Introduction
With
an unprecedented turn of events in the wake of COVID -19, the enforceability of
contracts have become a major lookout. Giants such as Inox Leisure Ltd., PVR,
Cinepolis are invoking the Force Majeure [“FM
Clause”] in their contracts for subduing the rental obligations to their landlords.[1] COVID-19
has caused serious market disruptions and financial dislocations. The basic
assumption is that there is a fundamental change in market circumstances due to the uncertainty of an outbreak, and there is a persisting problem until the
extenuation of the disease. In this light, it is pertinent to administer,
whether a party can invoke the doctrine of frustration under Section 56 of
Indian Contract Act [“ICA”] or the FM clause; if yes, under what set of
circumstances shall this be invoked.
A
claim to avoid adherence to legal obligations in the contract can be
fundamentally challenged on various grounds. Parties may seek to invoke the FM
clause on the primary grounds of impossibility due to the unforeseeable
COVID-19 outbreaks. Yet another ground that can be invoked is the performance
of the contract to be commercially impractical or fundamentally expensive to further
avow the contract.
The doctrine of Frustration under the ICA
and Impossibility
Section
56 of the ICA, 1872 states an agreement to do an act which has become
impossible or unlawful to be void. Unlike the common law jurisprudence which confides
in different theories like just and reasonable principle,[2]
construction,[3] multi-factorial approach,[4] it
enunciates positive rules for the frustration of a contract.[5] This
doctrine is applicable when a supervening event happens which was unexpected,
beyond the control of the parties leading to an impossibility performance of
the contract.[6] In
the seminal case of Satyabrata Ghose v
MugneeramBangur and Co,[7] impossibility is the second paragraph of Section
56 as interpreted,
‘[T] he performance of an act may not be literally impossible, but it may be
impracticable and useless from the point of view of the object and purpose
which the parties had in view. Therefore, if an untoward event or change of
circumstances totally upsets the very foundation upon which the parties rested
their bargain, it can very well be said that the promisor finds it impossible
to do the act which he promised to do.’[8]
This understanding creates a contrast with the
wordings of Section 56 of the ICA. Section 56, paragraph 2 envisages the
discharge of contract by two reasons – first, impossibility, and second
illegality by reason of any event which the promise could not prevent. In the
latter condition, illegality arises due to faults that are within the control
of a party, whereas; the former condition does not prescribe such the same. This
leads to an immaculate understanding of the non-enforceability of a contract if
performance has been rendered impossible due to the party’s fault. However,
this isn’t in conformity with the subsisting position. Self-induced frustration
cannot be a ground to avoid contractual obligations.[9]
However, this interpretation can be simulated in illustration 5 of Section 56;
Illustration
5: A contract to act at a theatre for six months in consideration of a sum
paid in advance by B. On several occasions A is too ill to act. The contract to
act on those occasions becomes void.
This illustration elucidates an understanding that
due to self-incapacitation, the contract shall deem to be void. Hence, a sharp
divergence from the literal interpretation of Section 56 can be noted down.
Further, any change of circumstances cannot be
considered an ipso facto ground for
avoiding contractual obligations. The landmark case of Alopi Parshad & Sons Ltd, v Union of India[10] held that a contract is not frustrated
merely because circumstances have changed. The court’s power to dissolve a
contract under Section 56 is limited in its scope. The contract is not
frustrated until the fundamental basis of the contract is changed,[11]
and is radically different from the existing circumstances.[12]
FM Clause
and Impossibility
The
Courts have applied the doctrine of frustration restrictively, and thus, are
reluctant to discharge a party from adhering to the contract.[13]
In Paradine v Jane,[14]
the court held that usually contracts are not discharged by any frustrating
event, and if such a scenario would have existed, the parties must have included
such eventualities in their contract. Therefore, to averse the risk, which is unforeseen
and beyond the reasonable control of human, the parties devise mechanism like the FM
Clauses. It should properly be inserted in a contract. Omissions of inclusion
of such provisions will render the incurrence of liability.
The
FM clause seeks to anticipate unforeseeable eventualities and settles the
allocation of risks beforehand rather than in an imposed manner.[15] Even
after having a close affinity with the common doctrine, it is very narrowly
interpreted in its relieving effect.[16] It
doesn’t include the acts of negligence, omission, or default of the contracting
party.[17]
For
an event to qualify as an FM, the event preventing performance must be
unforeseeable and irresistible.[18]
If there is an alternative way to perform obligations, even after the dramatic
change in market circumstances, such would not qualify to invoke a Majeure
clause.[19]
In Palmco Shipping Co. v. Continental Ore
Corp., [20] unavailability of the Suez Canal route cannot tantamount to frustration if goods can be transferred via
the Cape of Good Hope. There should be a direct link between the supervening
event and the impossibility of performance.
In
India, an FM can be traced back to Section 32 which stipulates the impossibility of
rendering performance on the ground of
an uncertain and unforeseeable future event becomes impossible. Impossibility
can be interpreted as the deviation of the basic foundations on which the
contract was agreed upon.[21]
Commercial Impossibility is not within the purview of impossibility.[22]
Since,
COVID-19 is an unprecedented outbreak that has ravaged businesses, including
stock exchanges meeting circuit breaks, it is forcing Govt. to impose nationwide lockdown which soars contractual obligations across the world owing
to commercial hardships. Therefore, it is quintessential to culminate meaning
from the construction of the contract through language and wordings.[23]
Covid- 19
and FM : A tale of uncertainty
To
ascertain whether COVID 19 is an FM event or not, the actual result would
depend on the contractual context and intention of the parties.
In
2003 SARs in an epidemic-related case Li Ching Wing v Xuan Yi Xiong,[24] a
tenant claims that the tenancy agreement is frustrated owing to an isolation order issued by the Govt. for which a tenant could not be inhabited for 10 days. The
Court held the SARS epidemic to be an unforeseeable event, and, 10 days are
insignificant to claim frustration in a two-year lease agreement. Similarly, even
though, COVID-19 is an unforeseeable and a supervening event, it is assumed to
be temporary in nature, thus, it is highly unlikely that frustration can be claimed within the framework of Section 56 of the ICA. Rather, if a contract contains
an FM clause containing specific inclusions like a pandemic, and epidemic
expressly, or by necessary implication, the contractual obligations may be suspended for a while. For instance, if the theatres are facing closure owing to
lockdown orders, it would be safe to invoke the FM clause in their agreement with
the landlords to suspend their legal obligation to pay rent till the outbreak
continues.
However,
the drafting of these FM clauses assumes an understanding to incorporate this
specific exclusion within its scope. The burden of proving for establishing the FM
clause rests on the party who invokes it.[25]. Effectively, in severity and unusual nature of events, the burden would be
wrapped under the general context of the contract unless a specific clause is directed towards a different event. Therefore, the burden would be on the parties to establish that COVID 19 has led to the impracticality and impossibility to
perform such contractual obligations, and no alternative way is available to
them for obeying such obligations.
Grounds for
Invoking FM Clause
· Temporary
Unavailability –The subject
matter of the contract, either a person or an object that is fundamental to
render the performance of the contract is temporarily unavailable. Time is the
essence of such contracts. In Play Larga,[26] due to the outbreak
of war, the Cuban Govt. denounced any trade with the Chilean Government. However,
the buyer from Chile invoked FM clause containing expression ‘temporary interruption’ which extended
to 30 days. The court held that such ‘temporary interruption’ cannot be subsumed with this catastrophic event because an extension of time was incomprehensible. Similarly, in various commercial contracts like supply contracts,
services, and outsourcing agreements, the inevitable consequence is a failure to
discharge contractual obligations owing to non-availability of the subject matter of the contract[27]
even at exorbitant prices,[28]
where an agreement was to deliver the goods at a particular time. Mere temporary
interruption without a time constraint cannot be invoked.[29]
However, in agreements of Computer and IT, Cloud
Computing, automation services contract, it would be difficult to prove the
direct causation because COVID-19 is not preventing them from any other alternative medium to provide services. However, if the FM clause contains specific
exceptions like a power cut failure, back-up arrangements, [30] it
can be beyond the reasonable control of the supplier.
· Failure of
Specific Sources – If the
subject matter of the contract is obtained from a specific source that became
unavailable owing to no fault of either party, the FM clause can be invoked,
for example, the deteriorations of the corps.[31]
For instance, 70% of the coffee produced in India is exported, and Italy is one of
the major importers. In such circumstances, where coffee could not be produced
owing to lockdown measures, the exporters can claim that the subject matter of contract to not be available, and cannot be arranged through any other medium, even with extra-ordinary efforts in the wake of COVID-19 outbreak, since the production of the coffee is a fundamental essence of the contract, and thus FM is
validly invoked.
· Method of
Performance – Due to COVID-19, Gateway Terminal, India’s biggest
container terminal has invoked FM Clause,[32]
because due to lockdown, all terminals have not been operation. In such
circumstances, where the availability of terminals for offloading stock is fundamental to the contract, this does lead to the impossibility of the contract, where
the performance cannot be rendered through any other medium available.[33] With
regards to Commercial Contracts like in terms of distribution; in Peter Dixon & Sons Ltd. v. Henderson,
Craig & Co. Ltd.[34],
during WWI when British Ships were not available, foreign ships could have made
available at an increased freight, the party couldn’t invoke the FM clause. For
example, in supply and distribution agreements, any imports from China, an
epic-center of the pandemic, would not be avowed owing to a total prohibition
of transport mechanism by Indian Govt. Since, the impact could have been
foreseen by the suppliers in China, it is flexible for them to invoke FM by relying
on impossibility.
· Illegality – On account of any amendment or enactment of any
new legislation which may fluster the purpose of existing contracts owing to
illegality, the contract may be rescinded. Any agreement cannot be acted
against the law.[35] Govt. of India invoking
Section 51 to 54 of Disaster Management Act, 2005 and Section 3 of Epidemic
Disease Act, 1882 to override any laws in specific circumstances like rental
obligations towards landlords is justified. In such rent agreements, the
landlords cannot force tenants to obey the contractual obligations. Also, if the supply of medicine has requisitioned for public services in India, and any
amount of export from India is strictly prohibited, the contractual obligation
may be discharged.[36]
Pressure
Points and Drafting Solutions
The
FM clause is a scheme of civil law,[37]
and thus, its scope is dependent on the construction, language, and wordings of
the contract,[38] which gives rise to
disputes and claims with respect to a specific set of facts. The FM can be
covered in different shapes and can be flexible, as may be construed by the
parties in the contract. Therefore, it
is pertinent to include FM clauses in the widest sense as to incorporate
unforeseen risks like COVID-19, and to decide the fate of the enforceability of
the contract thereon. A commercial contract is to be interpreted in a manner
which gives business efficacy to such contracts,[39]
and thus it is necessary to include a tenet of different measures in FM
clauses. Following are some drafting solutions that may be feasible to be
incorporated within the contract to avoid the liability.
1.
Whereas Clause:
Under
English Law, it is assumed that when a party entering into the contract, they are deemed
to have consented to the risks associated with the contract, even though the
circumstances change. However, incorporation of ‘whereas clause’ in the contract highlights the intention of the
parties, and provides a good example of a muddled meaning.[40]
This clause serves as an interpretative guide to further clauses, and the
contract in a whole.[41]
During this pandemic, a clause may allow a party to avoid contractual
obligations if significant market circumstances change. This clause is not
substantive to bestow relief, and thus, must be followed by some clauses like
hardship clause, MAC clause to gain relief.
2.
Use of Express Conditions along with a Hardship Clause:
The
principle to apply express conditions in a contract is pertinent because of a
robust trend of adhering to strict compliances to express conditions.[42]
For instance, a party may incorporate a clause ‘right of parties when significant market conditions changes’ in
which circumstances like COVID 19 can be encapsulated, and the party may decide
relief on whatever basis like renegotiation, adjustment, or any hardship
clause.
3.
Material Adverse Change [“MAC”]
MAC
clause is generally used in the context of Mergers and Acquisitions but can be
used in the contract of sale of goods. MAC is a clause which highlights that if
there is a significant material change in business, the affected may terminate
the contract.[43] Alternatively, the clause
could provide for renegotiation, and after the failure of renegotiation, the adjustment clause by the court can be rendered. Since, largest stock exchanges
of the world hitting circuit breakers, a downturn in the whole sectors leading to
MAC in the businesses across the world in the wake of a pandemic - is the safest
to incorporate the MAC clause.
4.
Hell or High Water Clause:
In
this clause, the parties agree that regardless of a dramatic change of circumstances,
the obligations are paramount duties to perform the contract, and thus making
payment even on the occurrence of impossible events. It is mutually agreed that
no party can obtain relief due to a substantial change in the contract.
5.
Renegotiation and Adjustment Claims:
On the occurrence of the supervening event, it is likely that the party would like to
renegotiate amongst themselves. Therefore, re-negotiation and adjustment claims through a price adjustment variance, the appointment of a third person as an agent,
escalator, or de-escalator clause are suggested.
Conclusion:
Amidst
the outbreak of COVID-19, the invocation of FM, and the doctrine of frustration
are practical and probable in all aspects. The doctrine of Frustration has been
narrowly applied, and the courts have been reluctant to bestow relief thereon.
This simulates an understanding that parties may renege the contract on the
grounds of the FM clause incorporated within the agreement. It would holistically
depend upon the construction of the contract as to pandemic like COVID-19 can
be assimilated within the explicit or implied meaning of the contract.
Therefore, the drafting of such an extensive clause is a safe approach. In the
future, parties may incorporate a set of clauses relieving themselves from the
consequences of such outbreaks.
SHUBHAMGUPTA
[1]Forum Bhatt, Inox Joins PVR To Invoke FM, BloombergQuint (Apr. 08, 2020, 3:57 PM), https://www.bloombergquint.com/business/inox-joins-pvr-to-invoke-force-majeure
[2]M. P. Ram Mohan et. Al., The doctrine of frustration under section 56
of the Indian Contract Act, 4 Ind. L.
Rev. 85, 89-90 (2020).
[3] Davis Contractors Ltd v. Fareham
Urban District Council, [1956] 3 AC 696 (Eng.) (‘Davis’).
[5] Frederick
Pollock & Dinshaw Mulla, Indian Contract Act and Special Relief Acts
323 (11th ed. 1990 ).
[6] Kesari Chand v. Governor-General
in Council, (1949) ILR (Nag.) 718 (India).
[7] AIR 1954 SC 44 (India).
[8] Id.
[9]Balwinder Singh v. State of
Punjab, (2017) 185 PLR 356 [16] (India).
[10] (1960) 2 SCR 793 (India).
[11]Dharanjamal Gobindram v. Shamji
Kalidas, AIR 1961 SC 1285 (India).
[12]Davis, supra note 3.
[13]British Movietonenews Ltd. v.
London and District Cinemas [1952] AC 166 (Eng.); Tsakirog- lou & Co. Ltd.
v. Noblee Thorl G.M.B.H [1962] AC 93 (Eng.); J. Lauritzen A.S. v. Wijsmuller
B.V. (The Super Servant Two) [1990] 1 Lloyd’s Rep. 1 (Eng.).
[14][1647] EWHC KB J5 (Eng.); 82 ER
897 (Eng).
[15] FM
and Frustration 45 (Ewan McKendrink eds., 2nd ed. 1995) (‘Ewan’)
[16]Nicholas, FM and Frustration, 27 Am. J.
Comp. Law 231 (1979).
[18] Ewan,
supra note 15, at 06.
[19] Nathan M. Crystal &
Francesca Giannoni-Crystal, Contract
Enforceability During Economic Crisis: Legal Principles and Drafting Solutions,
10 Global Jurist [i] (2010). (‘Nathan’)
[20][1970] 2 Lloyd’s Rep. 21. (Q.B.) (Eng.).
[21] Krell v. Henry [1903] 2 KB 740
(Eng.)
[22] Karl Ettinger v.
Changandas, [1916] 40 (Bom.) 301
(India).
[23] Energy Watchdog v. CERC, (2017)
14 SCC 80 (India) ( ‘Energy’).
[24][2004] 1 HKLRD 754 (H.K.).
[25]Tamplin SS Co v.
Anglo Mexican [1916] 2 AC 397 (Eng.). (‘Tamplin’).
[26] [1983] 2 Lloyd’s Rep. 171
(Eng.).
[27][1989] 1 Lloyd’s Rep. 148.
(Eng.).
[28]Tennants (Lancashire), Ltd. v. C.
S. Wilson and Co. Ltd. [1917] AC 495 (Eng.)
[29] Tamplin, supra note 25.
[30]Peter Savile & Sanjay Pritam,
FM and Cloud Computing Projects (Nov. 06, 2012), https://www.internationallawoffice.com/Newsletters/Tech-Data-Telecoms-Media/United-Kingdom/RPC/Force-majeure-and-cloud-computing-contracts
[31]Couturier v. Hastie, [1856] 5 HL
(Cas.) 67 (China).
[32]Manoj P, Gateway Terminal,
India’s Single Biggest Container declares FM (Mar. 29, 2020), https://www.thehindubusinessline.com/economy/logistics/gateway-terminals-indias-single-biggest-container-terminal-declare-force-majeure/article31190856.ece#
[33] Energy, supra note 23.
[34] 1919(2) KB 778 (Eng.)
[35] Indian Contract Act, Act. No. 9
of 1872, Imperial Legislative Council (1872) (India).
[36]Tennants (Lancashire), Ltd. v. C.
S. Wilson and Co. Ltd. [1917] AC 495 (Eng.).
[37] Ewan,
supra note 15, at 08.
[38] Energy, supra note 23.
[39] Id.
[40]Block Gertrude, Consider the Whereas Clause, 68 Wis. Law. 36, 37 (1995).
[41]UNIDROIT Principles, Preamble,
http://www.unidroit.org/english/principles/contracts/main.htm.
[42]Nathan, supra note 19.
[43]Timothy R. Donovan & Jodi A.
Simala, Successful Partnering between
Inside and Outside Counsel §41.32 (2010).
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