The initial impact of the coronavirus (Covid-19) pandemic disrupted supply chains as businesses along the chain were forced to close. With infection numbers rising again and the prospect of new lockdowns and business closures on the horizon, in this article, we explore whether the pandemic may provide a basis under Hong Kong contract law for a party to that contract to argue that it should be excused from performing its obligations through the doctrine of frustration and force majeure (i.e. without triggering a contractual breach). If you would like to discuss any of the issues raised in this article, please contact one of our Dispute Resolution or Commercial Litigation and ADR lawyers.
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The coronavirus (Covid-19) pandemic has wrought significant damage to a Hong Kong economy already battered by political unrest and a reset in relations between the United States and the People’s Republic of China. While the economy has now largely re-opened with virus numbers remaining low, the risk of further economic damage remains elevated as virus numbers in other parts of the world are now rising. In this environment, Hong Kong businesses face the prospect of substantially reduced revenues and cashflow.
Creditors, some under their own pressure to collect bills and service their own liabilities, may wish to take aggressive action to pursue debtors. Such action may include suing for non-payment. For their part, debtors may choose to dispute liability, on the basis that their obligation to perform their contracts has been excused as a result of the pandemic.
Force Majeure Clauses
One possible option for debtors to explore is whether their contracts are subject to force majeure provisions and if so, whether those provisions may apply. If yes, a debtor may be able to contest liability for performing a contract.
Depending on the drafting, a force majeure clause may allow the parties to be excused from performing the contract (in whole or in part) or to claim an extension of time for performance, provided that a pre-defined event or circumstance beyond the control of the parties has occurred.
Requirements
A debtor can only rely upon a force majeure to excuse performance of a contractual obligation if the contract contains an express force majeure clause which applies. A debtor cannot excuse his own performance on the basis of force majeure in the absence of an applicable force majeure clause.
The burden is on the debtor seeking to rely on a force majeure clause to show that:
an event referred to in the force majeure clause has occurred;
such event has prevented, hindered or delayed (as the case may be) the party from performing the contract; and
there have been no reasonable steps that the party could have taken to avoid or mitigate the event or its consequences (or for that matter, the party has already taken reasonably steps for mitigation purpose).
Force Majeure Events and Acts of God
The events referred to in a force majeure clause are commonly referred to as “acts of God” and may be:
specified events such as “natural disasters”, “strikes”, “war”, “embargo” and “legislative or administrative interference”; or
unspecified events such as “events due to natural causes” and “causes beyond the parties’ control”.
Impossibility of Performance
Whether a force majeure clause applies or not depends upon the construction of the clause. For example, some contracts may provide relief only when a force majeure event has rendered performance of an obligation physically or legally impossible.
In this case, a creditor may oppose the debtor being relieved from performance, arguing that such performance has merely become unprofitable or otherwise more difficult than the debtor originally contemplated.
Frustration
In the absence of an applicable force majeure clause, a debtor may argue that its performance of a contractual obligation was frustrated and thus, that it is excused from performance of the contract. At common law, frustration terminates a contract and discharges the parties from their respective obligations.
In general terms, frustration may be invoked where a circumstance emerges after the formation of a contract and, taking into account the nature of the contract and the circumstances surrounding it when the contract was entered into, the obligations under it are no longer capable of being performed or performance of those obligations will be radically different from what was originally contemplated. Frustration will only provide relief if the party seeking to rely upon it is without blame or fault.
Courts do not readily find frustration. Frustration is not lightly to be invoked to relieve contracting parties of the normal consequences of imprudent commercial bargains. The mere fact that the circumstance impairs the economic viability of performance of a contractual obligation is insufficient to frustrate a contract. If contracting parties wish to avoid hardship from circumstances outside of their control, it is open for them to make specific provision in the contract through force majeure provisions.
Uncertainty Surrounding the Operation of Force Majeure or Frustration during Covid-19
Businesses faced with recalcitrant counterparties unwilling to meet their obligations may consider the possibility of litigating the claims. However, they should be prepared for possible challenges by those counterparties given that the present pandemic provides a new and untested context for arguing force majeure or frustration.
For debtors seeking to rely on force majeure or frustration to dispute a claim or to avoid insolvency or corporate bankruptcy, it should be noted that debtors have historically faced difficulties succeeding with these arguments, and it is unclear how the courts will respond in the context of the pandemic. Force majeure or the frustration doctrine may not apply and hence, may offer no protection from a breach of contract claim in the event that a counterparty fails to perform.