3 April, 2020
With a lot of disruption and backlog due to coronavirus, all industries, along with the real estate sector, have taken a massive hit. The year 2019 was not such a progressive year and everyone was counting on 2020 to recover and improve from last year’s lows. However, the real estate sector is in a deep standstill on the back of the global economic crisis, coupled with the COVID-19 situation.
This scenario calls for anyone to take precautions and due to restrictive movement because of the travel ban and the stock market crash, developers for one are not looking to take any chance in blocking their money in launching any new projects. At this point, one of the challenges being faced by them is the impact on contracts/agreements due to COVID-19, which are currently in motion/existence. The question being raised is whether the COVID-19 pandemic calls for a force majeure consideration in the existing contracts. Force majeure clause acts as a protection to parties wherein due to any unforeseen circumstances, either of the parties are unable to fulfil their commitment as per the agreed terms and conditions of the contract. To put it simply, due to any acts of god such as fire, flood, war, etc., parties are unable to perform their part as it is not reasonably within the control.
A contract generally covers all the parameters with respect to a force majeure clause. A mechanism is already in place that is to be followed in case of any force majeureevent. The impact of this calamity is still not clear, but there is a lot of uncertainty in the real estate sector. When one invests in a project, there are always predictions and timelines to consider with respect to the outcome, but uncertainty is not considered good, and that is what is happening because of the pandemic.
Moreover, this outbreak will also hamper financing endeavors through Real Estate Investment Trusts (REITs). Investment to be done via REITs will take a back seat now and will give investors time to rethink about future strategies. Furthermore, due to tax implications imposed on the dividends and profits of investors/shareholders, it will cause more problems. Another aspect to consider is, if the current scenario of COVID-19 indeed is treated as force majeure, thereby allowing the lessees to not make payments or defer payments under the existing lease agreements for the income generating properties, which are part of the REITs structure, such disruption in income generation will eventually impact REITs and its unit holders.
At the moment, everyone wants to observe and not take any actions, which will in return cause delays and timelines will get postponed. Countries such as the US and China, who economically push our sectors are also in a huge upheaval, hence it is natural that India’s real estate sector will get impacted.
The shortage of supplies and workforce being interrupted by work from home will lead to forestalling from performing contractual obligations under the existing contracts. Parties may face hinderances due to containment observed by the government. The question that is being asked now is whether this pandemic will trigger the force majeure provision in the event of non-performance under the contract. Many are looking for this calamity to renegotiate the terms of the existing contracts or are using it as an easy tool to terminate the agreement by interpreting it as a force majeure event.
What can be observed is that the provision of force majeure does not defer the requisite of performance by the parties. Parties are obligated to perform their part to the extent possible, without getting interrupted by the event of force majeure. At a time when parties have exhausted all measures to take control of any such event and are further obstructed to carry on their performance under the contract for a certain amount of time as decided by the parties, the parties under the contract may have the right to terminate such agreement if covered under the mechanism of mitigation of force majeure event and/or also clear them by penalty provisions.
Under the Office Memorandum dated February 19, 2020 issued by Government of India, Ministry of Finance, Department of Expenditure, Procurement Policy Division, force majeure is characterised as a natural calamity. It further clarifies that, “a force majeure clause does not excuse a party’s non-performance entirely, but only suspends it for a duration of the force majeure” and it cannot be an ex-post facto event. It further speaks about mitigation of the event wherein, in any event of delay in performance in part or in whole of its obligation during the force majeure event for a period of more that 90 (ninety) days, the parties gets the option to terminate the contract without financial worry from either side.
The laws that are being contemplated in this current scenario are: a) Section 56 of the Indian Contract Act, 1872 (“ICA”), which talks about impossibility of performance of contract owing to certain unavoidable events i.e., “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”. Against this backdrop, one may interpret that the COVID-19 scenario falls within the ambit of Section 56 of ICA, however, the terms of the contract, which contains qualification/restriction such as obligations to mitigate prior to invocation to a force majeure clause will have to be factored in; b) Section 32 of ICA which states that, “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”, will be relevant from the perspective of insurance and indemnity. However, similar to interpretation of Section 56 of ICA, being subject to mutually agreed contractual terms, the interpretation of insurance and indemnity contracts on the back of a force majeure event will also be driven by the terms of mutually agreed contractual agreements.
Usual fluctuations in economy does not lead to a force majeure event. There is not a clear interpretation, identifying this crisis as one of the categories of force majeure. As explained above, the contracts will itself be considered and interpreted to see if it will trigger the force majeure clause. The terms and conditions in the agreements will get priority under such situations. Parties should mutually consider their options/remedies during this epidemic.
While the challenges posed in a given scenario make us interpret and analyse force majeure provisions under exiting contractual arrangements, one has to also take this as a learning opportunity to explore commercially viable legal solutions to avoid a scenario where such health pandemic may lead to an economic pandemic.
For further information, please contact:
Taher D Mandviwala, Partner, Cyril Amarchand Mangaldas
taher.mandviwala@cyrilshroff.com
