23 April 2020
Introduction
Economies and businesses across the world have been disrupted in the wake of the COVID-19 disease (COVID-19). The World Health Organisation (WHO) on 30 January 2020, in the second meeting of the Health Committee, constituted under the International Health Regulations 2005 (IHR), declared that the outbreak of COVID-19, constitutes a Public Health Emergency of International Concern (“PHEIC Declaration”). This calamitous event has brought to a standstill, commercial operations on a scale, hitherto unprecedented in recent human history.
While some countries are just beginning to implement a partial or total lock down, others like India, are well into what could possibly be the middle of the life cycle of such a measure. On the other hand, China has publicly proclaimed, that it has successfully controlled the spread and has commenced the process of gradual lifting of the lock down.
As a consequence of such a large scale global occurrence of COVID-19, governments have implemented “social distancing” practices. Social distancing is a measure aimed at curbing the velocity of spread of the virus and at ‘flattening the curve’, i.e. the rate at which people are infected. In view of such social distancing policies, factories and services dealing with non-essential production of goods and services have stopped operating. Due to such policies, businesses are facing a host of unforeseen situations, which will compel everyone, from the public to the private sector, to ramp up spending on health care, to come up with innovative solutions, by increasingly resorting to measures such as remote workspaces, video-conferencing, digital collaboration etc.
In the short run, there is likely to be a substantial increase in contractual disputes, owing to the inability and/ or failure of parties to perform contractually stipulated obligations.
Viewed in this backdrop, we have outlined below the position of law relating to obligations under a contract during the occurrence of a force majeure event, as well as once the said event ceases to exist. Obviously, this analysis takes into account the consideration of whether the lock down will amount to a force majeure event.
The concept of ‘Force Majeure’
‘Force Majeure’ is an expression, which owes its origin to the French Civil Code and describes a clause, which specifies circumstances, that would excuse non-performance of a contract. These specific circumstances may include natural disasters such as floods, earthquakes, etc. as well as man-made events such as strikes or lockouts, war, riot, civil unrest etc.
A Force Majeure clause defines supervening and unforeseen events, which occur owing to reasons beyond the control of the parties, and render impossible, the performance of obligations undertaken by them. Such events may entitle them, depending on the wording of the clause, the attending circumstances, and their conduct, to cancel the contract or excuse them from the performance of obligations, in whole or in part, or entitle them to suspend or seek extension of time for performance. One must be able to discern from the clause, the possible events that fall thereunder or can be readily implied therefrom.
Conditions for applying the clause
Force Majeure clauses are found in a variety of forms and must be interpreted keeping in mind the nature of the contract. The application of the force majeure clause, which is a defence set up to contest an action claiming compensation for the breach of a contractual obligation, is subject to certain conditions, which are illustrated as under:
Character of the event: The triggering event, must be one which could not have been foreseen by the parties and was not in their contemplation, when the contract was executed.
Nature of the event: The event must have the effect of rendering performance impossible and not merely onerous or less profitable. For instance, the High Court of England and Wales in Tandrin Aviation Holdings Ltd v Aero Toy Store LLC reported in [2010] EWHC 40 (Comm), rejected the defendant’s plea that the contract for procuring an executive jet had been frustrated on account of the downward spiral of the world’s financial markets.
Act or Omission: The failure/ inability to discharge contractual obligations must be on account of factors beyond the control of the party and not owing to any act or omission on its part. There should be nothing that the party could have done to avoid the breach of the contract.
Burden of Proof: The party that invokes the force majeure defence, is required to establish, the scope of the clause and the events that it covers and that the facts justify the application of the clause.
Obligation to intimate the invocation of the Force Majeure: Some contracts might require the issuance of a notice to the counter party, as a precondition for the invocation of the clause.
Time period: Courts have by and large, been wary of construing the clause widely and have subjected them to certain limitations. One such limitation, is that, if performance remains possible, it will be extended for a limited period and not indefinitely.
COVID-19 pandemic: Is it a force majeure event?
It is clear that the corona virus pandemic, based on the speed with which it has spread across the world, the thousands of people who have been infected, the death toll climbing north at an alarming rate, and the debilitating toll it has had on the global economy, would qualify as one. This is assuming that the contract contains a force majeure clause. While it may not be necessary for the clause to include a pandemic as one of the triggering events, it would certainly help if it does. There is no gainsaying that an event of this scale and magnitude could not have been foreseen or predicted with any reasonable degree of certainty by contracting parties and therefore any disruption owing thereto was not in the contemplation of parties when they executed the contract. Therefore, as long as the clause contains a reference to unforeseen events, it should suffice to excuse, suspend or extend performance. It is imminently probable that, going forward most commercial contracts, if not all, of any substantial size, will include pandemics as a force majeure event.
How it is likely to play out
The performance of contractual obligations may be rendered impossible, in the aftermath of the COVID-19 pandemic, in two broad possible eventualities.
First, owing to the pandemic, the workforce may fall ill or could have been placed under preventive quarantine and therefore be unable to participate and contribute to the manufacturing of goods or render the provision of services, thereby disrupting the ability to discharge contracted obligations.
Alternatively, another situation in which production and supply could be disrupted, is where owing to restrictions imposed by the government, such as lockdown, imposition of curfews, suspension of inter-state and / or intra-state public transport, rail services etc., staff may be unable to travel to their place of work, raw material supply chains might be disrupted, delivery of goods manufactured becomes impossible.
The consequences of such events could be myriad, ranging from the inability of businesses to service loans availed by them, to the inability to pay lease rentals for commercial space (Article in Economic Times), to taking delivery of products ordered, or manufacturing and delivering goods ordered, supplying services, etc., all of which would technically fall in the realm of a contractual breach.
Other consequences, which may be witnessed in the slightly longer term is that, even once the lockdown restrictions are lifted, it is unlikely that normalcy will be restored overnight and businesses may take time to regain lost ground, owing to work force migration and displacement. Disruption of supply chains and displacement of work force and delays could drive the cost of sourcing of raw materials and labour and as a sequitur, the cost of production northwards, thereby impacting the ability of business to supply goods or deliver services, at the contractually agreed rates. This may require negotiations for reworking pricing and lead to amendment of contracts.
In Metropolitan Water Board v Dick Kerr & Co. [1918] AC 119, the House of Lords held that where an executive order had rendered further performance of a contract illegal, such a contract would be discharged. The Court applied the maxim, ‘lex non cogit ad impossibilia’- the law does not compel one to do the impossible.
The Queens’ Bench in Baily v De Crespigny reported in [1869] LR 4 QB 180, held that the obligation to perform a contract is discharged, where owing to events which occur subsequently, insistence would mean performance of a new contract.
During the currency of the lockdown restrictions, quite clearly, performance of a contract cannot be insisted. It is open to a defendant to establish that, post the lifting of the lockdown restrictions, circumstances have been altered to such a great extent that performance of the original contract stands discharged.
Application to Specific Statutes
A crucial aspect which merits mention is the application of a force majeure clause in proceedings under certain special laws. Statutes such as Real Estate (Regulation and Development) Act, 2016 and National Food Security Act, 2013 and various rules and regulations such as those framed under the Mines & Minerals (Development & Regulation) Act, 1957, Telecommunication (Broadcasting And Cable) Services Interconnection (Addressable Systems) Regulations, 2017 and Central Electricity Regulatory Commission (Indian Electricity Grid Code) Regulations, 2010 recognize Force Majeure events.
However, certain statutes provide for a strict interpretation of its provisions and in such cases, a defence of Force Majeure may fall on deaf ears. One such statute is the Insolvency and Bankruptcy Code, 2016 (“IBC”). It appears from press articles (Business Today article) that the Government may relax the applicability of the IBC for a certain period of time to check insolvency situations arising out of the Covid-19 pandemic.
Invocation of the defence and examination by Courts
As is common knowledge, the functioning of the judicial machinery, across the country has been substantially affected and save and except for dealing with emergent cases and that too via video-conferencing, most courts have put regular hearings on hold at least for the immediate future. As and when things do limp back to some degree of normalcy, thereby permitting Courts to start functioning again, there is likely to be a slew of disputes brought forth, seeking reparations for violations of contractual obligations. Force Majeure clauses are in such cases likely to be a substantial plank, on which the edifice of the defence will be erected.
Contra punto: Plaintiffs / Claimants will seek to contest this by contending that prudent businesses ought to have put in place business continuity plans / back up plans, to cater to such a situation and keep operations functioning. It will be contended that epidemics are not unknown. The Emergency Committee of the WHO has issued several PHEIC Declarations- the 2009 H1N1 (swine flu) pandemic, the 2014 Ebola outbreak in Guinea, Sierra Leone, the Zika Virus epidemic in 2015-16 originating in Brazil, the Kivu Ebola epidemic in 2018 in the Democratic Republic of Congo being four of them. Therefore, it could be contended that the outbreak of an epidemic is not an unforeseen event and organizations ought to have been prepared and should have evolved back up plans.
Courts will then be called upon to perform a balancing act, while examining the scope and nature of the clause, its width and import and the hardship that has already been caused and is likely to be faced by businesses, already weakened by the onslaught of the virus and the consequences of penalizing them further. A bit of play in the joints, a little elbow room, if available, must surely weigh in favour of the party seeking to put forth the defence, subject of course to all other attendant requirements, being fulfilled. We may well see the relaxation of traditionally recognized limitations on the acceptance of a defence based on a Force Majeure clause.
The situation, absent Force Majeure clauses
Another crucial issue which arises is, whether, in a situation where a contract does not contain a force majeure clause, would it possible to defend an action for breach?
In such an eventuality, it might still be possible for the defendant, to argue that the performance of the contract has been frustrated, and thereby seek discharge from the performance of obligations, on the basis of principles flowing from Section 56 of the (Indian) Contract Act, 1872.
In one of the early cases (Taylor v Caldwell 3 B & S 826) in which it was formulated, the Queen’s Bench in 1863, held that, frustration was developed to alleviate the harshness of an absolute obligation. Blackburn, while dealing with a case where a music hall in which one of the contracting parties had agreed to give concerts on certain specified days was accidentally burnt by fire, held that such a contract must be regarded as subject to an implied condition that the parties shall be excused, in case, before breach, performance becomes impossible from perishing of the thing without default of the contractor. Although Courts in England have sought to go by not merely the plain words of the contract but have sought to ascertain what a reasonable man would have intended (Joseph Constantine Steamship Co. v. Imperial Smelting Corporation Ltd. 1942 AC 154). The Supreme Court has however held that in India the test that is to be applied is that of supervening impossibility or illegality, taking the word “impossible” in its practical and not literal sense. It was held that Section 56 lays down a rule of positive law and does not leave the matter to be determined according to the intention of the parties. However, relying on Section 32 of the (Indian) Contracts Act, 1872, which deals with contingent contracts, the Court did not completely exclude the operation of an implied term under the contract, whereunder, parties could be excused from performance.
The second limb of Section 56 will be attracted to the situation of a pandemic. The contract is voided when the (a) performance of the act/ obligation, is rendered impossible, by an event that occurred post the execution of the contract, or (b) performance is rendered unlawful by an event which the promisor could not prevent.
Therefore, it will be necessary to establish that (a) the triggering event, was one that was unforeseen, could not have been avoided despite the exercise of due diligence and that the performance of obligations has been rendered impossible or impracticable owing to its illegality; However, merely because the performance of obligations has become more expensive or onerous, is insufficient to attract the operation of Section 56 (Energy Watchdog v CERC (2017) 14 SCC 80; DDA v Kenneth Builders & Developers P. Ltd. (2016) 13 SCC 561).
It must be established that the very foundational basis of the contract has been materially altered or has ceased to exist.
The Way forward
The successful deployment of the Force Majeure defence, will depend on the facts and circumstances of each case and the language and wording of the clause, the nature of the contract, the nature and effect of the event on performance etc. In conclusion, it is imperative that businesses, apart from taking all necessary mitigation steps to minimize the fall out of a possible breach, also commence the exercise of conducting a review of their contracts, examine the nature and scope of the force majeure clauses and the stipulations contained therein, which may require to be met for invoking the operation of the clause. This will enable them to evolve strategies to deal with possible claims that may be instituted.
For further information, please contact:
Souvik Ganguly, Partner, Acuity Law
al@acuitylaw.co.in
