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Impact of corona virus outbreak on commercial contracts

COVID-19 has been declared a public health emergency of International Concern by the World Health Organization on January 30, 2020. Subsequently on 11th March 2020, COVID-19 has been assessed to be a pandemic by WHO. To curb the effects of the contagious virus, India has imposed a lockdown across the country. India has constrained the fundamental right to movement available to all the citizens under Article 19(1) (d) by imposing reasonable restrictions by virtue of Article 19(5).

The outbreak of the corona virus has social and economic impacts. The immediate results are supply-chain disruptions, unwanted delay in performance and carrying out of the ‘contractual’ obligations. From construction contracts to manufacturing and supply agreements, the variety of contracts which are likely to be affected by the spread of COVID-19 is undoubtedly humongous. The paper intends to discuss about its impact on commercial contracts disrupting the performance of the contractual obligations.

Introduction
Performance of the contractual obligations is the best way to discharge a contract. By default, the defaulting party has to pay damages to the aggrieved party for non-performance of the contract.

However, the defaulting party may be relived in certain situations where default has taken place due to some unavoidable circumstances beyond the control of the parties. The outbreak of the pandemic COVID-19 is such a situation where the parties can be exculpated from their contractual obligations either by including a contingent clause of Force Majeure by virtue of Section 32 of Indian Contract Act, 1872[i]or by virtue of Section 56 of the Indian Contract Act, 1872[ii].

Situations where the defaulting party is absolved for non performance of contract

Non Performance of contract can be excused in two situations by virtue of Section 32 and Section 56 of Indian Contract Act:

  1. Contracts where the arising of such situation was anticipated and reasonable measures were taken to allocate the risks by including a force majeure clause.
  2. Situations where it is not possible for the parties to anticipate due to its uncertainty and hence allocate the back-end risks. Doctrine of frustration comes to the rescue in such situations.
    Section 56 of Indian Contract Act, 1872 covers Doctrine of frustration and contracts embodying a Force Majeure clause to an extent is governed by Section 32 of Indian Contract Act, 1872[iii] which provides for Enforcement of contracts contingent on an event happening.
In non-legal terms the effect of both are somewhat similar. But it is actually different when it is looked at in terms of formation of an agreement regarding allocation of risks. Also the implications of both are different in terms of labilities. Doctrine of frustation is more restrictive in nature comparatively.
  • Force Majeure is a specific contract clause in which ex-ante risks has been allocated. It only applies where the parties have elected to include it within the contract. A force majeure clause cannot be implied under Indian law. It is strictly construed according to the words drafted in a contract and has nothing to do with the intention of the parties.
  • Doctrine of Frustration applies where the performance of a contract which was initially possible but becomes impossible or impracticable by reason of subsequent events. This doctrine applies in situations where risks are not been allocated regarding a particular situation.

Force majeure clause encompassing a pandemic

The expression force majeure is borne out from the Code Napoleon and has a wider meaning than act of God. Force majeure, a French term which means superior force is a contractual clause which absolves a party from something it promised in a contract because of reasons beyond its control. Contracts encompassing such clause can be termed as a contingent contract by virtue of Section 32 of Indian Contract Act, 1872. There is a certain list of events which the Force Majeure clause can cover. What all events are covered by this clause depends on the negotiation done by the parties based on their contemplation abilities.

There are two types of Force Majeure events:

  1. Natural Force Majeure events:
    Act of God, including, but not limited to lightning, drought, fire and explosion (to the extent originating from a source external to the Site), earthquake, volcanic eruption, landslide, food, cyclone, typhoon, tornado, or exceptionally adverse weather conditions which are in excess of the statistical measures for the last hundred (100) years.
     
  2. Non-Natural Force Majeure events:
    Any act of war (whether declared or undeclared), invasion, armed conflict or act of foreign enemy, blockade, embargo, revolution, riot, insurrection, terrorist or military action; or Radioactive contamination or ionizing radiation originating from a source in India or resulting from another, lockouts, slowdowns, prolonged shortage of energy supplies, and acts of state or governmental action prohibiting or impeding any party from performing its respective obligations under the contract.[iv]

Force Majeure clause should include four sine qua non factors in order to absolve the parties for non-performance of the contractual obligations due to COVID-19 outbreak:

  1. Definitive part of the force majeure clause should cover:
    # What happens when a pandemic occurs
    # Who can suspend the performance; and
    # What happens if the pandemic continues for more than a specified period of time
     
  2. Evidence that the pandemic and its subsequent effect was unforeseeable at the time of execution of the contract.
     
  3. The party claiming force majeure is usually under a duty to show that it has taken all reasonable endeavors to avoid or mitigate the impact of COVID-19 on the performance of the contract.
     
  4. Proof of causation between the outbreak of COVID-19 and the resultant non- performance of the contract.
     
  5. Evidence that the effects of the pandemic are so substantial that it affects the root of contract in query.

The mere presence of Force Majeure clause does not give a blanket protection against any non fulfillment of contractual terms.

Situations where Force Majeure clause will not be attracted and parties will not be exonerated from the liabilities:

  1. Contracts where the event has rendered performance relatively more financially burdensome or more expensive.
  2. Where time is not the essence of contract, hence it won’t be majorly affected in case obligations are performed after the outbreak ceases to exist.
  3. Contracts where the outbreak of COVID 19 is not the sole reason of non-performance and there are some other events which do not attract the force majeure clause.
  4. Where there is some other possible ways of performing the liabilities arising out of the contract.

Effect of Force Majeure clause when invoked:
  • Relieves the party from performing the contractual obligation subsequent to the happening of such event, or
  • Temporarily suspends the party from performing the contractual obligation until the situation prevalent due to the pandemic ceases to exist.
If Force Majeure clause encompasses the happening of the following events, the parties may be absolved from their liabilities due to non-performance of the contract because of the COVID-19 outbreak:
  • Pandemic alike situation: WHO has declared the coronavirus disease as a pandemic.
    Even if a Force majeure clause lists act of god, a court may or may not agree that COVID-19 is a covered event; an Act of God alone may be too broad to excuse a party from performance.
     
  • Governmental actions or actions taken by public authority: Due to this outbreak, government has imposed a lockdown across the country, thereby has put a reasonable restriction on the fundamental right to movement. Also, Section 144 CrPC[v] has been enforced in the country prohibiting public gathering.
Eg: If the contract requires supplies to be obtained from a high-risk area that is currently subject to shut-down or travel restrictions, and no alternatives are available, the requisite level of impact and causation are more likely to be met.

View of Supreme Court on invocation of Force Majeure clause in a contract:

In a very recent case, Energy Watchdog v CERC[vi], the honorable Supreme Court has held that:
force majeure clauses are to be narrowly construed. On a construction of the force majeure clause in the PPA, Hindrance could mean an event wholly or partly preventing performance. Since the fundamental basis of the contract in this case was never dislodged and since alternative modes of performance were available even though at a higher price, there was no force majeure. Further, since there was a specific clause addressing force majeure, Section 56 did not have any application.

Application of Force Majeure clause in Commercial contracts in present day scenario:
  • The Ministry of Finance, Government of India vide an office memorandum dated 19.02.2020 recently clarified with respect to Manual for Procurement of Goods, 2017, and declared that in the event of any disruption in the supply chains due to spread of corona virus in China or any other country, such situation will be covered in the Force majeure Clause (FMC) in the contract. It is further clarified that such a situation should be considered as a natural calamity and Force Majeure clause may be invoked, wherever considered appropriate[vii]
     
  • Similar initiative was taken by the Ministry of New & Renewable Energy with respect to ‘solar project developers’. The Ministry vide an Office memorandum dated 20.03.2020, recently declared that whoever failed to meet contractual obligation deadlines on account of COVID -19, can invoke the force majeure clauses to avoid any financial penalties.[viii]
     
  • Force Majeure clause in Life insurance policies:
    The Life Insurance Council of India has announced that all life insurance companies, both public and private, will process all coronavirus-related death claims. According to a press release from the Life Insurance Council, The Council also confirmed that the clause of Force Majeure will not apply in case of COVID-19 death claims. [ix]
     
  • Eicher Motors, the maker of Royal Enfield brand motorcycles, has suspended payments to a few of its suppliers, invoking is the force majeure clause[x].

Application of doctrine of frustration in contracts due to the apocalyptic spread of the lethal Corona virus

Although principle of frustration is subject to a very high threshold, it is possible to envisage a range of factual circumstances in which COVID-19 and the governmental measures taken in response could be construed as a frustrating event, provided it fulfills all the criterion discussed below. Section 56 of Indian Contract Act, 1872 deals with Doctrine of frustration. Doctrine of frustration is also known as:
  • Positive law
  • Doctrine of narrow limits:

This doctrine can be applied in the following cases:

  • If the object of the contract has become impossible to perform due to the unforeseen event (Covid-19).
  • Purpose of the contract has been frustrated because of the outbreak of the lethal coronavirus.
  • The focus is on the parties’ specific contractual obligations and whether they have ‘radically changed’ as a result of the spread of Covid-19 to the extent that requiring a party to comply with its strict contractual obligations would mean requiring it to do something fundamentally different from that which it originally promised to do.
  • If the contract becomes illegal as a result of emergency legislation introduced to deal with the pandemic (COVID-19).

Section 56 will come into the picture only when:

  1. a force majeure clause is not introduced in a contract. Hence the parties to the contract are left to the mercy of the narrow common law contract doctrines of impracticability and frustration of purpose, which rarely result in excuse of performance.
  2. a force majeure clause is included but it does not cover a pandemic and the subsequent restrictions imposed by the government.

Doctrine of Frustration as per section 56 of Indian Contract Act does not apply in the following situations:

  1. Where impossibility is self-induced.
  2. Where impossibility is due to certain act of the parties.
  3. Where there is some other possible ways of performing the contract.
  4. Where the occurrence of the event (pandemic) does not substantially affect the roots of the contract.
  5. Commercial impossibility:

Contract cannot be frustrated because of:

  • Exorbitant price
  • Failure to yield profit or financial gain
  • Performance becoming onerous or burdensome

Effect of Doctrine of Frustration when invoked:
  1. Contract becomes unenforceable or void by virtue of Section 56 of Indian Contract Act.
  2. It is not possible to suspend the performance of a frustrated contract only for the duration of the frustrating event (unlike some force majeure clauses).

Indian case laws clarifying the concept of frustation:

  1. The basis of the doctrine of frustration was explained by Supreme Court in the case of Satyabrata Ghose v. Mugneeram[xi]:
    When a contract contains a force majeure clause which on construction by the Court is held attracted to the facts of the case, Section 56 can have no application.
    Justice Mukherjee held that the basic idea upon which doctrine of frustration is based is that of the impossibility of performance of the contract and the expression frustration and impossibility can also be used as synonyms.

    The court further clarified that Impossibility u/s 56 doesn’t mean literal impossibility to perform (like 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 object and purpose which the parties intended to achieve through the contract.
     
  2. M/s Alopi Parsad and sons v Union of India[xii]
    It was held that:
    The courts have no general power to absolve a party from the performance of his part of the contract merely because his performance has become onerous due to the occurrence of unforeseen events.
     
  3. Naihati Jute Mills Ltd v Hyaliram Jagannath[xiii]
    To hold a contract to be frustrated, the change in events or circumstances must be so fundamental as to be regarded by law as striking at the root of the contract.
     
  4. Energy Watchdog v CERC [xiv]

This case summarizes the concept of frustration:

  • If contract includes a force majeure clause, Doctrine of frustration will not be applicable.
  • Application of Doctrine of Frustration must be within narrow limits.
  • Rise in expense will not frustrate the contract
  • Doctrine of frustration will not be applicable so long as the fundamental basis of contract remains the same.
Although principle of frustration is subject to a very high threshold, and is invoked very rarely, it is possible to envisage a range of factual circumstances in which COVID-19 and the governmental measures taken in response could be construed as a frustrating event, provided it fulfills the entire criterion discussed above. A contract will not normally be frustrated if the relevant event was foreseen at the time that the parties entered into their contract. Given the rapid spread of Covid-19, it is unlikely to have been foreseen by the parties other than in very recently concluded agreements.

Lauritzen AS v. Wijsmuller BV[xv]:

It has been held that the ‘object of the doctrine of frustration was to give effect to the demands of justice, to achieve a just and equitable result, to do what is reasonable and fair, as an expedient to escape from injustice where such would result from enforcement of a contract in its literal terms after a significant change in circumstances.'
This indicates that in times of crisis the doctrine of frustration may be applied, but only in cases where it is almost impossible to fulfill the contractual obligations.

Conclusion:
Non-performing parties may seek to rely on contractual force majeure provisions or the common law rules on frustration so as to avoid liability for what would otherwise be a breach of contract by virtue of Section 32 and Section 56 of Indian Contract Act, 1872.

The impact of the COVID-19 outbreak on contracts largely depends on the term of the contract. In particular, whether the contract contains a force majeure clause and if it does, whether the COVID-19 outbreak could fall within the terms of that clause. Performance of the contract, including payments under the contract, is usually suspended during the period of the force majeure event. The ability to terminate the contract for a force majeure event may depend on the length of time that the event persists. At this stage it is unknown how long the current circumstances arising from the COVID-19 outbreak will last.

If a contract does not contain a force majeure clause covering a pandemic and subsequent governmental orders, doctrine of frustration of contract can be applied however its application is quite limited. For invoking Doctrine of Frustration, the event must be unforeseen and must make performance of the contract impossible, or it must radically change the principal purpose of entering into the contract. Whether the doctrine can be invoked depends on how the COVID-19 outbreak has affected the performance of the contractual obligation and therefore has to be construed according to the facts of each case. Frustration of contract results in the termination of the contract.

End-Notes:
  1. Section 32, Indian Contract Act, available at, https://indiacode.nic.in/handle/123456789/2187?view_type=browse&sam_handle=123456789/1362
  2. Section 56, Indian Contract Act, available at, https://indiankanoon.org/doc/171398/
  3. Section 32, Indian Contract Act, available at, https://indiankanoon.org/doc/124768/
  4. Energy Watchdog v Central Electricity Regulatory commission and ors, , (2017)14 SCC 80
  5. Section 144 Code of Criminal Procedure, available at, https://www.oecd.org/site/adboecdanti-corruptioninitiative/46814340.pdf
  6. Energy Watchdog v Central Electricity Regulatory commission and ors, available at, , (2017)14 SCC 80
  7. No. F18/4/2020-PPD, Ministry of Finance
  8. No. 283/18/2020-GRID SOLAR, Ministry of New & Renewable Energy (MNRE)
  9. Force majeure clause won't apply to coronavirus death claims in life insurance policies, available at, https://economictimes.indiatimes.com/wealth/insure/life-insurance/force-majeure-clause-wont-apply-to-coronavirus-death-claims-in-life-insurance-policies/articleshow/75004294.cms
  10. Eicher Motors' Royal Enfield invokes force majeure clause to select vendors, available at, https://economictimes.indiatimes.com/industry/auto/auto-news/eicher-motors-royal-enfield-invokes-force-majeure-clause-to-select-vendors/articleshow/74902387.cms?from=mdr
  11. Satyabrata Ghose vs. Mugneeram Bangur & Co, 1954 AIR 44
  12. M/s Alopi Parshad & Sons Ltd. v. Union of India, 1960 (2) SCR 793
  13. Naihati Jute Mills Ltd v Hyaliram Jagannath, 1968 (1)SCR 821
  14. Energy Watchdog v Central Electricity Regulatory commission and ors, (2017)14 SCC 80
  15. Lauritzen AS v. Wijsmuller BV, The Super Servant Two [1990] 1 Lloyd's LR 1 at 8
Written By Poulomi Sen, student of Rajiv Gandhi School of Intellectual Property Law, IIT Kharagpur   

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