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Production stop and supply chain disruptions – What does the lockdown mean from a legal perspective?

Sebastian Wiendieck and Felix Engelhardt from Rödl & Partner, Shanghai.

Production stop and supply chain problems – What does the lockdown mean from a legal perspective?

Since late March, the 26 million metropolis of Shanghai has been subject to lockdown regulations, which have had an extreme impact on local residents as well as thousands of companies in the Shanghai metropolitan area. For the business community, the lockdown means a standstill or severely restricted operational business, disrupted supply chains, absence of staff and other obstacles. To minimize the damage, the Chinese central and local governments try to support the economy with the help of various emergency measures. Despite this assistance, companies face numerous issues that cannot be addressed with direct government support alone.

How should the production stop in Shanghai be dealt with? What is the current legal situation in this regard?

Pandemic control measures are based primarily on China’s Emergency Response Law, Law on Prevention and Treatment on Infectious Diseases, and local regulations such as the Regulations of Shanghai Municipality on Public Health Emergency Management. In theory, companies and individuals can take legal action against unlawful government actions under these regulations. However, the likelihood of successfully enforcing legal remedies is very low due to the importance of the “fight” against COVID-19. At best, action against such measures may only be successful in cases of particularly blatant legal violations (such as the sealing of buildings in evident violation of fire protection regulations). As a rule, however – including from a strategic perspective – the path of mitigating damage within the framework of applicable laws is preferable. Here, companies focus on compensating for lost revenue through temporary cost reductions, as well as capitalizing on government support.

Numerous emergency measures have meanwhile been enacted at both national and local level, primarily aimed at small and medium-sized enterprises (SMEs). In Shanghai, for example, a package of 17 financial support measures has been passed. These include measures to facilitate loan financing for SMEs. However, it is unclear whether foreign companies will also be able to benefit from these measures, particularly in the case of new loans.

On the expenditure side, the reduction of staff costs, rents and taxes plays a major role.

  • If employees are unable to work during a lockdown, the contractually owed salary must still be paid and the employment contract may not be terminated during this time. Many companies can mitigate consequences somewhat by offering home-office work. Should prove impossible, companies are permitted – after consultation with employees – to reduce working hours or require employees to take paid leave. In addition, the salary of employees who are unable to work can be reduced to the locally applicable minimum salary after one payment cycle (usually one month).
    However, such measures should always be coordinated with the local labor authorities. In the manufacturing sector, where home office work is naturally not possible, many companies have been following a government-imposed system of closed production processes (closed loop) in the past weeks. From a legal perspective, particular attention needs to be paid here to occupational health and safety regulations. Relevant authorities have issued a series of measures that companies must comply with when resuming business operations in order to avoid new infections. Practical implementation will present considerable challenges for many companies.
  • For rental payments, SMEs as well as sole proprietors who rent their production and office space from government agencies can be exempted from rent payments for up to six months. According to the Shanghai Municipal State-Owned Assets Supervision and Administration Commission, no proof that the business operation is affected by the lockdown measures is required for the rent waiver.

What are the risk mitigation options regarding persistent supply chain issues?

Despite the “closed-loop”, one of the biggest problems is that companies are unable to obtain urgently required parts and raw materials, are unable to obtain their own goods from their own factories, or can only do so with great difficulty. Shanghai has now issued a so-called “white list” listing 666 companies, which is to be extended to 1,188 companies that will be allowed to resume business operations. In addition, it is possible to apply for so-called transport passes for essential goods, pharmaceuticals, food and strategic reserves, power supply, key information technology and foreign trade. However, only a very small number of companies currently benefit from this.

A major follow-up problem is the possible breach of contractual obligations in the supply chain. Whether the situation can be mitigated on the basis of “force majeure” depends entirely on individual circumstances and the content of the contract in question. If there are no contractual provisions and the respective contract is subject to Chinese law, force majeure exists under the Chinese Civil Code if the epidemic or the resulting measures are an event that is objectively unforeseeable, unavoidable, and unmanageable.

In principle, the COVID-19 pandemic was classified as force majeure by the Legislative Affairs Committee of the National People’s Congress in early 2020. However, in a notice dated April 10, 2022, the Shanghai Supreme People’s Court emphasized that in individual cases, the causality and proportion of the pandemic for the complete or partial inability to fulfill a contract must be taken into account above all, and appropriate distribution of interests must be sought. For this reason, it is advisable to seek contact with contractual partners first before taking unilateral action, as partners may also suffer under the impact of government measures. At present, the only option open to companies is to prepare both operationally and strategically that measures will stay in effect for the time being, which includes contractual risk-sharing.

Sebastian Wiendieck is a lawyer and partner at Rödl & Partner in China. In Shanghai, he and his team mainly provide legal services to German and European companies that are represented in China by subsidiaries and branch offices or want to enter the Chinese market in other ways.

Felix Engelhardt is a German lawyer and a Senior Associate at Rödl & Partner in Shanghai. Since 2018, he has been providing legal counsel to foreign companies in various areas of their business in China, in particular on investment, commercial and corporate law issues, intellectual property protection as well as cybersecurity and data protection.

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