India - A Closer Look At Force Majeure, Frustration Of Contract And Impossibility To Perform Contracts During The COVID-19 Pandemic

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21 April, 2020

 

India - A Closer Look At Force Majeure, Frustration Of Contract And Impossibility To Perform Contracts During The COVID-19 Pandemic

 

Introduction

 

As the world is collectively entangled in fighting the Coronavirus or COVID-19 pandemic1, businesses globally are facing several financial and physical hardships due to the mandatory government lockdowns. With there being no visibility regarding the duration of the lockdown coupled with the fact that no known cure or vaccine is available to fight the pandemic, everyone is left with great deal of uncertainty and anticipation over the ‘new normal’. One of the major concerns which arose out of this standstill position is whether business will ever go back to ‘normalcy’ and will parties continue to perform their obligations as agreed under the contracts entered.

 

This situation has led to several discussions around whether this pandemic will be treated as ‘Act of God’ or ‘Force Majeure’ event, to excuse a party of non-performance of contract or has frustrated the contract rendering it impossible or impractical to perform. If so, whether the same is legally permissible, what are its repercussions, and what role would Courts play if such non-performing party is sued for breach of contract.

 

Scope of Force Majeure clauses in commercial contracts

 

Force Majeure2 means “an event or effect that can be neither anticipated nor controlled, is unexpected and which prevents someone from doing or completing something that he or she had agreed or officially planned to do.”3 Webster's Dictionary defines Force Majeure as: “(1) Superior or irresistible force. (2) an event or effect that cannot reasonably be anticipated or controlled.”4 In modern business practice, Force Majeure clauses are generally embodied in the form of contractual provisions, agreed upon between parties, to excuse non-performance of contract in cases of events beyond their control - such as an Act of God, natural calamities, war, labour unrest, epidemics, pandemics, etc. If the words ‘epidemic’ or ‘pandemic’ are used in the Force Majeure clause, then in all likelihood, the Force Majeure clause is triggered under the contract with the declaration of Covid—19 as a pandemic.

“Force majeure” is governed by the Indian Contract Act, 1872 (hereinafter “Contract Act”). If there is an express or implied clause in a contract stipulating ‘Force Majeure’ events, it is governed by Chapter III dealing with the contingent contracts, and more particularly, Section 32 - i.e., a term or Force Majeure clause – its scope and extent may vary from case to case. Force Majeure is usually set up as a defense for non-performance of the contract owing to impediments beyond parties’ control. Force Majeure is therefore an exception or defense to breach of contract.

 

Difference between Force Majeure clause and Frustration of contract or impossibility to perform:

 

The doctrine of Force Majeure is often intertwined and overlapped with the doctrine of frustration of contract or impossibility to perform. A contract is typically said to have been frustrated if the performance of contract becomes impossible. The word “impossible” was held not to be restricted to physical or literal impossibility. 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 purpose which the parties had in view.6

 

The doctrine of frustration of contract is an aspect or part of the law of discharge of contract by reason of a supervening impossibility or illegality of the act agreed to be done.7 Unlike Force Majeure clause which is typically in the form of a contractual provision, frustration of contract or impossibility to perform is statutorily provided under Section 56 of the Contract Act. Therefore, if the contract does not expressly or impliedly contain exemptions for non-performance in the nature of Force Majeure, a party seeking to set up a defense dehors the contract can place reliance on Section 56 of Contract Act.

 

The intention of Force Majeure, in both cases, is to save the performing party from consequences of some event beyond its control – affecting the performance of a contract.

 

  1. What are the essentials for invoking Force Majeure defense?

 

a) The event shall render the contract impossible to perform – For an event to qualify as Force Majeure event dehors the contract – such event shall totally upset the very foundation upon which the parties rested their bargain. The event or change in circumstance which strikes at the root of the contract is treated as frustrated. What is required to be examined is whether the changed circumstance had destroyed altogether the basis of the agreement and the underlying object.8 When the circumstances change drastically and the altered circumstances were never visualized or contemplated, the contract becomes ex facie unenforceable. The doctrine ‘non haec in foedera veni’ (it was not this that I had promised to do) is applicable. The

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b) courts accept that a contract which is impossible of performance in practical sense need not be performed.9

 

The event shall be unavoidable and economic hardship alone cannot result in Force Majeure – a rise in cost or expense has been stated not to frustrate a contract.10

 

  1. The Covid-19 pandemic is likely to make a dent or cripple the economy for some time and one can therefore expect harsher than normal economic conditions increasing the cost for performance of contracts – for example, increase in prices of raw materials, increase in cost of labour, inflation, currency fluctuations, etc. The question that arises is whether such circumstances i.e., economic hardships to perform the contract, can absolve the party from performing its bargain on the ground of Force Majeure or frustration of contract.

  2. A force majeure clause will not normally be construed to apply where the contract provides for an alternative mode of performance.11 A more onerous method of performance by itself would not amount to a frustrating event. The event should be unavoidable and absolutely beyond the control of the debtor.12 In fact, even a wholly abnormal rise or fall in prices, a sudden depreciation of currency, and a little obstacle to execution or the like cannot by itself affect the bargain made between the parties.13 Even under common law, a contract is not discharged merely because it turns out to be difficult to perform or onerous.14 In other words, to attract the doctrine of frustration, burdensomeness is not the necessary consideration; the impossibility of performance contract is the true criterion.15

 

The event must be unforeseeable – the event must be incapable of being anticipated or predicted by common due diligence. An advance warning for an expected Force Majeure event, shall not trigger the Force Majeure clause.16

 

i. One of the crucial tests for setting up the defense of Force Majeure is the test of foreseeability at the time of entering into the contract.17 A CEITAC Tribunal considering the defense of SARS outbreak in 2005, held against the non-performing party on the ground that SARS outbreak took place 2 months prior to executing the contract, and therefore the same was foreseeable.18 Even in one of India’s leading cases on frustration of contract viz. Satyabrata Ghose v. Mugneeram Bangur & Co.19, when a war/war like situation prevailed during the 1950s and the defense was attempted to be set up that the Government requisitioned a plot of land for military purposes, where the developer had to undertake development, it was held that war situation was prevailing at the time of

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c) executing the contract and that such requisitioning by the Government was temporary in nature and did not result in total impossibility or frustration of contract.

ii. Applying the aforesaid case to the present scenario of Government lockdown due to a pandemic precluding a party from performing the contract, it is likely that the contracts may not be deemed to be frustrated on account of pandemic, as the lockdown is temporary in nature and the Courts may take a view that the contract can be performed once normalcy restores. At the same time, courts cannot shut their eyes to harshness of the situation in cases where performance becomes impossible by causes which could not have been foreseen and which were beyond the control of the parties.20

 

d)  Causal test or ‘but for’ test – The event shall have occurred not by default of the party but only as a result of the supervening event. This is referred to as the “causal test” where the Court examines whether the non-performance is a direct result of a supervening event; and “but for” such supervening event, the contract would have otherwise been performed. This causal test is the most crucial test which shall be satisfied by adducing evidence. In a situation where Force Majeure event has indeed occurred, and if such event did not preclude the party from performing the contract, such party cannot take benefit of Force Majeure clause.

 

  1. e)  Conditions precedent must be fulfilled – Most Force Majeure clauses provide that a non- performing party seeking benefit of Force Majeure clause in the contract, shall put the other party to such notice. These terms are conditions precedent for invocation, failing compliance of such clauses, a party may not be able to take shelter under Force Majeure.

  2. f)  Duty to mitigate – A party relying on Force Majeure clause is supposed to take all the necessary measures to mitigate the loss caused due to its non-performance.

  3. g)  The Supreme Court in Industrial Finance Corporation of India Ltd. v. Cannanore Spinning and Weaving Mills Ltd.,21 held that there are three conditions are required to trigger off doctrine of frustration under section 56 of the Contract Act - firstly, there should be a subsisting contract; secondly, some part of the contract is still to be performed; and thirdly, after the contract is entered into it becomes impossible of performance.

 

V. What are the consequences of Force Majeure?

 

In case of express or implied terms Force Majeure clause in the contract, the consequences as set out therein would follow upon proper invocation of the stipulation. Typically, the Force Majeure clause provides for right to terminate the contract, suspension of contract during the subsistence of Force Majeure event, waiver of damages or penalty for non-performance, change in consideration, etc. The consequences, like a Force Majeure clause, can be tailor suited as per the agreement between the parties and the object sought to be achieved under the contract.

Whereas, in case of complete frustration of contract, it is well-settled law that the consequence under section 65 of the Contract Act follows i.e., principle of restitution. Principle of restitution states that once a contract becomes void or frustrated, any person who has received any advantage under such agreement or contract is bound to restore it to the person from whom he had received it. Therefore, when a contract is frustrated, the consideration received from the other party must be repaid.22

 

VI. Global treatment of pandemic as Force Majeure event

 

In some common law jurisdictions such as England and Singapore, despite of such previous events - like outbreak of SARS and Ebola, there is no reported caselaw directly on the operation of Force Majeure clauses in the context of epidemics or pandemics.23 One of the main reasons for this is that most of the long-term international contracts contain arbitration clauses and are confidential in nature, and most arbitral awards including the ones involving force majeure issues are not published.24 However, from the limited data available, the party relying on such clauses may not be met with much comfort, unless their contracts are tailor-suited to cover scenarios like pandemics or epidemics under the respective Force Majeure clauses.

 

For example, at the time of outbreak of Spanish Flu (in 1918), in 1921, the Illinois Supreme Court in Phelps v. School District No. 109, Wayne County, held that an epidemic was not an Act of God that would allow the school district to avoid paying teachers who were ready, willing, and able to teach, but were prohibited from doing so by school closures. In contrast to this, the North Dakota Supreme Court in Sandry v. Brooklyn School District No. 78 of Williams County25 held that a school district was excused from paying a driver for his services during the school closure, by determining that the pandemic was an Act of God and that non-payment be exempted.26

 

In 2015, during the Ebola outbreak which eventually killed more than 11,000 people, when the Moroccan government sought to rely on Force Majeure clause to postpone the African Nations Cup, its plea was rejected by the Confederation of African Football (CAF), on the grounds that it would still be possible for the country to host the soccer tournament, albeit with more difficulty. Ultimately, Morocco was held liable by the CAF, banned from the next two African Nations Cups, and fined $1 million.27

 

Similarly, as discussed above, in a dispute governed by the Convention on International Sale of Goods (CISG)28 before an arbitral tribunal constituted under CIETAC29, where a party could not perform the contract citing outbreak of SARS30 epidemic, plea of force majeure was rejected on the finding that the outbreak of SARS happened two months prior to the signing of the contract and that the impediment was therefore foreseeable by the parties.31

 

In China, the China Council for the Promotion of International Trade (CCPIT), a quasi- governmental entity has issued 5,637 Force Majeure certificates to exempt Chinese companies from their contractual obligations.32 Though not formally defined, ‘Force Majeure Certificates’ can be said to be certificates issued by trade councils or commercial chambers of different countries, to certify a particular event as a Force Majeure event. Similarly, the Chamber of Commerce and Industry of the Russian Federation (CCI of Russia), non-governmental non-profit organization, issued Force Majeure certificates to Russian entities, qualifying Covid-19 pandemic as a Force Majeure event.33 In our view, while these certificates can certainly qualify Covid-19 as a Force Majeure event domestically, the jury is still out there to determine the validity, enforceability and evidentiary value of such certificates in international contracts.

 

VII. Insight into India’s treatment of Covid-19 as Force Majeure event: 

 

a) Covid-19 pandemic read into ‘natural calamity’ in Government contracts?

 

Ministry of Finance has recently issued a clarification to all central Government Ministries that any disruption caused in supply chains due to the spread of Coronavirus will be considered as a ‘natural calamity’ under extent Force Majeure clauses.34 Although this is in nature of a direction to the governmental ministry and departments. It may also give a relief to various institutions and industries working in close partnership with government. The Ministry of Finance also reiterated that Force Majeure clause shall not be defense to non-performance in the entirety but can only suspend performance during the duration of the Force Majeure event.35

 

It is pertinent to point out that the ‘Manual for Procurement of Goods, 2017’ are merely inter-department directives or executive instructions based on which the contracts are entered with various parties. As such, the question of enforceability of such directives can arise as they are not statutory in nature.36 Therefore, a dispute arising out of the terms of such government contracts will be settled by the ordinary principles contract law.37

 

 

b)  Notably, in construction contracts – such as EPC/ Turnkey Projects for Infrastructure Development which widely import standard terms from FIDIC Red Book, ‘epidemics’ and ‘pandemics’ are enlisted as a Force Majeure events, consequence of which is extension of time for performance.38 FIDIC Red Book is commonly used in construction contracts in India as well. Whether the contracts have carried forward the boilerplate Force Majeure clauses from the FIDIC Red Book or not depends on case to case, it is pertinent to note that such clauses are highly necessary to expect the unexpected. Such boilerplate agreements in fact came to the rescue when several projects were impacted during the Swine-Flu outbreak in mid- 2009.39

 

c)  In the recent case of Standard Retail Pvt. Ltd. and Ors. v. M/s. G. S. Global Corp & Ors.,40 the Bombay High Court had the occasion to deal with the plea of Force Majeure and frustration of contract due to Covid-19 pandemic which was raised by a group of Indian Steel importers, who sought an injunction on the encashment of Letter of Credits in favour of South Korean exporters. In this case, the Force Majeure clause, although stipulated ‘epidemics’ as one of the events of Force Majeure, only exempted the suppliers from non-performance and not the importers. While the suppliers/exporters fulfilled their obligation, it was contended by the Importers that owing to the nation-wide lockdown and restraint on travel, the imported goods could not be picked up and therefore, the contracts with the supplier shall stand terminated on account of frustration and that Letters of Credit shall not be invoked.

 

d)  The Court however held that the force majeure clause does not apply to importers and that Letter of Credit is an independent transaction unconcerned with the underlying disputes. It was further observed that as per notifications and advisories issued by the Government of India, distribution of steel was categorized as essential service and there was no restriction of movement. Furthermore, it was observed that lockdown is temporary in nature, for a limited period of time, and therefore, cannot be relied upon for the purpose of frustration of contract. For the aforesaid reasons, the Court refused to grant any interim reliefs.

 

INDUSLAW VIEW

 

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. It is however, best left for the parties to draft proper Force Majeure clauses to include events precluding them from performing contracts. Hence, a surge in the number of commercial contracts incorporating Force Majeure clauses is very likely – to specifically cover situations such as Government imposed lockdowns, epidemics and pandemics, apart from traditional events such as Act of God, natural calamities, etc.

 

Going by the global treatment of non-performance of contracts during the past outbreaks - such as Ebola, SARS, etc., we feel that the threshold to establish the defense of frustration of contract successfully is very high, with no straight jacket formula. While more disputes pertaining pleas of frustration of contract and invocation of Force Majeure clauses in commercial contracts are likely to mount eventually, it would be an interesting development in the field of contract law in India – considering epidemics such as the Covid-19 are unusual in this modern age.

 

It is further interesting to note several proactive steps taken by the Governments - such as issuance of Force Majeure Certificates by China and Russia and inter-department advisory circulars in India to recognize Covid-19 pandemic under the ambit of ‘natural calamity’ in government contracts. Such measures are forthcoming to instill confidence and protect the interests of parties in testing times like these.

 

It is beyond doubt that contracts will be impacted by the pandemic and the current lock-down situation. However, in the times to come, we may be witnessing varied interpretation of clauses, terms, and parameters of performance of contracts under these unforeseen circumstances coupled with notifications and directives by the Government in this respect. The law relating to Force Majeure is likely to undergo a massive evolution in view of this pandemic which we will keep updating in the future. 

herbert smith Freehills

 

For further information, please contact:

 

Sushmita Gandhi, Partner, Induslaw 

sushmita.gandhi@induslaw.com

 

1 The World Health Organization (“WHO”) declared COVID-19 to be a pandemic on March 11, 2020 2 Derived from a French phrase meaning ‘superior force’
3 Black’s Law Dictionary (10th ed. 2014)
4 Webster’s 3rd New International Dictionary provision which is enforceable upon happening of an uncertain future (contingent) event and provides for its consequences. If a Force Majeure event occurs dehors the contract, it is dealt with by a rule of positive law under Section 56 of the Contract Act - which provides that an agreement to do an act impossible in itself is void; and that a contract which, after entering, becomes impossible or unlawful to perform due to an intervening event, becomes void in law.5

5 Energy Watchdog and Ors vs Central Electricity Regulatory Commission and Ors. (2017) 14 SCC 18 6 Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 S.C.R. 310: AIR 1954 SC 44
7 Ibid; Boothalinga Agencies v. V. T. C. Poriaswami Nadar, AIR 1969 SC 110: 1969 SCR (1) 65
8 Ibid; Smt. Sharda Mahajan v. Maple Leaf Trading International (P) Ltd., [2007] 78 SCL 367 (Delhi)

9 Ibid
10 Chitty on Contracts, 31st Edn. In Para 14-151
11 Treitel on Frustration and Force Majeure, 3rd Edn.
12 Article 1148 of the French Civil Code
13 Supra Note 6
14 Halsbury's Laws of England, Fourth Edition, Volume 9, paragraph 455
15 Badri Narain v. Kamdeo Prasad, AIR 1961 Patna 41; Peak Chemicals Corporation Inc. v. National Aluminium Co. Ltd., 188 (2012) DLT 680
16 Vedanta Limited v. Global Energy Private Limited, 2017 SCC OnLine Bombay 9439
17 Delhi Development Authority v. Kenneth Builders and Developers Private Limited and Ors., (2016) 13 SCC 561
18 L-Lysine case available at http://cisgw3.law.pace.edu/cases/050305c1.html [Accessed 17 April 2020]
19 Supra Note 6

20 Naihati Jute Mills Ltd. v. Khyaliram Jagannath, AIR 1968 SC 522 21 [2002] 110 Comp Cas 685 : (2002) 5 SCC 54

22 Bombay Dyeing and Manufacturing Co. Ltd. v. State of Bombay, [1958] SCR 1122 : AIR 1958 SC 328; Smt Sharda Mahajan vs Maple Leaf Trading International (P) Ltd., [2007] 78 SCL 367 (Delhi)

23 Pinsentmasons.com. 2020. [online] Available at: <https://www.pinsentmasons.com/out-law/guides/covid-19-force- majeure-clause> [Accessed 17 April 2020].

24 Hubert Konarski, Force Majeure and Hardship Clauses in International Contractual Practice, 2003 Int’l Bus. L. J. 405, 425 (2003) at 405 cited in Polkinghorne Michael & Rosenberg Charles, Expecting the Unexpected: The Force Majeure Clause, 16(1) BUS. L. INT’L (2015)
25 Sandry v. Brooklyn Sch. Dist. No. 78 of Williams Cty., 182 N.W. 689, 690-91 (N.D. 1921); Farris, A. and Chee, H., 2020. Contract Performance During Pandemic: Lessons From 1918 - Law360. [online] Law360.com. Available at: <https://www.law360.com/articles/1264775/contract-performance-during-pandemic-lessons-from-1918> [Accessed 19 April 2020].

26 Ibid; Phelps v. Sch. Dist. No. 109, Wayne Cty., 134 N.E. 312, 312 (Ill. 1922)
27 the Guardian. 2020.Morocco Banned And Fined $1M Over Africa Cup Of Nations Withdrawal. [online] Available at: <https://www.theguardian.com/football/2015/feb/06/morocco-banned-and-fined-africa-cup-of-nations> [Accessed 17 April 2020]
28 CISG, under Article 79 provides for exemption from performance due to ‘impediments beyond parties’ control’ – a phrase which is analogous to Force Majeure
29 China International Economic & Trade Arbitration Commission (CIETAC)

30 Severe Acute Respiratory Syndrome (SARS)
31 L-Lysine case available at http://cisgw3.law.pace.edu/cases/050305c1.html [Accessed 17 April 2020] 32

33

34 OM No. F.18/4/2020-PPD dated 19th February 2020 issued by Procurement Policy Division, Department of Expenditure, Ministry of Finance page6image21760

U.S. 2020. China Force Majeure Certificate Issuance Pass 5,600 Amid Virus Outbreak - Trade Body. [online] Available at:

Pannebakker, E., 2020. ‘Force Majeure Certificates’ Issued By The Russian Chamber Of Commerce And Industry. [online] Conflict of

industry/> [Accessed 17 April 2020]

35 Para 9.7.7. of ‘Manual for Procurement of Goods, 2017 –

available at: Page 6 of 8 Mumbai

https://doe.gov.in/sites/default/files/Manual%20for%20Procurement

%20of%20Goods%202017_0_0.pdf

36 GJ Fernandez v. State of Mysore & Ors. AIR 1967 SC 1753 37 Kerala SEB v. Kurien E. Kalathil & Ors., (2000) 6 SCC 293

38 Dzakula Peter, Pandemic flu risk for major projects, Const. L.J. 2010, 26(3), 160-167
39 Ibid
40 Order dated 8th April 2020 passed in Commercial Arbitration Petition (L) No. 404, 405, 406, 407 & 408 of 2020