Coronavirus crisis: Force Majeure or frustration of contracts? what it means for courts and businesses

Coronavirus crisis: Force Majeure or frustration of contracts? what it means for courts and businesses

Coronavirus impact: The shroud of non-performance of a contract or the facade of impossibility, a journey the courts must embark on to delve into surmise

It is inevitable that due to coronavirus induced lockdown, stakeholders in businesses would seek exoneration of contractual obligations they would have otherwise performed It is inevitable that due to coronavirus induced lockdown, stakeholders in businesses would seek exoneration of contractual obligations they would have otherwise performed

Non-performance of an obligation due to an unforeseen event did not fully develop until trade began to flourish in the medieval Mediterranean world as a legally acceptable excuse. The chasm or disjunction posed by the conflict between the sanctity of the contract or discharging of obligations by events beyond the control of parties to the contract has, over time, received varying treatment by judicial systems. While civil law and common law both acknowledged the doctrines of pacta sunt servanda1and rebus sic stantibus, there is substantial emphasis on certain aspects of each doctrine, and they did so at various historical periods.

Holt J.C. put it in the following terms in 1706, "when a man will for valuable consideration undertake to do an impossible thing, although it cannot be performed, yet he shall answer in damages". In later common law jurisprudence, common law came closer to acknowledging the non-performance due to unforeseen circumstances. 'The court does not compel a person to do what is impossible". The truest enshrinement of the non-performance due to supervening events was with Lord Blackburn's recital of the judgment in Taylor V/s Caldwel. The Queen's Bench led by Lord Blackburn authorship:

"There seems no doubt that where there is a positive contract to do a thing, not in itself unlawful, the contractor must perform it or pay damages for not doing it, although in consequence of unforeseen accidents, the performance of his contract has become unexpectedly burthensome or even impossible".

However, Lord Blackburn dismissed Taylor's claim for damages for the music hall's destruction. Yet it is significant that Blackburn J. noted that the destruction of the music hall was the fault of neither party, and that this fact rendered the performance of the contract by either party impossible.

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Such a ruling went beyond what was necessary to decide the case. The most relevant observation of this principle and also as the leading authority on force majeure in English law is the judgment of McCardie J. in Lebeaupin v Crispin which postulates that the precise ambit of the term will depend on the context in which it is used:

'A force majeure clause should be construed in each case with close attention to the words which precede or follow it, and with due regard to the nature and general terms of the contract. The e?ect of the clause may vary with each instrument.

A force majeure clause may provide relief from liability when a party is prevented from carrying out its obligations or is unable to do so. However, a party seeking to rely on a clause which states that it is relieved of its obligations if it is prevented from carrying them out, must show that performance has become physically or legally impossible, and not merely more difficult or unprofitable. He must prove the occurrence of the event he is relying on and that he has been prevented, hindered or delayed (as the case may be) from performing the contract by reason of the very occurrence of that event.

In the common law, Law of Contract can be elaborated as that a party to a contract is bound and must perform the covenants which he has undertaken and cannot seek to be excused by a mere fact that performance has subsequently become impossible.

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However, history tells us there are exceptions and English Courts have come about to circumvent the strictness of the aforesaid rule for example Lord Loreburn proposed the Theory of Implied Term by stating that:

"It is, in my opinion, the true principle, for no court has an absolving power, but it can infer from the nature of the contract and the surrounding circumstances that a condition which was not expressed was a foundation on which the parties contracted. Were the altered conditions such that, had they thought of them, they would have taken their chance of them, or such that as sensible men they would have said, "If that happens, of course, it is all over between us."

On the other hand, Lord Justice Denning put forth the Theory of Power of Court,

"Even if the contract is absolute in its terms, nevertheless, if it is not absolute in intent, it will not be held absolute in effect. The day is done when we can excuse an unforeseen injustice by saying to the sufferer, 'It is your own folly. You ought not to have passed that form of words. You ought to have put in a clause to protect yourself.' We no longer credit a party with the foresight of a prophet or his lawyers with the draftsmanship of Chalmers."

This theory concludes that the court has inherent jurisdiction to go behind the express words of the contract and attribute to the court the absolving power. However, the House of Lords in appeal discarded this theory entirely.

In an instructive English judgment which disposed a claim of force majeure discharge on the pretext that the contract of shipment of groundnut had become non-performable because of the closure of 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 which was much more expensive, namely, rounding the Cape of Good Hope. Despite this, the House of Lords held that even though the contract had become more onerous to perform, it was not fundamentally altered.

In the Indian jurisprudence, one of the primeval decisions to deal with the concept of force majeure is the Madras High Court decision in Edmund Bendit And Anr. vs Edgar Raphael Prudhomme, where the court cited the passage from Matsoukis v. Priestman and Co, wherein the definition given by an eminent Belgianlawyer of force Majeure meaning "causes you cannot prevent and for which you are not responsible," was held to be true. Force majeure does not simply mean anything outside the control of the parties to a contract. Its meaning, and applicability, depends on the particular contract, and the particular wording used. It is a contractual language intended to anticipate unforeseen events and provide for what happens to their occurrence.

However, Force Majeure sees assimilation and codification in Indian Laws under Section 32 and 56 of the Indian Contract Act, 1872. The seminal judgment of Satyabrata Ghose v. Mugneeram Bangur & Co passed by the apex court basically surmising that the event or change of circumstance totally upsets the very foundation upon which the parties rested their bargain. It held that "the word "impossible" has not been used in the section in the sense of physical or literal impossibility.

The 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 of the parties. If an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement, it can be said that the promisor finds it impossible to do the act which he had promised to do." This stands as one of the most exhaustive understandings of Force Majeure in the context of Indian laws.

Further down the legal parlances' corridor  the  Supreme  Court  in  Alopi  Parshad  &  Sons  Ltd. v. Union of India, the Supreme Court, premising on section 56, held, it is only when a consideration of the terms of the contract, in light of the circumstances existing when it was made, showed that they never agreed to be bound in a fundamentally different situation which had unexpectedly emerged, that the contract ceases to bind. It was further held that the performance of a contract is never discharged merely because it may become onerous to one of the parties.

More recently, Justice Nariman in Energy Watchdog v. Central Electricity Regulatory Commission and Others, held that if a contract has an express or implied force majeure clause, it will apply over the principles under Section 56 and the force majeure clause will not apply if alternative modes of performance are available.

Force majeure clause does not exhaust the possibility of unforeseen events occurring outside natural and/or non-natural events. But the thrust of their argument was really that so long as their performance is hindered by an unforeseen event, the clause applies.

"Hindered" must be construed with regard to words which precede and follow it, and also with regard to the nature and general terms of the contract. Justice Nariman also placed reliance on the English judgment of Tenants (Lancashire) Ltd. v. G.S. Wilson and Co. Ltd., for the proposition that a mere rise in price rendering the contract more expensive to perform will not constitute "hindrance".

It is established that the expression "hinders the delivery" in a contract would only be attracted if there was not merely a question of rise in price, but a serious hindrance in the performance of contract as a whole.

Frustration will apply when an unforeseen event makes it impossible, through no fault of either party, to perform the contract but the contract has not catered for that. The unforeseen event is so fundamental that it strikes at the root of the contract and far beyond what was contemplated by the parties when they entered the contract.

It renders further performance impossible, illegal, or makes it radically different from that contemplated by the parties at the time of signing the contract.

The doctrine of frustration is only a special case of the discharge of contract by an impossibility of performance arising after the contract was made. In modern judicial parlance, the term 'frustration' covers cases of both classes.

The Supreme Court of India in Satyabrata Ghose case also observes that in fact impossibility and frustration are often used as interchangeable expressions. Generally, the doctrine of frustration is considered to apply to a situation that is pursuant to the parties entering into a contract.

Frustration at the performance of the contract also arises either through delay, attributable to the fault of neither party, or of such a nature that the fulfilment of the contract, in the way envisaged, is so baroquely delayed that the fulfilment, when and if, ultimately, achieved is rendered futile to the objective of contracting parties. The defense of frustration can, therefore, be defeated by the proof of fault.

Intriguingly, there also exists a condition called 'pre-contractual frustration' where the impossibility of performance or completion of obligation is already existing however unknown to the parties, at the time of the agreement itself the result would generally be that the agreement is void ab initio.

Let's take for instance the applicability of Section 20 of the Indian Contract Act, 1872, an agreement entered into by parties under a mistake of fact would be void and if the mistake of fact existed at the time of entering into the agreement it would constitute pre-contractual frustration. A classic illustration is encompassed in the privy council judgement in Sheikh Brothers, Ltd. v. Ochsner, where the appellants contracted with the respondent to grant him a license to cut, process, and manufacture sisal grown on a particular estate in Kenya of which appellants were the lessees. In return, the respondent deposited a certain sum of money and undertook to deliver to the appellants 50 tons of sisal fiber, manufactured by him, each month.

The true position was that the estate, itself, was, in fact, not capable of producing such a quantity of sisal at all in the first place. The privy council without hesitation held the agreement to be void on the ground that both parties were entertaining the same mistake of fact essential to the agreement. The impossibility of growing the sisal in that estate was that of a pre-contractual frustration and not that of a force majeure.

This brings us to the discussion that frustration of contract is an important defense; it not only discharges a part from complying with contractual obligations when they become impossible or impracticable but also absolve them from exposure of damages due to the frustrating nature owing to which the discharge was granted in the first place.

It is important to understand that frustration has to be proved by establishing the aspect that the fulfilment of the obligation is beyond possibility and, had it not been so, even fulfilment at any stage beyond the instant would make it redundant and futile. Frustration can be cited when unforeseen events occur or also when unforeseen obstacles stall performance like statutory provision or statutory prohibition enforced pursuant to entering into the contract.

With the World Health Organisation (WHO) notifying the world that the spread of coronavirus (COVID-19) as a notified pandemic, several countries began enacting spontaneous guidelines, notified certain statutory norms in force in pursuance to contain the spread of the contagion. This has put the commerce industry into a frenzy about what could be achieved and what would eventually hit a dead end.

The world economy, including the economies of several trading nations, was in a precarious situation. Consequently, due to the lockdowns and sealed borders in many countries, business houses spontaneously have started citing the force majeure clauses and cited frustration of contract trying to wriggle themselves out of performing their obligations in contracts.

The mistake that these business houses are making is that people are trying to use invocation of force majeure or frustration as a grouse/excuse to renege from their contractual obligations to cut their losses and limit their exposure either domestically or internationally to compose and brace themselves for a period of government-imposed embargo on anything apart from medical attention.

An example for discussion is the sudden institution of suits by Indian importers to stall/stay invocation of letters of credit or encashment of Bank Guarantees. The Supreme Court in two landmark judgments of Himadri Chemicals Industries Ltd. vs. Coal Tar Refining Company and Hindustan Construction vs State of Bihar established a position of law that staying the operation of Bank Guarantees or letters of credit, even on the count of attempting to invoke frustration, is impermissible because to grant such stays is contrary in law.

Such invocations can only be injuncted in cases of fraud established of egregious nature can else this will break the established practices of international trade where letters of credit and bank guarantees are considered backbones of transactions.

A bank guarantee is a separate contract, which is absolute in nature and is not concerned with the underlying agreement between the parties. The bank giving such a guarantee is bound to honour it as per its terms irrespective of any dispute raised by its customers. Hence, the Indian Courts will not ordinarily grant injunctions to restrain the realisation of a bank guarantee, however, exceptions have been carved out, firstly, an established fraud and secondly, where special circumstances or special equities exist which are likely to result in irretrievable harm or injustice to the party concerned.

As to what is tantamount to frustrations in a given scenario of contractual stipulations will differ from case to case, there cannot be a straitjacketed formula for the same.

Another aspect where I have noticed this argument of frustration is attempted to bring relevance, especially in land lord and tenant relations and disputes. The fundamental commercial bargain in this relation ought to be examined, which is that the landlord provides vacant possession of tenantable premises to a tenant on a monthly contractual rent.

Per contra the tenant's obligation is to pay the rent and use the premises in a proper manner. Examples of frustrating events in tenancy could include an unavailability of a thing (e.g. if the premises which were leased have been burnt), unavailability of a person (e.g., if the person who was supposed to provide services has become unwell or passed away), or supervening illegality (e.g. performing the contract have become illegal through legislation or government's intervention, either permanently or for a prolonged period).

It is beyond obvious that the circumstances of the pandemic do not change this fundamental commercial understanding in a tenancy contract unless the aforesaid is established.

The current position, however, is that tenants are experiencing heightened difficulty in payment of rent because their incomes may have dried up or are facing severe deductions in incomes so as not to make up the rental amount itself. This may, at best, entitle the tenants to a breather or moratorium which can be mutually worked out with the landlords.

The tenants certainly cannot claim frustration of contract because the consequence of such a defence is from discharge from the obligation of rent. In the United Kingdom the government has passed The Coronavirus Act, 2020 which introduces a moratorium on forfeiture for non-payment of rent by commercial tenants and further issued advisory/directives that during these painful times landlords will not file suits for eviction and courts will not entertain the same. Needless to say, in a country like India where there does not exist statutory standard minimum wages across all fields, it would be prudent if the government would also come to the rescue of tenants by issuing similar directives.

It is not beyond the law to accept that a party to a commercial contract must act reasonably. Invoking the doctrine of frustration where it is evident that fundamental understanding of doing a certain activity for a pre-determined consideration is not altered or affected is not acceptable.

Justice Nariman's view in energy watchdog has emphasised that change in circumstances can never entail a change in commercials or change in statutory fees or charges. This reasonableness of commerciality changing and affecting business as such ought to be induced in the contract and be provided for.

Similarly, in recent times of COVID-19 as well, Delhi High Court in the Indiabulls Housing Finance vs SEBI case where Indiabulls prayed for temporary restrainment on any coercive action with respect to the repayment to be made by it to its non-convertible debenture holders citing RBI Circular dated March 27, 2020.

Indiabulls contended that it was impossible for it to effect recoveries of debts owed to it by various institutions. Given the peculiar facts of this case and the present lockdown, the Delhi High Court directed that there shall be an ad-interim order and no coercive steps ought to be taken for redemption of the debenture amount.

Similarly, in a matter before the Bombay High Court where I had the opportunity to appear for Future Group's Rural Fairprice Wholesale Limited (RFWL) which was faced with IDBI Trusteeship attempting to collect the debenture from the equity shares pledged as securities as the Indian markets continued to plummet in light of the coronavirus lockdown.

It was submitted that while the steep drop in share prices was a genuine commercial obstacle due to the COVID-19 pandemic, not being able to sustain such price was beyond the control of RFWL and that must not be overlooked. Although the prices of shares fell beyond the acceptable limits, it was not on account of any action by RFWL but on events absolutely beyond the control of anyone.

The lockdown had impacted an already perilous economy with a mighty blow. It contended the role the COVID-19 lockdown is playing is vital and that such a lockdown was unprecedented, unpredictable, and constituted a force majeure.

The Bombay High Court accepted this proposition prima facie and granted an ad-interim relief. The frustration where RFWL was not able to contain its share prices because the market itself was uncontainable was a reasonable ground for the court to interfere because had it not, irreparable harm and irreversible loss would have accrued.

The COVID-19 pandemic has already had a significant economic impact. It is inevitable that stakeholders in businesses would seek exoneration of contractual obligations they would have otherwise performed. What shall be a court's inclination is everyone's guess but one cannot turn a Nelson'seye to the fact that a pandemic of this nature has not been cast over the world in history, trade and commerce has not suffered so grotesquely before and, that, while it may be so, the law is not going to forget its history to concoct new positions discarding the precedents.

It will always be important for a party seeking exoneration to establish that the failure of performance of the contract was not because of a lack of commercial viability, but an actual impossibility. What eventually is going to pin an argument in invocation of force majeure or doctrine of frustration is whether the impossibility latched to the performance is true and undeniable or is simply being feigned by the party because the performance in comparison to a vanilla time has become onerous.

The journey that the court will have to embark upon in each of these cases will have to be a distinct and unique and the tales of these journeys will bring judicial gems which shall be crystalised as precedents of a time when the "Earth stood still".

(The author is Senior Advocate, Bombay High Court)

Published on: May 11, 2020, 5:57 PM IST
Posted by: Manali, May 11, 2020, 5:57 PM IST