Contracts in times of COVID-19 – Force Majeure and Doctrine of Frustration

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The COVID-19 crisis has affected businesses across India in various ways like a drop in demand, labour shortage, supply chain disruption, etc. One of the impacts of the crisis is on the firms’ ability to fulfil obligations under various contracts in India. In this context, firms are looking at the ‘Force Majeure’ clause to provide respite in times of such unforeseen crises not only in the present but also in the future.

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What is ‘Force Majeure’?

  • Force Majeure is a term used to refer to an unanticipated and uncontrollable event or effect. The Force Majeure clause is a contractual provision dealing with such events.
  • Though it hasn’t been explicitly defined in Indian statutes, the Indian Contract Act of 1872 provides for it under its Section 32.
  • According to this Section, if a contract is contingent on the happening of an event and this event becomes impossible, then this contract becomes void. This means that if a Force Majeure occurs, the contract becomes void.
  • Upon the occurrence of such an event, the Force Majeure clause in the contract provides a temporary reprieve to its party from fulfilling the obligation.
  • In some cases, the clause may allow for the termination of the contract if the Force Majeure event continues for a prolonged period.

What events are generally considered as Force Majeure events?

  • In some contracts, the Force Majeure clause lists events specifically. These can be natural calamities like hurricanes, earthquakes, plagues, epidemic outbreaks, etc. These can also include accidental events like a fire or explosion. Events beyond the parties’ control such as terrorist attacks, government Acts, etc. are also included in such lists.
  • In other contracts, the clause has a non-exhaustive list which simply describes what constitutes Force Majeure events and adds ‘and such other acts or events that are beyond the control of parties’.
  • These clauses typically mention which events would qualify as force majeure events, the conditions for the application of the clause to the contract and the consequence of such an occurrence.
  • For this clause to be applicable, there are 2 criteria:
  1. The event’s occurrence must be beyond the control of the parties.
  2. The party under obligation must demonstrate that efforts have been made to mitigate the event’s impact.
  • If a contract doesn’t include a Force Majeure clause, the parties to the contract have to ascertain the applicability of Section 56 of the Indian Contracts Act based on several factors like nature of the contract, nature of the event, etc.

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Why is this concept needed?

  • Force Majeure clauses are incorporated in a variety of contracts like supply contracts, power purchase agreements, distribution agreements, manufacturing contracts, finance agreements of projects, agreements between home buyers and real estate developers, etc.
  • This is a necessary provision to relieve the contract’s parties from their obligation during impossible conditions.
  • It is also needed to safeguard the parties from liabilities in such conditions.

What is the doctrine of frustration?

  • A contract is said to be ‘frustrated’ if, after its execution, the performance of an act becomes impossible due to the occurrence of an event beyond the control of the parties.
  • In this case, the contract becomes void.
  • The doctrine of frustration is envisioned in Section 56 of the Indian Contract Act.
  • Section 56 of the Contract Act says that ‘an agreement to do an act impossible in itself is void’.
  • The Indian courts interpret the word “impossibility” under Section 56 in a practical form and not in its literal sense.
  • Additionally, Section 65 of the Act is also significant in the context of the frustration of the contract. According to this section, when an agreement becomes void, like in the case of contract getting frustrated, the person who received any advantage under such agreement is “bound” to restore it or make compensation for it, from whom he received it.
  • Thus, the frustration of a contract is restitution whereby parties should put in the same position they were if the contract had never been executed.

How is ‘frustration of contract’ different from Force Majeure?

Impossible events:

  • Under the doctrine of frustration, the impossibility of a party to perform its obligations under the contract is linked to an event/circumstance that:
  1. Occurred after the execution of a contract
  2. Was not anticipated at the time of execution of the contract
  • Under force majeure, parties generally identify a comprehensive list of events that would attract the applicability of the force majeure clause prior to the execution of the contract.

Making contract void:

  • To invoke and apply frustration of a contract, the entire subject matter or underlying reason for the contract should be destroyed.
  • The Doctrine of Frustration makes the contract void and consequently, all obligations under such contract will cease to exist.
  • The frustration of a contract is the end-result of events arising after the contract was executed.
  • Force majeure is a contractual provision that contemplates an event that may result in the postponement of performance of contractual obligations. Thus, the rights of the parties thereunder until such event continue. It generally does not absolutely excuse parties from performing the activities.

Claiming of frustration:

  • If a force majeure event is not specifically covered under a contract, the frustration of contract may be claimed by the affected party.
  • However, if a particular event is covered a force majeure event under a contract, frustration of such contract cannot be automatically claimed

Where are these concepts not applicable?

Force majeure:

  • Force Majeure can’t be used
  1. As an excuse to negligence or other malfeasance of a party
  2. If a contract has become financially or commercially difficult to perform
  • To seek force majeure clause, the party must demonstrate that the event of force majeure was beyond its control, that necessary steps were taken, both commercially and financially, to overcome and mitigate the event and its consequence, and that there is are no other alternative means for performing under the contract.
  • The reasonableness of mitigation would depend on a case-to-case basis and the subject matter of the contract.

The frustration of a contract:

  • It is not applicable during the following situations:
  1. Self-induced frustration
  2. If the parties explicitly agree in the contract that the contract would stand despite such intervening circumstance or event

How will these concepts impact businesses in light of COVID-19?

  • The on-going coronavirus pandemic has impacted cross-border trade, real estate market, the developers, the homebuyers and the commercial lease arrangements, EPC (engineering, procurement and construction), joint venture agreements and M&A deals in India.
  • It also affected the parties’ ability to meet their contractual obligation because of restriction in movement, ceasing of production, supply chain disruption, increased cost because of raw materials scarcity and shortage in labour and funds
  • India may see an increased number of force majeure invocations. This raises the possibility of a slew of litigations if parties do not come to a workable understanding.
  • Also, in cases where a contract does not have an explicit clause on force majeure, there may be instances where parties may try to use Section 56 of the Contract Act and seek frustration of a contract.
  • In such cases, the courts will have to ascertain whether the contract has become impossible to perform and whether the doctrine of frustration of contract is applicable for such contract.
  • This depends on the courts’ interpretation of COVID-19 in relation to force majeure provision.
  • In February, the Finance Ministry has clarified that the COVID-19 situation will come under the ambit of force majeure clause and should be considered as a case of natural calamity.
  • However, such clarification has been provided only with respect to the supply chain disruption and on case-on-case basis depending on the terms of the contract.

What is the way forward?

  • It should be noted that proving ‘frustration’ in the Indian Court of Law would be difficult as the courts are only willing to interpret the COVID-19 crisis as mere hardship and not an impossibility.
  • Invoking force majeure is also difficult, as most of these contracts do not include epidemic under their clauses.
  • Organisations must take the necessary steps to prepare for all possible outcomes.
  • They should also review all contractual obligations for deadlines, governing law, the possibility of extensions and commitments, which may not be fulfilled due to a direct or indirect impact of COVID-19.
  • All organisational contracts should be reviewed to assess the force majeure clauses and their applicability in the current crisis in order to prevent instances of false claim of force majeure.
  • Special emphasis should be given in the reviewing of financing and insurance agreements to cover any unexpected losses.
  • Valuation studies can be conducted to highlight the major contractual relations that pose a great risk of creating losses. These losses should be quantified for clearer assessment of the situation.
  • They need to consider whether they can successfully claim the impossibility of performing their contractual obligations and invoke force majeure clause in their contract by carefully planning and having foresight about the crisis.
  • If the contracts are impossible to perform or that a force majeure event has occurred, the parties must identify the origin of such non-performance.
  • These organisations must also promptly inform and start a dialogue with the other party as soon as practically possible.
  • For parties that are receiving notices of force majeure, they must assess whether such notices are consistent with the protections contemplated by the clause, if due procedures have been followed and whether supporting documents are available.
  • The current uncertain situation is making it difficult to speculate all areas of business that could be affected by this crisis. However, the past instances of pandemic show that if businesses undertake proper planning and assess situations at hand to prepare for the unknown, it is possible to maintain continuous business and economic viability.

Conclusion

The Indian law does not allow escape from any contractual obligation and the party would still face strict liability. This makes force majeure and doctrine of frustration play a significant role in cases of non-fulfilment of performance of a contract. These concepts must be used efficiently so that no business suffers because of an unforeseen crisis like that of coronavirus outbreak.

Practice question for mains:

Critically examine the significance of Force Majeure in light of COVID-19 crisis. (250 words)

 

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