Month: April 2020

The impact of COVID-19 on domestic and international industries is severe, across all sectors. There are several legal issues that a company must face during the COVID-19 outbreak. One such legal issue is the occurrence of a force majeure event. A force majeure claim may protect a party from liability for its failure to perform its contractual obligation(s).

Manual for Procurement of Goods 2017 – Office Memorandum dated 19 February 2020

The Ministry of Finance (Department of Expenditure), vide its office memorandum (No. F.18/4/2020-PPD dated 19 February 2020), clarified that disruption of supply chains due to the spread of Coronavirus in China or any other country will be covered under the Force Majeure Clause (as defined in the Manual for Procurement of Goods, 2017).

Para 9.7.7 of the Manual for Procurement of Goods 2017 states the following with regard to the ‘Force Majeure Clause’:

1. Force majeure is an extraordinary event/circumstance that is beyond human control and has been described as an act of God, natural disasters, war, strikes, riots, crimes (but it does not include negligence or wrong-doing, predictable/seasonal rain or any other event specifically excluded in the clause).
   
2. Such a clause in the contract frees both parties from liability when prevented by such event from fulfilling their contractual obligations.
   
3. A Force majeure clause is not an excuse for the parties’ non-performance entirely, and only suspends it for the duration of the force majeure event.
   
4. If a force majeure clause is triggered, a notice of force majeure should be given to the other party as soon as such event occurs. Protection cannot be claimed ex-post facto.
   
5. Where a force majeure event affects only the purchase organization, the purchase organization is to communicate with the supplier along similar lines as above for further necessary action.
   
6. If the performance of the contract is prevented or delayed as a whole or in part for a period exceeding 90 days, either party may terminate the contract without any financial repercussion on either side.

This Office Memorandum essentially suggests that COVID-19 could be construed as a natural calamity which would excuse non-performance of contractual obligations, although certain prescribed procedural safeguards must be followed by the party seeking to invoke the clause.

However, it must be noted that the office memorandum does, to a large extent, over-simplify the grounds on which force majeure protection can be claimed by a party. Further, this office memorandum does not automatically assure the success of a party invoking such a claim, even on the grounds of COVID-19.

To appreciate the nuances relating to Force Majeure, it is important to understand the jurisprudence of the concept under the Indian Contract Act, 1872.

What is Force Majeure?

Force majeure is a French expression which translates, literally, to “superior force”.

In the context of law and business, the Merriam Webster dictionary states that force majeure usually refers to “those uncontrollable events (such as war, labor stoppages, or extreme weather) that are not the fault of any party and that make it difficult or impossible to carry out normal business. A company may insert a force majeure clause into a contract to absolve itself from liability in the event it cannot fulfill the terms of a contract (or if attempting to do so will result in loss or damage of goods) for reasons beyond its control”[1].

Black’s Law Dictionary defines Force Majeure as follows, “In the law of insurance, superior or irresistible force. Such clause is common in construction contracts to protect the parties in the event a part of the contract cannot be performed due to causes which are outside the control of the parties and could not be avoided by exercise of due care… Typically, such clauses specifically indicate problems beyond the reasonable control of the lessee that will excuse performance.”[2]

In India, it is often referred to as an “act of God”. However, the term “force majeure” has not been defined in any Indian statute. Various courts have, over time, held that the term force majeure covers not merely acts of God, but may include acts of humans as well.

The concept of Force Majeure is straightforward – in every contract in which parties undertake to fulfill obligations in the future (called an “executory contract”), the failure to perform such obligations will give the aggrieved party the right to claim damages from the defaulting party. However, if such failure to perform is due to events beyond the defaulting party’s control, then the defaulting party must not be held liable. The force majeure clause, therefore, allows one or more parties to a contract to avoid, suspend or postpone its performance, in whole or in part, on account of events beyond their control. The devil, as always, lies in the details.

Impossibility v. Frustration

The term “Force Majeure” is based on the concept of the Doctrine of Frustration under the Indian Contract Act, 1872 (particularly Sections 32 and 56, discussed in greater detail below); and has been developed through decades of judicial interpretation. The law uses the term “impossible” while discussing the frustration of a contract, i.e., a contract which becomes impossible has been frustrated. In this context, “impossibility” refers to an unexpected subsequent event or change of circumstance which fundamentally strikes at the root of the contract. This is construed in a practical, and not a literal, sense.

In a large body of cases, including Alopi Parshad and Sons Ltd vs Union of India, AIR 1960 SC 588 and the landmark Energy Watchdog and Ors. Vs. Central Electricity Regulatory Commission and Ors (2017) – 2017 3 AWC 2692 SC, the Supreme Court of India has categorically stated that mere commercial onerousness, hardship, material loss, or inconvenience cannot constitute frustration of a contract.

Furthermore, if it remains possible to fulfill the contract through alternate means, then a mere intervening difficulty will not constitute frustration. It is only in the absence of such alternate means that the contract may be considered frustrated.

Force Majeure under Indian Law

The two key sections of the Indian Contract Act, 1872 which are relevant for this discussion are:

Section 32 (Enforcement of contracts contingent on an event happening), which states that “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…”

The impossibility of a performing a contract under Section 32 may arise not only due to a force majeure event but also due to the non-occurrence of any underlying condition in the contract. For instance, illustration (b) of Section 32 under the Contract Act states: “A makes a contract with B to sell a horse to B at a specified price, if C, to whom the horse has been offered, refuses to buy him. The contract cannot be enforced by law unless and until C refuses to buy the horse”.

In Energy Watchdog and Ors. Vs. Central Electricity Regulatory Commission and Ors (2017) – 2017 3 AWC 2692 SC (paragraph 34), the Supreme Court observed, “where the Court finds that the contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself and such cases would be dealt with under Section 32 of the Act. If, however, frustration is to take place de hors the contract, it will be governed by Section 56.”

Section 56 (Agreement to do impossible act) states that “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.”

It must be noted that for a contract to be frustrated under Section 56, it is the performance of contractual obligations that must become unlawful/impossible, not the ability to enjoy benefits under the contract.

Section 56 will govern frustration of contract where the such frustration is not contemplated in the contract itself. In the absence of a force majeure clause in the contract, it must be shown by the party seeking protection that it has become impossible for such party to perform its contractual obligations, and that the intent of the parties in entering into the agreement has been so entirely frustrated, that the contract’s fundamentals have irreversibly changed. In such a case, the parties can seek to invoke section 56 of the Indian Contracts Act.

If Section 56 applies to a contract, then parties will be discharged from their obligation to perform a part of the contract, or the entirety of the contract.

The Supreme Court in Boothalinga Agencies v. V.T.C. Poriaswami Nadar (1968) [AIR 1969 SC 110] observed that, “The doctrine of frustration of contract is really an aspect or part of the 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 of the Indian Contract Act. It should be noticed 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.” The Court continued and stated that while the English Law treated frustration of contracts as a question of construction; depending upon the true intention of the parties, the Indian Contract Act lays it down a positive rule of law.

The Supreme Court in Energy Watchdog and Ors. Vs. Central Electricity Regulatory Commission and Ors (2017) – 2017 3 AWC 2692 SC lent further insight into interpreting a Force Majeure situation:

• Events beyond the reasonable control of one party should not render that party liable under a contract for performance, if that event prevents the party’s performance;
  
  
• The language of the agreement relating to duty to mitigate, best efforts, prudent man obligations to nevertheless perform etc., will all be taken into consideration in understanding the parties’ intent;
  
  
• Force majeure events must be unforeseeable by both parties;
  
  
• The requirement to put the other party on notice must be met with if the contract provides for notice requirements; and
  
  
• Burden of proof rests with the party relying on the defense of force majeure for its inability to perform the obligation.

Express Exclusions

It is crucial to note that where events or circumstances are expressly excluded from the definition of force majeure under a contract, there can be no frustration on the occurrence of such an event (Satyabrata Ghose vs. Mugneeram Bangur et.al., AIR 1954 SC 44).

Therefore, the definition of “Force Majeure” under a contract becomes critical.

Consequence of Force Majeure

Most commercial agreements contain a clause on force majeure, which provides protection to the parties to the agreement, against claims and liabilities arising out of non-performance or breach of the contract due to certain specified force majeure events.

If the force majeure clause in an agreement contains specific consequences, then it is those consequences that will apply, irrespective of the provisions of Section 32/Section 56. If no alternate consequence is provided for under the agreement, then the provisions of Section 32/56 will apply. Therefore, it becomes pertinent to carefully consider the language of the force majeure clause in the contract in question.

Temporary Suspension of Contract

The texts of Section 32 and Section 56 do not explicitly contemplate a situation where the contract remains valid although a party’s obligations are suspended or postponed due to force majeure.

Although Section 56, illustration (e), does discuss a situation of partial discharge of a contract, it may not be wise to place too much reliance on it, as the Supreme Court in Satyabrata Ghose vs. Mugneeram Bangur et.al., AIR 1954 SC 44 has noted that the illustrations to Section 56 are flawed in their wordings and, “cannot derogate from the general words used in the enactment”.

Additionally, Section 56 illustration (e) only envisages the partial discharge of a severable contract and does not envisage a temporary suspension of obligations under a contract.

There are no precedents for this concept and the manner in which various courts will interpret this aspect remains to be seen.

However, nothing prevents parties from contractually agreeing that the occurrence of certain events shall only cause temporary/partial suspension of obligations under a contract.

Burden of Proof

The onus of proving the existence of a force majeure event lies on the party claiming benefit under it. This includes the burden of proving that the non-performance was caused due to force majeure, that steps were taken to mitigate the loss, that the procedural requirements (if any) under the contract were observed etc.

Once the existence of a force majeure is proved, the burden of proving the existence of alternate means of fulfilling the contract will fall on the counterparty/counterparties.

The Court will, of course, carry out its own examinations to arrive at its conclusion.

Force Majeure in the time of COVID

COVID-19 may, at most, constitute a temporary impossibility in the fulfillment of a contract.

If time is of the essence in a contract, COVID-19 may result in the contract being frustrated. However, this is purely a question of fact and depends on the specific circumstances of each case. In all other contracts, unless COVID-19 renders a contract impossible, the obligations continue to persist.

Whether or not a Force Majeure clause, which permits temporary suspension of obligations, covers the COVID pandemic is a question of interpretation. The terms “pandemic” or “epidemic” may be expressly defined as forming part of Force Majeure, or it may be possible to argue that such terms are included by implication. However, if the clause expressly excludes such events, then COVID-19 will not constitute a force majeure event.

Therefore, the applicability of Force Majeure protection to COVID is a question of fact and interpretation and has no direct precedent in Indian jurisprudence.

[1] https://www.merriam-webster.com/dictionary/force%20majeure
[2] https://blacks_law.enacademic.com/11167/force_majeure