This content is from: Corporate

Practical tips for companies in applying force majeure

Chung Jin Chung, legal counsel at Korea Gas Corporation in Seoul, shares insights for companies in Korea and beyond

www.kogas.or.kr

Since March 11 2020, 181 countries have implemented travel bans or restrictions on movement of humans and materials. Many countries announced that all new visitors, including labour workers will not be allowed entry or must be quarantined for a certain period (normally 14 days from the date of the entry). Due to the early outbreak of Covid-19 in Korea, 181 countries banned or limited the entry of Koreans. This unprecedented scale of restrictions differentiates Covid-19 from other epidemics.

As Covid-19 continues to hinder, delay, interrupt or prevent construction works, construction companies may find it difficult or impossible to satisfy their obligations. This article shows key clauses that may be used by an affected party for excusing itself from its obligations or claiming extension of time or additional payment.

It must be noted that the following analysis depends on terms and conditions and governing law with specific facts.

Force majeure

Under Korean law, even if there is no black letter law about force majeure, there are Supreme Court cases which provide elements of a force majeure defence as follows:

1. the cause of the force majeure must be beyond the affected party's control; and

2. such an event was not foreseeable or preventable within the affected party's reasonable efforts.

If the affected party finds it impossible to perform its obligation due toa force majeure event which is not attributable to the affected party, it will be excused from contractual obligations and the other party shall not be entitled to enforce such obligations against the affected party, except for wilful misconduct or gross negligence of the affected party.

There are few cases to excuse the affected party from its obligations with a force majeure defence. For example, there was a case related to a hotel booking in 2016 at the Jeju District Court. The defendant had an agreement with the plaintiff to book 60 hotel rooms for Chinese tourists. But due to the MERS outbreak, many tourists cancelled their trips to Jeju. The defendant argued that his obligation to use 60 hotel rooms should be excused due to the MERS outbreak which prohibited him to perform his obligations. The court decided that the defendant should not be excused to pay for 60 rooms since his obligation under the agreement was to make payments for the hotel reservation, not to use 60 rooms. Therefore, the MERS outbreak did not lead to impossibility to make payments to the plaintiff.

Korean courts have interpreted force majeure with a very strict standard. Korean courts have not determined the outbreak of SARS and MERS as force majeure. However, the Ministry of Land, Infrastructure and Transportation issued an authoritative interpretation about Covid-19 as a force majeure event under Article 17 of the Standard Contract for Private Construction Projects on February 28 2020. It provides that a contractor can request an owner to extend construction periods and additional payments. The owner must immediately confirm the fact claimed by the contractor and take necessary measures, including additional payments or extension of construction periods considering conditions of the site. In addition, the owner cannot impose liquidated damages.

Even though Korean courts have set a high threshold to satisfy elements of force majeure, it should distinguish Covid-19 from SARS and MERS because of the nature and severity of Covid-19, and the significant and strong government measures taken by various countries.

Change in law

If a contract includes a clause to cover a change in law, an affected party might ask for extension of time and/or additional payment according to its contract.

On February 12 2020, the Ministry of Economy and Finance issued the public contract management guideline for Covid-19.According to this guideline, government authorities or public agencies must:

  • issue stop work orders on construction or service at sites where performance of work is deemed substantially impaired due to confirmed or presumptive positive cases of Covid-19,extend the deadline for performance as necessary, and increase the contract price to cover additional costs incurred by the contractors; and
  • where stop work orders are not issued, exempt contractors from liquidated damages for delays due to unavoidable impairment of performance in work or supply in connection with Covid-19 and adjust the contract price in accordance with the requirements for adjustment.

This guideline is only applicable to domestic contracts between government agencies and private parties, and limited to certain situations of public contracts. According to the guideline, if the government orders an employer to shut down a workplace because of a suspected or confirmed case of Covid-19, the employer must shut down the workplace and will be excused from obligations to pay wages to employees. In addition, the employer can apply for a government subsidy of up to KRW 130,000 ($109) per day to offer paid leave to confirmed or suspected employees.

Even though there are government guidelines, whether the employer can be excused from its obligations depends on the interpretation of the contract. If a contract broadly defines law and includes government guidelines, instruction or interpretation, it may satisfy the conditions under the public contract management guideline.

If a contract has very narrow and strict definitions of law or no definitions, it will be very unlikely to be successful to be exempt from its contractual obligations.

Termination

As a legal principle, a contracting party will be entitled to terminate a contract when there is a significant change of circumstances if the following conditions are satisfied:

1. it is unforeseeable at the time of signing of the contract;

2. a significant change of circumstance has occurred without a fault of a party which acquires a right to terminate; and

3. due to such change, it results in direct contradiction to the principle of good faith if contracting parties are bound by an existing contract.

However, Korean courts are reluctant to allow a contracting party to terminate a contract due to a change of circumstances. For instance, the global financial crisis was not a basis for termination.

Therefore, it will be hard to argue that a contracting party is entitled to terminate a contract due to Covid-19.

Liquidated damages

Under Korean law, if a party claims damages against the other party, it must be the other party's fault. The affected party might argue that he/she should be released from liquidated damages for delays if construction is only delayed due to Covid-19 without a fault of a party and pre-existing delay caused by the affected party prior to Covid-19.

International perspectives

In most countries, legal principles may excuse contractual obligations due to force majeure or frustration even though each court applies such principles differently. In the case of an international construction contract, if a party believes that it has been affected by Covid-19, it should firstly consider whether there is a clause to cover force majeure under its contract. If the contract contains such a clause, a party must carefully look at whether Covid-19 satisfies the definition of force majeure and other conditions under the contract. If there is no clause or Covid-19 does not fall within the force majeure clause, a party may seek to rely on the change in law or frustration.

Elements of force majeure

The force majeure clause expressly regulates for unforeseen and uncontrollable events in a contract. Many contracts include the force majeure clause to allocate risks of force majeure events affecting a party's obligations to perform its work on time. If the contract includes epidemic or pandemic as a force majeure event, after WHO's declaration of Covid-19 as an epidemic on March 22 2020, the affected party might argue that the outbreak of Covid-19 should be one of the force majeure events in the contract and trigger the force majeure clause.

For example, under New York law, if a contract has express terms and conditions to cover force majeure events, a party may be excused from its obligations after the occurrence of a force majeure event. However, New York courts may not enforce a force majeure clause unless a force majeure event is specified in a contract and unforeseeable at the time of signing a contract. In common law systems, there is no precise definition of force majeure. Therefore, the affected party should rely on contractual terms. Under civil law systems, there might be a doctrine of force majeure which means exceptional and unforeseen events. However, it depends on the interpretation of each country's court.

A common thing to consider is a notice to the other party. A typical force majeure clause requires an affected party to provide a written notice within certain period. Even if a party claims under law or there is no requirement for notice, an affected party should consider to provide the other party with a written notice of Covid-19 and its impacts to establish its claim. At the same time, the parties should establish protocol for who bears additional costs to mitigate another outbreak of Covid-19, how the relief may be provided, and which remedies will be granted. If a contract has a notice requirement, the party must strictly comply with the requirement. Even if there is no requirement of the notice, the claiming party should consider providing a written notice to the other party.

Frustration

After a party considers a force majeure clause, the next call is frustration. Frustration arises when the parties under a contract become incapable of performance due to an intervening event which makes further performance totally different from what the parties contemplated at the time of execution of the contract. To satisfy incapability of performance, such an event makes it commercially or physically impossible to perform further obligations from the date of frustration, or obligations being radically different than those undertaken at the time of execution of the contract. Therefore, a party cannot invoke the doctrine of frustration when there is delay of schedule, economic hardship, change in market situation, or financial loss to perform its works under a contract. It is a very high and strict standard to establish. To establish frustration under common law, a party has to show that an event or circumstance destroys its original purpose of a contract.

Under English law, Davis Contractors Ltd v. Fareham UDC [1956] AC 696 provides the general test for frustration as follows:

"…So perhaps it would be simpler to say at the outset that frustration occurs whenever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. Non Haec in Foedera Veni. It was not this that I promised to do."

Under New York law, the elements for frustration are as follows:

1. an event must be unanticipated, unforeseeable or unexpected;

2. risks related to such event has not been allocated by a contract; and

3. the parties might perform their obligations, but such performance by one party would not provide that the other party is promised to be bargained at the time of signing a contract.

In addition, according to Restatement Second of Contracts § 265, a contract is frustrated "where, after a contract is made, a party's principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary."

If the contract is frustrated due to Covid-19, contractual parties are automatically discharged from further obligations at the date of frustration, but still remain liable for obligations up to the time of frustration. It depends on the governing law of a contract.

Change in law

There are new regulations, guidelines, ordinance from various government on Covid-19 after WHO's declaration. Some governments only provided guidelines instead of new laws or regulations. Therefore, the affected party should precisely consider wording of the change in law clause to determine what kinds of relief may be allowed under such a clause.

Insurance

Parties should review any insurance policies to assist them. For example, if a party has business interruption insurance, it should analyse the policy, facts surrounding the causation and losses.

During and after Covid-19

There are two different approaches to capture the impact of Covid-19. One approach is to use a force majeure clause to include such a pandemic or epidemic. Another approach is to have an independent clause. The reason for an independent clause is that the remedies applicable to normal force majeure events and Covid-19 impacts may be different and contractual elements to satisfy the definition of pandemic or epidemic will also be different.

For example, under Korean law, a force majeure event should be unforeseeable and beyond a party's control. Since Covid-19 is a known event for future contracts, to avoid the risk that a similar situation in the future is deemed foreseeable and under a party's control, the parties must ensure that such a risk is properly addressed in a contract. Therefore, it is necessary to have a new clause to cover a pandemic or epidemic. When drafting or negotiating such clauses, it is important to exclude a foreseeability element from the definition. The definition should be broad in order to cover guidelines, notes, or interpretations from governments or international organisations. In addition to a new clause, to mitigate its risks, a party must pass its risks related to the epidemic to subcontractors and vendors, including the governing law.


Chung Jin Chung
Senior legal counsel, Korea Gas Corporation

Seoul, South Korea
www.kogas.or.kr

Chung Jin Chung is a senior legal counsel at Korea Gas Corporation in Korea. He has 10 years' experience, advising companies on their energy projects around the world and has experience across the energy value chain (particularly oil & gas and LNG) in developed markets and emerging markets.

He is a chairman of the Intra-Pacific Energy Coalition; international arbitrator at Korea Commercial Arbitration Board International; chairman for energy & natural resources at the International Association of Korean Lawyers; specialist mediator at the Singapore International Mediation Centre; legal advisor at the Korea Plant Industries Association; member of Marketing & Communication Committee of International Gas Union; and member of the Energy & Industry Committee at the Canadian Chamber of Commerce in Korea.

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