By Poorvi Sanjanwala and Kashmira Bakliwal
Apart from the devastating impact that COVID-19 continues to unleash on human beings and countries worldwide, its outreach has also reached commerce and business. COVID-19 has resulted in lockdowns or restricted movements in countries.
Consequently, businesses have been impacted and so have operations and consequently contracts and obligations under contracts are being revisited to assess these impacts. The term that has assumed relevance in contractual context today for businesses today and heard most often is “force majeure” and how will this term be construed in a contract in the background of COVID-19.
We have, through these questions and answers endeavored to demystify the concept of “force majeure” and “frustration of a contract”, the importance of the same in businesses, the difference between the two, key aspects that one may wish to keep in mind while drafting a force majeure clause and the repercussions of COVID-19 on contracts in India in light of of “force majeure” and “frustration of a contract”.
Q1. What do you mean by “force majeure”?
The term ‘force majeure’ has been defined in Black’s Law Dictionary, as ‘an event or effect that can be neither anticipated nor controlled. It is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled.’ While force majeure has neither been defined nor specifically dealt with, in Indian statutes, some reference can be found in Section 32 of the Indian Contract Act, 1872 (the "Contract Act") envisages that if a contract is contingent on the happening of an event which event becomes impossible, then the contract becomes void.
From a contractual perspective, a force majeure clause provides temporary reprieve to a party from performing its obligations under a contract upon occurrence of a of a force majeure event.
A force majeure clause typically spells out specific circumstances or events, which would qualify as force majeure events, conditions which would have be fulfilled for such force majeure clause to apply to the contract and the consequences of occurrence of such force majeure event. As such, for a force majeure clause to become applicable (should any force majeure event occur), the occurrence of such events should be beyond control of the parties and the parties will be required to demonstrate that they have made attempts to mitigate the impact of such force majeure event. If an event or circumstance comes within the ambit of a force majeure event and fulfils the conditions for applicability of the clause then the consequence would be that parties would be relieved from performing their respective obligations to be undertaken by them under the contract during the period that such force majeure events continue.
Further consequential liabilities, depending on the language of the clause, the parties maybe required to issue a notice formally intimating the other party of the occurrence of such event and invocation of the force majeure clause. Some contracts also contain a provision that if such force majeure event continues for a prolonged time period, the parties may be permitted to terminate the contract.
Q2. What would force majeure clauses typically include and what happens if, a contract does not include a force majeure clause?
A force majeure clause in a contract would typically include an exhaustive list of events such as acts of God, war, terrorism, earthquakes, hurricanes, acts of government, explosions, fire, plagues or epidemics or a non- exhaustive list wherein the parties simply narrate what generally constitute force majeure events and thereafter add “and such such other acts or events that are beyond the control of parties”. As discussed above, it would also include conditions which would have be fulfilled for such force majeure clause to apply to the contract and the consequences of occurrence of such force majeure event. Consequences would include the suspension of obligations of the parties upon occurrence of a force majeure event.
If a contract does not include a force majeure clause, the parties would have to ascertain in light factors such as the nature of the contract, the nature of event and so forth, as to whether Section 56 of the Contract Act (which deals with agreements between the parties to do an impossible act) and which has been briefly discussed below, can be applied to such contract so as to discharge the parties from their contractual obligations.
Q3. Why is this concept important for businesses?
Force majeure clauses can usually be found in various contracts such as power purchase agreements, supply contracts, manufacturing contracts, distribution agreements, project finance agreements, agreements between real estate developers and home buyers, etc.
This provision is important for businesses as it relieves the parties from performing their respective obligations and which are to be undertaken under the contract and consequential liabilities, during the period that force majeure events continue provided that the conditions for clause to become applicable (which have been discussed above) are met.
Q4. What do you mean by “frustration of a contract” and why is this concept important for businesses?
If performance of an act becomes impossible or unlawful, after a contract has been executed, and such impossibility is due to an event which the party undertaking the performance could not prevent, then such contract itself becomes void or one can say that the contract becomes ‘frustrated’.
Hence, frustration is the happening of an act outside the contract and such act makes the completion of performance of a contract impossible.Under the Contract Act, the doctrine of frustration of contract is envisaged in Section 56, which states that an agreement to do an act impossible in itself is void. On a plain reading of Section 56 of the Contract Act, it is evident that the section envisages some impossibility or unlawfulness of the performance of the act, which the parties had not contemplated at the time when they entered into the contract. It leads to a pertinent question as to what is such impossible act that would lead to frustration of contract.
The courts in India have held that the word ‘impossibility’ used in Section 56 of the Contract Act must be interpreted in a practical form and not in its literal sense. Thus, a contract would come under the purview of Section 56 of the Contract Act even if it is not an absolute impossibility, but the contract has fundamentally changed, which the parties had not contemplated at the time of the agreement. This principal has been upheld in Satyabrata Ghose versus Mugneeram Bangur & Co & Anr (AIR 1954 SC 44).
The concept of restitution as set out in Section 65 of the Contract Act also assumes significance in the context of the frustration of contract. Section 65 states that when an agreement is discovered to be void, such as in case of a contract getting frustrated, the person who has received any advantage under such agreement is ‘bound’ to restore it or to make compensation for it, from whom he received it. Thus, one of the consequences of frustration of a contract is restitution whereby parties are to be put in the same position they were if the contract had never been executed.
Q5. What is the difference between force majeure and frustration of a contract?\
Under the doctrine of frustration, impossibility of a party to perform its obligations under a contract is linked to occurrence of an event/circumstance subsequent to the execution of a contract and which was not contemplated at the time of execution of the contract.
However, under in case of a force majeure, parties typically identify, prior to the execution of a contract, an exhaustive list of events, which would attract the applicability of the force majeure clause.
Frustration of a contract to be invoked and applied requires that the entire subject matter or underlying rationale for the contract be destroyed. Doctrine of Frustration renders the contract void and consequently all contractual obligations of the parties cease to exist. Frustration of a Contract is a test dehors of contractual provisions and is the end result of events arising after the contract was executed.
Whereas a force majeure is contractual provision contemplating an event, which can result in deferment of performance of contractual, obligations and therefore rights of parties thereunder until such event continue and typically does not absolutely excuse parties from performing their obligations.Typically, where a force majeure event is not specifically covered under a contract, frustration of a contract may be claimed by the affected party, however, if the case is opposite and a particular event is covered as a force majeure event under a contract, frustration of such contract cannot be automatically claimed.
Q6. What are some of the key aspects related to the two concepts that legal teams should keep in mind while drafting contracts?
While drafting a force majeure provision, the following aspects should be covered:
(a) enumerating events which would constitute a force majeure event, based on the commercial understanding between the parties and the nature of the contract, the said list can be exhaustive or non-exhaustive in nature;
(b) actions required to be undertaken by the parties to invoke the provisions of force majeure by providing for issuance of notice to the other side intimating them about force majeure
(c) consequence of occurrence of a force majeure event, including requiring parties to the extent possible, to mitigate the consequences of the force majeure event, excusing the affected party from performing the contract in whole or in part or excusing a party from delay in performance or entitling them to suspend or claim an extension of time for performance; or giving that party a right to terminate the contract.
In addition to the aforesaid, the legal teams should also have a discussion with the parties to the contract to understand the sector they are engaged in and specific events if any need to be set as part of the force majeure provision.
Q7. Can you explain the concept of force majeure in the form of examples for each? (keeping in mind the current COVID-19 scenario)
The following is a hypothetical example to explain the concept of force majeure in a contract.
Company A had entered into a supply contract for a non-essential good with Company B and such supply contract makes specific reference to occurrence of a force majeure event and consequences of the same.The force majeure provision in the supply contract includes within its ambit any acts/orders of government and upon occurrence of a force majeure event, notice of the happening of such event shall be given by either party to the other within 30 days from the date of occurrence of such event, and consequently obligations of Company B to supply the goods to Company A and obligation of Company A to make payments to Company B for such goods shall be deferred for a period of six weeks.
Since in present times, due to the Corona Virus, the lockdown imposed by the government can be construed as an act/order of the government, Company B will be required to issue a notice to Company A indicating that such an event has occurred and the lockdown is beyond the control of Company B and therefore provisions of force majeure clause will trigger and all obligations of Company A and Company B shall be deferred for a period during which the order for lockdown continues to be in effect.
Q8. Can you explain the concept of frustration of a contract in the form of examples for each? (keeping in mind the current COVID-19 scenario)
The following is a hypothetical example to explain the concept of frustration of a contract.
A company had entered into a contract with an event organizer to provide sound and lighting for a concert.
However, due to the lockdown imposed in India, the concert can no longer take place. In this case, the contract between the company and event organizer will be frustrated since due to the lockdown imposed by the government, it is now impossible for the concert to take place and therefore for either party to perform its obligations and therefore the contract will, in light of Section 56 of the Contract Act, become void and if the event organizer has received any advance under the said contract, the event organizer will be ‘bound’ to repay the advance received by to the company.
Q9. Are there any areas wherein the concept of force majeure may not be enforceable on a particular matter?
Force majeure is not intended to excuse negligence or other malfeasance of a party, as where non-performance is caused by the usual and natural consequences of external forces, or where the intervening circumstances are specifically contemplated. It would also be important to note that force majeure cannot be invoked just because the contract has become financially or commercially more difficult to perform.
In order to seek reliance on a force majeure clause, a party will be required to demonstrate that the event of force majeure was beyond control of the party, that it has taken all reasonable steps (which may be commercial or financial in nature, like disbursing some additional money, hiring extra manpower, seeking alternative manufacturing lines or suppliers, etc.) to overcome or mitigate the event and its consequence, and that there are no alternate means for performing under the contract. However, the reasonableness of mitigation would depend on a case-to-case basis and the subject matter of the contract.
Q10. Are there any areas wherein the concept frustration of a contract may not be enforceable on a particular matter?
Frustration of a contract, may not be applicable in situation of
(i) self-induced frustration
(ii) where in a contract, parties have, expressly agreed that the contract would stand despite such intervening circumstance or event.
Q11. How will the two concepts impact businesses/organisations and companies in the wake of COVID-19?
COVID-19 has affected cross-border trade, real estate market, specifically the developers, the home-buyers and the commercial lease arrangements, EPC (engineering, procurement & construction), joint-venture agreements as well as M&A deals in India.
It has also impacted the parties ability to meet their contractual obligations due to restriction in movement, stoppage of production, increase in costs due to scarcity of raw materials components, labor shortages, shortage of funds, disruption in the supply chains.
Presently companies in various sectors have already declared or are likely to declare a force majeure which 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 the latest addition to this list being Hero MotoCorp.
With widespread disruption in business, manufacturing and transport, due to COVID-19 the stage seems set for India to see a flood of ‘force majeure’ invocations. It is expected that over a period of time more and more Indian companies may invoke ‘force majeure’ clauses in in their contracts resulting perhaps in a spew of litigations should parties not come to a workable understanding.
Of course, in such events, the courts and arbitrators will have to evaluate and decide each dispute on individual merits, which would be based on the terms of the contract, the intent of the parties, steps taken to mitigate.
Further, in cases where a contract does not have an explicit clause on force majeure, there could be scenarios where parties may try to seek shelter under Section 56 of the Contract Act and seek frustration of a contract.
The courts will then have to ascertain whether the contract has become impossible to perform and whether the doctrine of frustration of contract could be made applicable to such a contract.
How the courts will interpret COVID -19 in relation to force majeure provisions will be interesting to watch out in the course of this year once the impact of COVID-19 settles. Presently, the Ministry of Finance has by way of an office memorandum (O.M. No. 18/4/2020-PPD) issued on February 20, 2020 clarified that the disruption of the supply chains due to spread of coronavirus in China or any other country should be considered as a case of natural calamity and “force majeure clause” may be invoked, wherever considered appropriate, following the due procedure. However, such clarification has been provided only with respect to the disruption of the supply chains and as indicated above, invocation of force majeure provisions in light of COVID-19 will have to be assessed on a case-to-case basis depending on the terms of the contract entered into between the parties.
It will also be interesting to see the stand which the insurance companies will take vis-a-vis insurance policies taken by companies to cover loss arising due to certain unforeseen circumstances in their businesses, and whether COVID-19 will be covered under these policies. A recent ET article also indicates that experts experts have said that most insurers will also fall back on the Force Majeure, or “Act of God” clause.
( Poorvi Sanjanwala, is partner, Rajani Associates and Kashmira Bakliwal is senior associate, Rajani Associates)
Used here for the educational purposes of students of ICSI
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