By Aman Ahmed and Shraddha Ray Menon
Read PANDEMIC AND COMMERCIAL CONTRACTS – PART I by clicking here.
How the Pandemic affects contractual obligations?
COVID 19 has impacted the world and jeopardised contracts and contractual obligations. The outbreak has resulted in inability or impossibility of performance of contracts because of various domestic and international restrictions. Another probability is commercial impartibility due to difficulty in execution of obligations. The consequences of such non-performance of contracts will depend on principles of domestic laws.
What happens, for example, when a company is not able to fulfill its contractual obligations? Under what circumstances can a company seek protection under the contractual clauses for force majeure and the doctrine of frustration of a contract? And what is the right framework — and the application of the framework — for calculating economic/financial damages, if any, in a commercial dispute?
If we look at domestic commercial contracts, negotiations are the most preferred first step in case of a fall out. But if negotiations do not go through, the two provisions that would be pressed into service are the ones related to unforeseen events in case of force majeure and the ones dealing with unforeseen/unforeseeable events arising after the contract has been concluded.
These potential issues give critical importance to impact specific clauses like force majeure or frustration clauses invoked during an endemic or a pandemic have on a commercial contract of any class.
Indian Commercial Contracts
Domestic framework of India would need a deeper look to understand how it is combating the conflicts created by the pandemic on certain contractual obligations.
The Indian legal system had to weigh in on measures to combat the commercial impact of the novel Corona Virus. The Supreme Court has had to extend limitation period from standard 3 years, in all cases from the usual timelines stated under Limitation Act, 1963 by invoking Article 142 of the Indian Constitution which grants power to Supreme Court to pass any order necessary to do “complete justice”.
The impact of COVID-19 is similar in case of world economy as delays in performance of contractual obligations and disruptions in supply chain have become a norm. From the perspective of contracts, construction to manufacturing and supply contracts has taken serious brunt due to constant lockdowns. The challenges are humongous as counterparties to a commercial contract are moving towards delay in performance citing impact of performance due to an unexpected event which in many cases is resulting in re-negotiation of the terms and conditions of the contract.
Can Force Majeure be enforced during a lockdown?
To invoke the force majeure clause by citing the reason of a lockdown/pandemic, the following must be proved-
- Casual connection between the event and impossibility of performance of contract due to it;
- Harmonious construction with all the provisions; and
- Fulfilling all conditions precedents, if any.
S32 of the Contract Act, 1872 on the other hand, lays down-
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.
The basis of this clause is to save the performing party from consequences of breach arising from an event over which it has no control, making it an exception to the said breach.Various factors weigh in for Force Majeure to be invoked- nature of contract, terms of contract, proceeding and subsequent events and the facts of the case.
S56 of the Contract Act, 1872 states,
Agreement to do impossible act.—An agreement to do an act impossible in itself is void. —An agreement to do an act impossible in itself is void.” Contract to do act afterwards becoming impossible or unlawful.
To break down S56, having a valid, yet to be performed (or underway in some case) contract is important, and the performance become impossible/unlawful later. This is often referred to as the Doctrine of Frustration.
Section 56 of the Contract Act provides for compensation to be payable for loss of non-performance if the potential non-performance was known to such party. If a promisor is aware of the impossibility or unlawfulness of the contract but fails to inform the promisee, then the promisor is liable to compensate the promisee any loss they may suffer, in case of non-performance by promisor. However, a claim of frustration will be beneficial for parties to seek legal advice on establishing or defending a claim based on frustration of contract, as this will involve an analysis of factors such as the effect of the event, the motive of the contract etc.
Force Majeure on its own does not have a skeletal form in the Indian legislations and its scope is determined through the definition provided in the contract between the parties to understand the jurisprudence on terms like ‘extraordinary events’ and ‘events beyond reasonable control of parties.’ Force Majeure is inclusive of epidemics and pandemics, but the inference must be proved by the parties through the contractual performances.
Certain steps have been taken by government of India to safeguard the interest of parties involved in commercial contracts. The Ministry of Finance (MoF) issued clarification for ‘Manual for procurement of Goods, 2017’ and stated that any disruption in the supply chain caused due to COVID-19 shall be considered as a natural calamity and thus shall come under domain of the Force Majeure Clause in the contract, subjected to completion of due procedures.
The MoF vide a notification stated that the Force Majeure clause in the contract can be invoked by the parties in relation to construction/works contracts, goods and services contracts as well PPP contracts with governmental agencies. Extension has also been granted to complete the contractual obligations for a period of three months, but the contractual performance would have to be completed in less than six months from the date the extension was granted, considering the contract had to be completed on or before 20th February 2020.
What are the options available in case FM clause in invoked?
- Focus on when force majeure clauses are drafted for commercial contract. Successful completion of commercial contracts depends on factors beyond the contracting parties. Factoring the variable conditions, the pandemic has placed on the surface, it is critically opening areas which require attention at the time of preparing the contract.
- Impact-assessment: In terms of a force majeure clause, the clause could contain words that indicate the extent of impact on performance to invoke the clause, such as ‘prevent’, ‘hinder’, ‘delay’. To assess whether Covid-19 could trigger the relevant force majeure clause, or frustrate the contract, it will be essential to look thoroughly into the operational aspects of the relevant commercial transaction and the nature of force majeureclause.
- Termination: To terminate a contract, it is essential to dig deeply into the nature and terms of the contract, for example- when and how can a contract be suspended, how would election of an effective remedy take place in case of suspension, what circumstances could result in extension of suspension to a level of termination, when can termination be sought on grounds of frustration even in presence of a force majeure clause.
- Renegotiation: However, in cases where the performance has merely become commercially more difficult but not impossible, parties could consider whether it would be commercially viable to suspend the contract or use this opportunity to renegotiate the contract. Some parties may also view this as an opportunity to put an end to a bad deal by evaluating its options for ending the contract.
- Litigation: if a party fails to agree on the event being a Force Majeure event or fails to comply with the provisions or attempts to establish a claim of frustration of contract in presence or absence of a force majeure clause, they will need to investigate the contract and assess legal risk and remedies in terms of litigation or arbitration of the dispute arising out of such disagreement.
Concluding Remarks
Indian laws too, revealed its need for a major overhaul through statutory reform. The Supreme Court exercised its power under Article 141 of the Constitution of India to reconsider the application of the doctrine of hardship in the country and interpreted force majeure clauses in a different light. In Indian Law context, there has been no reported case in which contractual parties to an ICC have chosen Indian law to be governing law, during this pandemic. This highlights the unpreparedness of our country to deal with such complex legal claims. Indian law prevents access to justice by failing to acknowledge unforeseen, supervening circumstances which result in economic crisis.
The fragmented notion of breach under Indian law also makes it unsuitable to resolve transnational contracts – especially those concerning complex disputes that arise due to non-performance as the result of the COVID-19 outbreak. The parties must peruse more than a few provisions and maneuver their way through a jungle of case law to familiarize themselves with the consequences of breach. In such circumstances, the parties to an international contract will tend to prefer to settle their disputes according to the laws not of India but of other countries.
All information posted is merely for educational and informational purposes. Nothing contained herein is, purports to be, or is intended as legal advice and you should seek legal advice before you act on any information or view expressed herein. Endeavored to accurately reflect the subject matter of this alert, without any representation or warranty, express or implied, in any manner whatsoever in connection with the contents of this. This isn’t an attempt to solicit business in any manner.