THE FORCE MAJEURE CLAUSE AND ITS IMPACT ON CONTRACTS – Adv.Suyog Chandulal Shah 25/04/2020

The Force Majeure clause and its impact on contracts – Adv. Suyog Shah  

 

COVID-19: The Force Majeure clause and its impact on contracts

The global COVID-19 outbreak has disrupted all industries and has put a significant population of the world under lockdown. This prevents the efficient working of businesses and has impacted existing operations and contracts. On the issue of contracts, this outbreak has brought many new aspects to the fore, one of which includes the Force Majeure clause that impacts formal contracts. Given the disruption of supply chains caused by the COVID-19 pandemic, many contracts will be delayed, interrupted, or even cancelled.

 

What is Force Majeure?

As per the Manual for Procurement of Goods 2017, a Force Majeure means extraordinary events or circumstances beyond human control such as an event described as an act of God (like a natural calamity) or events such as a war, strikes, riots, crimes (but not including negligence or wrong-doing, predictable/seasonal rain and any other events specifically excluded in the clause). 

A Force Majeure clause in the contract frees both parties from contractual liability or obligation when prevented by such events from fulfilling their obligations under the contract. This clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the Force Majeure. The firm has to give notice of Force Majeure as soon as it occurs and it cannot be claimed ex-post facto. 

There may be a Force Majeure situation affecting the purchasing organization only. In such a situation, the purchasing organization is to communicate with the supplier along similar lines as above for further necessary action. If the performance in whole or in part or any obligation under this contract is prevented or delayed by any reason of Force Majeure for a period exceeding 90 (ninety) days, either party may, at its option, terminate the contract without any financial repercussion on either sides.

Notwithstanding the punitive provisions contained in the contract for delay or breach of contract, the supplier would not be liable for imposition of any such sanction so long as the delay and/ or failure of the supplier in fulfilling its obligations under the contract is the result of an event covered in the Force Majeure clause.

Is COVID-19 considered under the Force Majeure clause in India?

The Ministry of Finance notification dated 19th Feb 2020, addresses this doubt and clarifies that the disruption of supply chains due to the spread of corona virus should be considered as a case of natural calamity and Force Majeure clause may be invoked, wherever considered appropriate, following due procedures.

Invocation of Force Majeure clause in Indian contracts

Many contracts may not contain the Force Majeure clause explicitly to define clear execution/procedures to be conducted to claim benefits under the clause due to the COVID-19 outbreak. Whether a party can be excused from a contract on account of COVID-19 being declared a pandemic is a fact-specific determination that will depend on the nature of the party’s obligations and the specific terms of the contract.  If the contract does not include a Force Majeure clause, the affected party could claim relief under the ‘Doctrine of Frustration’ under Section 56 of the Indian Contract Act, 1872.

What is force majeure? The legal term everyone should know during Covid-19 crisis

What is known to exist but is not visible is surrounded by mystery. It excites the imagination and people spin yarns about it. Though that is not true when it comes to novel coronavirus ("COVID-19"), the outbreak of which has been globally reported. COVID-19 has caused worldwide unprecedented disruptions to business operations; and the commercial turmoil continues. The pandemic has impacted the ability of companies around the globe to maintain steady operations and perform their respective contractual obligations.

Perhaps the companies in order to mitigate the impact related to delayed operation and non-performance of the contracts inter alia will take recourse to force majeure clause contained in their contracts. An extraordinary event or circumstance beyond human control such as event described as an act of God (like natural calamity), government restrictions or other extraordinary circumstances which prevent fulfillment of contractual obligations would qualify as a force majeure event. This article, from the perspective of Indian Law, discusses the extent of immunity offered by a force majeure clause and whether the said immunity can still be claimed when there is no force majeure clause in the contact.

If Force Majeure clause is enshrined in the contract –

A classic force majeure clause would require that the disruption of performance be beyond the invoking party's reasonable control and that the event was not reasonably foreseeable. Whether the COVID-19 would qualify a force majeure event will depend on each particular contract i.e. the way force majeure clause has been worded in the contract or what all contingencies have been captured (explicitly or impliedly) in force majeure clause occurrence of which would qualify as a force majeure event. The burden of proof rests on the party invoking the force majeure clause. The said burden can be effortlessly discharged where force majeure clause in the contract explicitly provides for events like epidemics, pandemics or government restriction. However, the situation may become convoluted where a force majeure clause is not explicitly worded and simply uses the term "act of God" or "event beyond the reasonable control of parties". Apart from this, a party's entitlement to the benefit of force majeure clause would depend on the following factors:

Majority of contracts would require the party invoking a force majeure clause to adequately appraise the counterparty, within a stipulated time, regarding the event which prompted invocation of force majeure clause. Further, the invoking party would be expected to outline an estimation of the impact and duration of effects resulting from the said event.

There is a possibility that parties have an obligation to mitigate damages. In that case, what deserves consideration is whether there are other means through which a party can perform the contract or whether the party not affected by the force majeure event is obligated to mitigate the damages in some way. Depending upon the terms of a contract, the parties are expected to take reasonable steps.

Varied consequences of force majeure event should also be considered. For instance, performance of the contract may be suspended during the operation of force majeure event and performance may be suitably extended, the parties may have option of renegotiating and modifying the contract's terms or termination of contract would happen if the force majeure event continues for specific period of time.

Nature of evidence on which the claim of force majeure would be based is of utmost importance. It is vital that the party invoking the force majeure clause must keep all documents related to the force majeure event, which might be required in case a dispute arises in future. In the present scenario, the said documents may include (i) national and state government notice and guideline imposing restriction of trade, (ii) news articles related to COVID-19 outbreak, quarantines, restricted travel and mandatory shutdown of airports, trains stations and seaports, (iii) cargo booking and freight agency agreement, (iv) cancelled flight or train ticket or anything other documents relating to travel itinerary, and (iv) cancelled visa or rejected visa application.

If contract does not have a Force Majeure clause –

This situation may appear, but the same has been well guarded by doctrine of frustration prescribed under Section 56 of the Indian Contract Act, 1872 ("Act") and views adopted by the Hon'ble Supreme Court of India since 1954. In a landmark judgment titled Energy watchdog Vs. Central Electricity Regulatory Commission reported at 2017 (4) SCALE 580, Justice R.F. Nariman of the Supreme Court opined that the event leading to frustration which is relatable to an express or implied clause in a contract, is governed by Section 32 of the Act and if it occurs the contract, it is dealt with by a rule of positive law under Section 56 of the Act. Under the prevailing circumstances, reliance on Section 54 of the Act depends upon the following conditions: a valid and subsisting contract between the parties; there must be some part of the contract yet to be performed; and the contract after it is entered into becomes impossible of performance i.e. subsequent impossibility.

It is imperative to mention that the Indian Courts are according relief on account of subsequent impossibility when it is found that the whole purpose or the basis of the contract has been frustrated by the intrusion or occurrence of an unexpected event or change in circumstances, which was not contemplated by the parties during execution of the contract 1 or the performance of the contract becomes impracticable or useless having regard to the object and purpose the parties had in view 2.

Apart from the above, the initiatives taken by the Government of India deserve a special mention. Government of India is taking necessary measures in order to prevent further disruption in international trade and commerce by declaring outbreak of COVID-19 as a force majeure event. For instance, Ministry of Finance issued an office memorandum dated February 19, 2020 ("Memorandum") which states that Force Majeure clause can be invoked in Government contracts if there is a "disruption in supply chain due to spread of corona virus in China or any other country". The Memorandum further states that COVID-19 should be considered as a case of "natural calamity". Further gaining strength from the Memorandum, the Ministry of New & Renewable Energy has issued an Office Memorandum dated March 20, 2020 which directs all Renewable Energy implementing agencies of the Ministry of New & Renewable Energy (MNRE) to treat delay on account of disruption of the supply chains due to spread of COVID-19 in China or any other country, as Force Majeure event.

Are we prepared for potential dispute in India? 

Although currently it would be impossible to ascertain the quantum and extent of damage caused due to the outbreak of COVID-19, it would be prudent for any commercial organization to be adequately prepared to protect their respective businesses from the prospective disputes. Broadly, the following steps are accepted from a cautious business house:

Promptly notify the counterparty regarding the occurrence of a force majeure event, in the manner provided under the contract.

Collate all documents related to the force majeure event, as the same would serve as vital evidence at the time of dispute resolution.

It is to be noted, in this context that the Govt. of India Office Memo No. F.18/4/2020 PPD dated 19-2-2020 issued by the Deputy Secretary to Govt. of India, Ministry of Finance states as follows: “A doubt has arisen if the disruption of the supply chains due to spread of corona virus in China or any other country will be covered in force majeure clause. In this regard it is clarified that it should be considered as a case of natural calamity and force majeure clause may be invoked whenever considered appropriate, following the due procedure.” Though this Office Memo gives government recognition to COVID-19 as giving rise to force majeure in respect of the contracts dependent on the supply chains, the courts may not apply the same principle for all commercial contracts. The courts in India would rather go by aforesaid principles and decide the cases on the basis of facts and clauses in each contract. The courts will delve into whether the COVID-19 situation has affected the fundamental basis of the contract. Recently, the Bombay High Court passed an ad-interim order on March 30, 2020 in the matter of Rural Fair Price Whoelsale Ltd. And Anr. v. IDBI Trusteeship Services Ltd., IA No. 1/2020 in Commercial Suit No. 307/2020. In the said case, the plaintiffs sought an injunction in respect of shares pledged by them against the defendants. The plaintiffs submitted that an outstanding loan payable to the defendants is near about Rupees 610 Crores. Further, 8% of the equity shares are pledged with the defendants.

As on the date of the Debenture Trust Deed, the market value per share was Rupees 350. It was submitted that because of the present situation of COVID-19, the market has collapsed and on 1/3/2020, market value per share was below Rupees 303. It was submitted that the defendants are fully secured and hence, they be restrained from taking any steps for selling these shares in the market at present as in that event, irreparable loss will be caused to the plaintiffs. The said submission was opposed by the defendants stating that they have to recover more than Rupees 610 Crores and hence, relief should not be granted. The Court, taking note of the effect of COVID-19 on the market has granted ad-interim protection and passed the restraining order against the defendants.

 

  HIGHLIGHTS

•    A force majeure clause in a contract would typically include a list such as acts of God, war, terrorism, acts of government, fire, plagues.

•     It also includes epidemics or a non- exhaustive list wherein the parties simply narrate what generally constitute force majeure events and thereafter add “and such other acts or events that are beyond the control of parties”.

•    It would also include conditions which would have been fulfilled for such force majeure clause to apply to the contract.

•     Clauses in a contract and the nature of the contract must be carefully ascertained.

•     If there is a force majeure clause in the contract, inclusions and exclusions there from must be ascertained.

•      If there is a mention of pandemics or epidemics in the force majeure clause (which is not commonly found), the present COVID-19 situation will definitely attract it. Section 32 of the Indian Contract Act relating to contingent contracts will support the same.

•     If there is a clause in the contract which does not directly mention pandemics or epidemics, general words like ‘extraordinary events’ or ‘circumstances beyond reasonable control of the parties’ may be interpreted as attracting force majeure in COVID-19 situation.

•     In the absence of any force majeure clause in the contract, Section 56 of the Indian Contract Act, making a provision of frustration of contract, will apply. This provision states that an agreement to do an act impossible in itself or which becomes impossible or unlawful later is void. However, where such a force majeure clause is present in the contract, Section 56 cannot be made applicable.

Conclusion – 

The present COVID-19 situation may give rise to a lot of litigation in the corporate world, invoking the principle of force majeure. It will be therefore in the interest of the parties to renegotiate the contracts which are genuinely affected by COVID-19. The parties can after negotiation either terminate the contracts if found impossible of performance, or compensate a party if performance is extremely difficult, or accept suspension of the contract for certain period, or relax certain clauses in the contract.

 

Ensure a detailed evaluation of the contract and other related aspects by a legal expert.

At Adv.Suyog Shah & Associates we have promptly and effectively transitioned to working remotely. We are aware of the challenges our clients face as the businesses are being impacted due to COVID-19 and are here to legally support during these unprecedented times. Please feel free to reach us for any questions or concerns you may have.We would like to assist you better for any kind of help and Legal Assistance Kindly contact:-

Adv.Suyog Chandulal Shah

Adv.Suyog Shah & Associates,
Email :- advsuyogshah@gmail.com
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