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Contracts and CoViD-19

COVID-19 aka Novel Coronavirus is probably the biggest threat that mankind has faced in the present century. The virus which is highly contagious spread from China, now throughout the world and has shown that no matter how big a country economically is, it alone cannot do anything. The prime example being the USA and Europe both of which are considered to be the most developed places in the world and are now the epicenters of this disease.

As we all battle this confusion and fear which is brought out by the highly contagious nature of the virus and its mortality rate which is at least 20 times higher than a normal flu [1], a lot of businesses throughout the world as well as in India are in jeopardy. The sudden lockdown of the entire country was more on expected lines but still came as a shock to almost all the sectors of the economy as they did not get the time to set their house in order.

But what exactly will happen to contracts in such times, will their non-performance lead to computation of liquidated damages and will the penalty clause be activated or because of the nature of the pandemic and the subsequent actions by the state will lead to frustration of contracts.

The Indian Contract Act, 1872 lays down the general rules of a contract between two or more persons.

The Short Title to the Act states:
Nothing herein contained shall affect the provisions of any Statute, Act or Regulation not hereby expressly repealed, nor any usage or custom or trade, nor any incident of any contract, not inconsistent with the provisions of this Act.

This implies that unless it's expressly provided in the Act, no law already in operation or which might get enacted later will be affected by the provisions of the Indian Contract Act, 1872.

The Act does not proscribe for any special rules as such in detail. The provisions of The Indian Contract Act, 1872 can be for our users to be divided into two categories. The first is the essential provisions, all the contracts in India have to conform to these provisions for them to be valid

For Eg – No contract can be valid if it was not entered into with the free consent of the parties.

The second is the obligatory conditions, the contract might or might not follow it but if there is no provision to the contrary in the contract then the provisions of the Indian Contract Act, 1872 will be enforced if such a condition arises.

There can be three probable ways in which contracts which were entered into before the Coronavirus outbreak and whose performance has not been rendered amidst this lockdown.

The first scenario is when the contract has the Force majeure clause. The term Force majeure is a French term that literally translates to Superior Force. A force majeure clause intends to save the performing party from consequences of something over which it has no control.

Force majeure is an exception to what would otherwise amount to a breach of contract. A Force majeure clause in a contract is an expressed provision to identify those circumstances or situations in which performance under the contract by either one or both the parties become impossible to be carried out. Historically Force majeure clause in the contracts used to include epidemic/pandemic as a Force majeure event.

However, with the passage of time and rounds of modifications, this specific reference has been deleted.[2] Section 32 of the Indian Contract Act,1872 implicitly provides for this Force majeure situation. It states 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.''

Whether or not a particular non-performance of a contract can be attributed to a Force majeure depends on the construction of the contract by the courts and also the effect of the lockdown and the COVID19 on it specifically. Indian courts generally recognize the concept of Force majeure and have applied as well from time to time.

In Dhanrajamal Gobindram vs Shamji Kalidas And Co. [3], the Supreme Court dealing with FM held that:
19. McCardie J. in Lebeaupin v. Crispin ([1920] 2 K.B. 714), has given an account of what is meant by force majeure with reference to its history. The expression force majeure is not a mere French version of the Latin expression vis major. It is undoubtedly a term of wider import. Difficulties have arisen in the past as to what could legitimately be included in force majeure. Judges have agreed that strikes, breakdown of machinery, which, though normally not included in vis major are included in force majeure.

An analysis of rulings on the subject into which it is not necessary in this case to go shows that where reference is made to force majeure, the intention is to save the performing party from the consequences of anything over which he has no control.

This is the widest meaning that can be given to force majeure, and even if this be the meaning, it is obvious that the condition about force majeure in the agreement was not vague. The use of the word usual makes all the difference, and the meaning of the condition may be made certain by evidence about a force majeure clause, which was in contemplation of parties.

Even the Government of India has cleared its position that whether of outbreak of COVID19 should be considered a Force majeure or not. The Ministry of Finance of India has issued a clarification through an office memorandum [4] as below:

2. A doubt has arisen if the disruption of the supply chains due to the spread of coronavirus in China or any other country will be covered in the Force majeure Clause (FMC). In this regard it is clarified that it should be considered as a case of natural calamity and FMC may be invoked, wherever considered appropriate, following the due procedure as above.

So, it’s clear from the above discussion that though each contract's interpretation of Force majeure might be construed differently but the general consensus is that the outbreak of COVID19 comes under the definition of Force majeure.

The second scenario is when the provisions of the contract do not contain any Force majeure provision or if the Force majeure clause in the contract does not include epidemic/pandemic as a Force majeure event. How will then the non-performance by a party who is ascertaining the outbreak of COVID19 as a reason be looked into by the courts and does the Indian Contract Act, 1872 have a remedy to this conundrum that we have before us?

Section 56 of the Indian Contract Act, 1872 might come to the aid to address this problem. Section 56 states:
  • An agreement to do an act impossible in itself is void.
  • Contract to do act afterward 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.

The Roman doctrine of Frustration of Contract has been imbibed in Section 56 of the Indian Contract Act, 1872. Frustration in relation to contracts can be defined as something which is outside the contract but because of which performance of the contract becomes impossible.

The origin of the Doctrine of Frustration as many other laws have been from the Roman laws. It was part of the Roman contract law which extinguished obligations of innocent parties where the thing is destroyed without the debtor's act or default, and the contract purpose has ceased to be attainable [5].

It was applied in Roman times, for instance, to save, from liability, a man who promised to deliver a slave by a certain day if the slave died before delivery. Centuries later it was included in the English Law of Contracts in the famous case of Taylor vs Cardwell.[6]

In Satyabrata v. Mugneeram [7] the Supreme Court held:
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.

Further in Energy Watchdog vs Central Electricity Regulatory [8], the Supreme Court held that:
Force majeure is governed by the Indian Contract Act, 1872.

The Supreme Court held:
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. The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view.

It comes out clear that with the aid of Section 56 of the Indian Contract Act, 1872, the non-performance of a contract can be discharged. But in a recent interim order by the Bombay High Court passed on 11th April in Standard Retail Pvt. Ltd vs M/s G. S. Global Corp & Ors [9], 2020, the court held:
Force majeure clause in the present contracts was applicable only to the seller and could not come to the aid of the Petitioners who were the buyers.

It also noted that the distribution of steel was declared as an essential service and there were no restrictions on its movement. It was recorded that all ports and port-related activities including the movement of vehicles and manpower, operations of Container Freight Station and warehouses and offices of Custom Houses Agents had also been declared as essential services.

It also held that:
In any event, the lockdown would be for a limited period and the lockdown cannot come to the rescue of the Petitioners so as to resile from its contractual obligations with the Respondent No. 1 (sellers) of making payments

From this, we can conclude that each case will have to be treated on a separate basis and there can't be a general rule governing all contracts.

Finally, the third kind of contract can be the one that has an absolute/strict liability clause. Such contracts usually have a clause that any kind of Force majeure condition will not affect the performance by the parties. Though these contracts are not common but are still prevalent in certain sectors one such example are the contracts between the nuclear reactor operators and the nuclear power companies.[10]

This core regime is based on two key prongs: (1) the promisor is liable to the promisee for breach and that liability is unaffected by the promisor's exercise of due care or failure to take efficient precautions, and (2) the promisor's liability is unaffected by the fact that there existed a situation which might be termed as Force majeure in general.

On the face of it appears that COVID19 outbreak will not have an impact on such contracts and the parties will not be able to use the remedy provided under Section 56 of the Indian Contract Act but in certain special circumstances the court might even allow it, this can be an exception and not the rule and will have to be decided on a case by case basis.

Going forward, contracts can have a specific clause which mentions that in case the local/national government comes out with a notification terming a particular set of events/phenomena as a Force majeure then the performance of the contract will become voidable at the instance of either of the affected party.

End-Notes:
  1. https://www.livescience.com/new-coronavirus-compare-with-flu.html
  2. https://energy.economictimes.indiatimes.com/energy-speak/classification-of-covid-19-as-force-majeure-event-grants-relief-to-solar-developers-under-the-solar-ppas/4142
  3. AIR 1961 SC 1285
  4. https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf
  5. https://www.mondaq.com/india/contracts-and-commercial-law/407868/doctrine-of-frustration
  6. 122 ER 309
  7. AIR 1954 SC 44
  8. (2017) 14 SCC 80
  9. Commercial Arbitration Petition (L) NO. 404 OF 2020
  10. https://energy.economictimes.indiatimes.com/news/power/westinghouse-set-to-sign-pact-with-npcil-for-nuclear-reactors-during-trump-visit/74234592

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