COVID-19 or the Corona Virus was declared as a pandemic on March 11, 2020. This has led to lockdowns and financial slowdown across the country in all sectors. The impact on the businesses has been severe, and the force majeure clauses will play a crucial role if the businesses are not able to perform their contractual obligations amidst this crisis.
In the aftermath of the closedown, many suppliers would not be able to perform their contractual obligations and, to say the least, they would be delayed. The suppliers are seeking to delay and/ or avoid contractual obligations/ performance. They wish not to be held liable for their contractual non- performance. The companies might not be able to honor their customer agreements. The same is true for the consideration, which either of the party to a contract might not be able to fulfill under the terms of the contract. Under such scenarios, the force majeure clause would be a determining factor to understand the implications of these events.
“On Feb.17, 2020, the China Council for the Promotion of International Trade (CCPIT), revealed that it had already issued over 1,600 “Force Majeure certificates” to firms in 30 sectors, covering contracts worth over $15 billion.”
On February 19, 2020, the Department of Expenditure, Procurement Policy Division, Ministry of Finance issued an Office Memorandum with respect to the “Manual for Procurement of Goods, 2017”, which serves as the dictum for procurement by the Government of India.
This memorandum, in essence, states that the COVID-19 could effectively be covered under force majeure clause because it is a “natural calamity” and all the departments who should invoke it by following the “due process.”
But this implication of COVID-19 cannot be upheld for every contract, and the clause needs to be interpreted based on different circumstances.
Force Majeure and the Doctrine of Frustration: “Frustration is an English contract law doctrine that acts as a device to set aside contracts where an unforeseen event either renders contractual obligations impossible, or radically changes the party’s principal purpose for entering into the contract.”
Force Majeure (S.56 of the Indian Contract Act, 1872): A force majeure clause relieves one or both parties from liability to perform contract obligations when performance is prevented by an event or circumstance beyond the parties control. Typical force majeure events may include fire, flood, civil unrest, or terrorist attack. Force majeure is a term used to describe a “superior force” event. The purpose of a force majeure clause is two-fold: it allocates risk and puts the parties on notice of events that may suspend or excuse service.
The Doctrine of Frustration (S.56 of the Indian Contract Act, 1872.): The essential idea upon which the doctrine of frustration of contract is based is that of the impossibility of performance of the contract; in fact, “impossibility” and “frustration” are often used as interchangeable expressions. The changed circumstances, it is said, make the performance of the contract impossible, and the parties are absolved from the further performance of it as they did not promise to perform an impossibility.
The parties shall be excused if substantially the whole contract becomes impossible of performance or, in other words, impracticable by some cause for which neither was responsible. The spirit of force majeure and the doctrine of frustration have been embodied in sections 32 and 56 of the Indian Contract Act.
While the doctrine of frustration is a common law principle, the force majeure clause is a creature of contract. It is a civil law concept that has no settled meaning in the common law. It must be expressly referred to and defined in a contract.
The entire jurisprudence on the subject has been stated by Justice RF Nariman of the Supreme Court in the case of Energy Watchdog vs. CERC (2017).
“Force majeure” is governed by the Indian Contract Act, 1872. In so far as it is relatable to an express or implied clause in a contract, it is governed by Chapter III dealing with the contingent contracts, and more particularly, Section 32 thereof. 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. Sections 32 and 56 are set out herein:
“Section 32: Enforcement of Contracts contingent on an event happening – Contingent contracts to do or not to do anything if an uncertain future event happens, cannot be enforced by law unless and until that event has happened. If the event becomes impossible, such contracts become void.”
“Section 56: Agreement to do impossible act – An agreement to do an act impossible in itself is void.
Contract to do act afterwards becoming impossible or unlawful. A contract to do an act which, after the contract made, becomes impossible or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.
Compensation for loss through non-performance of act known to be impossible or unlawful. Where one person has promised to do something which he knew or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promise for any loss which such promisee sustains through the non-performance of the promise.”
Prior to the decision in Taylor vs. Caldwell, (1861-73), the law in England was extremely rigid. A contract had to be performed, notwithstanding the fact that it had become impossible of performance, owing to some unforeseen event, after it was made, which was not the fault of either of the parties to the contract. This rigidity of the common law in which the absolute sanctity of contract was upheld was loosened somewhat by the decision in Taylor vs. Caldwell in which it was held that if some unforeseen event occurs during the performance of a contract which makes it impossible of performance, in the sense that the fundamental basis of the contract goes, it need not be further performed, as insisting upon such performance would be unjust.
“Impossibility” under S.56 doesn’t mean literal impossibility to perform (owing to strikes, commercial hardships, etc.) but refers to those cases where a supervening event beyond the contemplation and control of the parties (like the change of circumstances) destroys the very foundation upon which the contract rests, thereby rendering the contract “impracticable” to perform, and substantially “useless” in view of the object and purpose which the parties intended to achieve through the contract. In Satyabrata Ghose v. Mugneeram Bangur, war condition was known to the parties while entering into the contract such that they were aware of the possible difficulty in the performance of the contract, in such circumstances, the requisition of property did not affect the root of the contract. Secondly, no stipulation as to time was provided in the agreement such that the work was to be completed within a reasonable time. Still, having regard to the nature of the development contract and the knowledge of the war conditions prevailing during the contract, such a reasonable time was to be relaxed. Therefore, the contract had not become impossible of performance under S.56.
“A contract is not frustrated merely because the circumstances in which it was made are altered. The Courts have no general power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.”
It has also been held that applying the doctrine of frustration must always be within narrow limits. In an instructive English judgment namely, Tsakiroglou & Co. Ltd. v. Noblee Thorl, despite the closure of the Suez canal, and despite the fact that the customary route for shipping the goods was only through the Suez canal, it was held that the contract of sale of groundnuts, in that case, was not frustrated, even though it would have to be performed by an alternative mode of performance which was much more expensive, namely, that the ship would now have to go around the Cape of Good Hope, which is three times the distance from Hamburg to Port Sudan. The freight for such a journey was also double. Despite this, the House of Lords held that even though the contract had become more onerous to perform, it was not fundamentally altered. Where performance is otherwise possible, it is clear that a mere rise in freight price would not allow one of the parties to say that the contract was discharged by the impossibility of performance.
This view of the law has been echoed in Chitty on Contracts, 31st edition. In paragraph 14- 151, a rise in cost or expense has been stated not to frustrate a contract. Similarly, in Treitel on Frustration and Force Majeure, 3rd edition, the learned author has opined, at paragraph 12-034, that the cases provide many illustrations of the principle that a force majeure clause will not normally be construed to apply where the contract provides for an alternative mode of performance. It is clear that a more onerous method of performance is not sufficient to invoke the doctrine of frustration.
“The application of the doctrine of frustration requires a multi-factorial approach. Among the factors which have to be considered are the terms of the contract itself, its matrix or context, the parties‟ knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed mutually and objectively, and then the nature of the supervening event, and the parties‟ reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances. Since the subject matter of the doctrine of frustration is contract, and contracts are about the allocation of risk, and since the allocation and assumption of risk is not simply a matter of express or implied provision but may also depend on less easily defined matters such as “the contemplation of the parties”, the application of the doctrine can often be a difficult one. In such circumstances, the test of “radically different” is important: it tells us that the doctrine is not to be lightly invoked; that mere incidence of expense or delay or onerousness is not sufficient; and that there has to be as it were a break in identity between the contract as provided for and contemplated and its performance in the new circumstances.”performance by itself would not amount to an frustrating event. The same learned author also states that a mere rise in price rendering the contract more expensive to perform does not constitute frustration.”
The most generic clause under most force majeure clauses is the “Act of God”, and the COVID-19 can be brought under the ambit of the same. But the effect of this clause can be mitigated through the “duty to mitigate” and “exercise due diligence clause.” The subjective standards on the case to case basis have to be applied in order to determine their effect on the overall contract. “The best endeavor” clauses might also play a crucial role in order to define the ambit and implications of the force majeure clause, as the presence of the same might end up mitigating the effects of force majeure clauses. The foreseeability of the event has to be gauged too, especially for the contracts entered after the month of December 2019 as for the force majeure clauses to become effective, the event must not be foreseeable in essence, and the COVID-19 outbreak had effectively begun from December 2019 onwards.
The wordings of the clause(s) also becomes very important. Some contracts provide that it can be put on hold until the force majeure event is resolved. Some contracts provide for limitations in time, after which either party may cancel the agreement with written notice to the other. Others require the contract to remain in effect until the force majeure event is resolved. The burden of proof lies with the party who wants to invoke the force majeure clauses, and the Courts have traditionally interpreted these clauses in a very strict manner.
And if the party wishes to invoke the force majeure clause, the dispute resolution clause of the contract shall be checked and the appropriate adjudicatory mechanism shall be adopted by the procedure mentioned under the terms of the clause, or the law of the land, whichever is applicable.
In the absence of a force majeure clause, any party could also invoke the doctrine of frustration under Section 56 of the Indian Contract Act, 1872. In order to invoke the same, parties must show that the performance of a contract has become impossible, and the arrangements and conditions have become fundamentally different from those envisaged in the contract. The parties also have the option to invoke several clauses such as price adjustment clauses, limitation or exclusion clauses, material adverse change clauses, and many others such clauses in order to limit the liabilities arising from non-performance or the partial performance of the contractual obligations. The ability to invoke such grounds would depend on the wording of the Contracts, the application of case-laws on these clauses, and how these clauses would be interpreted by the tribunals, courts, and other adjudicatory bodies.
Keeping the above blog into consideration, the implications of the COVID-19 would have to be decided on the case by case basis.
