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COVID – 19 has resulted in many changes globally and its is felt by industries across sectors. government across the globe has ordered lockdown, restricted international travels and purchases for luxury. As a result of all these the financial burden coupled with a huge uncertainty over the performance of existing contracts.
The businesses have been impacted and so have operations and consequently contracts under this situation has been obligated to look upon this issue. The most common term that has shown the relevance during these times is “force majeure” and this will be constructed in a contract in the background of COVID – 19.
The definition of “force majeure” and “contract frustration,” the importance of the same in firms, the importance of the same in industry, the difference between the two, main aspects that one would like to keep in mind while drafting this clause and the repercussions of COVID -19 contracts in India.
From the corporate point of view, the force majeure could be in the form of “material adverse effect or adverse change”. The exact impact of COVID-19 pandemic on parties’ liabilities under commercial contracts is unforeseen. The highly diverse nature of resources and services are required to perform contractual obligations, there is danger that many parties may be unwillingly or unable to continue with their obligations.
What is a force majeure?
Force majeure is a concept that is taken from the English common law. It is understood as an universally applicable concept in civil law tradition as a contractual clause to those events which are not under the control of the parties and is unforeseen and the contractual obligations cannot be performed. The rules are usually refereed to as act of god, unavoidable necessity, impracticability, frustration of contract.
Under the UNIDROIT principles of International Commercial Contracts, the concept of force majeure is defined as – the party that proves arty proves that the non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences“. The force majeure clause is usually expressly mentioned and will not be ordinarily be implied on contracts.
The claims that arise due to force majeure events are to be proved that the event happened under no control of both parties’ obligations and has resulted in damage or failure.
Under the Indian Contract Act 1872, it does not define the term force majeure rather its interpreted in court through various forms depending on the circumstances of the case. Section 32 of Indian Contract Act 1872, Deals which contingent contracts and provide legal basis for the force majeure clause and will be applied strictly if an event such occurs like COVID-19. Section 56 of Indian Contract Act 1872, incorporates the Common Law doctrine of frustration and provides that contractual obligations which become impossible or unlawful to perform by virtue of an event which could not be prevented by the affected party, will become void once such obligations become impossible or unlawful to perform. The stringent threshold of establishing impossibility or unlawfulness under Section 56 has to be met.
Any consequential liabilities, depending on the language of the clause the parties may send notice to the other intimating of the occurrence of such events. Some contracts also contain a provision that if such force majeure event continues for a certain period then parties are permitted to terminate the contract.
Essential clauses in force majeure agreements:
- An unexpected/unforeseen intervening event occurred;
- The parties to the agreement assumed that such an event will not occur;
- Such an event has made the performance of the obligations under the contract impossible or impracticable;
- The parties have taken all such measures to perform the obligations under the agreement or at least to mitigate the damage; and
- The affected party claiming relief under force majeure, will have the burden of proof to show that the force majeure event has affected such party’s performance of the contract.
Covid -19 constitute Force Majeure Event
In the past, many similar events such as SARS and Ebola have occurred, but interestingly the law in relation to pandemic/epidemic and Force Majeure is still not settled. There is hardly any case law that may be considered even indicative or purposive for the same. However, in a few cases, Executive Orders to stop production, supply or manufacturing have been deemed to be Force Majeure events. Similarly, travel restrictions, lockdowns, suspension of free movement, can be argued for claiming Force Majeure. In the case of Channel Island Ferries Ltd v. Sealink UK Ltd, , force majeure could be relied upon once the affected party had taken measures to prevent the impact of the event. The court said that at present event of COVID-19 pandemic, force majeure events are not in control of the parties.
The affect of the force majeure clause at such circumstances and the right to use those clauses are determined by the following factors:
- Establishing a casual connection between force majeure events and impediments to the performance of contracts;
- Construction harmonious with all provisions; and
- Compliance with the preceding requirements provided for in the force majeure clause
Few things to keep in mind while terminating the contract during this pandemic:
- Are you restricted or prevented or unable to perform the contract ?
- does your contract have a force majeure clause?
- are your obligations under the contract dependent on the happening of the event which event has become impossible due to the lockdown and/ or Covid-19?
- Have to send the notice to the parties regarding the non-fulfilment of your obligations?
Principles derived from the judiciary for such events:
- When the contract contains force majeure section 56 will not be applicable, for the same to be applicable it shall be shown that it is impracticable and useless to perform such events and parties cannot execute them.
- A party cannot be relieved from the performance just because of the unforeseen event, the language used by the parties to state such events must be observed carefully and narrowly.
Various governments across the world has been declaring that such pandemic cannot be completely relive the parties from performing their obligations at such emergency situations. To prove that the entire performance of the party is not applicable one has to contemplate in the force majeure clause or that it has become impossible or unlawful for you to perform your obligations. Additionally, you will also need to show that you have taken all reasonable steps that could have taken by you to avoid or mitigate the event or its consequences.
There was a recent case held in March –Rural Fairprice Wholesale Limited and Anr vs IDBI Trusteeship Services Limited and Ors. The Bombay high court took notice of the COVID- 19 situation and provided the parties interim relief, although the case was regarding the pledged shares and share price had fallen this does not appear that the contract had force majeure clause but adding the interim relief was only the technical approach at such situations.
In another leading judgment on Section 56 of the Indian Contract Act, 1872, Energy Watchdog vs. Central Electricity Regulatory Commission and Anr the Supreme Court held ruled as:
“in so far as a force majeure event occurs de hors the contract, it is dealt with by a rule of positive law under Section 56 of the Contract. The performance of an act may not be literally impossible, but it may be impracticable and useless from the point of view of the object and purpose of the parties.“
If the contractual obligations of the defaulting party are rendered impossible for performance, or even if they are not impossible but impractical or substantially different from what was conceived under the agreement, Section 56 may be used by the said party.Since a positive finding of impossibility or frustration leads in every sense to the conclusion of the contract, the courts and tribunals tend to be extremely cautious in dealing with the same.
Recourse available in Case of no Force Majeure Clause in the Contract
Force Majeure as mentioned above is a statutory right and not a general rule of law. When a Force Majeure clause is not in the contract, the suffering party must rely on other contractual provisions for any possible assistance. If the same can not be done, then the only remedy available is to plead contract frustration and/or impossibility of fulfilling contractual obligations.
The common law has developed the doctrine of frustration to deal with three types of cases that concern excuses for non-performance because of a fundamental change in circumstances and these are;
- frustration of purpose
- temporary impossibility.
The first type of situation is where the frustrating occurrence made production impossible. To that respect, to common law, failure is a subset of the wider doctrine of frustration. Therefore, the expression “impossibility” needs to be distinguished from “frustration,” even though both terms are often used interchangeably.
At the end, it will still be open to parties to contend that despite the contract not specifically contemplating the events such as the COVID-19 pandemic as a Force Majeure event, the performance of its obligations is adversely affected by it and is rendered impossible during the said period.
What if business and companies do not have force majeure clauses?
If a contract does not include a force majeure clause, the parties would have to evaluate, in light of factors such as the nature of the contract, the nature of the event and so on, whether
Section 56 of the Contract Act (which deals with agreements between the parties for an impossible act) and which has been briefly discussed below can be applied to that contract in order to discharge that part.
COVID19 has affected cross border trade, the real estate market, in particular developers, home buyers and leasing arrangements, EPC (engineering , procurement & construction), joint venture agreements and M&A deals in India.
This has also affected the ability of the parties to meet their Scontractual obligations because of limitations on travel, production stoppage, rise in costs due to scarcity of raw materials components, labor shortages, shortage of funds.
Currently, companies in different sectors have already declared or are likely to declare a force majeure that includes Gateway Terminals India Private Limited, Adani Ports in Gujarat, Indian Oil and Mangalore Refineries, based on a recent newspaper article, private highway developers such as Ashoka Buildcon and IRB Infrastructure, and Hero MotoCorp, the newest addition to that list.
Because of COVID19 the stage seems set for India to see a flood of ‘force majeure’ invocations, with widespread disruption in industry, manufacturing, and transport. More and more Indian companies are expected to invoke ‘force majeure’ clauses in their contracts over a period of time , resulting perhaps in a spew of litigation should parties not come to a workable understanding.
It will be fascinating to look out how the courts view COVID -19 in relation to force majeure provisions in the course of this year once COVID-19 has settled its effect. Actually, by way of a memorandum of office (O.M. No. 18/4/2020-PPD) released on February 20, 2020, the Ministry of Finance has explained that the disruption of supply chains due to coronavirus spread in China or any other disruption in the supply chains
In order to reach and evaluate whether force majeure clause is attracted or not, the following are the key points to be taken into account:
- Whether a contract contains force majeure clause or not?
- If the contract contains Force Majeure clause, Section 32 of the Indian Contract Act, 1872 is attracted.
A party which successfully creates the force majeure clause shall be relieved of its obligations to fulfill its obligations under the contract during the period that the force majeure case lasts, the performance of the obligations under the contract shall be suspended and shall be relieved of its responsibility to pay damages for violation. Invoking a force majeure clause might make the right thing
- If the contract does not contain Force Majeure clause, Section 56 of the Indian Contract Act, 1872 is attracted.
The three important parameters which help in determining whether there is frustration of contract or not are:
- Has the contract allocated the risk of the particular event occurring?
- Has there been a radical change in obligations?
- Was the radical change due to the fault of one party?
- Mere difficulty or inconvenience of a party is not force majeure.
The situation due to corona virus outbreak, subsequent lock-downs and government-declared restriction on movement, and a halt to economic activity, is something that no reasonable and average contracting party could have foreseen. Depending on the current jurisprudence, the aforementioned extraordinary circumstances will lead to litigation only in a catena of comme. It is then a matter of interpretation by the courts whether a contract containing force majeure clause would cover such restrictions in movement and lock downs imposed by the Government.