COVID-19 has resulted in lockdowns or restricted movements in countries. Consequently, businesses have been impacted and so have operations and consequently contracts and obligations under contracts are being revisited to assess these impacts. The term that has assumed relevance in contractual context today for businesses today and heard most often is “force majeure” and how will this term be construed in a contract in the background of COVID-19.
COVID-19 has affected cross-border trade, real estate market, specifically the developers, the home-buyers and the commercial lease arrangements, EPC (engineering, procurement & construction), joint-venture agreements as well as M&A deals in India. It has also impacted the parties’ ability to meet their contractual obligations due to restriction in movement, stoppage of production, increase in costs due to scarcity of raw materials components, labor shortages, shortage of funds, disruption in the supply chains, etc.. Presently companies in various sectors have already declared or are likely to declare a force majeure.
What is Force Majeure?
Force majeure translates into “superior force”. Force majeure 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, 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. A force majeure may work to excuse all or part of the obligations of one or both parties. For example, a strike might prevent timely delivery of goods. A force majeure may also be the overpowering force itself, which prevents the fulfillment of a contract.
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.
o To illuminate this distinction, take the example of an outdoor public event abruptly called off.
– If the cause for cancellation is ordinary predictable rain, this is most probably not force majeure.
– If the cause is a flash flood that damages the venue or makes the event hazardous to attend, then this almost certainly is force majeure, other than where the venue was on a known flood plain or the area of the venue was known to be subject to torrential rain.
– Some causes might be arguable borderline cases (for instance, if unusually heavy rain occurred, rendering the event significantly more difficult, but not impossible, to safely hold or attend); these must be assessed in light of the circumstances.
Any circumstances that are specifically contemplated (included) in the contract—for example, if the contract for the outdoor event specifically permits or requires cancellation in the event of rain.
The importance of the force majeure clause in a contract, particularly one of any length in time, cannot be overstated as it relieves a party from an obligation under the contract (or suspends that obligation). What is permitted to be a force majeure event or circumstance can be the source of much controversy in the negotiation of a contract and a party should generally resist any attempt by the other party to include something that should, fundamentally, be at the risk of that other party.
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 (1) more difficult, (2) more expensive, and/or (3) less profitable.
Under Indian Contract law, the consequences of a force majeure event are provided for under Section 56 of the Indian Contract Act, 1872 which states that on the occurrence of an event which renders the performance impossible, the contract becomes void thereafter. Section 56 of the Contract Act stands as follows:
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.
When the parties have not provided for what would take place when an event which renders the performance of the contract impossible, then Section 56 of the Contract Act applies. When the act contracted for becomes impossible, then under Section 56, the parties are exempted from further performance and the contract becomes void.
Hon’ble Supreme Court in Satyabrata Ghose v. Mugneeram Bangur & Co. has held: These differences in the way of formulating legal theories really do not concern us so long as we have a statutory provision in the Indian Contract Act. In deciding cases in India the only doctrine that we have to go by is that of supervening impossibility or illegality as laid down in Section 56 of the Contract Act, taking the word “impossible” in its practical and not literal sense. It must be borne in mind, however, 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, there is no doubt that the parties may instead choose the consequences that would flow on the happening of an uncertain future event, under section 32 of the Contract Act. The concept of restitution as set out in Section 65 of the Contract Act also assumes significance in the context of the frustration of contract. Section 65 states that when an agreement is discovered to be void, such as in case of a contract getting frustrated, the person who has received any advantage under such agreement is ‘bound’ to restore it or to make compensation for it, from whom he received it. Thus, one of the consequences of frustration of a contract is restitution whereby parties are to be put in the same position they were if the contract had never been executed.
The general rule of force majeure under Section 56 of the Indian Contract Act, 1872 does not apply to lease deeds. The Supreme Court clarified this position early on in Raja Dhruv v. Raja Harmohinder Singh. The Supreme Court dismissed the claim of force majeure under Section 56 on two broad grounds. First, it held that rights under a lease are not simply contractual rights but are instead governed under the provisions of the Transfer of Property Act, 1872. Second, the Court reasoned that Section 56 does not apply to a concluded contract where no further performance was required. The Supreme Court re-affirmed this position in Sushila Devi v. Hari Singh which also involved a claim for refund of rent and deposit in relation to lands that now formed part of Pakistan. It is important to bear in mind that although the general law of force majeure is inapplicable to lease deeds, this does not prevent parties by way of contract to agree to certain protections in the event a force majeure event does arise. In Shankar Prasad and Ors. v. State of MP (ILR  MP 2146) the High Court held that the obligation to pay rent by the lessee did not cease, even though the godown leased out was completely destroyed by a fire, as the lessee had not sent a notice under Section 108(B)(e) of the TPA to the lessor. This position of law has also been followed by the High Court of Bombay in Amalgamated Bean Coffee Trading Company v. Surjit Singh Jolly and the Delhi High Court in Chamber of Colours and Chemicals Pvt. Ltd. v. Trilok Chand and Airport Authority of India v. Hotel Leela Venture Ltd. The logic governing these transactions is that unless the lessee satisfactorily surrenders the property by way of a notice, the lessee is deemed to be using the property and is obligated to pay rent. The lessee should be mindful to elaborate, in its notice, reasons as to why COVID-19 is an event of irresistible force under Section 108(B)(e) of the TPA. It is also settled law that a financial inconvenience in making payment does not qualify as a force majeure event.
Is Covid-19 a force majeure event?
Force majeure clauses will generally adopt one of the following approaches to defining the type of event which may, depending on its impact, relieve a party from contractual liability:
Listing specific events
These may include events such as war, terrorism, earthquakes, hurricanes, acts of government, plagues or epidemics. Where the term epidemic, or pandemic, has been used, that will clearly cover Covid-19.
An act of government will have occurred where a government body has imposed travel restrictions, quarantines, or trade embargoes, or has closed buildings or borders, however the position is less clear where the government makes recommendations rather than makes orders using legal powers.
Where no relevant event is specifically mentioned, it is a question of interpretation of the clause whether the parties intended such an event to be covered. This involves considering whether the list of events included was intended to be exhaustive or non-exhaustive. Unless specific words are used to suggest that a list is non-exhaustive, it can be difficult to argue that parties who set out a list of specific events but did not include a particular event, such as an epidemic, nonetheless intended that event to be covered.
In unprecedented circumstances like the present, the courts are likely to be generous in their interpretation by holding that the events or circumstances were “beyond the parties’ reasonable control” when faced with parties who have encountered genuine difficulties in performing.
Ministry of Finance has issued Office Memorandum No. 18/4/2020-PPD dated 19.02.2020 inter alia citing “A force majeure (FM) means extraordinary events or circumstance beyond human control such as an event described as an Act of God (like a natural calamity)” clarifying that spread of corona virus should be considered as a natural calamity and Force Majeure clause may be invoked.” This has been followed by similar clarifications issued by Ministry of Railways, etc. Thus there should be NO DOUBT left that the present lockdown due to COVID-19 would fall under Force Majeure event.
What if there is no force majeure clause?
Since force majeure is a creature of contract rather than a rule imposed by the general law, if there is no force majeure clause, an affected party will have to look to other provisions of the contract for potential routes out of its difficulties. If the contract does not provide any such routes, it may in certain circumstances be possible to rely on the doctrine of frustration of contract.
However, it is very difficult to show that a contract has been frustrated. Frustration requires that an unforeseen subsequent event outside the control of the parties has made the contract impossible to perform, or has transformed performance of the obligations under the contract into something so radically different from that which the parties intended that it would be unfair to hold the parties to their obligations. One extreme situation where the courts have held that a contract was frustrated was when war broke out and the government banned the works and seized and sold the necessary equipment.
As with the test for “prevention” of performance under force majeure clauses, the fact that performance has been made more difficult or costly is not enough. In addition, it is questionable whether an epidemic, or even a pandemic, would be considered to be unforeseeable, given previous recent epidemics and warnings that further epidemics or pandemics are likely to occur. However, it might be possible to argue that the extent of the global government enforced lockdowns was unforeseeable.
Frustration may also be commercially undesirable in some circumstances, since its effect, regardless of the wishes of the parties, is to bring all parties’ obligations under the contract to an end immediately.
Practical steps if seeking to rely on a force majeure clause:
Parties seeking to rely on a force majeure clause should follow the following practical steps:
Consider in detail the precise wording of the force majeure clause, the contract as a whole and the circumstances that have arisen. Determining whether performance is excused by a force majeure clause can be a difficult and highly fact-sensitive exercise, so early legal advice should be sought.
Explore alternative means of performing, reducing delay, or minimizing any loss to the other party. This may require considering alternative suppliers, or alternative methods of delivery, even if at higher cost.
Serve any notices as required under the contract, as soon as possible and in accordance with the notice provisions. Consider carefully what event or circumstance you allege constitutes the force majeure event, taking into account the wording of the clause and the timescales required for service of notice: the outbreak of Covid-19 itself, or subsequent government restrictions put in place.
Do not attempt to rely on increased costs to excuse non performance or delay, as this will not usually be sufficient.
Keep a documentary record, particularly of: why performance was impossible, hindered or delayed as the case may be; the steps taken to find alternatives and mitigate loss; and the service of any notices.
If there is no force majeure clause, consider frustration, but be aware of the high bar for establishing that a contract has been frustrated.
Consider other routes and remedies, either under the contract or through agreeing binding variations to contracts with other parties.
A party seeking to rely on a force majeure clause must also show that:
the force majeure event was the cause of the inability to perform or delayed performance;
their non-performance was due to circumstances beyond their control; and
there were no reasonable steps that they could have taken to avoid or mitigate the event or its consequences.
As a result, where a party anticipates falling into difficulty with meeting its obligations, for example due to staff shortages through self-isolation in accordance with government guidelines or issues with the supply of materials, it is crucial to explore whether alternatives, such as alternative sources of labour or materials, are reasonably available – including at higher cost, unless this involves breaching existing contracts.
With widespread disruption in business, manufacturing and transport, due to COVID-19 the stage seems set for India to see a flood of ‘force majeure’ invocations. It is expected that over a period of time more and more Indian companies may invoke ‘force majeure’ clauses in their contracts resulting perhaps in a spew of litigations should parties not come to a workable understanding. Of course, in such events, the courts and arbitrators will have to evaluate and decide each dispute on individual merits, which would be based on the terms of the contract, the intent of the parties, steps taken to mitigate.
How the courts will interpret COVID-19 in relation to force majeure provisions will be interesting to watch out in the course of this year once the impact of COVID-19 settles. Invocation of force majeure provisions in light of COVID-19 will have to be assessed on a case-to-case basis depending on the terms of the contract entered into between the parties. The courts will then have to ascertain whether the contract has become impossible to perform and whether the doctrine of frustration of contract could be made applicable to such a contract.