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Inter-Relation Between Section 56, Force Majeure Clause, And Commercial Hardship Clause In Relation To The Effect Of The Pandemic

Force Majeure clause and the supervening impossibility doctrine is applicable in India under the legislation and the court has time and again given landmark precedents on the same. In the year 2020, due to pandemic Covid-19 affected many contracts commercially. 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 this De Jure endeavoured to demystify the concept of force majeure and frustration of a contract, the importance of the same in businesses.

Force Majeure

  • Force majeure is a concept in contract law that describes a clause, included in many contracts, that frees the parties to the contract from their contractual obligations in the event of highly unusual and unforeseen circumstances. As per Black's law dictionary, 'Force Majeure' is an event or effect that can neither be anticipated nor controlled. It is a contractual provision allocating the risk of loss if performance becomes impossible or impractical, especially as a result of an event that the parties could not have anticipated or controlled.
  • Act of God or Force Majeure is an event, where a party to a contract of non-performance is excused or has frustrated the contract rendering it impossible or impractical to perform.

Distinctions Between 'Force Majeure' Clause And Frustration Of Contract/Impossibility To Perform The Contract

  • Force Majeure doctrine is often mixed and overlapped with the doctrine of contract frustration or the inability of performing. 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. The doctrine of contract frustration is a part of the law of contract discharge due to a supervening impossibility or illegality of the act agreed to do.
     
  • Unlike the Force Majeure clause, which is usually in the form of a contractual provision, the frustration of a contract or the impossibility of performing it is given by statute in compliance with section 56 of the Contract Act. Accordingly, if the contract does not explicitly or implicitly include exemptions for non-performance in the context of Force Majeure, a party seeking to set up a defense dehors the contract can place reliance on section 56 of the Contract Act.
     
  • There are three main differences between frustration of contract and force majeure. First, frustration can be invoked by any party to a contract without being referred to in the contract, while force majeure must be included in a contract to be invoked. Second, a party generally has to meet a higher threshold to rely on frustration than on force majeure. Lastly, while a finding of frustration automatically results in the discharge of all parties from their obligations, force majeure offers the flexibility for parties to fashion the responses as they see fit.
     
  • The entire jurisprudence on the subject has been stated by Justice RF Nariman of the Supreme Court in the case of Energy Watchdog vs. CERC (2017).
Force majeure is governed by the Indian Contract Act, 1872. In so far as it is relatable to an express or implied clause in a contract, it is governed by Chapter III dealing with the contingent contracts, and more particularly, Section 32 thereof. 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.

In the case of Energy Watchdog v. Central Electricity Regulatory Commission & Ors. The Supreme Court of India restated the law of force majeure and laid down the following guidelines to be mindful of while invoking a force majeure clause:
  1. The basis of such a clause is that the events are beyond the reasonable control of the parties and in such conditions parties cannot be held liable for non-performance of obligations in the contract.
  2. The occurrence of the event has actually rendered the performance impossible or illegal.
  3. For any event to qualify as a force majeure, it is necessary that the same is unavoidable by the parties even taking all the measures necessary or capable in their capacity.
  4. While analysing the force majeure clause or considering the force majeure event, it is also necessary to take into consideration that best endeavours have been taken to mitigate force majeure events.

Doctrine Of Frustration Is Defined In Section-56 Of Indian Contract Act, 1872.

Section 56: Agreement to do impossible act:
  1. An agreement to do an act impossible in itself is void.
  2. Contract to act afterwards becomes 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.
The Doctrine of Frustration is really an aspect or part of law of discharge of contract by reason of supervening impossibility or illegality of the act agreed to be done and hence comes within the purview of Section- 56.

Landmark Indian decision which explains the ambit of Section 56.
  1. Satyabrata Ghose v. Mugneeram Bangur & Co., 1954
    • Here, the defendant was a company, which was engaged in the construction and development of house plots. There was an agreement for sale of a plot between the plaintiff and the defendant. Meanwhile, during the Second World War, the plots were compulsorily acquired by the military
       
    • The issue was whether the agreement was frustrated due to requisition by the military. In fact, the Court held that the contract cannot be held to be frustrated, as its performance was possible even after the war-time.
       
    • In our opinion, having regard to the nature and terms of the contract, the actual existence of war conditions at the time when it was entered into, the extent of the work involved in the development scheme and last though not the least the total absence of any definite period of time agreed to by the parties within which the work was to be completed, it cannot be said that the requisition order vitally affected the contract or made its performance impossible, the Court held.
       
    • Few principles stated by the Court in the decision are:
      1. The word impossible in Section 56 does not mean physical or literal impossibility.
      2. Contract can be held to be frustrated if its performance is impracticable and useless from the point of view of the object and purpose of the parties, though the performance is not literally impossible.
      3. If the untoward event totally upsets the very foundation upon which the parties entered their agreement, the contract can be held to be frustrated.
      • In this case, the Court found that the delay was not of the character which totally upset the basis of the bargain and commercial object which the parties had in view.
      • The Court also held that if the contract has an express or implied force majeure clause, then the situation will be analysed on the basis of that, and not through the application of principles under Section 56.
      • According to the Indian Contract Act, a promise may be expressed or implied. In cases, therefore, where the court gathers as a matter of construction that the contract itself contained impliedly or expressly a term, according to which it would stand discharged on the happening of certain circumstances the dissolution on of the contract would take place under the terms of the contract itself and such cases would be outside the purview of section 56 altogether.

     
  2. Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968
    • In this case, the Court held that even if a contract is held to be void under Section 56, it will not affect the arbitration clause contained in it.
    • Even if the appellants had established frustration, it would not be as if, the contract was ab initio void. In cases of frustration it is the performance of the contract which comes to an end but the contract would still be in existence for purposes such as the resolution of disputes arising under or in 'connection with it: and the question whether the contract was discharged under the doctrine of frustration would still have to be decided under the arbitration clause which operates in respect of such purposes.
    • The Court also held that to hold a contract as 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.
    • In fact, the Court held that the change in government policy on jute import did not frustrate the contract in question.
       
  3. Sushila Devi vs. Hari Singh AIR 1971
    • The case concerned the lease of a property, which went to Pakistan after partition.
    • The impossibility contemplated by Section 56 of the Contract Act is not confined to something which is not humanly possible., If the performance, of a contract becomes impracticable or useless having regard to the object and purpose the parties had in view then it must be held that the performance of the contract has become, impossible, the Court observed, holding the lease agreement as frustrated.
    • Ultimately, the Court concluded that a contract is not frustrated merely because the circumstances in which it was made are altered. The Courts have no general power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.

Doctrine Of Supervening Impossibility

  • According to Para 2 of Section 56, which states that, A contract to do an act which after the contract is made, becomes impossible, or by reasons of some event which the promisor could not prevent. Unlawful becomes void when the act becomes impossible or unlawful.
     
  • In other words, subsequent impossibility refers to the impossibility which arises subsequent to the making of the contract. If the contract was capable of performance at the time of making it, but subsequently because of some event the performance becomes impossible or unlawful, the contract becomes void and the parties get discharged from their obligations. However, supervening impossibility differs from initial impossibility, as in case of initial impossibility the agreement is void-ab-initio whereas in case of supervening impossibility the contract becomes void.
     
  • The contract becomes void on the basis of supervening impossibility if the following conditions are satisfied:
    1. The act should have become impossible.
    2. The impossibility should be the reason for some event which the promisor could not -prevent.
    3. The impossibility should not be self-induced by the promisor.
       
  • However, in the following cases the performance of a contract becomes subsequently impossible:
    1. Destruction of Subject-Matter.
    2. Death or Personal Incapacity.
    3. Change of Law.
    4. Cessation of a state of things.
    5. Declaration of War.
       
  • Exceptions to the Doctrine of Supervening Impossibility:
    1. Difficulty of Performance.
    2. Commercial Impossibility.
    3. Default of a Third Party.
    4. Strikes, Lockouts and Civil Disturbances.
    5. Partial Impossibilities.

Mere Difficulty Or Commercial Hardship Not Enough For Pleading Frustration Or Force Majeure

  • Mere difficulty in carrying on the operations or disruptions that affect the financial profitability from the contract, are not enough for the purpose of frustration, unless there is express contractual provision for such a situation. Financial downturns or unfavourable environment for conduct of business, even if the main reason for such downturn was the COVID-19 pandemic, may not suffice.
     
  • It is likely that many Companies will face difficulties on account of supply chain disruptions, non-availability of workforce due to quarantine measures or issues with flow of materials, however, even in such situations, alternative routes are to be explored. It is worth remembering that escalation of prices on account of the pandemic or any Government measure, may not be a ground to plead frustration or even Force Majeure.
     
  • A plea of Force Majeure in defence of non-performance of obligations is pegged at an extremely high level. Therefore, parties must identify which obligations are affected by COVID-19 pandemic and bring the same to the notice of other parties. Parties must make their best endeavor to perform such activities and obligations, whose performance is possible even during the ongoing crisis.

M/s Alopi Parshad & Sons Ltd. v. Union of India, 1960:
Contract not frustrated merely because its performance has become onerous.
  • This case concerned an agreement to supply ghee to army personnel. The parties sought enhanced rates citing the outbreak of World War II. The contractor claimed that it was entitled to amounts over and above the rates revised as per agreement in 1942.
  • The Court rejected the claim, noting that the contract was revised three years after the hostilities commenced, and that the party was fully conscious of the circumstances.
  • A contract is not frustrated merely because the circumstances in which it was made are altered. The courts have no general power to absolve a party from the performance of his part of the contract merely because its performance has become onerous on account of an unforeseen turn of events, the bench observed.

Does The Covid-19 Outbreak Constitute A Force Majeure Event

  • Covid-2019 has either made performance difficult or impossible. It has caused commercial hardship to some parties in performance of their contractual obligations, while rendering others completely incapable of performance.

Covid-19 and force majeure
  • In the present scenario and circumstances where the world was at standstill axis due to pandemic coronavirus, it is likely that performances under many contracts were delayed, interrupted, or even cancelled. There would be chances that the suppliers in contracts may seek to delay or avoid performance (or non-performance liability) of their contractual obligations or terminate contracts, either because Covid-19 has legitimately prevented them from performing their contractual obligations, or because they are seeking to use it as an excuse to extricate themselves from an unfavorable deal. Also, parties may also cite Covid-19 as a basis for renegotiation of price or other key contractual provisions.
     
  • Force Majeure can be classified to be Natural Force Majeure Events and Non Natural Force Majeure Events. The present widespread coronavirus which has caused the lockdown of the entire nation falls within the ambit of Non Natural Force Majeure Events and the COVID-19 could make performance of the contractual obligations to be more difficult.
     
  • In the persisting circumstances, the consideration of the COVID-19 pandemic to be Force Majeure depends on the fact that the clause of Force Majeure is incorporated in the Contract to be considered. A force majeure clause cannot be implied under Indian law. It must be expressly provided for under the contract and protection afforded will depend on the language of the clause. In the event of a dispute as to the scope of the clause, the courts are likely to apply the usual principles of contractual interpretation. In case, if the force majeure event clause expressly includes a pandemic event then Covid-19 outbreak would activate a force majeure clause in the contract. Although, whether a party can be excused from a contract on account of Covid-19 being declared a pandemic is a fact-specific determination that will depend on the nature of the party's obligations and the specific terms of the contract.
     
  • As a matter of fact, the Ministry of Finance, Government of India has already issued an office memorandum dated 19th February, 2020 inviting attention to para 9.7.7 of the Manual for procurement of Goods, 2017 issued by Department of Expenditure, stating that disruption of the supply chains due to spread of coronavirus will be covered in the Force Majeure clause (FMC) and should be considered as a case of natural calamity and FMC may be invoked, wherever considered appropriate, following the due procedure. The supply can be ranging from articles, material, commodities, livestock, medicines, furniture, fixtures, raw material, consumables, spare parts, instruments, machinery, equipment, industrial plants, vehicles, aircrafts, ships, railway rolling stock, assemblies, sub-assemblies, accessories, or such other goods etc.
     
  • If the contract does not contain force majeure provisions as the party may nevertheless be able to rely on the common law doctrine of frustration of contract. The doctrine will apply where an unforeseen event either renders a contract impossible to perform or makes the outcome of the performance radically different from what was envisaged by the parties at the time the contract was formed.
     
  • The said Doctrine of frustration has been enshrined in Section 56 of the Indian contract act 1872 which deals with those cases where the performance of contract has been frustrated and the performance of it has become impossible to perform due to any unavoidable reason or condition. Although the frustration principle is subject to a very high threshold, it is possible to envisage a range of factual circumstances in which COVID-19 and the ensuing governmental response measures could be construed as a frustrating event.
     
  • If the force majeure clause refers to pandemics and/or epidemics, then it will almost certainly be applicable given that the World Health Organization on 11th March 2020 declared COVID-19 a pandemic.
     
  • However, the position becomes more uncertain where the clause may, for example, refer to an act of God without further definition. If the outbreak does fall within the scope of the clause, it must then be determined to what extent the contractual obligations are affected. It is possible for example that some obligations within the contract are not impeded by the outbreak and some obligations may simply be postponed.
     
  • Therefore, both parties will need to closely scrutinize the relevant evidence, including the timing of the alleged performance difficulties as compared to the spread of COVID-19 and corresponding government measures are taken in the particular place of operation at a given time.
     
  • It is important to note that the doctrine of frustration, though similar in effect to the doctrine of force majeure, is more restrictive. Courts will generally not allow a party to use the doctrine of frustration as a tool to escape a bad bargain. The doctrine of frustration will also not relieve a party from performing a contractual obligation simply because the event complained of has made the performance more difficult or expensive. Economic hardship is not a ground for invoking the doctrine of frustration.

Conclusion
I want to conclude that the implications of the Covid- 19 would have to be decided on the case by case basis. Since, it depends on what has been stated and incorporated in the clause of force majeure in the contract, it becomes utmost necessary at this point of time of pandemic situation to analyze the key contracts and the clauses inculcated therein. Force Majeure and doctrine of frustration of contract have been continuously regarded as exceptional defenses in events of complete impossibility. While the threshold of proof shall continue to be high, the Courts will ascertain practicalities of the situation more dynamically

Written by Shashwata Sahu, Advocate, LLM, KIIT School of Law

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