Implication of Covid 19 on Contracts in India

Effect of Covid 19 (CoronaVirus) on Force Majeure law/provision In Indian contracts!

The novel coronavirus or COVID-19 outbreak has managed to take the whole world into hostage within less than four months, and disrupted the lives of millions across the globe and the global economy has been hit the hardest with the markets across the world also taking a tumble amid the virus outbreak. The businesses have suffered with multiple contracts and transactions being terminated. The Governments across the globe are implementing stringent policies including lockdown to control the coronavirus outbreak.

The pandemic today, especially in India, after the nationwide lockdown has gravely affected the business which has now put forth unprecedented challenges and impediments to businesses in conducting their normal day to day operations by causing delays in the performance of contracts and transactions With parties being unable to fulfill their obligations under various agreements.

A common question which arise is whether the inability of a party to perform its obligations under an underlying agreement due to the circumstances caused by the COVID-19 outbreak would be classified as a force majeure event in India? In other words “whether the current situation of the Pandemic can enable parties to a contract to alter their obligations with non-compliance of terms neither being regarded as a “default committed by any party” nor a “breach of contract”?” In this regard, at first we need to understand the concept of “Force Majeure”.

The term Force majeure – or vis major (Latin) – meaning “superior force”, also known as cas fortuit (French) or casus fortuitus (Latin) “chance occurrence, unavoidable accident”, is a common clause in contracts that essentially frees both parties from liability or obligation when an extraordinary event or circumstance beyond the control of the parties, such as a war, strike, riot, crime, epidemic or an event described by the legal term act of God (hurricane, flood, earthquake, volcanic eruption, etc.), prevents one or both parties from fulfilling their obligations under the contract. In practice, most force majeure clauses do not excuse a party’s non-performance entirely, but only suspend it for the duration of the force majeure

The term ‘Force Majeure’ is also been defined in Black’s Law Dictionary, as ‘an event or effect that can be neither anticipated nor controlled. It is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled.

Force majeure is generally intended to include occurrences beyond the reasonable control of a party, and therefore would not cover: Any result of the negligence or malfeasance of a party, which has a materially adverse effect on the ability of such party to perform its obligations. Any result of the usual and natural consequences of external forces. Parties who wish to have force majeure relief must spell out what constitutes force majeure in the contract itself (or the relevant event does not fall within the scope of the force majeure clause).

Failure to do so means that a supervening event which prevents performance of the contract will not be caught as a force majeure event, so as to provide relief from performance – because it has not been named as a qualifying event in the contract. In India we recognise the Doctrine of Frustration, a narrower concept that applies when the actual performance of the contract is radically different from what the parties intended. When force majeure has not been spelled out in the contract and / or the relevant event does not fall within the scope of the force majeure clause and a supervening event prevents performance, it will be a breach of contract.

The law of frustration will be the sole remaining course available to the party in default to end the contract. Supreme Court has held in Dharnrajmal Gobindram v. Shamji Kalidas [A.I.R 1961 SC 1285], that “An analysis of ruling on the subject shows that reference to the expression is made where the intention is to save the defaulting party from the consequences of anything over which he had no control.”

One should also keep in mind that even if a force majeure clause covers the relevant supervening event, the party unable to perform will not have the benefit of the clause where performance merely become more difficult, more expensive, and/or less profitable. While the Term ‘Force Majeure’ has neither been defined nor specifically dealt with, in Indian statutes, some reference can be found in Section 32 and Section 56 of the Indian Contract Act, 1872 to combat situations of ‘Act of God’ or similar circumstances. As long as it is relatable to an express or implied clause in a contract, it is governed by Chapter III dealing with the contingent contracts, and more particularly,

Section 32 of the Indian Contract Act which reads as follows :

Section 32 reads as “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.” From a contractual perspective, a force majeure clause provides temporary reprieve to a party from performing its obligations under a contract upon occurrence of a force majeure event.

A force majeure clause generally spells out specific circumstances or events, such as acts of God, War, Terrorism, Earthquakes, Acts of Government, plagues or epidemics and some other events wherein the parties narrate and thereafter simply add “and such other acts or events that are beyond the control of parties” in the contracts which would qualify as force majeure events, conditions which would have be fulfilled for such force majeure clause to apply to the contract and the consequences of occurrence of such force majeure event.

As such, for a force majeure clause to become applicable (should any force majeure event occur), the occurrence of such events should be beyond control of the parties and the parties will be required to demonstrate that they have made attempts to mitigate the impact of such force majeure event. If an event or circumstance comes within the ambit of a force majeure event and fulfils the conditions for applicability of the clause then the consequence would be that parties would be relieved from performing their respective obligations to be undertaken by them under the contract during the period that such force majeure events continue.

Further consequential liabilities, depending on the language of the clause, the parties maybe required to issue a notice formally intimating the other party of the occurrence of such event and invocation of the force majeure clause. Some contracts also contain a provision that if such force majeure event continues for a prolonged time period, the parties may be permitted to terminate the contract. It is common for force majeure clauses to specify the impact that the event or circumstances in question must have, in order for the clause to be triggered. References may be made, for example, to the event or circumstances having “prevented”, “hindered” or “delayed” performance. These terms require different levels of impact on performance before a party can claim recourse to these clauses.

In other words, the force majeure to what would otherwise be treated as a breach of contract. Certain contracts may state that, if a force majeure clause is applied, the contract may automatically be terminated. In the event, wherein a contract does not include a force majeure clause or it is spelled out and / or the relevant event does not fall within the scope of the force majeure clause, then such event is dealt with by a ‘rule of positive law’ also known as “The Doctrine of Frustration of Contract” under Section 56 of the Indian Contract Act so as to discharge the parties from their contractual obligations by reading the nature of the contract, the nature of event and so forth.

The said Section 56 of the Indian Contract Act, 1872, reads as follows “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.

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.

1. 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.

2. Compensation for loss through non-performance of act known to be impossible or unlawful. Where one person has promised to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promisee for any loss which such promisee sustains through the non-performance of the promise.

Where one person has promised to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promisee for any loss which such promisee sustains through the non-performance of the promise.”. This principal has been upheld in Satyabrata Ghose versus Mugneeram Bangur & Co & Anr (AIR 1954 SC 44) which reads as follows : The ‘Doctrine of Frustration’ 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.

The view that Section 56 applies only to cases of physical impossibility and that where this section is not applicable recourse can be had to the principles of English law on the subject of frustration is not correct. English cases can have only a persuasive value, and are only helpful in showing how English courts decided cases under similar circumstances. Section 56 of the Indian Contract Act lays down a rule of positive law and does not leave the matter to be determined according to the intention of the parties. According to the Indian Contract Act, a promise may be express or implied. In cases, therefore, where the court gathers as a matter of construction that the contract itself contained impliedly or expressly a term, according to which it would stand discharged on the happening of certain circumstances, the dissolution of the contract would take place under the terms of the contract itself and such cases would be outside the purview of Section 56 altogether.

Although in English law these cases are treated as cases of frustration, in India they would be dealt with under Section 32 of the Indian Contract Act which deals with contingent contracts or similar other provisions contained in the Act. In the large majority of cases however the doctrine of frustration is applied not on the ground that the parties themselves agreed to an implied term which operated to release them from the performance of the contract. The relief is given by the court on the ground of subsequent impossibility when it finds that the whole purpose or basis of a contract was frustrated by the intrusion or occurrence of an unexpected event or change of circumstances which was beyond what was contemplated by the parties at the time when they entered into the agreement.

Here there is no question of finding out an implied term agreed to by the parties embodying a provision for discharge, because the parties did not think about the matter at all nor could possibly have any intention regarding it. When’ such an event or change of circumstance occurs which is so, fundamental as to be regarded by law as striking at the root of the contract as a whole, it is the court which can pronounce the contract to be frustrated and at an end. The court undoubtedly has to examine the contract and the circumstances under which it was made.

The belief, knowledge and intention of the parties are evidence, but evidence only on which the court has to form its own conclusion whether the changed circumstances destroyed altogether the basis of the adventure and its underlying object. This may be called a rule of construction by English Judges but it is certainly not a principle of giving effect to the intention of the parties which underlies all rules of construction. This is really a rule of positive law and as such comes within the purview of Section 56 of the Indian Contract Act. The reason underlying the rule of English law that the doctrine of frustration does not apply to contracts for the sale of land. is that under the English law, is soon as the agreement to sell is complete the buyer becomes the owner of the land in equity.

As a mere agreement to sell does not confer any rights of ownership on the buyer under the Indian law, the doctrine of frustration is as applicable in India to agreements for sale of land as in the case of other agreements. As there cannot be any one specific solution to this question, as it depends upon how the force majeure clause is worded in every specific contract; and in the absence of the same, applicable laws related to the same will be required to be taken into consideration. There are still certain well-accepted practices for dealing with such extraordinary situations in commercial transactions by the inclusion of force majeure clauses. Determination of the types of circumstances so covered by the force majeure clause contained in a contract is essential. Provisions of force majeure often cover natural disasters like floods, and earthquakes as “acts of God.”

Other covered events may include war, terrorism, civil disorder, fire, disease medical epidemics or by reasons of applicable laws or regulations. The courts have interpreted the term “Force Majeure” as an event that can neither be anticipated nor controlled by either of the contracting parties. A force majeure clause applies in the context of ongoing contractual arrangements. Pandemic and related consequences such as government action is a type of event covered by a force majeure clause, however, its impact on the affected party’s ability to perform its contractual obligations may vary depending upon contractual terms.

On the other hand, some contracts may even state that the duty to fulfill the contractual obligation may be suspended for a certain period of time and if the force majeure event is not curbed or treated even after such time, then eventually the contract may be terminated.

After the break out of COVID-19, while reinforcing the settled position in law that letters of credit are independent transactions and the banks are not concerned with underlying disputes between the parties, the High Court of Bombay in its decision dated 8 April 2020, in the matter of Standard Retail Private Ltd Vs GS Corp & Others held that force majeure cannot be invoked by the purchaser in making payments when the seller has performed its part of the contract. Counterparties may argue that COVID-19 is a force majeure event that excludes them from their contractual obligations.

However, the impact of the force majeure event cannot be generalised and shall vary depending on the nature of the transaction and its impact on the same. There exists a fine line of difference between cases of force majeure and those of hardship. In order to correctly identify an individual instance and its possible legal implications, therefore, it is necessary to undertake a case by case analysis.

FORCE MAJEURE AND INDIAN GOVERNMENT

The Indian government have considered the event of COVID-19 as a force majeure and have taken possible steps to ensure the minimum possible hardships to the common people. The Finance Ministry had on February 19, 2020, by its Office Memorandum No. F. 18/4/2020-PPD clarified that the meaning of force majeure shall include the present pandemic as a case of natural calamity.

Notification is as follows: https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf

The courts during the lockdown in India have been constrained to operate on an extremely limited scale via video conferencing, exclusively for urgent matters. Various ministries and government authorities including the Ministry of Corporate Affairs, Ministry of Finance, Department of direct and indirect Tax have also notified extension for mandatory compliances. For contracting parties, there is no definitive rule to follow. Every commercial entity which has been impacted by the spread of the COVID-19 must first begin to examine the specific provisions of their contracts with the goal of establishing if there is a precise definition of the circumstances of force majeure (or hardship) and their relative consequences.

FORCE MAJEURE & INDIAN CONTRACTS

A force majeure provision in a commercial arrangement is an express provision of circumstances in which performance under the contract will be excused or suspended temporarily.

Section 56 of The Indian Contracts Act, allows for temporary discharge of obligations on grounds of impossibility in the instance of any untoward event or change in circumstance that is totally outside its very foundation of the contract agreement upon which the parties entered their agreement.

There are three essential conditions for invoking such a clause which are

(a) an existence of a valid contract between the parties;

(b) the contract is yet to be performed (during the period of temporary struggle for which force majeure is sought for);

(c) the contract after it is entered into becomes impossible to perform due to fact or law.

The underlying principle with respect to a Force majeure event is that, upon the occurrence of an event or circumstance that is not reasonably within the control of a party and is unavoidable, and which prevents or delays that party from performing some or all of its contractual obligations, that party will be relieved from its contractual obligations/ liability.

The party claiming force majeure is under an obligation to prove that it has taken all reasonable endeavors to avoid or mitigate the force majeure event and its effects. This being subjective standard, differs from case to case and therefore needs to be interpreted accordingly. In some contracts, if the period of force majeure is prolonged, parties may be permitted to terminate the contract depending on the practical difficulties being faced by them.

SAFEGUARDS IN COMMERCIAL CONTRACTS

• In the light of this current pandemic, few safeguards to be resorted in commercial contracts are:-
• Re-assess and review the contract in which the force majeure clause exists.
• Ensure and strictly Comply each and every conventional ‘notice’ formalities.
• Mutually analyze the impact of the outbreak of COVID-19 on the contract and its performance.
• Initiate a chance to perform the contract in a possible alternative way;
• Keep a strict record of the various notifications and orders by government and administrative bodies. The same may be evidenced during the litigation/arbitration stage.
• All records with respect to unavoidable additional expenditure incurred must be maintained.

IMPACT ON REAL ESTATE SECTOR

Another sector which is heavily impacted by the COVID-19 pandemic is the Real Estate sector. All stakeholders from the builders to the lessees, are affected from the pandemic and the resultant lockdown. The Builder Agreements usually contain such Force Majeure clauses and the same can easily be invoked but the same is not the case with lease agreements. In case there is no Force Majeure clause in the lease agreements, then Section 56 of Indian Contract Act does not come to the aid of the parties either. The Hon’ble Supreme Court of India, in Raja Dhruv v. Raja Harmohinder Singh [1968 AIR 1024] has made this clear by stating that Section 56 has limited application to covenants under a lease and does not apply to cases where there is a completed transfer. The court further observed that a lessee cannot avoid the lease because he does not or is unable to utilize the land for the purpose for which it is let to him if the land is fit for usage and as such, section 56 of the Indian Contract Act does not apply in that scenario.

OTHER CONSIDERATION

Any party to a contract can either invoke the Force Majeure clause or the Doctrine of Frustration under Section 56 ofthe Indian Contract Act. However, in situations where the same cannot be done and an obligation is required to be fulfilled, the same can be suspended by mutual consent of the parties.

Section 3 of the Epidemic Disease Act, 1897 states that any person who disobeys any regulation made under it would be punishable under the Indian Penal Code, 1860 and Section 4 of the same also provided that no suit or legal proceedings can be made against any person for anything done by them under the Epidemic Disease Act. Furthermore, Section 73 of the Disaster Management Act, 2005 states that no proceedings can be initiated against any person acting in good faith in pursuance of the regulations framed under it. Hence, non-fulfilment of obligations under the contracts cannot lead to legal proceedings if the same were affected by the lockdown imposed by the government or owing to any hindrances caused by COVID-19, in performance of obligations arising out of a contract by either part, as long as it is sufficiently established that the situation that had arisen was such that it was impossible for the party seeking exemption from performance, to perform its part of the contract.