“AN ANECDOTE OF TWO THINGS: FRUSTRATION & FORCE MAJEURE CLAUSES IN THE TIME OF THE COVID-19 PANDEMIC SITUATION.”

 

AUTHORED BY – DEBARJUN DEY

 

 

Introduction:

The spread of Coronavirus had an enigmatic repercussion on almost every sector. Every contractual obligation including sponsorship contracts is being affected by COVID-19. It has not only affected India’s economy, but also affected other countries’ economies too like the United Kingdom. One sector most affected by this pandemic is the sports industry. Many championships and games scheduled this year including the UEFA European Championship and the Tokyo Olympic Games have been postponed from 2020 to 2021. The Indian Premier League (IPL) too has been postponed. As we should know, every tournament and championship contains so many contracts and there is also an agreement between every sport tournament comptroller and television broadcasters. So, due to the prevalence of this pandemic, will there be any lawful action against party who is unable to perform contractual obligations by an aggrieved party? If the answer to this question is no then what is safeguarding them? The answer to this question will be no because of some exceptions given under English as well as Indian law, popularly known as the doctrine of frustration and the doctrine of force majeure.

 

If any person is unable to perform any contractual duty, they will not be liable for not fulfilling those duties if they have a valid defense under the concept of force majeure or the common law doctrine of frustration.Covid-19 or the Corona Virus was declared as a pandemic on March 11, 2020. This has led to lockdowns and financial slowdown across the country in all sectors. The impact on the businesses has been severe, and the force majeure clauses will play a crucial role if the businesses are not able to perform their contractual obligations amidst this crisis.

 

In the aftermath of the closedown, many suppliers would not be able to perform their contractual obligations and, to say the least, they would be delayed. The suppliers are seeking to delay and/ or avoid contractual obligations/ performance. They wish not to be held liable for their contractual non- performance. The companies might not be able to honor their customer agreements. The same is true for the consideration, which either of the party to a contract might not be able to fulfill under the terms of the contract. Under such scenarios, the force majeure clause would be a determining factor to understand the implications of these events.

 

"On Feb.17, 2020, the China Council for the Promotion of International Trade (CCPIT), revealed that it had already issued over 1,600 'Force Majeure certificates' to firms in 30 sectors, covering contracts worth over $15 billion."[1]

On February 19, 2020, the Department of Expenditure, Procurement Policy Division, Ministry of Finance issued an Office Memorandum with respect to the 'Manual for Procurement of Goods, 2017', which serves as the dictum for procurement by the Government of India.

 

This memorandum, in essence, states that the Covid- 19 could effectively be covered under force majeure clause because it is a 'natural calamity' and all the departments who should invoke it by following the 'due process.'

But this implication of Covid- 19 cannot be upheld for every contract, and the clause needs to be interpreted based on different circumstances.

 

English Law Perspective:

Force Majeure and the doctrine of frustration: "Frustration is an English contract law doctrine that acts as a device to set aside contracts where an unforeseen event either renders contractual obligations impossible, or radically changes the party's principal purpose for entering into the contract."[2]

Force Majeure (S.56 of the Indian Contract Act, 1872.): A force majeure clause relieves one or both parties from liability to perform contract obligations when performance is prevented by an event or circumstance beyond the parties' control. Typical force majeure events may include fire, flood, civil unrest, or terrorist attack. Force majeure is a term used to describe a "superior force" event. The purpose of a force majeure clause is two-fold: it allocates risk and puts the parties on notice of events that may suspend or excuse service.

The doctrine of frustration (S.56 of the Indian Contract Act, 1872.): The essential idea upon which the doctrine of frustration of contract is based is that of the impossibility of performance of the contract; in fact, 'impossibility' and 'frustration' are often used as interchangeable expressions. The changed circumstances, it is said, make the performance of the contract impossible, and the parties are absolved from the further performance of it as they did not promise to perform an impossibility.

 

The parties shall be excused if substantially the whole contract becomes impossible of performance or, in other words, impracticable by some cause for which neither was responsible. The spirit of force majeure and the doctrine of frustration have been embodied in sections 32 and 56 of the Indian Contract Act.

 

While the doctrine of frustration is a common law principle, the force majeure clause is a creature of contract. It is a civil law concept that has no settled meaning in the common law. It must be expressly referred to and defined in a contract.

 

The entire jurisprudence on the subject has been stated by Justice RF Nariman of the Supreme Court in the case of Energy Watchdog vs. CERC (2017).[3]

 

INDIAN LAW PERSPECTIVE-Force Majeure or Act of God

Force majeure literally translates from the French as “superior force”. Immediately apparent is its continental roots within the civil law systems of the world – the foundational basis of the principle is one crystallised in the Napoleonic Code in the 1800s, although its origins can be traced to Roman Law[4]

 

"Force majeure" is governed by the Indian Contract Act, 1872. In so far as it is relatable to an express or implied clause in a contract, it is governed by Chapter III dealing with the contingent contracts, and more particularly, Section 32 thereof. In so far as a force majeure event occurs de hors the contract, it is dealt with by a rule of positive law under Section 56 of the Contract. Sections 32 and 56 are set out herein:

"Section 32: Enforcement of Contracts contingent on an event happening - Contingent contracts to do or not to do anything if an uncertain future event happens, cannot be enforced by law unless and until that event has happened. If the event becomes impossible, such contracts become void."

Illustration: 1) A, a person, contracts with another person, B, that A will pay B if B marries C. If C then dies without marrying B. Now this contract becomes void.

 

Illustration: 2) A, a person, makes a contract with another person, B, for buying B’s horse if A survives C. This contract of obligation cannot be enforced unless and until C dies in A’s lifetime.

 

"Section 56: Agreement to do impossible act - An agreement to do an act impossible in itself is void.

 

Contract to do act afterwards becoming impossible or unlawful. A contract to do an act which, after the contract made, becomes impossible or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.

 

Compensation for loss through non-performance of act known to be impossible or unlawful. Where one person has promised to do something which he knew or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promise for any loss which such promisee sustains through the non-performance of the promise."[5]

Prior to the decision in Taylor vs. Caldwell, (1861-73) All ER Rep 24, the law in England was extremely rigid. A contract had to be performed, notwithstanding the fact that it had become impossible of performance, owing to some unforeseen event, after it was made, which was not the fault of either of the parties to the contract. This rigidity of the common law in which the absolute sanctity of contract was upheld was loosened somewhat by the decision in Taylor vs. Caldwell in which it was held that if some unforeseen event occurs during the performance of a contract which makes it impossible of performance, in the sense that the fundamental basis of the contract goes, it need not be further performed, as insisting upon such performance would be unjust.

 

'Impossibility' under S.56 doesn't mean literal impossibility to perform (owing to strikes, commercial hardships, etc.) but refers to those cases where a supervening event beyond the contemplation and control of the parties (like the change of circumstances) destroys the very foundation upon which the contract rests, thereby rendering the contract 'impracticable' to perform, and substantially 'useless' in view of the object and purpose which the parties intended to achieve through the contract. In Satyabrata Ghose v. Mugneeram Bangur[6], war condition was known to the parties while entering into the contract such that they were aware of the possible difficulty in the performance of the contract, in such circumstances, the requisition of property did not affect the root of the contract. Secondly, no stipulation as to time was provided in the agreement such that the work was to be completed within a reasonable time. Still, having regard to the nature of the development contract and the knowledge of the war conditions prevailing during the contract, such a reasonable time was to be relaxed. Therefore, the contract had not become impossible of performance under S.56.

 

Illustration: 1) A, a person, contracted to sell the horse to B on 1st January 2020. But the horse died on 31st Dec. Therefore, the previously made contract between A and B becomes void because the object of the contract is not in existence.

 

Illustration 2 is more relevant to the present context:

Illustration: 2) A, a resident of India, entered into a contract with B, a resident of another country i.e. China. Some portion of the contract was performed but a major portion was still to be performed and the Government of India declares war on China and suspends all transaction with China. After this the contractual obligation becomes void and party who is unable to perform his obligation can claim the defense of impossibility of contract.

 

There are some specific situations in which the doctrine of frustration applies:

• Change of circumstances: A contract will frustrate where circumstances arise which make the performance or fulfillment of contact impossible in the manner and the time contemplated.
• Death or incapacity of Party: A party to a contract is excused from performance of the contract if it depends upon the existence of the given person and that person dies or becomes too ill to perform.
• Government, Administrative or Legislative Intervention: A contract will perish when legislative or administrative intervention has so directly operated upon the specific performance of the contract as to change the contemplated conditions of fulfillment.

 

The ongoing Covid-19 pandemic meets the first situation, making doctrine of frustration a defense against the obligations to fulfill a contract. Hence, the World Health Organization declared Coronavirus an Act of God and parties to a contract can use Coronavirus as a defense or protection from legal consequences.

 

"A contract is not frustrated merely because the circumstances in which it was made are altered. The Courts have no general power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events."[7]

It has also been held that applying the doctrine of frustration must always be within narrow limits. In an instructive English judgment namely, Tsakiroglou & Co. Ltd. v. Noblee Thorl GmbH[8], despite the closure of the Suez canal, and despite the fact that the customary route for shipping the goods was only through the Suez canal, it was held that the contract of sale of groundnuts, in that case, was not frustrated, even though it would have to be performed by an alternative mode of performance which was much more expensive, namely, that the ship would now have to go around the Cape of Good Hope, which is three times the distance from Hamburg to Port Sudan. The freight for such a journey was also double. Despite this, the House of Lords held that even though the contract had become more onerous to perform, it was not fundamentally altered. Where performance is otherwise possible, it is clear that a mere rise in freight price would not allow one of the parties to say that the contract was discharged by the impossibility of performance.

 

This view of the law has been echoed in 'Chitty on Contracts', 31st edition. In paragraph 14-151, a rise in cost or expense has been stated not to frustrate a contract. Similarly, in 'Treitel on Frustration and Force Majeure,' 3rd edition, the learned author has opined, at paragraph 12-034, that the cases provide many illustrations of the principle that a force majeure clause will not normally be construed to apply where the contract provides for an alternative mode of performance. It is clear that a more onerous method of performance is not sufficient to invoke the doctrine of frustration.

"The application of the doctrine of frustration requires a multi-factorial approach. Among the factors which have to be considered are the terms of the contract itself, its matrix or context, the parties' knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed mutually and objectively, and then the nature of the supervening event, and the parties' reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances. Since the subject matter of the doctrine of frustration is contract, and contracts are about the allocation of risk, and since the allocation and assumption of risk is not simply a matter of express or implied provision but may also depend on less easily defined matters such as "the contemplation of the parties", the application of the doctrine can often be a difficult one. In such circumstances, the test of "radically different" is important: it tells us that the doctrine is not to be lightly invoked; that mere incidence of expense or delay or onerousness is not sufficient; and that there has to be as it were a break in identity between the contract as provided for and contemplated and its performance in the new circumstances."performance by itself would not amount to an frustrating event. The same learned author also states that a mere rise in price rendering the contract more expensive to perform does not constitute frustration."[9]

The most generic clause under most force majeure clauses is the 'Act of God', and the Covid- 19 can be brought under the ambit of the same. But the effect of this clause can be mitigated through the 'duty to mitigate' and 'exercise due diligence clause.' The subjective standards on the case to case basis have to be applied in order to determine their effect on the overall contract. The 'best endeavor' clauses might also play a crucial role in order to define the ambit and implications of the force majeure clause, as the presence of the same might end up mitigating the effects of force majeure clauses. The foreseeability of the event has to be gauged too, especially for the contracts entered after the month of December 2019 as for the force majeure clauses to become effective, the event must not be foreseeable in essence, and the Covid-19 outbreak had effectively begun from December 2019 onwards.

 

The wordings of the clause(s) also becomes very important. Some contracts provide that it can be put on hold until the force majeure event is resolved. Some contracts provide for limitations in time, after which either party may cancel the agreement with written notice to the other. Others require the contract to remain in effect until the force majeure event is resolved. The burden of proof lies with the party who wants to invoke the force majeure clauses, and the Courts have traditionally interpreted these clauses in a very strict manner. And if the party wishes to invoke the force majeure clause, the dispute resolution clause of the contract shall be checked and the appropriate adjudicatory mechanism shall be adopted by the procedure mentioned under the terms of the clause, or the law of the land, whichever is applicable.

 

In the absence of a force majeure clause, any party could also invoke the doctrine of frustration under Section 56 of the Indian Contract Act, 1872. In order to invoke the same, parties must show that the performance of a contract has become impossible, and the arrangements and conditions have become fundamentally different from those envisaged in the contract. The parties also have the option to invoke several clauses such as price adjustment clauses, limitation or exclusion clauses, material adverse change clauses, and many others such clauses in order to limit the liabilities arising from non-performance or the partial performance of the contractual obligations. The ability to invoke such grounds would depend on the wording of the Contracts, the application of case-laws on these clauses, and how these clauses would be interpreted by the tribunals, courts, and other adjudicatory bodies.

 

Does Spread of COVID-19 in the Aggregate Qualify as an Act of God?

For any act to be considered an Act of God, it must be unusual, extraordinary, grave and sudden such that it is very hard to foresee such a turn of events. Conclusively, COVID-19 cannot be considered an Act of God by the court. This is a decision the court will soon have to face.

 

Conclusion

COVID-19 is a game changer in many respects – whether it will upend the prevailing principles of force majeure and frustration of contracts due to “impossibility” remains to be seen. The existing legal provisions and the Indian legal jurisprudence surrounding the same appear robust enough to address the large and wide-ranging legal consequences of the viral pandemic. Whether in particular cases, such consequences will actually lead to parties being able to successfully avoid their obligations, still continues to depend on the time-tested benchmarks of each case – namely, whether the changed circumstances destroyed altogether the basis of the contract and its underlying object, and whether the contractual bargain was indeed at an end as a result of the significantly altered conditions.

That is until the fullness of the COVID-19 disaster unfolds.

 

Lastly, I would like to end with a legal maxim which is based on the doctrine of frustration: “les non cogit ad impossibilia” which means “a man cannot be compelled by law to do what he cannot possibly perform.”

 

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[1] https://www.bloombergquint.com/opinion/coronavirus-key-legal-issues-for-india-inc-with-covid-19LAST VISITED ON 10TH JULY 2020 AT 2.30 PM

[2]  Taylor v Caldwell (1863) 3 B & S 826;

[3] Supreme Court of India: Civil Appeal Nos.5399-5400 of 2016

[4] See Laurence Lieberman & Abhimanyu Bhandari, “The forgotten Force Majeure clause and its relevance today under Indian and English Law”, Bar & Bench, dated 27-3-2020.

[5] The Indian Contract Act, 1872

[6]  Satyabrata Ghose v. Mugneeram Bangur 1954 AIR 44

[7]  Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968 (1) SCR 821

[8] 1961 (2) All ER 179

[9] Supra, note 3