Commercial Contracts and the Importance of the Force Majeure Clause

Commercial Contracts and the Importance of the Force Majeure Clause

Commercial Contracts and the Importance of the Force Majeure Clause 1600 1065 Christopher Hooley
Reading Time: 6 minutes

The outbreak of the COVID-19 novel coronavirus has dramatically affected day to day operations and business dealings around the world.

It is a global pandemic and Hong Kong, like the rest of the world, is feeling the effects of this unprecedented event. These effects are further exacerbated by the fact that Hong Kong experienced some of the worst civil unrest it has seen, in the months leading up to the outbreak.

What is the force majeure clause?

Under both English law and Hong Kong law, force majeure has no expressly agreed definition and is a contractual creation. The force majeure doctrine can only be relied upon, if there is an express force majeure clause within the contract, although the narrower doctrine of frustration may still apply.

A force majeure clause allows the parties to alter or abandon their performance duties under a contract if an event occurs that is significantly impactful, unforeseeable and beyond the party’s control.

Whether a party can rely on a force majeure clause in light of the COVID-19 outbreak will depend on the specific wording of the relevant force majeure clause.

It is important that parties to contracts governed by Hong Kong law keep themselves informed as to the possibility of force majeure clauses being used.

Recent examples of force majeure

Many Hong Kong events have had to be cancelled due to the virus outbreak and event goers, who have already bought tickets are having their losses mitigated in different ways.

The Hong Kong International Diamond, Gem & Pearl Show, and the Hong Kong International Jewellery Show, have both been rescheduled. The organizers have given participants discounts and have assured those who have already paid, that their money is safe should they decide not to attend an event they have paid for. In contrast to this, Informa Markets, who are organizing the Hong Kong Jewellery & Gem Fair in June and September, are not offering refunds to customers who have already paid for the event.

The Tokyo 2020 Olympics has now been postponed till 2021. “Official” sponsors and broadcasters may attempt to rely on force majeure clauses to claim their money back. There have already been reports that the ticketing policy includes force majeure clauses covering “states of emergency connected to public health”, which could mean no refunds for ticket holders. It seems unlikely that a force majeure clause would be enacted in this case, as huge adverse publicity would result.

Flights worldwide have been cancelled. Different airlines have dealt with this in different ways. Some offer full refunds; some will refund but apply a cancellation fee; some have kept customer money and allowed them to change their flights to a later date.

These are just a few examples of how force majeure will vary depending on the contract, the industry and associated external factors.

What constitutes force majeure?

COVID-19 may fall within a contract’s definition of force majeure, but it depends on the express wording used in the contract. Indications that the virus is a force majeure event include:

  • Express reference to health crisis’s or epidemics occurring in Hong Kong or internationally.
  • Reference to unforeseeable events causing travel restrictions.
  • Catch-all provisions referring to any unforeseeable circumstances that are out of the parties’ control.

Once a force majeure event has been established, it is important to determine whether it legitimately interferes with a party’s ability to perform their obligations under the contract.

Some contracts will exempt a party from performing their obligations if it is “rendered impossible”, or “prevented”. This would allow performance relief if something occurred that made carrying out the performance impossible.

Alternatively, the contract may say “hindered” or “delayed”. This would allow performance relief if something occurred that made carrying out the performance substantially difficult.

What are the obligations when invoking a force majeure clause?

A party may have obligations when invoking a force majeure clause. These could include:

  • Special notification procedures. If notification must be made within a certain number of days, it is important to observe if calendar days or business days are referred to. The method of notification should also be observed as travel restrictions may affect this.
  • A duty to reasonably mitigate any loses that occur as a result of the lack or partial completion of a performance.
  • A duty to carry out other means of performance if possible. If this is stated, the party may have to explore all possible means of carrying out the performance in alternative ways.
  • A duty to keep performing other obligations. The contract might explicitly state that the party must continue to perform other performance obligations that are not affected by the force majeure event.
Will insurance cover be affected by force majeure?

This depends. It is essential that parties check their insurance cover with relation to force majeure. Insurance may cover events, such as COVID-19. If it does the insurance provider may have to be informed immediately for cover to be issued.

Force majeure jurisdiction

The jurisdiction that is followed will have significant effects on whether the force majeure doctrine applies.

Many Hong Kong businesses will have contracts with Mainland Chinese businesses. In PRC law, force majeure is a defined concept codified in statute. In Hong Kong law, force majeure is a contractual creation.

On 10 February 2020, Mainland China released a statement confirming that the virus can exempt parties from performing contracts as it is an “unforeseeable, unavoidable and insurmountable” event and could amount to force majeure under PRC contract law.

If the contract was formed in Hong Kong according to Hong Kong law, the specific contract’s definition of force majeure will be relied on. If it was formed in Mainland China according to PRC law, PRC statute’s definition of force majeure will be relied on.

What considerations should be given to future contracts?

The pandemic has highlighted the need for catch all provisions and referencing specific possible events, as well as unforeseeable events, when drafting commercial contracts.

Unfortunately, many businesses will learn this the hard way and may find themselves tied into a contract that is significantly difficult to complete and substantially expensive. Drafting of future contracts and force majeure clauses within them, should be thoroughly contemplated.

There is now a global knowledge of the current and potential scale of COVID-19. A force majeure relying on the un-foreseeability of COVID-19, will unlikely be applicable to contracts that are being drafted now as it will not satisfy the standard “unforeseeable test”. It is a typical condition that the event is unforeseeable at the time of drafting.

The current global emergency will now give rise to questions as to whether a global pandemic can be deemed as an “unforeseeable event”. If another virus outbreak were to happen, “unforeseeable events” in a force majeure clause would unlikely change or excuse parties from carrying out their obligations under the contract because of the outbreak.

Parties should give all future force majeure definitions serious thought. These definitions should be defined clearly and allocate the risks faced by the parties – including the threat of non-performance due to pandemic-related contingencies.

When allocating the risk associated with force majeure events, it is important that consideration is given to the parties’ obligations should such an event occur. For example, a clause could be drafted to suspend performance, allow a party additional time to perform, or cancel performance altogether should a force majeure event occur.

Parties can also include changes in law in their definitions of force majeure. It is essential to explicitly state what constitutes as a change in the law. For example, are governmental recommendations and guidance classified as changes in the law?

Conclusion

It may still be too early to identify the scale of the problems brought about by COVID-19, and the consequential effects, that may well continue for some time.

As always, this shows the critical importance of good business management and forward planning and of sound risk management in respect of all contractual and legal obligations.

Moving forward, parties should consider including ‘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’ within their definitions of force majeure and be sure to state the obligations that would remain.

For now, the following practical tips can be followed:

  • Review all contracts in which force majeure or frustration may be a factor and assess the requirements and consequences.
  • Comply with the notice formalities.
  • Continue to communicate and negotiate with the other contracting parties (preferably on a ‘without prejudice’ basis).
  • Explore alternatives to mitigate the effect of the force majeure event.
  • Keep a record of documentation – cancellation/delays, customs declaration etc.
  • Ensure that tax returns are filed to avoid penalties and keep a record of the additional expenditure for tax relief calculation.
  • Review existing insurance cover.

 

Our team at Hugill & Ip has extensive experience in dealing with commercial and contractual legal issues – so if you need further advice on these subjects and other topics discussed, get in touch with us to find out how we can help.

This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.

Christopher Hooley

Christopher Hooley

Chris advises on a wide range of corporate commercial, corporate finance, mergers and acquisition, information technology matters, from strategising on tech driven start ups to drafting documentation required for complex cross border transactions.

All articles by : Christopher Hooley
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