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Coronavirus Supply Chain Disruption and Force Majeure

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Image from Commercial Carrier Journal, https://www.ccjdigital.com/coronavirus-to-impact-freight-volume/

Significant Freight Disruption

The deadly coronavirus outbreak that began in Wuhan, China is predicted to have a significant impact on freight volume entering the United States from China.  https://www.ccjdigital.com/coronavirus-to-impact-freight-volume/

Wuhan is a major industrial and transport hub in central China.  According to a report from DHL’s Resilience360, Wuhan is known as China’s “motor city,” due to a large manufacturing presence of domestic and foreign car makers and global auto parts suppliers.  DHL reports “severe disruptions to inbound and outbound air cargo shipments, trucking and rail cargo services, as well as heavy port congestions for vessels along the Yangtze River near Wuhan will likely persist as the coronavirus crisis unfolds.”  Id.  

On February 4, 2020, Hyundai Motor announced it will suspend production in South Korea because of a disruption to the supply of parts, becoming the first major carmaker to do so outside of China. https://www.reuters.com/article/us-hyundai-motor-virus-china/hyundai-to-halt-south-korea-output-as-china-virus-disrupts-parts-supply-idUSKBN1ZY0GG

Hyundai and Kia are predicted to be more affected by the coronavirus outbreak as they tend to import more parts from China than other global automakers.  See id. (quoting Lee Hang-koo, senior researcher at the Korea Institute for Industrial Economics & Trade).

According to Standard & Poors (“S&P”), Volkswagen Group is the most exposed automaker because it produces and sells almost 40 percent of its cars in China, and its main plants are likely to be closed for extended periods. https://www.autonews.com/manufacturing/vw-automaker-most-exposed-virus-impact-sp-says  

S&P also reports Nissan is at high risk “considering its high exposure and recently weak performance” Id.  And, S&P singled out Honda which has a production base in Wuhan and relies on China for 30 percent of sales and output.  Id.  

According to S&P, the following automakers have prolonged existing Chinese holiday shutdowns at their China operations due to the virus outbreak:  

  • BMW’s China venture with Brilliance plans to restart car production on Feb. 17, according to a post on its social media.
  • Ford Motor Co. plans to resume production on Feb. 10 at its factories in Chongqing and Hangzhou.
  • Honda plans to extend the closure period for its three car plants in Wuhan, which it operates with Dongfeng Group, until Feb. 13.
  • Nissan said it is considering restarting production in China in its venture with Dongfeng sometime after Feb. 10. Production in Hubei will start sometime after Feb. 14, it said.
  • PSA Group said its three plants in Wuhan, the epicenter of the outbreak, will remain closed until Feb. 14.
  • Toyota shut factories in China through Feb. 9. The automaker, which runs plants in regions such as the northern city of Tianjin and the southern province of Guangdong, said it was assessing its parts supply situation.

The chief executive of Robert Bosch, the world’s biggest auto components supplier, warned on January 29, 2020, that the coronavirus could impact its global supply chain, which is heavily dependent on China.  https://www.reuters.com/article/us-china-health-bosch-virus/bosch-ceo-warns-coronavirus-could-hit-global-auto-supply-chains-idUSKBN1ZS10H  Bosch has been in China since 1909 and has 23 automotive manufacturing facilities in more than 60 locations in the country, and the largest Bosch workforce outside of Germany.  Id.  

China’s Response

Companies in China have started to declare force majeure as a result of the disruption caused by the coronavirus outbreak.   China National Offshore Oil Corp (CNOOC) has reportedly declared force majeure on prompt liquefied natural gas (LNG) deliveries from at least three suppliers.  https://business.financialpost.com/pmn/business-pmn/chinas-cnooc-declares-force-majeure-on-some-prompt-lng-deliveries-sources

The China Council for the Promotion of International Trade (“CCPIT”), the agency that promotes China’s foreign trade and investment, has also reportedly issued a force majeure “certificate” to a Chinese car parts supplier facing potential legal action for failing to fulfil an overseas order by Peugeot because of coronavirus shutdowns. https://www.scmp.com/business/china-business/article/3048767/peugeot-parts-supplier-risk-missing-overseas-orders-amid

The CCPIT states that its force majeure certificates are accepted by governments, customs, trade associations and enterprises in more than 200 countries and that they exonerate companies from liability by proving they were victims of events beyond their control.  CCPIT claims it has received over 1,000 enquiries from companies in relation to the applications. Id.  

Force Majeure

1)  Does your Contract Have a Force Majeure Clause (and if not . . . you likely should).

Most trade contracts contain a force majeure clause that excuses a party that is not able to perform obligations that become impossible or impractical because of an event that the parties could not have anticipated or controlled.  

However, even a force majeure clause does not always provide protection from liability.  As noted below, economic hardship standing alone will not suffice:  “[n]onperformance dictated by economic hardship is not enough to fall within a force majeure provision. A mere increase in expense does not excuse performance.  See, e.g., Rexing Quality Eggs v. Rembrandt Enters., 360 F. Supp. 3d 817, 841 (S.D. Ind. 2018).

2)  The Language of a Force Majeure Clause Will be Narrowly Construed.

Regardless of the provision of a “force majeure certificates” as being provided by the Chinese government in an effort to shield Chinese companies from legal liability, the language of the contract is of paramount importance in determining whether contractual obligations can be enforced.

Assuming your contract has a force majeure provision, look at the precise language.  Some contracts specifically refer to “epidemics” and others do not.  See Gulf Oil Corp. v. Fed. Energy Regulatory Com., 706 F.2d 444, 448 n.8 (3d Cir. 1983) (listing 27 possible force majeure events and also contains a standard disclaimer clause). Ordinarily, only when a force majeure clause specifically and unambiguously includes the event alleged to have prevented performance, will a party be excused from performance. The clause in Gulf Oil Corp. read in part:

X. FORCE MAJEURE

In the event of either party hereto being rendered unable, wholly or in part, by force majeure to carry out its obligations under this Agreement, other than to make payments due hereunder, it is agreed that on such party giving notice . . . then the obligations of the party giving such notice, as far as they are affected by such force majeure, shall be suspended during the continuance of any inability so caused . . . and such cause shall as far as possible be remedied with all reasonable dispatch. The term “force majeure” as employed herein shall mean acts of God, strikes, lockouts or other industrial disturbances, acts of the public enemy, wars, blockades, insurrections, riots, epidemics, landslides, lightning, earthquakes, fires, storms, floods, washouts, arrests and restraints of governments and people, civil disturbances, explosions, breakage or accidents to machinery or lines of pipe, the necessity for making repairs to or alterations of machinery or lines of pipe, freezing of wells or lines of pipe, the failure of production facilities for causes other than depletion of the source of gas supply, and any other causes, whether of the kind herein enumerated or otherwise, not within the control of the party claiming suspension; provided, however, that said term shall not mean or include any cause which by the exercise of due diligence the party claiming force majeure is able to overcome; and provided, further, that in no event shall said term mean or include partial or entire failure or depletion of gas reserves or sources of supply of gas. Such term shall likewise include (a) in those instances whether either party hereto is required to obtain servitudes, rights of way grants, permits or licenses to enable such party to fulfill its obligations hereunder, the inability of such part to acquire, or the delays on the part of such party in acquiring, at reasonable cost and after the exercise of reasonable diligence, such servitudes, rights of way . . . .

Id. (emphasis added).

3)  A Force Majeure Clause Will be Narrowly Construed Against the Party Invoking It.

Courts narrowly construe force majeure clauses against the party seeking to invoke the clause to excuse their performance. See, e.g., Kyocera Corp. v. Hemlock Semiconductor, LLC, 886 N.W.2d 445, 452 (Mich. 2015).  

In Kyocera Corp. the force majeure clause included “acts of God; acts of the Government or the public enemy; natural disasters; fire; flood; epidemics; quarantine restrictions; strikes; freight embargoes; war; acts of terrorism; [or] equipment breakage . . . .”  The court held that a “trade war” between China and the United States did not constitute force-majeure because plaintiff did not allege any “act[] of the Government” that directly prevented its performance under the contract.  Id. at 453.  

But compare Touche Ross & Co. v. Mfrs. Hanover Tr. Co., 434 N.Y.S.2d 575, 577 (N.Y. Sup. Ct. 1980) (Former President Carter’s executive order blocking all Iranian assets in the United States and severing diplomatic ties with Iran considered force majeure under contract defining force majeure to include “Flood, epidemics, earthquake, War, cases which are generally accepted by international practice as Force Majeure.”).

4) Price Fluctuations Are Generally Insufficient for Relief Under Force Majeure.

If a force majeure clause does not specify the event at issue, it is unlikely to cover events that result in price fluctuations.  Price fluctuations are typically not considered as outside the control of the buyer and will not render a contract unenforceable especially when there is any ambiguity in the language of the force majeure clause.  This issue was addressed by the Fourth Circuit in Langham-Hill Petroleum, Inc. v. S. Fuels Co., 813 F.2d 1327, 1330 (4th Cir. 1987).  

In Langham-Hill Petroleum, Inc., the price of crude oil in the world market collapsed January of 1986 as a result of Saudi Arabian attempts to regain its share of the world oil market. After the collapse, Southern invoked the force majeure clause and informed Langham-Hill that based upon the drop in world oil prices caused by the Saudi Arabians, it would not perform under its contract with Langham-Hill.  Id. at 1329.  Southern argued that the Saudi Arabians were “outside Southern’s control.”  Id. at 1329. The force majeure clause at issue included “acts of God, and the public enemy, the elements, fire, accidents, breakdowns, strikes, differences with workmen, and any other industrial, civil or public disturbance, or any act or omission beyond the control of the party having the difficulty, and any restrictions or restraints imposed by laws, orders, rules, regulations or acts of any government or governmental body or authority, civil or military.”  Id. at 1329 n.1.  

  

Langham-Hill sued Southern for breach of contract. The trial court granted Langham-Hill’s motion for summary judgment holding that the fall of oil prices in the world market did not relieve Southern Oil from its obligations under the contract. 

On appeal, the Fourth Circuit affirmed, stating: “‘[s]hortage of cash or inability to buy at a remunerative price’ cannot be regarded ‘as a contingency beyond the seller’s control.’  If fixed-price contracts can be avoided due to fluctuations in price, then the entire purpose of fixed-price contracts, which is to protect both the buyer and the seller from the risks of the market, is defeated.” Id. (quoting Wheeling Valley Coal Corporation v. Mead, 186 F.2d 219 (4th Cir. 1950)). The Fourth Circuit stated that market price fluctuations are a normal risk in any fixed price contract and that Southern took that risk when it entered the contract with Langham-Hill: 

A force majeure clause is not intended to buffer a party against the normal risks of a contract. The normal risk of a fixed price contract is that the market price will change. If it rises, the buyer gains at the expense of the seller (except insofar as escalator provisions give the seller some protection); if it falls, as here, the seller gains at the expense of the buyer. The whole purpose of a fixed price contract is to allocate risks in this way. A force majeure clause interpreted to excuse the buyer from the consequences of the risk he expressly assumed would nullify a central term of the contract.  

Id. at 1330 (citing Northern Indiana Public Service Co. v. Carbon County Coal Co., 799 F.2d 265 (7th Cir. 1986)). 

5) Ensure All Notice Requirements Are Satisfied (Theirs and Yours).

In order to receive relief under a contractual force majeure clause, the party seeking relief must demonstrate that any contractual prerequisites have been satisfied – including specifically any notice requirements in the contract.  

A typical notice provision may state: 

In the event of Force Majeure when the performance of this Contract becomes impossible the afflicted party must inform in writing to the other party of the occurrence of the said event or events, and also mention in his letter the estimated duration of time during which these circumstances will continue.  

E.g., Touche Ross & Co. v. Mfrs. Hanover Tr. Co., 434 N.Y.S.2d 575, 577 (Sup. Ct. 1980).  Ensure any requirements are strictly complied with.

Likewise, if you intend to reject a force majeure claim, ensure that your rejection is timely and in accord with any contractual requirements.  

A French energy company recently rejected a force majeure notice from a buyer of liquefied natural gas in China.  The head of the company’s gas, renewables and power division stated “Some Chinese customers, at least one, is trying to use the coronavirus to say I have force majeure. . . .We have received one force majeure that we have rejected.”  https://www.yahoo.com/news/frances-total-rejects-force-majeure-134245609.html

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Photo: Jiangnan Shipyard

https://www.tradewindsnews.com/shipyards/chinese-shipyards-declare-force-majeure-on-newbuilding-contracts-in-coronavirus-fallout/2-1-749561

8) Other Arguments – Frustration of Purpose

Depending on the specific facts and the jurisdiction, there may be other arguments that the party in breach can assert that are similar to force majeure.  For example, the frustration of purpose doctrine may offer some relief but the analysis will be jurisdiction and fact specific.  

A typical frustration of purpose doctrine requires the following elements: (1) the party’s principal purpose in making the contract is frustrated; (2) without that party’s fault; and (3) by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made. See, e.g., Rembrandt Enters. v. Dahmes Stainless, Inc., 2017 U.S. Dist. LEXIS 144636, at *25-27 (N.D. Iowa 2017).

In Rembrandt Enters., Rembrandt, a large-scale producer of eggs and egg products, entered into an agreement with Dahmes for certain equipment as part of a planned expansion to become a more significant supplier for Kellogg. After the contract was entered into but before it was performed, an epidemic of Highly Pathogenic Avian Influenza (Avian Flu) hit the United States.  The Avian Flu is an aggressive illness fatal to domestic poultry and Rembrandt was forced to eliminate over a million birds, which cut its production capacity by over 50%.  Id.  at *3-7.  As a result of its lost capacity, Rembrandt lost its opportunity to supply eggs to Kellogg and canceled the planned expansion.  Dahmes sued and Rembrandt moved for summary judgment arguing that the purpose of the contract was thwarted by the Avian Flu outbreak.  

The court denied the motion for summary judgment noting that there were multiple disputed findings of fact.  Id. at *25-27.  As to the first element requiring a showing of frustration of principal purpose, the court noted that Rembrandt could not point to the specific moment that the contract’s purpose was frustrated: “Was it when the outbreak of Avian Flu occurred? Was it later, when Rembrandt’s board decided not to go forward with the Thompson plant? Was it when Kellogg decided to reduce its dependence on egg products?  Was it when Rembrandt’s financing collapsed?” Id. at *24. The court noted that the second and third elements presented similar uncertainties. Id. at *24.   As to the third element (i.e. “the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made”) the court noted that the occurrence must also be understood by both parties to the contract. Id. at *26.   

7) Other Considerations – Has There Been a Material Breach?

For a breach of contract to be actionable, a party must establish a material breach. Vienna Metro LLC v. Pulte Home Corp., 786 F. Supp. 2d 1076, 1081-82 (E.D. Va. 2011) (citing Horton v. Horton, 254 Va. 111, 115, 487 S.E.2d 200 (1997)). A material breach is a failure to comply with a fundamental aspect of the contract, so that the failure to perform that obligation defeats an essential purpose of the contract. See id.; see also PBM Prods., LLC v. Mead Johnson Nutrition Co., 678 F. Supp. 2d 390, 398 (E.D. Va. 2009).

If a contract makes timely performance essential, a failure to timely perform can be a material breach. See id. (citing United States ex rel. Virginia Beach Mech. Servs., Inc. v. SAMCO Constr. Co., 39 F. Supp. 2d 661, 672 (E.D. Va. 1999)).

There are also trade rules “that allow the buyer to fix an additional period, but if the export fails in the new period then the exporter might still be liable for damages.”  https://www.scmp.com/business/china-business/article/3048767/peugeot-parts-supplier-risk-missing-overseas-orders-amid

If you have any questions about this article, please contact Alison Feehan (afeehan@setlifflaw.com) at 804-377-1279 or Steve Setliff (ssetliff@setlifflaw.com) at 804-377-1261.