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Konstantin Christie
Peter & Kim, Sinagpore
KChristie@peterandkim.com

Charis Tan
Peter & Kim, Singapore
CharisTan@peterandkim.com

Mino Han
Peter & Kim, Seoul
MinoHan@peterandKim.com

 

Introduction

When circumstances change to alter the balance between the parties to a contract, the law nonetheless seeks to do justice. Due of its diverse legal traditions and history, the Asia-Pacific region is home to a number of different approaches that address such situations of hardship and changed circumstances.

In this context, two European legal traditions have been influential in the development of distinct approaches to hardship. In the Asia-Pacific region, the German Civil Code has formed the basis of the civil laws of Japan and South Korea. The English common law system was a precursor to that of the region’s Commonwealth countries (Australia and Singapore). This article will first discuss some of these differences by focusing on South Korean law and comparing its provisions with German and Swiss laws. It will then address force majeure and frustration under Singapore law as an example of the common law approach to changed circumstances. Finally, it will briefly outline the most recent versions of the International Chamber of Commerce (ICC) Force Majeure and Hardship Clauses published in March 2020 which aim to bridge the gap between the two approaches.

Concepts from civil law

Dealing with changed circumstances under South Korean law

The law of contracts in South Korea, is in great part codified in the Korean Civil Act (the 'Act'). The term ‘hardship’ neither appears in the Act nor does the Act provide for such a principle in more general terms. While for certain types of contracts, such as employment contracts, special provisions do exist in the Act which provide that a party may terminate the contract where an ‘unavoidable cause’ has occurred, no definition of ‘unavoidable cause’ is contained within the Act itself. It is therefore unclear whether ‘unavoidable cause’ as a ground for termination of an employment contract is equivalent to ‘hardship’ which is generally understood to be a circumstance ‘where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished (...)’.^[1]

In 2004 and 2014, respectively, amendment bills of the Act were submitted to South Korea’s parliament. Each of these bills included a clause stating that if there was a significant change of circumstance that was unforeseeable at the time of the contract performance and where validly maintaining the contract would result in manifest injustice, a party may request the counterparty to modify the relevant terms of a contract in light of the changed circumstance, and may terminate the contract if the parties fail to reach an agreement on modification. On both occasions, however, the bill was not passed. Therefore, a general hardship provision has yet to be incorporated into the Act.

In the absence of a general hardship provision, South Korea’s courts have assessed the possibility of construing hardship as a ground for termination of a contract where circumstances underlying a transaction have significantly changed. For instance, in 2007, South Korea’s Supreme Court ruled that a contract may be terminated on grounds of a ‘change of circumstances’ if: (1) an objective factual circumstance underlying the contract has materially changed; (2) such change was unforeseeable by the parties at the time of execution of the contract; (3) such change is not accountable to either party; and (4) validly maintaining the contract would result in a serious violation of good faith.^[2] In a more recent judgment in 2017, the Supreme Court held that hardship (or ‘change of circumstances’) could be relied on as a grounds for terminating a contract if the first two elements above are met, ie: (1) a material change of an objective factual circumstance underlying a contract; and (2) the ‘unforeseeability’ of such change.^[3]

Importantly, however, while the above decisions mention the ‘possibility’ of hardship as a ground for termination, hardship was never actually applied and determined by South Korea’s courts as a ground for contract termination, except in some limited cases on the termination of guarantee contracts with no fixed term.

Separately, South Korea’s courts also recognise the principle of force majeure which operates to release parties from their contractual obligations. The event in question, however, must be ‘unforeseeable and unavoidable’. Furthermore, just because an event is unavoidable, it does not per se constitute a force majeure event. Under South Korean law, therefore, a party may not be able to rely on a statutory force majeure defence if the event in question was foreseeable.

In practice, the gap in the law is frequently filled with contractual hardship clauses. These clauses are most often seen in contracts for construction works. In this regard, South Korea’s Framework Act on the Construction Industry (Framework Act) provides that where the terms of a contract are remarkably unfair to a party to the contract, the following part(s) of a contract shall be deemed ineffective:

‘1. Where either party to the contract does not approve changes to the contract amount which occur due to design change or changes in economic conditions after the conclusion of the contract without good cause, or passes the burden on to the other party to the contract’ (emphasis added).^[4]

In other words, a construction contract governed by South Korean law should in principle include a hardship clause (ie, a clause that allows for a change in the contract amount resulting from a ‘change in economic conditions after the execution of the contract’). Where such remedy is precluded, the Framework Act would render the relevant part of the contract ineffective. This statutory provision provides some protection to the contractor who, for whatever reason, failed to include a hardship clause in a contract for construction works governed by South Korean law. Whether such an approach would be applicable in the context of other industries is, however, unclear.

Changed circumstances (clausula rebus sic stantibus) under German Law

Compared with the treatment of hardship under South Korean law, German legislators codified the legal doctrine of changed circumstances (clausula rebus sic stantibus).^[5]

Originally developed to mitigate the consequences of the First World War, in particular, shortages of goods, production difficulties, and the devaluation of currency, the Supreme Court of the German Reich first recognised the doctrine of clausula rebus sic stantibus in the 1920s.^[6] In 2002, this doctrine of clausula rebus sic stantibus (Wegfall der Geschäftsgrundlage) has been codified in Section 313 of the German Civil Code, which stipulates:

‘(1) If circumstances which became the basis of a contract have significantly changed since the contract was entered into and if the parties would not have entered into the contract or would have entered into it with different contents if they had foreseen this change, adaptation of the contract may be demanded to the extent that, taking account of all the circumstances of the specific case, in particular the contractual or statutory distribution of risk, one of the parties cannot reasonably be expected to uphold the contract without alteration.

(2) If material assumptions that have become the basis of the contract subsequently turn out to be incorrect, they are treated in the same way as a change in circumstances.

(3) If adaptation of the contract is not possible or cannot reasonably be imposed on one party, the disadvantaged party may terminate the contract. In the case of a contract for the performance of a recurring obligation, the right to terminate is replaced by the right to terminate on notice.’^[7]

If the requirements set out in section 313(1) are fulfilled, a party will be entitled to demand from the court or the arbitral tribunal an adjustment or cancellation of the contract. When assessing whether or not the party can be reasonably held to its contractual obligations, courts and arbitral tribunals will usually perform a case-by-case analysis taking into account the circumstances of each case and, in particular, the allocation of risk which is provided by contract or by law.^[8] For instance, section 313 was the clause most commonly relied on by German gas suppliers (and customers) in price-revisions during the 2012 excess gas supply.

In this respect, one may observe that German law allows contract parties to rely on hardship as a grounds for contract adaptation or termination in a more predictable manner as it provides for an explicit and codified provision on this issue, whereas South Korea’s courts appear to be far more reluctant to apply the doctrine of hardship unless a specific contractual provision is applicable, such those contained in construction contracts.^[9]

Hardship under Swiss law

The Swiss Code of Obligations (SCO), which also stems from the Germanic civil legal tradition, does not codify the principle of clausula rebus sic stantibus. However, the doctrine of hardship due to a radical or extraordinary change in the contract equilibrium is recognised by the Swiss Supreme Court as a matter of general principles of good faith and fair dealing (Article 2 of the Swiss Civil Code).

Swiss contract law, specifically governs the impossibility of performance in case of an unforeseen event (more closely associated with the doctrine of force majeure) under Article 119 SCO as follows:

‘(1) An obligation is deemed extinguished where its performance is made impossible by circumstances not attributable to the obligor.

(2) In a bilateral contract, the obligor thus released is liable for the consideration already received pursuant to the provisions on unjust enrichment and loses his counter-claim to the extent it has not yet been satisfied.

(3) This does not apply to cases in which, by law or contractual agreement, the risk passes to the obligee prior to performance.’^[10]

According to Article 119 SCO, therefore, the legislator anticipated a number of consequences for the party affected by a specific circumstance and the Swiss Supreme Court further mandated that for a party to be released from performance under article 119(1) SCO that event has to be unexpected and unforeseeable, and be beyond the control of the parties (ie, could not have been prevented by applying due care).^[11]

If the obligor is not responsible for the impossibility of performance, the obligee’s claim is extinguished by operation of law at the time of the occurrence of the impossibility. The obligor is thus released and the obligee loses his claim definitively (if the impossibility is a permanent one).

However, while impossibility falls under Article 119 SCO, impracticability or hardship is covered by the principle of clausula rebus sic stantibus, and not by Article 119 SCO. This is so because the legal consequence of Article 119 SCO (discharge of obligation) is considered to be inappropriate in situations of impracticability (hardship).^[12] Impracticability and the application of the clausula principle do not discharge the relevant obligation (or release the obligor), but may lead to an adaptation of the contract by the court or arbitral tribunal.^[13]

Concepts from common law

Dealing with changed circumstances under Singapore law

Under English law and Singapore law, there is no generally applicable principle of force majeure, and events of such nature are contractually provided for. Contracts commonly contain force majeure clauses.

As a contractual remedy, the effect of a force majeure clause depends on its formulation and its precise wording is important in determining its effect. Such clauses would usually spell out the conditions under which the clause can be invoked and the duration for which the performance of the contract would be suspended. Such clauses would also often specify a period of suspension, beyond which either or both parties could give notice to terminate the contract. Therefore the contractual clause could be of a similar effect to the statutory provisions outlined above which recognise that a party may be entitled to suspension of performance or termination. The key difference is that, under Singapore law and common law in general, force majeure would have to be contractually provided for.

Under Singapore law, there is also no generally applicable principle of ‘hardship’, such as that under South Korean law, but this can be contractually provided for. For instance, construction contracts often contain hardship clauses that allow for adjustment of the contract price due to changes in the contractual equilibrium.

Even where a contract does not contain a force majeure or hardship clause, however, a contract may nonetheless be terminated and the parties discharged from further performance, based on the doctrine of frustration.

Where an unforeseen event occurs, without fault of either contracting party, and that event causes the contract to be impossible to perform, or radically differ from that contemplated by the parties to the contract, the contract will be deemed frustrated. Under this doctrine, however, the threshold is high and mere difficulty or extra cost is insufficient to amount to a frustrating event. The requirement is that of near impossibility and its applicability is not, therefore, easily established. Traditionally, English and Singapore law rejected the notion of relief for changed circumstances not amounting to impossibility. The doctrine of frustration is not generally, therefore, extended to situations where due to unforeseen circumstances; performance could only be rendered with slight additional difficulty, expense or loss.

Against this backdrop, on 2 April 2020, the Singapore government stepped into the fray, introducing the Covid-19 (Temporary Measures) Bill in parliament. The new law is intended to provide temporary relief for businesses and individuals who are unable to meet contractual obligations due to the economic impact of the pandemic. While this legislation will not remove the parties’ contractual obligations, such obligations can be suspended for six months and may be extended to up to 12 months.

ICC Force Majeure and Hardship Clauses 2020

On 25 March 2020, the ICC published its new force majeure and hardship clauses (ICC Force Majeure and Hardship Clauses 2020)^[14] updating its 2003 versions.^[15] The new clauses offer a simpler definition and extend their applicability to suit various companies’ needs, allowing them to opt for a considered set of events and circumstances by reference, in time for the numerous disruptions caused by the Covid-19 pandemic.

The ICC Force Majeure and Hardship Clauses 2020 essentially follow the structure of their predecessors. However, a major change from the 2003 version is that it allows parties specifically to choose as a remedy a judge or arbitrator-ordered adaptation or termination of the contract if the parties fail to agree on alternative contractual terms which would allow them to overcome the situation of hardship. The previous version of the clause provided only for the right of termination in such situations. The latest ICC Hardship clause proposes three practical alternative formulations from which the parties can choose (options 3A, 3B and 3C).

With regard to the ICC force majeure clause, some important changes have been made. First, the new clause is now offered in a ‘Long Form’ and ‘Short Form’ versions, making it more user-friendly.

Unlike the previous version of the clause, the new ICC clause provides for a definition of a ‘force majeure’ event and specifically designates an ‘affected party’:

‘ “Force majeure” means occurrence of an event or circumstance […] that prevents or impedes a party from performing one or more of its contractual obligations under the contract, if and to the extent that the party affected by the impediment (‘the affected party’) proves:

a. the impediment is beyond the affected party’s reasonable control;

b. it could not reasonably have been foreseen at the time of the conclusion of the contract; and

c. the effects of the impediment could not reasonably have been avoided or overcome by the affected party.’

Perhaps more importantly, as noted by the drafters, the ICC force majeure clause may provide a lower threshold for invoking force majeure than the impossibility of performance, by reference to the reasonableness language in the cumulative conditions (a) to (c) set out above.

Furthermore, while the number of ‘conditions’, or categories of events that are presumed to qualify as force majeure remained the same in the 2020 version, there are some significant differences, including the new title of ‘Presumed force majeure events’.

First, reference to ‘civil commotion or disorder, mob violence, act of civil disobedience’ has been deleted under condition ‘(b)’ and this provision, which deals with civil war and revolutions, has now been merged with acts of terrorism, sabotage and piracy previously found in condition ‘(c)’. Gandhi would certainly have disapproved.

Second, under condition ‘(c)’, the ICC force majeure clause now includes completely new events, which have not been previously included in its list, which are ‘currency and trade restriction, embargo, sanction’.

Third, perhaps as a sign of increasing secularity of our times, all references to ‘acts of god’ under condition ‘(e)’ have been deleted from the 2003 version, and the typical enumeration of such acts as floods, storms, cyclones, typhoons, droughts and blizzards have been replaced with reference to a ‘natural disaster or extreme natural event’.

Amid the global Covid-19 pandemic, it must be mentioned that the said list still specifically considers plagues and epidemics as being force majeure events.

Finally, the new 2020 clause includes a ‘prolonged break-down’ of an ‘information system or energy’ as a force majeure event alongside industrial incidents such as explosion, fires, etc, replacing the somewhat dated reference to ‘telecommunication or electric current’.

Conclusion

Significant variations exist in how different civil and common law legal traditions deal with a change in circumstances. Nonetheless, parties to a contract can address these differences by paying particular attention to the drafting of the hardship (and/or force majeure) clause and by examining the applicable principles under the laws that govern the contract. Using industry or ICC clauses as a reference could be a tool to bridge the civil and common law divide and increase predictability in the application of a hardship (and/or force majeure) clause. Even so, the implications of the governing law of a contract on any such clause should not be overlooked. This is especially so given that the treatment of hardship, force majeure, changed circumstances and other relevant principles in each jurisdiction may evolve over time, by development of the law or enactment of legislation.