February 2020

BG: The Commercial Consequences of Coronavirus

The World Health Organization has declared China’s coronavirus as a global health emergency. With some businesses in China set to reopen this week after the new year break, the first few economic symptoms are beginning to appear. As China’s supply chain reaches to every corner of the globe, the virus will undoubtedly affect a vast range of commercial contracts; delays, disruptions and termination of contracts are already happening. But we have seen this before and we explain what to look out for in the next few weeks and months as the commercial toll of the virus unravels.

Force Majeure – that Old Juggernaut

Force Majeure or “FM” in short is often a knee jerk reaction when unforeseeable events disrupt business contracts. The China Council for The Promotion of International Trade (CCPIT) announced on 30 January 2020 that it will issue force majeure certificates to Chinese businesses for international trade contracts although its scope and impact on trading contracts typically governed under English is law is unclear. The phrase FM often gets bandied about but in the present situation, it may be vital to go back to basics to understand when the concept applies.

When faced with a decision relating to FM, the following 7 considerations are essential:

  1. Is there an FM clause in your contract? There is no free-standing concept of FM: it is a creature of contract and the express wording of the contractual clause will dictate when contractual obligations are suspended although other doctrines such as frustration, commercial impracticability may apply with different consequences depending on the governing law of the contract.
  2. Is the event covered by your clause? FM clauses dealing specifically with viruses are not common although it is arguable that the current situation falls under more typical provisions such as “epidemics” or “acts of government/ national laws”.
  3. Is there a link between the event covered and the contractual obligation and has the affected party met the threshold required? Establishing causation between non-performance and the event is key. FM clauses are couched in terms such as “prevented”, “hindered”,” disrupted” or “delayed” – each term connotates a different degree of impact that has to be established. If a manufacturing facility is affected, companies need to consider whether they can fulfil their obligations and ship from other plants, even if it means additional costs.
  4. Has the affected party mitigated its position? The party affected by an FM event needs to take reasonable steps to mitigate its position such as sourcing alternative suppliers.
  5. Are there connected or downstream contracts? The party affected by a declaration of FM may not have the same ability to declare FM to its downward counterpart in a string contract. For example, the FM certificates issued by the CCTIP may cover a Chinese supplier and its international buyer but it does not immediately follow that FM would apply in all contracts further down the chain.
  6. Can price volatility be considered FM? Prices are likely to be volatile in this period as supply dynamics are affected but a more expensive contract in itself does not warrant an FM declaration.
  7. Has the procedure been followed? An FM clause typically sets out the procedure and timing for notification of the FM event. Compliance with the procedural steps will be essential.

Experience has shown that businesses should be prepared for the worst. We have only seen the tip of the iceberg of the commercial effects of the virus. If the FM period is prolonger (which is conceivable in the present case), then parties would need to assess termination rights and whether mutual cancellation may be a viable option.

Where do we see the problems?

(i)      International Trade Contracts

International trade contracts are the hardest hit leading the CTTIP to announce its intention to issue FM certificates. The issue permeates throughout the supply chain from manufacturing, logistics and port clearance. Delays to shipment periods will be inevitable and commodities prices have been affected. The quality of goods may also be affected as they lie in port amidst port congestion and insufficient manpower. Such factors not only affect pricing between buyers and sellers but also the level of security that lenders have obtained in their trade finance. Traders should keep one eye on the expiry dates of guarantees or letters of credit while lenders should be alive to port closures and diversions impacting an already opaque business of trade finance.

(ii)     Charterparties

Trade contracts and charterparty contracts go hand in hand but they are not in-sync. An FM declaration in a trade contract may not necessarily give a right to an FM declaration in charterparty contracts (refer to the 7 step guideline above). There are several areas of a charterparty that will need to be examined in the event vessels are delayed, quarantined or diverted. Parties will need to examine whether such events can fall under the scope of safe port, laytime and off-hire clauses in charterparties.

(iii)    Shipbuilding Yards

Chinese yards typically at full capacity at this time of the year are hit with labour shortages. Deliveries of both newbuildings and scrubber retrofits have been delayed with knock-on consequences for owners and charters intending to deploy these vessels. Buyers of vessels will need to assess whether their contracts allow for termination in the present circumstances and even if so, whether the refund guarantees will respond to their claim. As with trade finance, security documentation will need to be revisited or reissued to ensure coverage over construction delays.

Concluding remarks

We do not see these problems going away that easily. Delays and costs implications will be substantial and every party, whether a trader, transporter, buyer, end-user or financier, needs to reassess its own contractual obligations. Even if FM does not apply, other contractual clauses or doctrines may apply such as frustration and commercial impracticability under other systems of law.

Time to dust off those old contracts.

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