Force Majeure and Covid-19 - Impact on Commercial Agreements
Updated: May 28, 2020
Introduction Since the reporting of Covid-19 virus in December 2019 in China, it has been declared a “pandemic” by World Health Organization. As a result, many countries including India, started taking preventive and precautionary measures to control the spread of the virus. Accordingly, India imposed a complete lockdown in the country, March 24, 2020 onwards upto April 14, 2020. As a result of the lockdown, there has been an adverse impact on the Indian and global economy. The adverse impact has affected the domestic market at its core including disruptions, and unintentional and imminent delays in performing one’s contractual obligations to complete impossibility of performance of contractual obligations. Performing parties may seek to avoid immediate performance of their contractual obligations or even immediate termination by citing the limitations imposed by Covid-19 and resultant lockdown. In these unforeseen circumstances which are beyond the control of either party which has affected the performance of contracts, it becomes important to assess the scope and relevance of Indian law on contracts i.e. Indian Contract Act, 1872 (“ICA”), and the common law principle of Force Majeure which finds mention in almost all kinds of contracts. What is Force Majeure and itspurpose? 'Force Majeure' can be defined as occurrence of an event beyond the reasonable control of the parties which prevents a party from performing its obligations as per the terms of the contract. According to Black’s Law Dictionary, the term ‘Force Majeure’ means “an event or effect that can neither be anticipated nor controlled”. In Merriam Webster Dictionary, the term has been defined as “superior or irresistible force” and “an event or effect that cannot be reasonably anticipated or controlled”. ICA does not expressly refer to 'Force Majeure', however, the concept has been derived from and is embodied under Section 32 and Section 56 of ICA. Force Majeure is therefore a contractual provision mutually agreed between parties so as to protect a party from a liability arising out of its failure to perform a contractual obligation as per terms due to unforeseen circumstances beyond the control of the parties. Such a clause assigns risk among the contracting parties if performance as per agreed terms becomes impossible or impracticable because of a Force Majeure event, and may allow for inter alia suspension of the contract and/or renegotiation of the contract and/or termination of the contract. Typically, Force Majeure clauses include an Act of God, war, labour unrest or strikes, government regulationsetc. Force Majeure - Scope and Interpretation In Indian context, courts have generally construed “Force Majeure” clauses narrowly. The Hon’ble Supreme Court (“SC”) in, Energy Watchdog v CERC [(2017) 14 SCC 80], held that “Force Majeure clauses are to be narrowly construed” which means, only those events that are explicitly mentioned in the contract can excuse a party from performance. This is critical because the event or circumstance must fall within the definition of Force Majeure if the affected party is to have any prospect of securing relief. For example, if “pandemic” has been specifically included in the Force Majeure clause, then subject to the applicable terms, Covid-19 would be considered as one. However, at times parties use generic phrases like “unforeseeable events” or “events beyond the control of the parties” or the Force Majeure clause may set out an inclusive list mentioning several events followed by general words such as “any other similar event”.
In such scenarios, the Force Majeure clause is construed using the doctrine ofejusdem generis (of the same kind), so as to engulf within its folds only such happenings which are of the nature and type illustrated in the same class, with a close attention to words which precede or follow it, while also considering the nature of thecontract. Force Majeure - Doctrine of Frustration andICA Doctrine of Frustration Doctrine of Frustration means the termination of the contract due to unforeseen events beyond the control of the parties as a result of which it becomes impossible to perform. Doctrine of Frustration brings the contract to an automatic end. As such, Doctrine of Frustration is different from “breach of contract” where the non-breaching party can choose to terminate the contract or not, subject to the terms of the contract. Similarly, Doctrine of Frustration is also different from a contract which is void on the grounds of “mistake”, as, such a contract is a complete nullity from the beginning. Doctrine of Frustration andICA The Doctrine of Frustration has been enshrined in Section 56 of the ICA which deals with frustration of a contract where the performance of a contract has become impossible due to an unavoidable reason. The SC, while confirming the embodiment of Doctrine of Frustration in Section 56 of ICA, in Industrial Finance Corporation of India Ltd. Vs. The Cannanore Spinning & Weaving Mills Ltd. and Ors. [(2002) 5 SCC 54] held that the “Statute itself has recognised the doctrine of frustration”. Section 56 of ICA is being reproduced herein below. 56. Agreement to do impossible act - An agreement to do an act impossible in itself is void. Contract to do an act afterwards becoming impossible or unlawful.— A contract to do an act which, after the contract is 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 promisee for any loss which such promisee sustains through the non performance of the promise. Interpretation of the term “Impossible” under Section 56 of ICA The SC has interpreted the term “impossible” contained in Section 56 of ICA in various judgments including in Satyabrata Ghose v. Mugneeram Bangur & Co [AIR1954 SC44] and recently in Energy Watchdog v CERC [(2017)14SCC80] wherein it held the scope of the term ‘impossibility’ to mean not only physical or literal impassivity but also ‘impracticable’ and ‘useless’ from the point of view of the object and purpose of the contract. The SC has held that for examining whether an event struck at the root of the contract for it to be held impossible to be performed and thus frustrated under Section 56 of ICA, the courts have to examine the contract and the circumstances under which it was negotiated and executed, on a case to case basis, so as to ascertain if the changed circumstances significantly altered the underlying object and purpose of the contract, thereby frustrating it.
Considering the high threshold that has been laid down by the courts for invoking and enforcing the Doctrine of Frustration in terms of the interpretation given to the word “impossibility” under Section 56 of ICA while keeping in view the fundamental principle of contract law i.e. “pacta sunt servanda”, which means “agreements must be kept”, establishing such “impossibility” is therefore difficult in most cases. This is evident from the fact that events such as escalation in price, temporary inability/bar in performing the contract, commercial hardships etc. were not considered by courts to satisfy the threshold of “impossibility”. Infact, courts have gone on to hold that interalia hardships or inconvenience or material loss or even performance of the obligation becoming onerous on account of an unforeseen event, does not bring about the principle of frustration into play. Interrelation between Force Majeure and ICA The SC in Industrial Finance Corporation of India Ltd. Vs. The Cannanore Spinning & Weaving Mills Ltd. and Ors. [(2002) 5 SCC 54] held that Section 56 of the ICA recognises the Doctrine of Frustration, and that the concept of Force Majeure is embodied in it, whereby the performance of a contract is excused for reasons beyond the control of the performing party and which could neither be foreseen at the time of entering into the contract nor can the effect of the supervening event be avoided or overcome. Considering the concept of Force Majeure is also governed by the Doctrine of Frustration i.e. meeting the test of “impossibility”, the enforceability of a Force Majeure clause would not widen the scope of “frustration”. As such, mere occurrence of a Force Majeure event will not be enough to seek successful enforcement of a Force Majeure clause as the enforcing party will also have to prove that such event caused the object and purpose of the contract ‘impracticable’ and‘useless’. However, parties may not always want a contract to be frustrated because of a Force Majeure event but continue their relationship by adapting to the situation. A Force Majeure clause therefore gives the flexibility that the Doctrine of Frustration does not. Inclusion of a Force Majeure clause ensures that the parties mutually decide on the recourse to be followed in case of a Force Majeure event which otherwise underSection 56 of ICA would contemplate termination of thecontract. Requisites of ForceMajeure In the backdrop of the above discussions, it is important to understand that for an event to be considered a Force Majeure event, the following criteria is to be fulfilled: a. Existence of a valid contract; b. Occurrence of a Force Majeure event; c. Force Majeure event is beyond the reasonable control of the parties; d.Force Majeure event should have caused the object and purpose which the parties intended to achieve through the contract ‘impracticable’ and ‘useless’;and e. The enforcing party has taken all measures to perform the contractual obligations or atleast mitigate the damage. The burden of proof to prove the above facts is on the party invoking the Force Majeure clause. Consequences of a ForceMajeure Applicability of Section 56 of ICA in case the contract contains a Force Majeure clause The judicial precedents effectively lay down that parties to a contract containing a Force Majeure clause are to invoke the provisions of the Force Majeure clause in case their performance of the contract obligations have been affected by events captured therein, subject to adherence to terms regarding manner of invocation, timing of invocation etc. The SC, in Satyabrata Ghose v. Mugneeram Bangur & Co [AIR 1954 SC 44] held that if there is a Force Majeure clause in a contract, then the said clause would decide the effects of an event beyond the control of parties and not the principles under Section 56 of ICA. However, if the event leading to frustration of a contract occurs de hors the terms of the contract, it is dealt with by Section 56 of ICA. This interpretation has been reiterated by SC in Energy Watchdog v CERC [(2017) 14 SCC 80] and the Hon’ble Delhi High Court in NTPC v. Voith Hydro Joint Venture, [2019 SCC Online Del9014]. Effect of invocation of a Force Majeure clause Upon invocation of the Force Majeure clause on happening of a Force Majeure event, the consequences contemplated thereunder will follow. As such, the effect of invocation of a Force Majeure clause would completely be governed by the terms thereof. Such consequences could be in the nature of an immediate termination or suspension of the contract for a specific period of time with (or without) termination to follow if the event continues even after the specified period or suspension of the contract uptill the continuance of the Force Majeure event or renegotiation of the terms of thecontract. Events which do not qualify as a Force Majeureevent The general rule propounded by courts is that a party to a contract is not to be absolved from performing its part of the contract only because its performance has become onerous on account of an unforeseen event or such an event has caused hardship or inconvenience etc. For instance, in Alopi Parshad & Sons Ltd. v. Union of India, [1960 (2) SCR 793], the SC observed that “the Act does not enable a party to a contract to ignore the express covenants thereof and to claim payment of consideration, for performance of the contract at rates different from the stipulated rates, on a vague plea of equity. Parties to an executable contract are often faced, in the course of carrying it out, with a turn of events which they did not at all anticipate, for example, a wholly abnormal rise or fall in prices which is an unexpected obstacle to execution. This does not in itself get rid of the bargain they have made.”.Similarly, in Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968 (1) SCR 821, the SC referred to the English law on frustration, and concluded that a contract is not frustrated merely because the circumstances in which it was made are altered. The SC in Energy Watchdog v CERC [(2017)14SCC80] also observed that“The price of coal is the price of raw material and if prices go up, a contract does not get frustrated merely because it becomes commercially onerous” Even the English courts in Tsakiroglou & Co. Ltd. v Noblee Thorl, GmbH, 1961(2) All ER 179 observed that mere closure of the Suez Canal did not qualify as a condition for frustrating the contract as an alternative route was available even though longer than the original route. Similar view has been taken in ‘Chitty on Contracts’, 31st edition, where a rise in cost or expense has been stated not to frustrate acontract. Material Adverse Change (MAC)clause Meaning and Effect MAC clause confers the right in favour of a party to terminate the contract before closure of a transaction upon occurrence of any event which materially affects the transaction. MAC clauses usually find mention in mergers and acquisitions where the time period between the signing and closure of the transaction is very crucial.
Enforceability of MAC Judicial precedents regarding enforceability of MAC clauses are very limited, especially in India and therefore reference should be placed on global precedents which have construed MAC narrowly with emphasis on durational significance and long term impact of an MAC event. MAC and Force Majeure As for MAC and Force Majeure, both are independent provisions contemplating similar consequences i.e. termination of the contract. Therefore, MAC can be equated with Force Majeure. However, while MAC clauses are generally vague and do not specify the triggering event for enforcing it, Force Majeure clauses specify the circumstances (specifically or in general) that will excuse performance of the contract, which comparatively makes it easier to interpret a Force Majeure clause. Another difficulty when it comes to MAC clause is the absence of a definite threshold for quantifying materiality and the interpretational hurdle in determining the context/meaning of ‘materiality’ in the MAC clause. Lastly, as discussed above, both concepts are based on the Doctrine of Frustration, where a contract is terminated and the non-performing party is discharged from its obligations if such performance is impossible. This could make the enforceability of MAC a challenge as it is not necessary that a MAC event would cause for the performance of the transaction to be impossible. Force Majeure clause in commercial agreements Commercial agreements generally contain Force Majeure clause. The contracting parties are duty-bound to perform the obligations under the contract, till such time the parties are obstructed to further perform their part under the contract due to a ‘Force Majeure’ event and the parties have exhausted all measures to take control of the event. The parties may decide to either suspend the performance of the contract or terminate the contract for a specific time period, if provided or invoke the penalty provisions, if any or terminate the contract, as the casemaybe. Following are some of the commercial agreements and impact of a ‘Force Majeure’ clause on such agreements.
Commercial Lease Agreements Lease agreements are governed by the provisions of Transfer of Property Act, 1882 (“TPA”). While TPA does not have provisions for “waiver of rent”, however, Section 108(B)(e) of TPA entitles the lessee to terminate the lease “if by fire, tempest or flood, or violence of an army or of a mob, or other irresistible force, any material part of the property be wholly destroyed or rendered substantially and permanently unfit for the purposes for which it was let.” and Section111(b) of TPA enables parties to determine the lease upon happening of a mutually contemplated event. It is in the above context that it becomes relevant to assess the effect of a Force Majeure clause in a lease agreement, specifically a commercial lease, including effects such as waiver of rent and/or termination oflease. Application of Section 56 of ICA to lease agreements The SC adjudicated on the applicability of Section 56 of ICA to lease deeds in Raja Dhruv v. Raja Harmohinder Singh [AIR 1968 SC 1024] where it held that Section 56 of ICA is not applicable to lease deeds as firstly, lease is governed by the provisions of TPA, which is a special statute and not by the general law of contract under ICA, and it is settled law that a special statute would trump a general statute (Kedar Lall v. Hari Lall, [AIR1952SC47]). Secondly, Section 56 of the ICA does not apply to a concluded contract where no further performance was required (Sushila Devi v. Hari Singh [(1971) 2 SCC 288] and T. Lakshmipathi v. P. Nithyananda Reddy [(2003) 5 SCC 150]). Though Section 56 of ICA is not applicable to lease deeds, it does not prevent parties by way of contract to agree to a Force Majeure clause. This principle finds support vide Section 111(b) of TPA which recognizes the parties’ right to mutually agree to determination of the lease upon the happening of an event such as events captured in the Force Majeure clause. Effects of Force Majeure clause in lease agreements Inclusion of a Force Majeure clause in a lease agreement would mean that the non-performing party can invoke the Force Majeure clause to avail the rights contained therein subject to the terms agreed. Suspension/Deferment of Rent In case the lease deed does not have a Force Majeure clause for suspension/ deferment of rent - The lessee would be legally obligated to pay the monthly rent to the lessor as the liability to pay rent is absolute. In case the lease deed has a Force Majeure clause for suspension/deferment ofrent- Subject to the strict terms of such provision, the lessee can avail the right to suspend or defer the rent, as the case maybe, subject to the event being a Force Majeure event and the requisites of Force Majeure being met. However, mere inability to pay rent or loss in business etc. may not attract the Force Majeure provisions. Termination of Lease In case the lease deed does not have a Force Majeure clause- The determination of the lease on the happening of unforeseen events shall be governed by Section108(B)(e) of TPA. However, it is important to keep in mind that in case the provisions of Section 108(B)(e) of TPA are attracted, the same by itself does not amount to a determination of the lease i.e. there is no automatic determination. The above said provision confers an option on the lessee to treat the lease as void. Therefore, the lease subsists, and the lessee is liable to pay the contractual rent, till the lease is terminated by the lessee by issuing a requisite notice to thelessor. For terminating a lease under Section 108(B)(e) of TPA, the property would have had to be “wholly destroyed or rendered substantially and permanently unfit” for the purpose for which it was let out, specifically because of “fire, tempest, flood, violence of an army or a mob, or other irresistible force”. The burden would be on the lessee to show that because of fire, tempest, flood, violence of an army or a mob, or other irresistible force, the property has either been wholly destroyed or rendered substantially and permanently unfit for use by the lessee. In this regard, the term “irresistible force” has been defined by Black’s Law Dictionary, 4th Edition, to mean “an interposition of human agency as is, from its nature and power, absolutely uncontrollable; as the inroads of a hostile army”. Therefore, the event has to be beyond control of the lessee and such event has to wholly destroy the property or substantially and permanently render the property unfit for use by the lessee. A temporary inadequacy of the property will not entitle termination of the lease under Section 108(B)(e) of TPA. In Alanduraiappar Koil Chithakkadu v. T.S.A. Hamid, [AIR1963Madras94] the Madras High Court did not consider two instances of cyclone, including one where for a period of six months the property was unfit for use by the lessee, to be of a substantial and permanent nature. Further, the court also considered the duration of the lease to be able to iron out the variations and provide for a fair average profit during the period as a whole.
As such, the threshold for invoking and enforcing Section108(B)(e) of TPA is quite high, and the burden is on the lessee to not only satisfy the strict conditions of Section 108(B)(e) of TPA but also communicate its intention to terminate the lease to the lessor, failing which the lease would be considered to be continuing and the lessee would remain obligated to pay rent irrespective of the condition of the property and use/non- use of the same by the lessee. Accordingly, to justify termination of the lease deed basis Covid-19 and/or lockdown, the triggering party will have to satisfy the complete destruction of the leased property or the leased property having become substantially and permanently unfit for use. In case the lease deed has a Force Majeure clause– The determination of the lease shall be in accordance with the terms of the lease deed which could inter alia include an initial suspension/deferment of rent for a specific period of the Force Majeure event followed by right to termination in case the Force Majeure event continues beyond the specified period or an immediate right of termination upon the happening of the Force Majeure event. In the circumstances, the lessee will be entitled to exercise the rights under the Force Majeure clause of the lease deed subject to the event in question being a Force Majeure event as envisaged under the lease deed. It is however unclear as to the principles that would govern the applicability of a Force Majeure clause in a lease deed considering Section 56 of ICA is inapplicable to lease deeds. There being no judicial precedents on this aspect, it would be interesting to see if Force Majeure clause in lease deeds would be governed by principles of “impossibility” as under Section 56 of ICA or the principles governing Section 108(B)(e) of TPA. Be that as it may, upon considering the application of either principles to a Force Majeure clause in lease deeds, the lessee would either have to show “impossibility” of performance of the lease deed i.e. impossibility of use of the leased premise due to the Force Majeure event, or that the leased property has “wholly been destroyed”/“substantially and permanently become unfit” as a result of the Force Majeure event. As for agreements to lease and leave and license agreements, considering they are not governed by TPA, the principles of Force Majeure applicable to such agreements would be those interpreted under Doctrine of Frustration and Section 56 of ICA i.e. principle of“impossibility”. Supply Agreements Most supply agreements include ‘Force Majeure’ clauses spelling out the consequences of default in performance because of Force Majeure events subject to the principle of “impossibility” being met. Triggering parties would be required to invoke the Force Majeure clause in terms of the contract and seek consequences as captured in such provision which, as discussed above, could be in the nature of suspension/termination/suspension followed by termination etc. Further, the Department of Expenditure, Procurement Policy Division, Ministry of Finance issued an Office Memorandum dated February 19, 2020, in relation to the Government’s ‘Manual for Procurement of Goods, 2017’, which states that the Covid-19 outbreak could be covered by a Force Majeure clause subject to compliance with due procedure. Likewise, the Ministry of New & Renewable Energy has also issued a notification dated March 20, 2020 whereby all renewable energy implementing agencies are directed to treat delay on account of supply chain disruptions due to spread of Covide-19 in China or any other country as Force Majeure if they are actually affected. However, such notifications may only have a persuasive value and not form the sole basis of deciding whether Covid-19 is a Force Majeure event or not. Therefore, parties should be careful in solely relying on such notifications to reach the conclusion that Covid-19 is a Force Majeure event.
Employment Agreements The applicability of Force Majeure to an employment contract would be on the same lines as its applicability to any other contract. However, the practical application of Force Majeure in an employment contract might be limited, considering the fact that Force Majeure events which render the performance of employers’ obligations impossible might be limited. Additionally, employers would need to consider the fact that the Government of India and various State Governments have issued advisories with respect to non- termination of employees and workers, and payment of wages without deduction during the ongoing lockdown. While, such advisories could be argued to be legally non-binding, however, knowing the unprecedented nature of the situation and larger impact that reduction in employee salaries or termination of employment could cause, therefore, any action on the ground that Covid-19 and related lockdown are Force Majeure events might successfully be challenged in courts. Insurance Agreements While Force Majeure clauses would have application in insurance agreements too, like any other contract, however, with respect to Life Insurance policies, The Life Insurance Council of India has issued a press release stating that Force Majeure shall not be applicable to Covid-19 deaths. Additionally, IRDAI has provided additional time for payment of renewal premium in health insurance policies and motor insurance policies. Other relevant clauses andconditions Governing Law clause Before invoking the Force Majeure clause, it would be important to review the governing law clause in the agreement so as to ascertain the jurisdictional law that will be applicable to the agreement. This is important because different jurisdictions could deal with contractual provisions differently, depending on their respective laws. Notice clause The party invoking the Force Majeure clause should ascertain if there are any obligations for formal notifications to be sent to the other party, the timelines and the manner of issuing and serving such notifications. This is relevant because in case the terms of invoking the Force Majeure are not adhered to, such invocation could be considered to be invalid. Limitation clauses Clauses which limit the liability of the non-performing party should also be reviewed to understand the possibility and extent to which such clause can be invoked for the purpose of limiting the potential liability. Force Majeure Certificates Force majeure certificates issued by governmental agencies may aid an affected party's efforts in securing Force Majeure relief, but they may not prove determinative. Though these certificates may not be binding, however, it could have a persuasive value.
In view of the discussions, it is clear that the threshold for enforcing Force Majeure clause is quite high and its scope has been interpreted narrowly keeping in mind the Doctrine of Frustration. Force Majeure events would therefore be fact reliant and highly dependent on the wording of the contract. Events causing hardship, economic difficulties, onerousness of obligations etc. will not be covered under Force Majeure.
As for Covid-19 and the ongoing lockdown, as discussed, various departments of the Government of India have issued advisories regarding considering Covid-19 as a Force Majeure event. Similarly, it may also be noted that in China, the China Council for the Promotion of International Trade (CCPIT) is offering “Force Majeure certificates” to help companies deal with disputes with foreign trading partners arising from government control measures.
While the advisories and notifications suggest a view by governments to consider the ongoing pandemic as a Force Majeure event, however, it is not necessary that Covid 19 and the resultant lockdown would be considered as a Force Majeure event by courts of law for all contracts and purposes. The question whether Covid–19 and/or the resultant lockdown is a Force Majeure event will depend on the facts and circumstances of each case and the scope of the Force Majeure clause. A party triggering Force Majeure on the basis of Covid-19 and/or the resultant lockdown will have to show that the changed circumstances caused by Covid-19 and/or lockdown altogether destroyed the basis of the contract and its underlying object such that the performance of the contract has become impossible. Therefore, the evaluation of whether Covid 19 and/or the lockdown is a Force Majeure event will have to be considered on a case-to-case basis. While a contract for delivery of goods during the period of lockdown could be considered to be falling within the ambit of Force Majeure, however, inability to use a lease property during the lockdown period may not be considered as one.
Triggering parties also need to keep in mind that, considering the fact that the inability to perform the obligations are primarily being caused by the resultant lockdown, Covid-19 as a “pandemic” may not be considered a Force Majeure event. Rather,it might be the governmental restrictions which may qualify as a Force Majeure event. As a result, triggering parties need to careful when invoking the Force Majeure clause. Parties need to carefully evaluate each contract independently on their independent footing, for the purpose of ascertaining the application, scope, extent and enforceability of the Force Majeure clause in each such contract.
Kindly treat this as an information update and the same shall not constitute as an advisory by the firm.
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