When is an outbreak an act of God? Mitigating commercial and operational risks during the COVID-19 crisis (Global)

Plane and shipping containers

Litigation, Arbitration and Investigations Alert

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The ongoing global coronavirus outbreak, now officially designated as COVID-19 by the World Health Organization, will significantly impact international business and cross-border commercial operations, and it is unclear at this point how long this will last. Supply chains are being affected and containers are backing up on Chinese docks. Chickens in Hubei are at risk of starvation. Lobsters in New Zealand are being freed. Some factories in China are only now slowly getting back online, while others do not plan to restart production for several more weeks. Many Chinese citizens are increasingly bored and working from home (or not working), as a result of quarantines and restrictions on travel. Medical supplies, such as face masks and certain drugs, have either been depleted or are running low. In the US, Federal Reserve officials suggested the outbreak may cast uncertainty on the US economic outlook.

On January 30, the WHO declared the coronavirus outbreak a public health emergency of international concern (PHEIC). Neither medical professionals nor the WHO can yet predict how long the outbreak will last or how far it will spread globally.

These events are unprecedented in modern times and could have profound business implications if not proactively addressed. At what point do these events allow a party to a contract to delay performance, not perform, renege on agreed provisions, and/or renegotiate the terms of a business agreement? A closer look at a standard but often overlooked “act of God” or force majeure clause in contracts may provide some insight into options for mitigating commercial and operational risks during the ongoing health crisis.

Acts of God are often defined as events that occur due to natural causes which cannot be avoided through the use of caution and preventative measures. Examples of acts of God are natural disasters like earthquakes, tornadoes, or floods. Some contracts may even specify epidemics or pandemics as acts of God. In a commercial contract context, acts of God provisions eliminate or limit liability for injuries or other losses resulting from such events, deeming them beyond the control of the parties to the contract. An act of God may be interpreted as a defense against breach for failing to perform due to impossibility or impracticality; it could also provide a basis to renegotiate business arrangements affected by COVID-19.

Is COVID-19 an act of God?

When it comes to a public health crisis such as COVID-19, the threshold question is whether the specific circumstances are or may warrant a “triggering event” under the contract:

  • Does the contract define an Act of God or force majeure? What does it say?
  • Does the contractual definition include specific designations such as PHEIC, pandemic, or epidemic? If so, what standard applies (eg, World Health Organization, Centers for Disease Control and Prevention)?
    • During a WHO designated PHEIC, the WHO can issue temporary recommendations. These are non-binding measures that may address travel, trade, quarantine, screening, and treatment. WHO can also set global standards of practice during a PHEIC.
  • Some act of God provisions differentiate between naturally occurring disasters and government actions. Is the basis for non-performance due to the naturally occurring component (the virus itself) or a government action component (eg, quarantines, limitations on transportation)? Does it matter for your contract?
  • Is your contract governed under US, Hong Kong, or PRC law? The legal definition of an act of God may vary based on governing law.
  • In the PRC, there appears to be support that the outbreak of the coronavirus would be considered an unforeseeable and unavoidable event:

    The sub-committee in charge of legislative affairs under the PRC’s National People’s Congress Standing Committee appears to take the view that the outbreak of coronavirus is unforeseeable and unavoidable, and therefore shall be considered a force majeure event in accordance to PRC law [link in Chinese only].

    The China Council for the Promotion of International Trade (CCPIT) – the commerce chambers of China – is now issuing force majeure certificates to Chinese companies free of charge, recognizing the outbreak as a triggering event.

It is important to note that, at least for common law jurisdictions such as Hong Kong and the United States, there are no generally accepted or implied definitions for acts of God or force majeure events. Therefore, whether the current outbreak would apply to your contract will largely depend on the language of the contract, governing law, and specific circumstances.

Does your contract contain an international arbitration clause, involve an international contract for the sale of goods, and/or shipping and shipbuilding contracts? If so, special issues may arise.Please refer to this article for more details.

Notice and documentation

Contractual provisions may require that the party seeking to benefit from protection in an act of God event provide formal written notice as soon as that party becomes aware of the potential event. Some act of God provisions include time limitations and failure to notify in a timely manner could potentially jeopardize the company’s ability to invoke the provision. The party seeking this notice should also ensure that all evidence pertaining to the event and its direct causal link to the company’s inability to perform are properly documented and retained.

If you are on the receiving end of such a notice or anticipate that COVID-19 may pose an issue for your third-party vendors or suppliers in China, consider whether appropriate procedures and timely notification are being followed and that there is adequate documentation. A party cannot use COVID-19 as an excuse to escape liability for a breach that would have occurred regardless of the virus.

Thinking strategically

Before claiming protection under an act of God provision or taking your third-party vendor or supplier to court, consider the long-term implications of a dispute as well as any immediate consequences. For example, some act of God provisions may also trigger rights and remedies for the other party, such as the ability to terminate any exclusivity provisions or important master framework agreements. Would claiming protection allow a customer to break off an otherwise lucrative long-term partnership?

Furthermore, given the widespread impact of COVID-19, it is likely that your business partners and competitors are all facing similar issues. Even if you did sue your vendor or supplier for breach of contract, where else could you go? Given the impact of the outbreak, it may be difficult to quickly find a replacement vendor or supplier.

It is also likely that your customers may themselves be impacted by the outbreak. This offers you an opportunity to work with them and find creative solutions via a “we’re all in this together” mindset. Where all the parties to a contract value the arrangement and expect to continue to work together, the best outcome may be to negotiate new terms that address delayed performance and future expectations.

Disclosures and insurance

Companies should also consider other legal issues, including any required disclosures to customers, consumers, and/or regulators about the effects of the outbreak on their business. The US Securities Exchange Commission, for example, is monitoring companies’ disclosures related to the impact of COVID-19 on businesses.

Companies may also have insurance policies that provide coverage for such issues as business interruption or other disease-related losses. This is a sensible time to review your policy and remind yourself of its parameters, and to look ahead, proactively evaluating the adequacy of your current insurance coverage to mitigate any potential losses resulting from future infectious disease outbreaks.

Businesses and their business partners may also have questions about their legal obligations to employees in these unusual circumstances. If you have employees in China, Asia-Pacific, or the US, you will also want to review your obligations as an employer and identify and address key employment challenges.

COVID-19 is posing novel issues to businesses globally, and it is not possible to know the full effects it will have on business and trade. Proactive efforts to understand your rights, provide timely notices and disclosures, and seek practical solutions to business interruptions will best protect your business in the short term and for the future.

You may also be interested in our reports on breaking developments in the COVID-19 outbreak.