COVID -19 brought along catastrophic impact on health and business. It chose not to spare, either. Compelling governments, world over, to take steps they don’t seem to be joyous about and some of those are causing businesses to grudgingly close down.
GoI has been proactively involved with speedy steps and,
– announced COVID-19 pandemic scenario, a Force Majeure event.
Ministry of Finance in the Manual for Procurement of Goods, 2017 issued a memo on 19 February 2020 (“FM Memorandum”) declaring currents’, a Force Majeure evet.
What does application of Force Majeure in prevalence of COVID–19 pandemic in India mean for you/ your business, contractually? How does this seemingly relieve and prompt decision of the GoI help your over burdened delivery obligations?
Take a look.
A quick checklist to look at your FM clause to seek refuge of excusability for business owners:
- If yours is a Government Contract, it is a square hit by FM, look no further.
- Do you have a FM clause in the contract?
- Does the clause set out a procedure to be followed in an FM event?
- Have you followed that procedure?
- If there is no clause, bear reliance on Indian Contract Law for claiming relief of FM.
- Is the delivery impacted due to the EM event?
- Have you tried everything reasonably possible to deliver the contract?
- Are you seeking relief/ re-negotiation/ termination?
- Are you one of the parties in a big ticket contract tied in with multiple smaller contracts?
In what ensues as a long read, have tried to keep it legalese free and give an insight into the legal stand point on FM in India with broad overview of implications for your contracts.
Highly recommend get a health assessment of your contracts and obligations therein. Afterall, it will only stand you in mitigated position for the 2nd and the 3rd rounds of outbreak. IMO, this turns out to be very effective and worthwhile investment for altering business realities.
1. How did we land here?
1.1 March 9, 2020, the WHO felt compelled to declare COVID–19, causing a medical outbreak worldwide, a pandemic. Till any better cure or response is attained, WHO recommended social isolation / quarantining as only known combative response against the virus COVID-19. As an outcome of this prompt, March 24, 2020, the GOI preferred a nationwide lockdown elasticised till May 3, 2020 barring essential services and selective and intermittent relief coming from April 20, 2020.
1.2 Resultantly, the lull before the storm has put everything on a standstill. The rippling and the crippling effect of playing “statue” is felt on the network of supply chain, contracts, rents, employees, businesses. The larger contracts, like Shipping and Cargo, Power, Infrastructure Contracts are likely to see significant impacting delays, this is bound to cause significant negative impact on smaller vendor-supplier contracts. Cascading costs due to delays, risk reduction, alternative models will impose arduous economic weight which businesses will struggle to lift.
1.3 Supplier, vendors, manufacturers, dealers have started looking at relieving exclusion clauses, specifically the FM clause dealing with epidemics, pandemics, natural calamities and/or government orders/directives, particularly since GoI has offered the FM Notification. Successfully invoking the FM clause could excuse liability for suspension/ non-performance of predetermined contractual obligations.
1.4 The FM Memorandum will for sure render persuasive value for interpretation of transactional contracts. Performance and payment obligations, in light of the governing law along with your state issuing their respective advisory, will determine the legititmate application of the FM clause or voidability or suspension of contracts.
2. IS THE FM Memorandum GOOD ENOUGH OR INTERPRETATION UNDER LAW IS GOING TO WRAP YOU UP?
2.1 A random meaning search on the web on Force Majeure says, “irresistible compulsion or superior strength”. So, what does that meant?
In normal parlance, an FM clause in commercial agreements dictates terms of excusing parties from their contractual obligations, if and when performance of the contract / agreement becomes impossible or impracticable due to unanticipated events, beyond the party’s control.
The Black’s Law Dictionary[1] defines FM as ‘an event or effect that can be neither anticipated nor controlled’. It offers an exception to the grunt norm of pacta sunt servanda Latin for all agreements must be kept. [Side note: there is huge academic potential for young lawyers, if it interests some to dive in.]
2.2 For partys’ to invoke FM, it must be establish :
- Existence of a valid contract;
- Performance of contractual obligation, halted for a (temporary or permanent) period;
- Impossibility to perform after execution of a contract on account of or due to fact or law.
2.3 Typical Force Majeure clauses in commercial contracts, are likely-
– An exhaustive clause with inclusions, exclusions of categories, thresholds of an occurrence of events/ circumstances/ factors that would constitute an FM event solely for the purposes of the contract like war, civil strife, epidemics, acts of Government, terrorist attacks etc. simultaneously with a specific provision for events/circumstances/factors that do not constitute FM event and instead operate as an onerous circumstance/ hardship on the affected party.
– A non-exhaustive clause with undefined and open-ended events/circumstances/factors that could not have been contemplated at the time of execution of the contract, and that are beyond the reasonable control of either party but would also constitute an FM event for the purpose of the contract.
2.4 In absence of a FMclause, the parties could consider taking refuge under common law doctrines of impossibility or impracticability of fulfilling contractual obligations.
3. How does it play out CONTRACTUALLY under Indian law?
3.1 Considerations for invoking Force Majeure in contracts?
(i) Causation:Establishing a direct link between the FM event and hindrance to performance of the contract is a central burden to be dispensed by the affected party, the invoker of FM. The invoker seeking benefit of the FM clause will have to show:
- Its inability to perform its obligations because of the FM event;
- FM event was solely sufficient to cause the non-performance as against being one of the causes for non-performance.
(ii) Harmony with prevailing laws:Specific provision mentioned in the contract specifying FM event. In cases where the contract plays specific as a rule of lex specialis derogat legi generalii.e., the special prevails over the general will be deployed. In such cases, the interpretive provisions contained in Contrat Law will not be relied upon.
(iii) Procedural requirement stipulated in FM clause: An affected party/ invoker must comply with procedural requirement of serving a notice with relevant FM clause or government order indicating occurrence of FM and impossibility to perform the works. Typically, the contractual notice requirement will be time bound and failure to perform this may hinder the invoker’s ability to claim relief.
- Lack of alternative methods to effectuate performance of Contract: It is critical that the invoker, affected party shows that there are no other exhaustible grounds to deliver on the contract. Additionally,conditions like inadequate human labour, machinery, raw materials and other means impacting its abilities to fulfil the obligations did not exist which made delivering on the obligations, impossible & subsequently the FM event came as a pretext for seeking discharge from obligations at the time of claiming the relief.
- Diligent approach to mitigation of loss: It is imperative that all reasonable endeavours were carried out by the affected party within its ability to carry out the contractual obligations. Disproportionate labour could cause large loss to all interested parties.
Bearing the above parametres and considering COVID-19 stands classified as an FM event, with potential for indefinite delays and breakdown of business networks caused due to the lockdowns, contracts stand a good chance of legitimate excusability.
For contracts, where time is of essence, completion and delivery will not be possible reinforcing COVID–19 outbreak as an FM event. Even if contractual terms we considered as prime motivations to be fulfilled, it still indicates that the fundamental purpose of the contract is frustrated due the party’s inability to perform arguably, leaving them discharged from performance of their obligations.
3.2 What does the Common Law say about interpreting FM Clause?
The Common Law through a series of landmark ‘coronation cases[2]’ envisaged consquences of loss as a burden on the party who sustained it before the FM event occurred. However, this ruling ultimately got retaliated with introduction of the Doctrine of Restitution in the celebrated case of Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd. [1942] UKHL 4 which recognized unreasonably harsh consequences of frustration to render a contract as void.
3.3 What does Contract Law say about interpreting FM Clause?
The Indian mercantile laws do not expressly define, Force Majeure, thus, the complete essence, under Indian law is caught in Sections 56 and 32 of the Indian Contract Act, 1872 (Contract Law).
(i) Section 56[3], relates to performance of contracts. It deals with law ensuing from impossibility or illegality which causes performance, impossible in its practical sense, not literal. It does not statutorily capture the concept of unforeseen contingencies resulting in temporary suspension of performance and resumption of the contract.
The concept of FM becomes applicable in such situations. This section operates automatically from the date of the impossibility and puts the contract to an end. The unforeseen event may render performance impossible only during a limited period during the operation of the event. This allows, for resuming normal contractual obligations after the event ceases to operate.
(ii) Section 32[4], deals with contingent contracts in which an express key term is included, based on such term the contract would stand suspended or discharged on the happening of certain circumstances. In such cases, the dissolution of the contract happen as per the terms of the contract.
3.4 How does the judiciary view it?
Some instances, of how the Indian judiciary has illustrated FM provisions:
(i) In Satyabrata Ghose vs Mugneeram Bangur & Co. AIR 1954 SC 44, [Side Note: the case has significant interest value, encourage a separate read.] the SC held that to determine whether a FM event has occurred, it’s not necessary that the performance of an act should literally become impossible, a mere impracticality of performance would also suffice. It observed that Section 56 of ICA lays down a rule of positive law and does not leave the matter to be determined according to the intention of the parties derogating from the general idea of party autonomy that is central to contracts, globally today. This case has been heavily relied on in subsequent years in determining the same aspects of law.
(ii) In M/s Alopi Parshad & Sons Ltd. vs Union of India 1960 (2) SCR 793, the SC held that acontract is not frustrated merely because the circumstances in which it was made are altered.
(iii) In Industrial Finance Corporation of India Ltd vs The Cannanore Spinning & Weaving Mills Ltd. and Ors. (2002) 5 SCC 54the SC held that the liability of parties stand discharged when a statute itself recognises the doctrine of frustration, within an exhaustive FM provisions. This would excuse non-performance by parties because of an unforeseeable impediment outside their control.
(iv) In Energy Watchdog v Central Electricity Regulatory Commission and Anr. (2017) 14 SCC 80, it held that if a contract has an express or implied FM clause, it will apply over the principles under Section 56. However, FM clause will not apply if alternative modes of performance are available to the parties.
3.5 GoI on Force Majeure
(i) The FM Notification briefly states that “a force majeure clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the force majeure. The firm has to give notice of force majeure as soon as it occurs and it cannot be claimed ex-post facto… If the performance in whole or in part or any obligation under the contract is prevented or delayed by any reason of force majeure for a period exceeding ninety days, either party may at its option terminate the contract without any financial repercussion on either side”.
(ii) Subsequently, the Ministry of New & Renewable Energy[5] vide an Office memorandum dated March 20, 2020 with respect to ‘solar project developers’ declared that missed contractual obligations on account of COVID–19, can be justified under force majeure clauses to avoid any financial penalties. However, only on account of COVID-19.
(iii) The GoI memorandum renders a persuasive value for contracts with FM clauses, which could not be fulfilled in time, because of the outbreak and the steps that followed the oubreak. It might dwell briefly on available alternatives to fulfilling the performance obligations. Probability of such alternatives would be bleak.
Contracts for Essential Services and Goods will be viewed differently from the other contracts.
3.6 Indian judiciary on interpretation of GOI notifications as Force Majeure
- In South East Asia Marine Engineering and Constructions Ltd. (SEAMEC Ltd.) v Oil India Limited C.A. No. 673 OF 2012, the Supreme Court held that any price fluctuations in essential component required for full and proper sustenance/ delivery of contractual obligations is not to be considered as change due to ‘subsequent change in law’ clause. Even if such change arose due to a change order by the Government. If the clause stipulates a pre-determined agreed payment of FM rate to patronize a temporary FM event, it would not be considered as a case to be viewed as an FM event, unless specifically worded to that effect. The Court rejected the contention for further claim of reimbursement for additional costs incurred due to triggering FM event on account that that though this subsequent change in law’ vide a GOI notification is pari materia to FM, the parties prudently elected to mitigate the harsh consequences of an uncertain event and uphold santity of contract by fixing a compensatory rate for an increase in advance.
- It is imperative to note that the Court based its ruling on appreciation of evidence on record that indicated existence of a specific clause reinforcing obligation of the Contractor to supply the essential component. In light of this, the Court established that a written contract must be read as a whole in its entiretiy, and mutually explanatory.
4. HOW HAS COVID–19 IMPACTED MAJOR CONTRACTS?
Given the COVID–19 resultant FM, the imperative step is to assess its impact on commonly affected contractual obligations such as:
(i) Supply-chain contracts: Domestic and international supply contracts have got impacted with asks of relaxed timelines, tolerance to delay and interruptions or in some cases even termination of contracts to avoid performance / claiming exemption from liability placing reliance on FM clauses. It is presenting a possibility of renegotiation of price in import/export. With delay in acceptance of delivery items, the demurrage costs are riding high which eventually will be loaded on the downstream markets.
(ii) M&A Agreements: Situation has triggered price adjustment clauses to meet demand expectations, assessing Materially Adverse Effect/Change on the businesses, revision of warranties, limitation on invocation to restrict liability, full / fair disclosure of risk mitigation, contingency planning, negotiation of waivers for potential unintentional circumstances lead breach of representations, post-completion covenants, subsequent conditions etc. Delay is likely the constant for long term.
(iii) Debt Financing Agreements: Stagnanting supply chains and unenthusiastic consumer demands, mid to high-staked companies are compelled to realign their distressed commercial activities. Businesses want re-financing and protection from long-term creditors. With remedies as invoking FM and Adverse Effect provisions, insolvency remains hovering around the dark allies.
(iv) Lease: Despite fulfilling the requirements of a valid contract, leases are governed as instrutments of conveyance under the Transfer of Property Act, 1882 (ToP). Section 108 (B)(e)[6] of ToP recognises limited events similar in nature to a FM event. If such events would have caused for destruction of leased premises due to supervening forces of flood, violence etc.
Automatic determination of a lease, for Lessee to claim benefit of unilateral suspension of payment of outstanding rent in absence of an order from court or pre-determined agreement from the lessor for complete abatement or a portion for remainder of rent due to pandemic outbreaks for any duration, is not entertained under section 108. Thus, as onerouse it may be for the lessee to tide over the current situation, exercising protocols of FM clause is not going to be viewed as impossibility of fulfilling the obligations under the Lease Deed, making it unavailable for the Lessee to call FM clause to excuse payment of rent.the fulfilling the obligations unlikely .
(v) Real Estate contracts: Directly impacted, under-construction properties, commercial lease arrangements especially the ones executed by foreign entities, brands/franchisees start-up entities etc. Developers would be tempted to take refuge under FM under the Real Estate (Regulation and Development) Act, 2016 and relevant laws for legitimising extended timelines for project completion, repayment of loans etc.
(vi) Infrastructure projects:All ongoing infrastructure projects have been indefinitely deferred until further directions of the Ministry of Home Affairs, GOI till May 17, 2020 with an exception of Renewable Energy Generation Stations including Solar Power Plants, Wind Power Plants etc. as an essential services on condition of strict compliance with sanitary norms.
(vii) Tender Documents: In case of Tender documents, the chances of FM clause being imposed based on the current scenario is remote. Largely, because, long term contracts, typically hedge price change and related costs over a long period of time. South East Asia Marine Engineering and Constructions Ltd. (SEAMEC Ltd.) v Oil India Limited C.A. No. 673 OF 2012 is a point in case.
5. Where to from here?
Potentially, a least conflict based way forward could be:
(i) mutually agree with opposite interested party to either suspend or cesse the contract for a temporary period entitiling their contractual obligations as contigent contracts, without giving the either to unilaterlly termintate the contract or claim a higher compensation for repesentations and warranties included in it.
(ii) alternatively, mutually agree to incorprate relevant clauses by way of alteration or novation of contract to give effect to deemed non-performance.
(iii) prepare plan and apply strategy for 2nd and 3rd outbreaks with titrated outcomes. Hopefully, the degree of disruption and your preparedness, both, would have altered from today.
(iv) efficiently monitor, strategize and plan a future clear course of action including payment of mobilisation forces to avoid financial risks and goodwill loss. An effective method could be to substantiate while performance is withheld is to grant an extension of time to non-performing party to evade payments of additional prolongation costs or compensation.
Larger corporates with more stakeholders may find renegotiation, hard. However, it would be advisable to embark that journey to prevent protracted litigation as we navigate COVID-19.
Do not get overwhelmed by the multiple anouncements by the Government through advisories, memos, guidelines. Conduct a systematic evaluation of your obligations, deliverables and your vendors’ abilities for contingent arrangements and get to the negotiation table, or negotiation call, should we say!
[1] 9th Ed (2009).
[2] Chandler v Webster, [1904] 1 KB 493., wherein dispute arose over satisfaction of due considersation for a space rented specifically to witness the coronation procession of King Edward VII that was subsequently postponed.
[3] Section 56. Agreement to do impossible act.—An agreement to do an act impossible in itself is void.
Contract to do act afterwards becoming 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.
[4] Section 32. Enforcement of contracts contingent on an event happening.—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. —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.” If the event becomes impossible, such contracts become void.
[5] No. 283/18/2020-GRID SOLAR, Ministry of New & Renewable Energy (MNRE).
[6]108. Rights and liabilities of lessor and lessee.—In the absence of a contract or local usage to the contrary, the lessor and the lessee of immoveable property, as against one another, respectively, possess the rights and are subject to the liabilities mentioned in the rules next following, or such of them as are applicable to the property leased:— (B) Rights and Liabilities of the Lessee – (e) if by fire, tempest or flood, or violence of an army or of a mob, or other irresistible force, any material part of the property be wholly destroyed or rendered substantially and permanently unfit for the purposes for which it was let, the lease shall, at the option of the lessee, be void: Provided that, if the injury be occasioned by the wrongful act or default of the lessee, he shall not be entitled to avail himself of the benefit of this provision.
Disclaimer: This Note is for general information only and not intended for solicitation. Please do not treat this as a legal advice of any sort. Views contained in this, are personal with interpretive value of the author and teams assisting the author. Readers are encouraged not to rely solely on these contents before making any decision