COVID-19 & LOCKDOWN: A Force Majeure in Commercial Contracts?

-Aayushmaan Gauba, Partner, Adwitya Legal LLP[1]

Introduction

A common question being asked nowadays is “ Can the COVID- 19 lock down regarded as a force majeure event for all contracts?”. If so, will it provide a cushion to the parties claiming impossibility of performance? If a party is unable to perform its end of the bargain, will it be non-compliance of the terms of the Contract? Can it be regarded as a “default committed by any party” nor a “breach of contract”?

The Indian Contract Act, 1872 (“Act”) does not elaborate on the concept of Force Majeure. Thus, much of this doctrine has developed through judicial precedent.

What is a Force Majeure Clause?

Force majeure clauses are provisions in contracts which defer or release parties from contractual obligations. They are triggered due to specific circumstances beyond the control of the parties.  Such clauses allocate the risks of certain unforeseeable events which might result in a party’s non-performance. They are (or at least should be) specifically tailored to the nature of the transaction.

What kind of events can be termed as Force Majeure?

Some common examples of what might constitute force majeure include-

  • Acts of God, 
  • War
  • Riots, 
  • Strikes, labour disputes, casualty
  • Terrorism, civil commotion, 
  • earthquakes, floods, 
  • shortages of or delays in obtaining, or an inability to procure labor, utilities or materials.

 The common thread running through them is that they are generally beyond the control of the relevant party.

Is Force Majeure Applicable to the entire contract or some parts of it?

Ideally, parties should agree that force majeure is applicable to only certain types of events. They should not be drafted in a manner to enable a party to take advantage of its own wrong.  In some documents, force majeure may apply to any breach of the agreement without limitations. This is a Pandora’s box just waiting to be opened and should be avoided at all cost. Typically, a force majeure provision will NOT apply to an obligation to pay rent or an obligation to pay an acknowledged debt.

What should a claim of force majeure satisfy?

  • the event must be beyond the reasonable control of the applicable party;
  • the applicable party must have been prevented from performing its obligation;
  • the applicable party must have taken all reasonable steps to avoid its non-performance. It must have satisfied its duty to mitigate damage as a result thereof; and
  • applicable and timely notice must be given to the counterparty in accordance with the relevant agreement.  (This usually means “in strict accordance”, with time being of the essence.) 

Is COVID-19 a Force Majeure Event?

The answer to this question varies from case to case. What matters is the way that Force Majeure has been defined in a particular contract. Another factor is the contingencies captured in the clause, and whether the clause is an inclusive or exclusive one.  Considering COVID-19, it is easy to invoke the force majeure clause if the contract explicitly provides for such events as epidemics, pandemics or government restriction. The situation may become difficult when a force majeure clause is not explicitly worded. For example, a clause may simply use terms like “act of God” or “event beyond the reasonable control of parties”.

What to do in the event the contract has no Force Majeure clause?

At first blush, the situation may appear to be tricky. Yet, the Doctrine of Frustration prescribed under Section 56 of the Act comes to the rescue. In a landmark judgement titled Energy watchdog Vs. Central Electricity Regulatory Commission, the Supreme Court opined that if the event leading to frustration which is relatable to an express or implied clause in a contract, is governed by Section 32 of the Act. If the event occurs de hors the contract, it is dealt with by a rule of positive law under Section 56 of the Act. This implies that if a contract has a Force Majeure clause, it shall be governed by the said clause. In absence of such clause in a contract, the law of frustration will come into play.

The essential ingredient to invoke Section 56 of the Act is “subsequent impossibility“. In other words, performance becomes impossible after the contract is entered into. The key phrase is subsequent impossibility. To invoke the doctrine of frustration, it must be shown that the inability to fulfil the obligation was triggered by an event which hadn’t yet occurred when the contract was entered into. In other words, the party claiming frustration has to show that-

  1. It cannot perform its obligations anymore-
  2. Because of an event outside its control
  3. which didn’t exist when it entered into the contract.

Courts are grant relief on account of subsequent impossibility only when 

  • it is found that the whole purpose of the contract is lost;
  • due to an unexpected event or change in circumstance that was not contemplated by the parties; or
  • the performance of the contract becomes impracticable or useless having regard to the object and purpose the parties had in view.

The Courts have held that “impossible” as used in Section 56 does not mean impossibility in the physical or literal sense. It is not necessary to show that the performance of the obligation in question has become literally impossible. It is enough to show impracticality of performance from the Parties’ Perspective while considering the object of the agreement. If an unanticipated event upsets the very foundation of the agreement, the same may be considered as an “impossibility”.

What is not covered in Force Majeure?

 The Courts have also concluded that a contract isn’t frustrated  because the circumstances in which it was made have changed. A party cannot escape its obligation  just because it has become onerous to perform due to unforeseen circumstances. Something more is needed. The inability to sell at a profit is not the contemplation of the law of a force majeure event.  A party cannot declare a force majeure just because the costs of contract compliance are higher than it had anticipated. Thus if there is an alternative, albeit more expensive or less profitable. The doctrine of Force Majeure will not come into play. 

What is the next action step?

It is imperative to go through all contract and trigger the Force Majeure clauses now. Prompt intimation to the other party is one of the most important obligations that one has. Even if the contract doesn’t contain a force majeure clause a part has to communicate its impossibility to act to the counter-party. A party must do this as soon as possible to avoid future disputes, as well as increased losses on account of costs. Further, it is imperative to collate all notifications, press releases and advisories issued by the government wherein government is invoking the Force Majeure clause and/or has determined COVID-19 to be a force majeure event.

We will soon be sharing a follow up post, about whether the COVID-19 Force Majeure can be invoked to avoid payments of any kind or to avoid rent. 

In the meantime, If you’re interested to read about how the rights & obligations and relationship of Employers and Employees is changing due to the COVID-19, please read here.


[1] Grateful to Soumya Bhattacharjee, student of law, currently interning with Adwitya Legal LLP, for his research inputs.

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