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Effect of COVID-19 on Contracts-Force Majeure

By March 28, 2020 May 1st, 2020 No Comments
In the everyday context, the term ‘impossible’ refers to the lack of possibility in an event or to perform a task. In the Indian Contract Act, 1872, this impossibility ...
Effects of COVID-19 on contracts

Effects of COVID-19 on contracts

A. INTRODUCTION:

In the everyday context, the term ‘impossible’ refers to the lack of possibility in an event or to perform a task. In the Indian Contract Act, 1872 (“Contract Act"), this impossibility to perform a contract has been detailed under Section 56. In a commercial scenario, the parties to the contract often foresee the impossibility to perform a contract, as most of the contractual negotiations revolve around the technical, commercial and legal aspects of a contract. The term ‘frustration’ has been defined in the Black’s Law Dictionary[1] as “The prevention or hindering of the attainment of a goal, such as contractual performance”.

As a general rule, the parties to a contract shall have a mutual intention on the performance of their obligations with reference to contact, and in the case of a breach, the party breaching is liable to compensate for non-performance. Be that as it may, a special case to this standard is mentioned in Section 56 of the Contract Act. Section 56 deals with a situation wherein, in the event of impossibility to perform the obligations under a contract, the promisor is calmed of his/her/its obligations and the contract is rendered void.

Therefore, a contract when entered into initially between the parties was capable of being performed by the parties, however, thereafter becomes impossible to perform for reasons of the occurrence of an event which a party could not prevent or in some situations the essence of the contract becomes unlawful. Under such a situation the contract itself becomes void or rather to say the contract becomes 'frustrated'. The parties to such a contract are discharged of their obligations. The concept of frustration of contract is principally based on the impossibility of the performance of the contract.

1. Ingredients for the application of the doctrine of frustration:

a. The essence of the contract has become impossible to perform for the parties to the contract;

b. An event has occurred making the performance of the contract impossible to perform by the obligatory party;

c. No existing impossibility to perform the contract.

B. INDIAN JURISPRUDENCE:

One of the landmark judgements dealing with the concept of impossibility of contract is enshrined in the case of Satyabrata Ghose vs Mugneeram Bangurn[2], wherein it was held that "doctrine of frustration of contract is really an aspect or part of the law of discharge of contract by reason of supervening impossibility or illegality of the act agreed to be done and hence comes within the purview of Section 56 of the Indian Contract, Act".  In the case of Karl Ettlinger vs Changandas & Co[3], the court has taken the view that not only the performance of such obligation is impossible to perform in the opinion of the promise, but also such performance is impossible to be performed in itself. In the case of Sushila Devi V. Hari Singh[4], the Hon'ble Supreme Court has further held that, the impossibility to perform is not merely a physical impossibility but also, an impossibility with regards to its object and purpose of the contact. In an important judgement with regards to the very invocation of Section 56 of the Contract Act, the Supreme Court in the case of Surpet Singh vs Shao Prasad has held that the doctrine of frustration can only be invoked if the event which caused such frustration was not foreseeable by the parties and even with reasonable diligence it couldn't have been foreseen.

C. FORCE MAJEURE AND ADVENT OF COVID-19

In light of the rapid spread of the novel coronavirus (“COVID-19”) that was first reported in Wuhan, China at the end of 2019, the World Health Organization declared COVID-19 to be a pandemic on March 11, 2020. Covid-2019 has made a great adverse effect on the performance of contracts, causing commercial hardship to some parties in the performance of their contractual obligations and either made performance difficult or impossible, which has attracted section 56 of the Contract Act.

The inability being looked at by organizations in playing out their obligations because of the widespread COVID-19 could have neither been foreseen nor constrained by the businesses. It is pertinent to determine whether COVID- 19 can be categorized under Force Majeure and assuming this is the case, what steps should be taken by organizations to secure their business interests.

To be very precise, a force majeure event refers to the occurrence of an event that is outside the reasonable control of a party and which prevents that party from performing its obligations under a contract. Further, pursuant to various case laws, few of which are mentioned above, in order to determine whether an event attracts section 56 of the Contract Act and falls under the category of ‘force majeure’ event, the following three conditions shall be satisfied:

a. The event must be beyond the reasonable control of the affected party;

b.the affected party’s ability to perform its obligations under the contract must have been prevented, impeded or hindered by the event; and

c. the affected party must have taken all reasonable steps to seek to avoid or mitigate the event or its consequences.

D. Force Majeure Clause:

Generally, a 'force majeure' clause is split into two categories, which is:

a. defining a specific list which would amount to a ‘force majeure event’; and

b. the impact and duty of the affected party while invoking the ‘force majeure’ clause.

A standard ‘force majeure’ clause may be seen herein-below:

No party shall be liable to the other if, and to the extent, that performance or delay in performance, of any of its obligations under the Agreement, is prevented, restricted, delayed or interfered with, due to circumstances beyond the reasonable control of such party, including but not limited to, Government legislations, fires, floods, explosions, epidemics, accidents, acts of God, wars, riots, strikes, lockouts or other concerted acts of workmen, or any other events. The party claiming an event of force majeure shall promptly notify the other party in writing and provide full particulars of the cause or event and the date of first occurrence thereof, as soon as possible after the event and also keep the other party informed about the future developments. The party affected by the event shall use its best efforts to remove the cause of non-performance and the parties shall resume performance as soon as such cause is removed."

As may be seen above, many contractual provisions set out a specific list of force majeure events which are deemed to be events of force majeure beyond the control of the parties, such as "pandemics," "epidemics" or "diseases.", however, if the provision does not include language to that effect, then it will be necessary to test whether COVID-19 or its impact on the performance of the contract, is captured by a different concept, such as an "Act of God," "action by the government" or a broad provision. Most force majeure provisions contain a broad language in respect of events which are "outside the reasonable control of the party affected”. It seems fairly clear that a pandemic such as COVID-19 would qualify as force majeure under such a provision. Further, a highly alike scenario with COVID-19 would be the inability to perform a contract due ‘lock-down’ situation, which is a current scenario in India, being self-isolate from office or a team due to the outbreak of COVID-19. Under many force majeure clauses, this would likely have the necessary impact and causal link to qualify as a force majeure event shall be established, subject to the party affected having taken all reasonable measures.

E. DUTY TO MITIGATE:

While invoking the ‘force majeure’ clause, the performing party shall bring to view that it has taken every possible step to mitigate and avoid the event from having an effect on the performing party’s obligations and that there are no alternative means for performing under the contract. For example, in the current situation in India, where the Hon’ble Prime Minister has announced a complete lock-down and curfew throughout the nation a few days ago, the clients are advised to examine all possible alternative mechanisms in relation to the performance of the obligations under the contracts.

In relation to employment scenario, the employees, or rather their performances fall under two models. In case of the first model, where the employees, such as employees of IT or compliance industry, may opt for the facility to work from home and perform their obligations in distant, and does not need to be physically present at the workplace, for them situations such as COVID-19 cannot hinder their performance, such employees cannot invoke the force majeure clause or, in case of absence of force majeure clause in their employment contract, section 56 of the Contract Act. Whereas, on the other hand, sectors wherein the physical presence of the employee is necessary to perform his/her obligations i.e. pilots in the aviation sector or bankers, it is impossible for them to travel to their workplace due to Covid-19 along with the lock-down of the nation, where the right to free movement of every citizen has been suspended. In such a scenario, the employee can invoke force majeure.

In another scenario, where loans have been availed by a sector from various financial institutions, at present is shut due to COVID-19 and nationwide lockdown, no revenues are being generated by these sectors., force majeure can be invoked by them and relaxation in repayment of the loans can be taken whereas, on the other hand, sectors which has the alternative to perform their obligations under their respective contracts and generate revenues during this COVID-19 and when all the banking operations are continuing without any hindrances, the person would be obligated to repay the loan availed as per the terms of its respective contract without any relaxation for the reason that in circumstances, the repayment of loan EMI is not 'impossible' for it. However, the Reserve Bank of India, through its notification RBI/2019-20/186 dated March 27, 2020, has permitted the Lending Institutions[5] to grant a moratorium of three months on payment of all instalments falling due between March 1, 2020, and May 31, 2020, thereby putting the ball in the court of the Lending Institution to decide if they desire to extend the relaxation to their customers/borrowers.

For the sectors which are involved in the manufacturing and supply of essential and necessary commodities for sustenance, the Government has ensured that the pandemic shall in no manner hinder or cause a delay with regard to the provision of essentials to the community at large. However, on the other hand, other sectors which are involved in the activities or businesses that remain un-exempted by the Government does not have any other alternative to perform their obligations and manufacture/supply commodities under their respective contracts due to suspension of all fundamental rights at the current lock-down scenario and at the amidst of pandemic throughout the nation, can invoke force majeure or section 56 of the Contract Act, as the case may be.

F. REMEDIES:

The remedy available to the parties is usually dependent on the terms of the contract. Certain contracts provide for the termination of the contract and however, certain contracts provide for the resumption of the contract after the resolution of the event. Certain contracts provide time limits after which the contract would terminate automatically.

G. FORCE MAJEURE CLAUSE- NOT INCORPORATED IN AGREEMENT:

In the event, the contract does not have a force majeure clause; the parties can seek a remedy under Section 56 of the Contract Act. For the purpose of seeking a remedy under the doctrine of frustration, the party claiming the relief shall prove that the obligations under the contract have become impossible to perform.

What shall a party making claims of ‘force majeure’ keep in mind?

A party making claims of force majeure event, in the current case, Covid-19 shall take necessary measures to document the steps it has taken to mitigate the impact of the outbreak of Covid-19 on its ability to perform its obligations. Further, such a party must also look into the framing of the force majeure event and the consequences. For example, a target company could claim that the COVID-19 outbreak constitutes the force majeure event, or it could rely upon a supervening government regulation or a disruption, such as lock-down in India as a current situation.

What shall a party receiving notice claims of ‘force majeure’ determine?

 A party receiving a notice of a claim of force majeure shall carefully examine the claim and determine if it is in line with the provisions of the clauses or if it falls within the ambit of a ‘force majeure’ event. In the event, if the party receiving the notice, is involved in back to back contracts, it needs to take a strategic approach, taking into account the overall impact of the claim for force majeure on its obligations under the related contracts.

H. REMEDIAL MEASURES:

The companies shall ensure that the essential clauses of the agreements such as termination, dispute resolution, force majeure, jurisdiction, governing law have been properly analyzed, a proper review of the operations and transactional aspects of the business with the other party has been keenly looked into, legal advises have been obtained as to whether COVID-19 can be included or excluded from the force majeure purview under the contract. The parties can also renegotiate the terms and conditions of the contract. The parties shall also keep in mind that they do not make any wrongful or false claims in this regard to avoid a breach of contract.

 I. CONCLUSION:

In the current scenario, wherein a definite need emerges to apply the force majeure provision in the agreements or seek the remedy under Section 56 of Contract Act, it is important for the parties to submit to the clauses as may be enshrined in the agreement or to the aforementioned Section 56. The very application of force majeure is dependent on the scope and language as captured in the agreement, as far as the general practice is concerned, there always exists a window for such uncertain and extraordinary scenarios. Under such scenarios, the performing party shall expeditiously provide the essential details as may be required under the contract to trigger the force majeure clause. Both parties shall exercise diligent behavior in order to mitigate the loss suffered and extract the best outcome possible.

Authors: Prashant Jain, Co-Founder & Partner; Abhishek Gupta, Associate.

Disclaimer: The content of this article is intended to provide a general guide to the subject matter. For any queries, the authors can be reached at (i) prashant@samistilegal.in (ii) abhishek@samistilegal.in.

Updated as on March 28, 2020.

References:

[1] https://blacks_law.enacademic.com/11676/frustration_of_purpose_doctrine

[2] AIR 1954 SC 44

[3] 1915- 17 BOMLR 1087

[4] AIR 1971 SC 1756

[5] https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11835&Mode=0

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