Coronavirus, Force Majeure And Impact On Commercial Contracts
Given the supply chain disruption caused by the Covid-19 pandemic, it is likely that performances under many contracts will be delayed, interrupted, or even cancelled.
Counterparties (especially suppliers) to such contracts may seek to delay and/or avoid performance (or non-performance liability) of their contractual obligations and/or terminate contracts, either because Covid-19 has legitimately prevented them from performing their contractual obligations, or because they are seeking to use it as an excuse to extricate themselves from an unfavorable deal.
Further, companies may not be able to perform their obligations under their customer agreements because of their suppliers’ non-performance and may in turn seek to delay and/or avoid performance (or liability for non-performance) of their contractual obligations and/or terminate contracts. Parties may also cite Covid-19 as a basis for renegotiation of price or other key contractual provisions (e.g. volume of materials exported from or imported into affected areas due to shifts in supply and demand).
In this context, it is important to determine if Covid-19 will be considered as a ‘force majeure’ event.
1. What Is Force Majeure?
The law relating to Force Majeure (a French phrase that means a ‘superior force’) is embodied under Sections 32 and 56 of the Indian Contract Act, 1872. It is a contractual provision agreed upon between parties. The occurrence of a force majeure event protects a party from liability for its failure to perform a contractual obligation. Typically, force majeure events include an Act of God or natural disasters, war or war-like situations, labour unrest or strikes, epidemics, pandemics, etc. The intention of a force majeure clause is to save the performing party from consequences of something over which it has no control. Force Majeure is an exception to what would otherwise amount to a breach of contract.
Whether a contractual obligation can be avoided on the grounds of force majeure is a factual determination based on the specific terms of the contract. The courts would examine, whether in each case, impact of Covid-19 pandemic prevented the party from performing its contractual obligation. Indian courts have generally recognised this concept and have enforced it where appropriate.
The law in India has been laid down in the seminal decision of the Supreme Court in the case of Satyabrata Ghose vs Mugneeram Bangur & Co. (AIR 1954 SC 44). The entire jurisprudence on the subject has been well summarised by Justice R.F. Nariman of the Supreme Court in a recent decision in the case of Energy Watchdog vs CERC (2017) 14 SCC 80.
2. How Is A Force Majeure Clause Defined Under A Contract?
Force majeure related language used in most contracts vary widely and, therefore, it is important to review these clauses carefully. Some contracts list specific examples of force majeure events that automatically meet the standard upon the happening of such event, while others rely on generic language usually included in such force majeure clauses.
3. Can A Force Majeure Clause Be Implied Under The Contract?
A force majeure clause cannot be implied under Indian law. It must be expressly provided for under the contract and protection afforded will depend on the language of the clause. In the event of a dispute as to the scope of the clause, the courts are likely to apply the usual principles of contractual interpretation.
4. Can A Force Majeure Clause Be Successfully Invoked In Light Of Covid-19 Being Declared A Pandemic?
A Covid-19 pandemic could make it more difficult for parties to perform their contractual obligations.
There are two possible instances, which may suggest that a force majeure clause covers a pandemic:
(a) if the contractual definition of a force majeure event expressly includes a pandemic. Inclusion of pandemic to the list of force majeure events will provide clarity as to whether Covid-19 outbreak would trigger a force majeure clause in a contract; or
(b) if the force majeure clause covers extraordinary events or circumstances beyond the reasonable control of the parties. Such general, catch-all wording may be invoked if it is determined that the factual circumstances caused by the pandemic are beyond reasonable control of the affected party.
Having said that, 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.
5. Does The Party Invoking Force Majeure Have A Duty To Mitigate?
The party claiming force majeure is usually under a duty to show that it has taken all reasonable endeavors to avoid or mitigate the event and its effects. This is a subjective standard and will be interpreted on a case-to-case basis.
The force majeure event or circumstance must be causative to the contractual breach and a party claiming force majeure is typically required to establish that it was the force majeure event (and not some other factor) that caused the party to be unable to fulfil its contractual obligations.
6. Does The Force Majeure Event Have To Be Unforeseeable?
Most contracts provide that for an event to qualify as force majeure, it must be unforeseeable or not reasonably foreseeable at the time of execution of the contract.
7. Any Notification Requirements Prior To Invoking A Force Majeure Clause?
Force majeure clauses commonly contain a prompt and time bound notification requirement, which can operate as a contractual condition precedent to relief or not. Such provisions are generally enforceable, and so complying fully with all notice requirements will be important for parties seeking to invoke force majeure.
8. Who Has The Burden Of Proof To Establish A Force Majeure Event?
Courts place the burden on the party asserting force majeure defense to demonstrate the existence of force majeure. Such clauses are construed strictly by the courts.
9. Remedies Available As A Consequence Of A Force Majeure Event?
The language of the force majeure clause will determine the remedies available to the parties.
Some contracts may provide for immediate termination of the contract upon the happening of the force majeure event.
Others may provide that the contract will be put on hold until the force majeure event is resolved.
Some contracts may provide for limitations in time after which either party may terminate the agreement with written notice to the other (i.e. if non-performance caused by the event is prolonged or permanent).
Others may require the contract to remain in effect until the force majeure event is resolved. Some contracts will only allow for certain obligations to be suspended.
10. Implications Of Force Majeure Certificates Issued By Governmental Departments?
On Feb. 17, 2020, the China Council for the Promotion of International Trade, revealed that it had already issued over 1,600 ‘Force Majeure certificates’ to firms in 30 sectors, covering contracts worth over $15 billion.
In India, the Department of Expenditure, Procurement Policy Division, Ministry of Finance issued an Office Memorandum on Feb. 19, 2020, in relation to the Government’s ‘Manual for Procurement of Goods, 2017’, which serves as a guideline for procurement by the Government. The Office Memorandum effectively states that the Covid-19 outbreak could be covered by a force majeure clause on the basis that it is a ‘natural calamity’, caveating that ‘due procedure’ should be followed by any Government department seeking to invoke it.
However, while such a certificate may be used to argue that a contract cannot be performed, Covid-19 is unlikely to give rise to a valid force majeure defense under every contract and in every circumstance, as different contracts and governing laws stipulate different requirements for different situations. Companies are, therefore, well advised to proactively manage the related legal risk and carefully assess which party must ultimately bear the financial losses caused by Covid-19.
11. What If The Contract Does Not Have A Force Majeure Clause?
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. However, in order to claim that the contract is frustrated, it must be established that the performance of the contractual obligations has become impossible by reason of some event which the claiming party could not prevent and that the impossibility is not self-induced by the claiming party or due to his negligence.
12. Besides Force Majeure, What Are The Other Possible Consequences For Contracts?
Counterparties may also attempt to invoke other contractual clauses like price adjustment clauses, material adverse change clauses, limitation or exclusion clauses, to limit or exclude liability for non-performance. The ability to invoke such other grounds will depend on the wording of the relevant clause, and how the clause is construed by courts.
Further, companies should also consider the ramification of non-performance clauses under the contracts, such as liquidated damages clauses, under which the amount of compensation for non-performance has been predetermined and agreed by the parties.
13. Risk Management Measures To Be Considered In The Context Of Non-Performance/Breach Of Contract?
Companies may consider the following curative actions in connection with their commercial contracts:
- Key contracts should be analysed to assess the parties’ rights and obligations, including with respect to termination, force majeure, governing law and dispute resolution.
- Copies of critical correspondence and other communications should be maintained if disputes arise later. This can be particularly important in establishing that the company has done all that was reasonably possible to mitigate the losses.
- Detailed review of supply chains should be conducted to understand geographic scope of operations, dependencies and business risks and legal rights.
- Legal views should be obtained on whether the force majeure clause in key contracts is open-ended or exhaustive in relation to the list of force majeure events and whether the Covid-19 outbreak is covered or excluded.
This has been excerpted from a Covid-19 report authored by Cyril Amarchand Mangaldas partner Bharat Vasani and associates Molla Hasan, Samiksha Pednekar and Esha Himadri.
The views expressed here are those of the authors, and do not necessarily represent the views of BloombergQuint or its editorial team.