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Contractual Silver Bullet in the COVID-19 Pandemic
10 August 2020

The COVID-19 pandemic and public health measures taken by governments have brought about global economic hardship including disrupting production flows, causing demand for non-essential goods to drop and forcing enterprises to scale down or even stop operations. Consequently, many businesses have been prevented from performing their contracts. In this exceptional environment, can the affected party be relieved from the performance of the contract without incurring any legal liability ?

After months of legal discussions, it is fairly established that under Hong Kong laws, one would be liable for breach or repudiation of the contract if it fails to perform the contract regardless of how severe the public health measures brought about by the pandemic may be unless the party can successfully establish one of the following grounds of defence :-

(1)    Statutory Force Majeure;

(2)    Contractual Force Majeure;

(3)    The Doctrine of Frustration; or seek

(4)    Other Alternatives.

Possible Grounds of Defence

We briefly analyse each of the grounds of defence as follows :-

(1)        Statutory Force Majeure

Unlike the laws in the People’s Republic of China (“PRC”), there is no statutory or precise definition of force majeure and force majeure has no statutory basis for exemption of liabilities under Hong Kong laws. Therefore, if the contract is not governed by the laws of PRC, the various PRC laws, provisions or opinion relating to adjudicating disputes on the issue of COVID-19 would not be applicable.

(2)        Contractual Force Majeure

Under Hong Kong laws, force majeure is a term of contract to be relied upon. A well-drafted force majeure clause in a contract can protect a party from liability when it is unable to perform the contractual obligations due to circumstances beyond its control (or reasonable control). The clause usually contains a list of events that the parties to a contract have decided will be disadvantageous to the continuation of the contract.  Common examples of force majeure events are war, rebellion, civil commotion, natural calamities, epidemics or “any other causes beyond the control of the parties”. It is noteworthy that the World Health Organisation has classified COVID-19 as a pandemic and not an epidemic.

In the current third wave of the pandemic in Hong Kong, the government has further tightened and imposed severe measures and controls including mobility restrictions such as all non-Hong Kong residents coming from any overseas country by plane will be denied entry into Hong Kong and all arrivals from PRC, Macao and Taiwan will be subject to a 14-day compulsory quarantine at designated places; policy measures such as no dine-in service between 6:00 pm and 4:59 am the following day. Meanwhile, bars and pubs, fitness centres, beauty parlors and night clubs must suspend operations and all designated public facilities e.g. sport grounds and beaches are closed. The number of persons allowed for public gatherings is reduced from 4 to 2.

Therefore, you may ask : “Is COVID-19 an event covered by the force majeure clause (if there is such a clause in the contract) and the affected party may be excused from the contract ?” This is a question of interpretation of the force majeure clause. Generally speaking, the Court would interpret a force majeure clause based on the language used, the subject matter of the contract, the context of the transaction, the purpose for which the clause is inserted, the substance but not the form of the clause, and other relevant factors in the circumstances of each case (see Arnold v Britton [2015] UKSC 36, Maeda Kensetsu Kogyo Kabushiki Kaisha v Bauer Hong Kong Ltd [2020] HKCU 544). It is important to note that the event triggering the force majeure clause i.e. the COVID-19 pandemic in this case must be supervening and beyond the control of the party seeking to rely on the clause, and the party can do nothing to overcome the event.

(3)        The Doctrine of Frustration

If a contract does not contain a force majeure clause or the clause is otherwise defective or invalid due to poor planning and drafting, a party may still be relieved from a contract by operation of the common law doctrine of frustration.  The doctrine applies when there is a radical change in circumstances making performance of the contract impossible or fundamentally different from what the parties have contracted for. The event (the change in circumstances) must be radical or extraordinary to the root of the contract.  The Court will determine whether the event has the consequence of suspending or terminating the contract.  The events that result in frustration of the contract are often narrow and beyond the parties’ actions.

As an example, in the case of Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754, which concerned the SARS epidemic in Hong Kong in 2003, the Court rejected the tenant defendant’s attempt to rely on frustration to discharge a 24-month’s lease which he was 13 months into. The tenant defendant was subjected to a 10-day isolation order due to SARS in 2003. The Court rejected the tenant defendant’s case on the ground that the isolation order was only for a short period of time in the context of the entire lease.

In a force majeure clause, in order to suspend or terminate the contract or to get  remedy, a party seeking to rely on the clause is usually require to take positive steps to notify the other party of the occurrence of the triggering event and to follow certain procedures set out in the clause. Frustration, on the other hand, automatically terminates the contract and the parties need not do anything. The Court will decide what remedy to award to the parties after making a ruling that the contract has been frustrated.

However, an automatic termination of the contract may not always be desirable. In such a situation, parties can consider whether or not they can avail themselves of the doctrine of temporary impossibility – a concept similar to frustration and also narrowly applied – which affords parties the right to suspend performance for the period during which it is impossible to perform a contract.

(4)        Other Alternatives

If a party to the contract is affected by the public health measures e.g. border control to enter Hong Kong, to perform the contract, the parties may consider other clauses such as material adverse change, operation of law, price escalation and adjustments, limitation of liability and damages clauses to address the situation. They can also negotiate and mutually agree to amend, cancel or extend the contract. This amendment can be for suspension or reduction of rental payments, extension of timelines, apportionment of increased costs, changing the scope of performance, suspension for a certain duration or even inclusion of a force majeure clause that caters to the pandemic situation.

If you have any questions about the above eNews or queries relating to litigation or dispute resolution generally, experienced lawyers in our Litigation team will be happy to assist you.

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