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Validity Of Contracts Made During Pandemic

What constitutes a valid contract!
Offer+acceptance = promise
Offer+acceptance+consideration = agreement
An agreement enforceable by law = valid Contract

Travel restrictions, event cancellations, and sick and self-isolating workforces due to the impact of COVID-19 are causing difficulties for businesses across the globe, many of which are now unable to perform contracts in the manner agreed with their contractual counterparties.

To seek reliance on a force majeure clause, a party will be required to demonstrate that the event of force majeure was beyond the 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 alternative means for performing under the contract.

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 promise for any loss which such promise sustains the non-performance of the promise.
Frustration of a contract, may not be applicable in situation of:
  1. self-induced frustration
  2. wherein a contract, parties have, expressly agreed that the contract would stand despite such intervening circumstance or event.

Theories of frustration
Two theories are most well-known
  1. Theory of implied term
    A court can and ought to examine the contract and the circumstances in which it was made, not of course to varying, but to explain it, to see whether or not from the nature of it the parties must have made their bargain on the footing that a particular thing or state of things would continue to exist. And if they must have done so, then a term to effect will be implied, though it be not expressed in the contract It is, in my opinion, the true principle, for no The court has absolving power, but it can infer from the nature of the contract and the surrounding circumstances that a condition which was not expressed was a foundation on which the parties contracted. ... Were the altered conditions such that, had they thought of them, they would have taken their chances of them, or such that as sensible men they would have said: "If that happens, of course, it is all over between us"?

    To my mind the theory of the implied condition is not really consistent with the true theory of frustration. It has never been acted on by the court as a ground of decision, but is merely stated as a theoretical explanation." "The court has formulated the doctrine by virtue of its inherent jurisdiction, just as it has developed the rules of liability for negligence, or for the restitution or repayment of money where otherwise there would be unjust enrichment.

    I find the theory on the basis of the rule in the pregnant statement of Lord Sumner that the doctrine of frustration is really a device by which the rules as to absolute contracts are reconciled with the special exceptions that justice demands.

    Just and reasonable solution
    In a subsequent case British Movietoneivs Ltd v London & District Cinemas Ltd, 1952 AC 166 (HL) Denning LJ attempted to explain the doctrine of frustration on a different basis. He said:
    The court really exercises a qualifying power—a power to qualify the absolute, literal or wide terms of the contract—in order to do what is just and reasonable in the new situation.

    The day is done when we can excuse an unforeseen injustice by saying to the sufferer 'it is your own folly, you ought not to have passed that form of words, you ought to have put in a clause to protect yourself. We no longer credit a party with the foresight of a Prophet or his lawyer with the draftsmanship of a Chalmers." But this statement was not approved when the case went before the House of Lords.

    The observation of Lord Loreburn that "no court has an absolving power", was re-emphasized. Viscount Simon said: "The principle remains the same. Particular applications of it may greatly vary and theoretical lawyers may debate whether the rule should be regarded as arising from implied terms or because the basis of the contract no longer exists.
     
Theories not applicable in India
Referring to the theories B.K.Mukherjea J of the SupremeCourt said in Satyabrata Ghose v Mugneeram Bangur & Co:
These differences in the way of formulating legal theories really do not concern us so long as we have a statutory provision in the Indian Contract Act. In deciding cases in India, the only doctrine that we have to go by is that of supervening impossibility or illegality as laid down in Section 56 of the Contract Act, taking the word 'impossible' in its practical and not literal sense. It must be borne in mind, however, that Section 56 lays down a rule of positive law and does not leave the matter to be determined according to the intention of the parties."

Legal issues discussed:
A number of questions have to be answered before assessing the validity of force majeure clauses.
  1. Whether the contract made during covid -19 was discharged and came to an end by reason of the supervening circumstances?
  2. Whether the parties are entitled to Compensation for loss through non-performance of acts known to be impossible or unlawful.
  3. What will be the legal consequences of invoking force majeure or doctrine of frustration?
  4. If there is no force majeure clause in the contract then what other legal remedy can be used?

Statutory provisions:
Section 32 of Indian Contract Act 1872:
Enforcement of contracts contingent on an event happening.

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.

Section 56 of Indian Contract Act 1872: Agreement to do impossible act.

An agreement to do an act impossible in itself is void.

Contract to do an 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 the 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 nonperformance of the promise.

Section 65 of Indian Contract Act 1872:
The obligation of the person who has received advantage under the void agreement, or contract that becomes void:
When an agreement is discovered to be void, or when a contract becomes void, any person who has received any the advantage under such agreement or contract is bound to restore it or to make compensation for it to the person from whom he received it.

The government issued office memoranda dated 19 February and 20 March 2020 treating the spread of Covid-19 as a force majeure event applicable to contracts to which it is a party. The memoranda do not bind parties to private commercial contracts, but may be of persuasive value.

The consequences of invoking a force majeure clause should be set out in the clause itself, and may include the suspension of contractual obligations during the currency of the force majeure event, the termination of the contract, and the suspension of contractual obligations with termination should the force majeure the event continues beyond an agreed period.

Evaluation of legal issues with examples:
Legal issue 1:
A contract which is capable of performing at the time it was entered into, may owing to some event beyond the control of the promisor, become incapable of performance or render it unlawful. In either case the contract becomes void.

For example:
A contract to act at a theatre for six months, in consideration of a sum of money paid in advance by B. On several occasions A is too ill to act. The contract on those occasions becomes void.

Legal issue 2:
According to section 56 of the Indian Contract Act,1872 if the impossibility is not obvious and the promisor knows or with reasonable diligence might have known , such promisor is bound to compensate the promise for any loss he may suffer due to non –performance of the promise.

For example:
A contracts to marry b, being already married to c, being forbidden by the law to which he is subject to practice polygamy. A must make compensation to b for the loss caused to her by the non-performance of his promise.

Legal issue 3:
The expression “force majeure” means irresistible force or compulsion; circumstances beyond one’s control.

It means an act of God, war, insurrection, riot, civil,strike, earthquake and any other happening which the lessee would not reasonably prevent or control.If the “force majeure ” clause is not provided in the contract then the contract would be discharged if it comes within the provision of section 56.

The doctrine of frustration is applicable in two types:
  • where the performance is physically impossible
  • where the object that the parties had in mind has failed to materialize.
For example A contracts to sing for b at a concert for 1,000 rupees which are paid in advance. A is too ill to sing. A is not bound to make compensation to b for the loss of profits which b would have made if A had been able to sing, but must refund to b the 1,000 rupees paid in advance.

Legal issue-4:
From a contractual perspective, a force majeure clause provides temporary reprieve to a party from performing its obligations under a contract upon the occurrence of a force majeure event. 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.

Under section 65 of ICA, 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.

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.

Recommendations:
Whether the parties can invoke force majeure or doctrine of frustration that will depend upon the facts and circumstances.
  • The parties can opt for a waiver which means giving up of a right which a party is entitled to under the contract, and thus the other party is released from his obligation
  • The parties to the contract can mutually decide to extend the time of performance of the promise.
  • The promisee may accept any satisfaction which he thinks fit instead of the performance.
  • The parties can opt for rescission by mutual consent. However, it is not possible for the vendor to make a deed of cancellation of the sale deed made and registered earlier and get it registered, even if the ground is that full consideration was not received by the vendor, Such deeds amount to rescission of the contract. It would require an order of the court under Section 31 of the Specific Relief Act,1963
  • 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.
References
  • Contract and Specific Relief (Avtar Singh)
  • Indian Contract Act (1872)
Written By: Naman kulshrestha - Faculty of law, university of Delhi

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