all levels must correctly understand and prudently apply the Article 26 of Interpretation of the Supreme People’s Court on Several Issues Concerning Application of the Contract Law of the PRC (II). If, in light of the special circumstances of a case, it is indeed necessary to apply the same in the individual case, such case shall be reviewed by the high people’s court and shall be reported to the Supreme People’s Court for review if necessary. Therefore, parties also need to be more prudent and cautious in applying the principle of change of circumstances in practice.

【1】According to the Decision of the Supreme People's Court on Abolishing Certain Judicial Interpretations and Judicial Interpretation Documents (Tenth Batch) Published Between July 1, 1997 and December 31, 2011, this notice has been abolished.

【2】See the cases with the number of (2015) Long Min Chu No.1524; (2018) Jin 0423 Min Chu No.491; (2005) San Ya Min Yi Zhong No.79; (2007) E Min Si Zhong No.47; (2013) Liao Shen Er Min Kang No.14.

02

Recommendations on contracts performance affected by the coronavirus outbreak

2.1 Promptly inform the counterparty in writing of any delay or inability to perform due to the coronavirus outbreak and provide evidence of the force majeure event as soon as possible.

Article 118 of the PRC Contract Law provided that, “If a party is unable to perform a contract due to an event of force majeure, it shall timely notify the other party so as to mitigate the losses that may be caused to the other party, and shall provide evidence of such event of force majeure within a reasonable period.” Therefore, where the PRC law is the applicable law, the affected party must perform the aforementioned notification and proof obligations, as well as retain necessary written evidence of delivery and receipt of the relevant documents.

With respect to the force majeure certificate, it is common practice to apply to the China Council for the Promotion of International Trade and its authorized branches (“CCPIT”) and various industry associations for issuance of such certificate. Now CCPIT and various industry associations are assisting enterprises in applying for the force majeure certificate for this outbreak. As reported by the media, CCPIT’s the first force majeure certificate was issued for an auto components and parts manufacturer in Huzhou, Zhejiang Province.

In this regard, we drafted notification letter of force majeure event from the perspective of the affected parties and produced multi-language versions for readers’ reference【3】.

However, it is worth mentioning that, when the law applicable to the contract is not PRC law, especially in common law countries such as the UK and the US, it should not be taken for granted that such force majeure certificate will trigger the exemption causes, unless it is explicitly agreed in the contract that the force majeure certificate issued by the CCPIT and relevant organization is sufficient.

2.2 Pay close attention to the trend of policies on epidemic prevention and control, collect and preserve relevant evidence of the impact of the coronavirus outbreak on the enterprise.

Afore-mentioned measures will help affected company to make the further decision to deal with this outbreak and promptly make corresponding claims to the counterparty of the contract based on relevant facts and legal and contractual basis, such as claiming for a delay in performance or termination of the contract, requesting for reduction or exemption of rents for the suspension period, attempting to negotiate with the purchaser to adjust the supply price if there is a significant price surging for raw materials after resumption of the work, and arranging for resumption of the work as soon as the outbreak has been resolved, etc.

【3】See Attachments

03

Issues to be noted if a force majeure clause is agreed in the contract between the auto components and parts supplier and the purchaser

As far as we are concerned, a force majeure clause is fairly common in domestic and foreign commercial contracts, including auto components and parts supply transactions (the expression of which may differ, for example, in cases where the cause is in the form of an Excusable Event or a Hardship Clause), and the parties to the transaction often include any force majeure events that may affect the performance in the contract, and in the event of a situation where delay in or impossibility of performance due to such event, the affected party may directly invoke relevant clauses to protect its own interests.

According to relevant PRC laws (such as Article 8 of the PRC Contract Law) and international common practices, in the event of any force majeure event that has been explicitly agreed upon by the parties, the force majeure clause clearly agreed upon by the parties shall apply for remedy. Therefore, a relatively comprehensive force majeure clause can largely protect the interests of the performing party in the following aspects【4】:

（1） Whether the definition of force majeure event in the force majeure clause is clear, whether certain specific events are included in force majeure clause, whether the ejusdem generis rule of contract interpretation can be applied to the force majeure clause【5】;

（2） The responsibility of the affected party to promptly notify the other party after the occurrence of a force majeure event, the time limit of the notification, the content of the notification, and the consequences of the failure to send a notification within the time limit, etc.;

（3） The consequences of the force majeure event, that is, the impact on the contract;

（4） Whether the force majeure clause is an exemption clause;

（5） Whether there are alternative methods of performance that can be applied to force majeure clause;

（6） Force majeure events cannot be foreseen at the time of signing, cannot be reasonably avoided and controlled;

（7） Burden of proof for force majeure.

Of course, even if an explicit force majeure clause is stipulated in the contract, the affected party shall promptly notify the other party of the delay or inability to perform, and shall also pay attention to the following:

（1） Whether the events provided in the force majeure clause include coronavirus outbreak and related policies implemented by the government to prevent the spread of the coronavirus outbreak;

（2） Whether there is a direct causal relationship between the force majeure event and the impact on the performance of the contract;

（3） Whether the force majeure event is the sole reason that affects the performance of the contract;

（4） Whether the main performing party has taken measures to avoid or mitigate the impact of the force majeure event on the performance of the contract.

【5】Yang Liangyi, Si Jia, The Outbreak of Novel Coronavirus Pneumonia and Force Majeure in the International Commercial Contract, https://mp.weixin.qq.com/s/coHDhfj2qmB3A5 _ DrI7RjQ

【6】The ejusdem generis rule means that if a party define a particular item and then uses a more general, inclusive term for it, then its intention is to include items similar to the specific item. For example, in practice, lawyers often use the expression “including but not limited to” to clarify the application of ejusdem generis rule when drafting a contract in practice.

04

If there is no force majeure clause included in the contract, how could the enterprises affected by the coronavirus outbreak mitigate or exempt their liabilities?

4.1 If relevant contract is governed by the PRC law, those enterprises affected by the coronavirus outbreak can refer to the first point aforementioned, and try to protect their interests in accordance with the principles of force majeure or changes of circumstances.

4.2 In the common law context, the implied terms of contract law do not have the concept of force majeure, so we need to look at the specific principles of the laws of each country, below we will take the UK law and the US law as examples for a brief analysis:

a) Relevant principle under the UK law

While the contract cannot be performed due to an unforeseeable event, it is worthwhile to consider using the doctrine of frustration of contract under the UK law. Generally, if frustration of contract is successfully applied, the contract will be discharged, which is different from rules of force majeure that could delay the performance of contract. Common law takes legally binding contract seriously, therefore frustration of contract can only be applied if radical change has happened. There are four elements needed to fulfil in order to establish frustration of contract:

Frustration of Contract is the doctrine that applies in the UK law where the contract cannot be performed because of an unforeseen event. In general, where the doctrine of frustration is successfully invoked, the contract is terminated, this is different for the force majeure principle which still allows delay in performance. Under common law, the claim of frustration of contract can stand only in relatively extreme cases. Generally speaking, the precondition for frustration of contract are as follows:

（1） There has to be a radical change in circumstances which would causes the performance of the contract to become unjust and unreasonable;

（2） The consequence for frustration of contract would be termination of contract;

（3） Once frustration of contract establishes, the contract will be terminated automatically and neither party shall bear any responsibilities to each other;

（4） The reason why the contract is frustrated shall not be the act or choice of the frustrated party to avoid the performance of the contract, instead, it shall be completely a result of unexpected external circumstances【6】.

b) Relevant principle Under the US law

Where the performance of the contract has been affected by this coronavirus outbreak, the first rule that came into our mind in the laws of the US could be the doctrine of impossibility, which is similar to the frustration of contracts under the UK law.

However, in practice, the doctrine of impossibility has been gradually replaced by the doctrine of impracticability. The standard applicable to doctrine of impracticability is less strict than the doctrine of impossibility. As long as the continuation of performance has become impractical, then the affected could be excused from its liability, and the doctrine of impracticability also allows affected parties to excuse delay in performance under certain circumstance【7】.

According to the doctrine of impracticability, delay in delivery or non-delivery in whole or in part by a seller …… is not a breach of his duty under a contract for sale under a contract for sale if 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 or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid【8】.

The provision stated above is provided in the Article 2 (Sales of Goods) of US Uniform Commercial Code (UCC), which has wide application throughout the US except the Louisiana State and Puerto Rico (of course, somewhat modification could be made by each state). Under the doctrine of impracticability, US courts usually require the affected party to prove that:

（1） The special occurrence made it extremely expensive or difficult to perform the contract;

（2） The parties initially entered into a contract under a basic assumption that certain special circumstances would not occur (this does not mean an absolute possibility in theory, otherwise this requirement would have become meaningless. What is actually required is the real possibility that a particular circumstance may arise under the specific circumstances) and there is no contractual provision on bearing of risk arising from such particular circumstances.

（3） Contrary to the basic assumption made by both parties, special occurrence actually happened which hindered the performance of contract【9】.

In view of the above, and considering the specific situation of this outbreak, the author takes the view that courts in common law countries would mainly focus their attention on the degree of the impact of the outbreak on the performance of contracts, whether such outbreak would fundamentally cause the failure of performance, delay of performance or failure to realize the purpose of contracts, and whether there is any alternative plan. Therefore, whether it’s feasible to claim that the performance of contracts is hindered or impractical due to the outbreak remains to be further discussed, and shall be decided in individual cases based on specific circumstances.

【6】Yang Daming, International Sales of Goods, p388.

【7】Zhang Ning, Liu Zhiping, The Outbreak of Novel Coronavirus Pneumonia and Force Majeure Clauses, https://mp.weixin.qq.com/s/yJP-2dMnWBoefF-Q50LqvQ.

【8】 § 2～615 The Uniform Commercial Code (UCC).

【9】 § 2～615 The Uniform Commercial Code (UCC).

Summary

In summary, the author takes the view that, even if the current coronavirus outbreak  can be identified as a Force Majeure event under the PRC law, the question of whether the affected party can invoke such event to rescind the auto components and parts supply contract or be exempted from liabilities still needs to be comprehensively determined based on the governing law of the contract, the description of the Force Majeure event in the contract, the nature of the contract and the impact of this outbreak. In cases where this outbreak has not directly contributed to the fundamental and complete non-performance of the contract, it would be risky to claim an exemption from liability or termination of contract by invoking the principle of force majeure. Also, for the change of circumstances based on the theory of fairness, the applicable standards in practice are relatively high.

At present, China is in a critical period of epidemic prevention and control, and the time of resumption of production by domestic manufacturers of automobile components and parts may be further delayed. Therefore, enterprises shall pay close attention to and strictly abide by the policy trends of epidemic prevention and control adopted by governments at all levels, and meanwhile, enterprises shall also pay attention to collect relevant evidence and perform necessary mitigation and notification obligations in accordance with relevant laws and contracts so as to maximize the protection of their own rights and interests. We believe that, with the concerted efforts of the people throughout the country, the coronavirus outbreak will be controlled and eliminated eventually.

Attachments：Force Majeure Notification Letter Templates

Notification Letter_force majeure_zlwd-Chinese&French

Lettre de notification _force majeure_zlwd-Chinese&French

Notification Letter_force majeure_zlwd-Chinese&Janpanese

Carta de Notificación_Fuerza Mayor_zlwd-Chinese&Spanish  

Clicking "Read More" in the lower-left corner, you will be led to a website. 

Entering the extraction code 5m88,templates will be available in the above four languages.

l  Team Members  l

Wei LIN

Managing Partner

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Dr. Wei LIN is the managing partner at P.C.Woo & Zhonglun WD L.L.P. and Zhonglun W&D Law Firm Shanghai Office. Qualified to practice law in mainland China since 2001. He also serves as Registered Foreign Lawyer for P.C. Woo & Co. in Hong Kong. Dr. Lin has participated in numerous international arbitration cases in relation to cross-border investment, trade and maritime affairs, and engaged in dozens of transnational M&A projects in E.U., Americas and Africa.

Jinsheng LI

Associate

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Mr. Jinsheng Li is an associate of ZhongLun W&D Law Firm Shanghai Office, Jinsheng focuses his practice on various corporate matters, including corporate governance advisory, mergers and acquisitions, share transfer, investment and finance, commercial litigation/arbitration, etc.

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