Frustrating Times? Contracts in the Times of COVID

– Abhishek Tripathi & Mani Gupta

The spread of Covid-19 across the globe, which was characterized as a pandemic by World Health Organisation, is testing the resilience of human beings in all its myriad forms. Legal/ contractual relations are no exception. As of date, Covid-19 has led to the following, amongst many other, actions:

a) suspension of travel from one country to another followed by effective sealing of borders, and suspension of passenger movement across countries;

b) lockdowns – both national and local – leading to almost complete cessation of movement of persons and goods;

c) cessation of economic activities, such as shutting down of factories, offices, and manufacturing activities and services (except in certain excepted categories); and

d) disruption in supply chains, particularly due to shutting down or curtailment of manufacturing and transport from major manufacturing hubs like China and South East Asia.

In this situation, parties are being forced to take a closer look at their contracts to assess the risk arising directly or indirectly due to this global pandemic. It is likely that in the aftermath of the present crisis, clauses like force majeure, and “notice” which were drafted like boiler plates, would be paid closer attention. It is also anticipated that multiple disputes between contracting parties on how to deal with the impact of the pandemic or resultant actions on their commercial bargain[1]. The legal position in India needs to be examined in this background.

Contracts containing a Force Majeure Clause

The letter of the contract will obviously be the first port of call for assessing the impact in contracts where a ‘force majeure’ (“FM”) clause exists. While examining FM clause in a contract, one has to specifically examine the following:

a) scope or definition of FM;

b) conditions precedent, if any, to the invocation of the FM clause;

c) consequences of the FM events.

The Supreme Court of India in the case of Energy Watchdog v. Central Electricity Regulatory Commission[2] held that where a contract contains an express or an implied FM clause, Section 32 of the Contract Act, 1872 shall apply to such clauses[3]. Section 32 normally applies to contingent contracts where the parties agree to do or not to do certain things when an uncertain future event happens. Such contractual terms cannot be enforced until the uncertain future event happens, and if such event becomes impossible, the contract becomes void. Section 32 is attracted to such FM clauses in a limited sense, in so far as the party seeking its benefit shall not be permitted to avail such benefit until the FM event has occurred.

Defining ‘force majeure’

Typically, most FM clauses define FM as acts of God, flood, earthquake etc. Where specified events are included in the definition of FM, the words used have to be given their normal meaning in the context of the contract. Where specified events are followed by general words such as ‘other such events’, the general words shall be normally be given their meaning following the principle of ‘ejusdem generis’. Further, where the definition uses words such as ‘means’, ‘means and includes’, ‘means…..and includes’, ‘means… but excludes’, it would normally indicate an exhaustive definition, though exceptions to this rule may exist. On the other hand, words such as ‘includes’, ‘includes without limitation’, would normally indicate an inclusive definition, with scope to include more instances in the scope of FM. Generic terms like ‘usual force majeure clause shall apply’ may run the risk of being void for vagueness[4], however, Supreme Court has given effect to such clauses by reading into them the FM clauses that are found in similar contracts specific to a trade and geography, based on specific evidence brought to its notice[5].

It is also normal for FM clauses to contain overarching qualifying language that the event ought to be beyond the reasonable control or contemplation of the parties. This will be relevant for contracts executed after the spread of Covid-19 began as such an event (and its consequent effect on party’s ability to perform the contract) is reasonably within the contemplation of the parties, or should have been.

The FM clause may also contain qualifiers suggesting that event must hinder, delay or prevent the performance of the contract by a party before it can be invoked to excuse performance. As per Chitty on Contracts, words such as ‘hindered’, ‘delayed’, ‘impeded’, ‘impaired’, or ‘interfered with’ may show a lower threshold to be satisfied before invoking FM[6]. Similarly, use of the word ‘prevented’ may show a much higher threshold, in so far as the performance of the contract must be ‘physically and legally impossible’, and not merely more difficult and unprofitable’[7]. It is invariably true that commercial hardship such as a rise in prices is normally not considered a hindrance sufficient to invoke FM[8].

On February 19, 2020 Government of India, Ministry of Finance, Department of Expenditure, Procurement Policy Division issued an office memorandum characterizing disruption of supply chain due to Covid-19 in China as natural calamity and a fit case for invoking FM[9]. Similar circulars have been issued for various other sectors. However, the applicability of such circulars to private contracts (that is, contracts with private parties instead of government) would have to be assessed on case-to-case basis.

Conditions precedent to force majeure

Once a party wishes to rely on the contractual FM clause, it must assess the conditions in the contract to avail the benefit of such clause. The most typical requirement is that, the party seeking to claim the benefit ought to notify the other party within a specified time period of its intent to seek the benefit of the FM exception. If the contract states that failure to provide notice within a specified period of time shall disable the party to the benefit of the FM clause, courts tend to view the notice to be a necessary pre-condition.

In Covid-19 situation, there may be instances where while notice clause is a necessary pre-condition to the FM exception, given the lockdown it may not be possible to provide notice itself, particularly in the hard copy format. In long-term contracts, it also needs to be seen whether email is a valid notice or not. The clauses will have to be carefully examined to assess if it can be argued that the FM continues till the lockdown which prevented serving of physical notice/ hand-delivery, and thereby extending the period for notice till the lockdown is removed. Alternatively, by applying the doctrine of blue pencil or severability, it may be possible to argue that the notice clause alone was frustrated, under Section 56 of the Contract Act (discussed later) while the remaining clause remained operative.

Consequences of Force Majeure

FM clauses prescribe varying consequences for the occurrence of the force majeure events. Most common consequence of FM is that, it excuses either party from performance of their respective obligations in the contract without affecting their accrued rights. For example, in a supply contract with such FM clause, the obligation to supply will be suspended, as also the obligation to make the payment for the supply, however the obligation to make the payment for supplies already made would survive.

In certain other contracts, the occurrence of FM may also entitle the affected party to an extension of time for fulfilling its obligations. Similarly, the contract may also provide for compensation to the affected party. In these situations, parties may have agreed to bear their own losses or in agreed proportions.

Where the FM continues for a long duration, the contracts may provide the affected party the right to terminate the contract, without affecting accrued rights and obligations. Such termination may also specify other consequences, such as in construction contracts, it may entitle an employer to purchase or a contractor to sell, the work done.

Other Considerations

For a party to claim the benefit of FM clause, it shall ordinarily have the burden to prove the existence of the events causing the FM. Such burden would normally have to not only be discharged to show that the event falls within the confines of the contract, but also that the party could not have taken reasonable steps to avoid or mitigate the impact of the event. Lastly, contractual parties should assess other requirements such as any reporting requirements during the continuance of the FM event.

Remedy of Frustration

Where a contract does not contain FM clause or where the FM clause does not consider a specific event like Covid-19, Section 56 of the Contract Act[10] comes into picture, often referred to as the doctrine of frustration. It stipulates that a contract to do an act which becomes impossible or unlawful to perform after the contract is made, becomes void when the act becomes impossible or unlawful.

The threshold for frustration of a contract is fairly high, such that a mere commercial unviability due to a higher cost to fulfil the contract would normally not lead to frustration of contract, particularly when alternate modes of fulfilment of the contractual obligations are available to the parties[11]. However, in the case of Satyabrata Ghose v. Mugneeram Bangur & Co[12], the Supreme Court has broadened the horizons of what would constitute frustration under Section 56. The court recognised that the word ‘impossible’ as used in Section 56 is not one referring to literal or physical impossibility alone, but also to such events where ‘the performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and the purpose that the parties had in view’, and where the change in circumstances due to the supervening events ‘totally upsets the very foundation upon which the parties rested their bargain’. While expanding the scope of impossibility to include impracticability, the court still laid down a fairly high standard to be fulfilled.

Having said this, parties need to be mindful of the practical challenges of invoking Section 56. Under Indian law, where a contract is discovered to be void, or becomes void, such as under Section 56, the principle of restitution set forth under Section 65 of the Contract Act becomes applicable. Principle of restitution implies that the party that has received a benefit under a contract that has become void must restore such benefit that it has received or provide compensation for such benefit. This too may pose practical challenges to the invocation of the remedy of frustration for contracting parties.

Conclusion

The disputes that Covid-19 may fuel are likely to expand the jurisprudence on FM and frustration of contract to unchartered territories, particularly when more unique commercial situations are brought to the court’s attention. Some situations may require out of the box reasoning by the courts; and in some cases, parties may be left high-and-dry in light of technological innovations. The current jurisprudence around frustration of contracts may not be entirely reassuring to the parties that find themselves being forced to fulfil commercial bargains which are no more economically viable. FM clauses too may not fully capture the impact of Covid-19 in all cases. In some cases such as leases, and service contracts, the only solution may lie with the government stepping in with a legislative framework to deal with such unique contractual issues arising out of Covid-19, but it may still be early days for such legislative intervention. To this end, the Government of India, and its various agencies have come out with various executive instructions which may have a bearing on contractual obligations, but that may not be sufficient.[13] Recognising the limitations of the existing legal framework, Government of Singapore has already proposed a specific legislation to provide relief from contractual obligations in private contracts to take care of the hardships arising out of Covid-19.[14] This may be an interesting model which some other common law jurisdictions, like India, may like to emulate.

Should you have any specific query on how COVID-19 may impact your existing contract, please feel free to write to us at abhishek.tripathi@sarthaklaw.com or mani.gupta@sarthaklaw.com.

[1] https://www.business-standard.com/article/companies/use-of-force-majeure-clause-by-gail-ioc-expected-to-end-in-disputes-120040101760_1.html
[2] (2017)14 SCC 80.
[3] This is merely an affirmation of the legal position that has prevailed in India since the decision of Supreme Court in Satyabrata Ghose v. Mugneeram Bangur & Co, AIR1954SC 44, and Naihati Jute Mills Ltd. v. Khyaliram Jagannath, 1968 (1) SCR 821.
[4] British Electrical and Associated Industries (Cardiff) Limited v. Patley Pressings Limited, [1953] 1 WLR 280.
[5] Dhanarajamal Gobindram v. Shamji Kalidas & Co., [1961] 3 SCR 1020.
[6] Chitty on Contracts, Volume I, 31st edn, 2012, Sweet and Maxwell, page 1092-1093.
[7] Chitty on Contracts, Volume I, 31st edn, 2012, Sweet and Maxwell, page 1090.
[8] The view expressed in several English cases found support of the Supreme Court in Energy Watchdog v. Central Electricity Regulatory Commission, (2017)14 SCC 80.
[9] Sourced from: https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf
[10] In Naihatti Jute Mills Limited v. Khyaliram Jaggannath, AIR 1968 SC 522, the Supreme Court concluded that where the contract provided the consequences of a specified event, the doctrine of frustration under Section 56 shall not be available. This may lead to a conclusion that defense of frustration may not be available in contracts providing for force majeure clauses, however, depending on the language of the force majeure clause, it may be possible to apply doctrine of frustration where there is a legal or real impossibility to perform an act.
[11] Supra note 2.
[12] AIR 1954 SC 44
[13] Some of the notifications issued by various Government agencies may be viewed at https://prsindia.org/covid-19/notifications
[14] https://www.drewnapier.com/DrewNapier/media/DrewNapier/1Apr2020_NEW-BILL-TO-BE-PASSED-IN-PARLIAMENT-NEXT-WEEK-EXPECTED-TO-GIVE.pdf