EFFECTS ON COMMERCIAL CONTRACTS DUE TO COVID -19

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EFFECTS ON COMMERCIAL CONTRACTS DUE TO COVID -19 (Force Majeure & Frustration of Contract)

As Legal practitioners we have drafted so many Commercial Contracts and have added the Force Majeure clause number of times, fortunately, without having much opportunity to face the real life action of this clause so far!

This is definitely the most overlooked clause by most of the contracting parties during negotiations.

However, COVID-19 situation has made all of us to rethink on the gravity of this NOT-SO- GLAMAROUS CLAUSE.

According to “The Guardian”, the first case of Covid-19 was traced back to 17th November, 2019 which was weeks before the announcement of this newly discovered virus in China. The Chinese government was broadly criticized for failing to break the news globally regarding the seriousness of this virus, and it was too late to stop the multiplying effect of the deadly contagious virus. On 11th March, 2020, WHO(World HealthOrganization) declared Covid-19 as a pandemic after carefully assessing the threat it contains globally. The Covid-19 is malevolence in the eyes of the global economy as it severely threatens the health and economic wellbeing of populations across the globe.

The world economy fuels on trade and commerce between countries.. The commercial contracts are drafted in a manner to suit the nature of business and efficient enforcement of such obligations in a time bound manner while also keeping in mind, the contingencies which  are beyond the control of the parties to the contract. Insertion of a Force Majeure clause gives a way out from such unpredictable occurrence of any such devastating events that frustrates the parties from performing the contract on time.

“Force Majeure” or “vis major” (Latin) means superior force. The term is similar to Act of God and widely applied to commercial contracts by way of insertion of a Force Majeure Clause. Force Majeure is an exception to what would otherwise result in a breach of contract. Such a clause, allows a party to a contract to take a defense for non-performance or delay in performing contractual obligation due to unanticipated circumstances which the parties have no control over, such as strike, crime, riots, war, pandemic or an event of Act of God (uncontrollable natural forces like earthquake, volcano eruption, flood, hurricane.

These clauses are often mis-used by parties to refrain from performing undesirable obligations for which the Court scrutinizes such cases to examine if such event prevented the party from performing its obligations and if any other preventive and cautious measures were adopted. Basically, the willingness and the efforts made by the party to deliver what is promised under the contract needs to be scrutinized to ascertain the applicability of the Force Majeure clause.

Covid-19 is a situation which has impacted the globe at a very fast pace due to its contagious nature and currently India also like many other countries is at its crucial juncture in the fight against Covid-19.

Due to disruption in the supply chain and many other restrictions on movement of the citizens,  caused by the “pandemic”, there have been rising concerns about performing contractual obligations existing between parties to a contract.

Most of the parties to contracts  are increasingly getting affected by this Act of God and “Force Majeure” and are contemplating to invoke the provisions for non-performance or  inability to perform contractual obligation due to the pandemic.

GLOBAL SCENARIO: –

China has also invoked “Force Majeure” to protect businesses by issuing force majeure certificates due to the epidemic.

UK is applying the Doctrine of Frustration. Where frustration is applied, the parties are excused from all further performance and are not liable for damages for non-performance. The contract is permanently set aside.

INDIAN SCENARIO: –

A. The Concept of Force Majeure

  1. Force Majeure concept is not specifically provided under the Indian Contract Act, 1872. It is a contractual term which is interpreted based on the manner it is drafted and embodied by the parties to the Contract.
  2. Force Majeure instances are governed by the Indian Contract Act, 1872 under Chapter III, Section 32 dealing with Contingent Contracts. The word “contingent” means occurring or existing only if (certain circumstances) are the case. Section 32 defines enforcement of contracts contingent on an event happening.
  3. Exhaustive or Inclusive contents of the Force Majeure clauses: –

The contents arranged in an Force Majeure clause are significant when it is required to be invoked. A Force Majeure clause generally covers situations like the invocation of a war, an epidemic, a terrorist strike, floods, fire, lightning strikes, earthquakes, governmental action & embargoes etc….. the list may be  very long sometimes; which impede the performance of contractual obligations.

However, in a situation where the Force Majeure clause is not very exhaustively drafted and crafted and in case the same needs to be invoked the aggrieved party would run the risk of burden of proof in case of a dispute on interpretation of the same, the recourse to an aggrieved party is litigation. However, COVID-19 is an unprecedent situation and one need not be worried about the burden of proof with respect to the incapability to perform due to various Lock Down notifications by the Government of India.

  • A party having a force majeure clause in a contract, needs to prove before the Court, the happening of such an unprecedented event. If such an event makes it impossible for the party to perform its obligation/ the parties’ inability to perform for a particular period due to the intervening circumstances, such contract becomes voidable.
  • Thus, the contract may be temporarily suspended or in case the intervening circumstances continue for more than reasonable period and causes hardship, the contract may be repudiated by the parties to contract.

But what happens when a Contract does not have a force majeure clause?

In such cases the party can invoke Section 56 of the Indian Contract Act, 1872 which enunciates the Doctrine of Frustration.

Section 56 is based on the maxim “les non cogit ad impossibilia” which means the law does not compel a man to do that which he cannot possibly perform.

The Doctrine of Frustration is greatly influenced by the English law and paves the way for parties to seek relief in cases of unprecedented supervening event which hinders performance of obligation under the contract without any fault of the parties.

Thus, the concept of The Doctrine of Frustration is specifically provided under the Indian Contract Act, 1872, and a simple reading of Section 56 gives us a clear understanding that any act which was obligated to be performed after the contract is made and such act has become unlawful and impossible to perform which the promisor could not prevent, then such unlawful and impossible act will become void.

The impossibility to act shall not be self-contributory in nature by the claiming party.It was in the case of Satyabrata Ghose vs MugneeramBangur& Co.(1953), a clear demarcation was drawn between the applicability of Section 32 and Section 56 of the Indian Contract Act, 1872.

The essentiality for the Doctrine of Frustration to work was on the basis of impossibility to perform such an obligation.

  • The Threshold of burden of proof is higher under this concept, since the act is to render the performance of obligation as impossible and thus making the contract void.
  • There is a situation due to which there is a disability to perform and notice needs to be served for the same and affirm that the Contract becomes void and does not remain enforceable further.
  • The aggrieved party must be able to evidence that there is no future left and all future obligations cannot be performed
  • The aggrieved party must be able to evidence that all the services used/ products purchased before the event- have been paid and all applicable compensations were paid up to date to protect the interest of both the parties and the only reasonable approach is to invoke Doctrine of Frustration

In the time of distress, the Covid-19 has given a broader perspective to look at commercial contracts and may impact the way a commercial contract will be drafted in future by including necessary clauses to protect the interest of the businesses and parties to the contract.

Recently, we have witnessed a contradicting perspective between the Bombay High Court and Delhi High Court.

CASE 1: The Bombay High Court dismissed the application filed by Steel importers namely Standard Retail Pvt. Ltd., Integral Industries Pvt. Ltd., Vinayaga Marine Petro Ltd. &Anr, Hariyana International Pvt. Ltd  and Prabhat Steel Traders Pvt. Ltd filed under Section 9 of the Arbitration and Conciliation Act, 1996 to get a restraint order against the encashment of letter of credit by Korean Based Steel Exporters due to Covid-19 pandemic.

The contract between the parties contained the “Force Majeure clause” and an “Arbitration Clause” for which the Petitioner moved to the Court to invoke the Force Majeure clause seeking to restrain the Korean Based Steel Exporters from encashing the Letter of Credit.

Justice A. A. Sayed observed that Letter of Credit is considered to be an independent transaction with the Bank and that the Bank has no role to play between the disputed arising between the Petitioners, who are the buyers and Respondents, who is the seller.

It was further held by the Court, “The contract terms are on Cost and Freight basis (CFR) and the Respondent No. 1/Steel Exporters has complied with its obligations and performed its part of the contracts and the goods have been already shipped from South Korea. The fact that the Petitioners would not be able to perform its obligations so far as its own purchasers are concerned and/or it would suffer damages, is not a factor which can be considered and held against the Respondent No. 1”.

And the Court dismissed the case showcasing a rigid approach towards parties for preventing unnecessary litigation and mis-using Force Majeure clause.

CASE 2: In the case of Halliburton Offshore Services vs Vedanta Ltd (April, 2020) that the Delhi High Court did not hesitate to impose an interim order restricting Vedanta Ltd from invoking eight bank guarantees by Halliburton Offshore Services for not meeting the contractual deadline to drill petroleum wells. The application was filed by Halliburton Offshore Services under Section 9 of the Arbitration and Conciliation Act, 1996.

The restraint order was passed by Justice C Hari Shankar who observed that, “The countrywide lockdown, which came into place on 24th March, 2020 was, in my opinion, prima facie in the nature of force majeure. Prima facie, in my view, special equities do exist, as would justify grant of the prayer, of the petitioner, to injunct the respondent from invoking the bank guarantees of the petitioner, forming subject matter of these proceedings, till the expiry of a period of one week from 3rd May, 2020, till which date the lockdown has been imposed”.

The Court granted interim protection to save the Petitioner from facing irreparable damage by restraining Vedanta from invoking the bank guarantees till the next hearing.

Commercial strategies for minimizing the risk during Lock Down and Covid-19 crisis: –

  1. Please notify the other party when a Force Majeure event/ Doctrine of Frustration situation has begun.
  2. Re-analyses of the business model- Revenue generation options/ cost parameters/ supply & and Demand of the products offered.
  3. Moving to regional models from global model and not to concentrate on a product or particular zone
  4. Relook at the product features and pricing to ensure that in post COVID-era, your position stands strong
  5. Renegotiate your contracts and seek guidance from your lawyers at right time!

By: Santali Konar

Disclaimer:

This article captures the personal views of the author and is limited only for Academic discussion purpose only. This is not intended to be considered as any endorsement of views / legal opinion by the Firm.

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