Coronavirus impact: Can't fulfill your contractual obligations? May the Force Majeure be with you

Coronavirus impact: Can't fulfill your contractual obligations? May the Force Majeure be with you

It is common for force majeure clauses to specify the impact that the event or circumstances in question must have, in order for the clause to be triggered

Counterparties may argue that COVID-19 is a force majeure event that excludes them from their contractual obligations Counterparties may argue that COVID-19 is a force majeure event that excludes them from their contractual obligations

The COVID-19 pandemic has taken the entire world hostage in less than four months, and the global economy has been hit the hardest with governments across the globe implementing stringent policies including lockdown to control the coronavirus outbreak.

The pandemic today presents unprecedented challenges and impediments to businesses in conducting their normal operations. The lockdown across the world has caused delays in the performance of contracts and transactions. Now, the question that arises is whether the current situation can enable parties to a contract to alter their obligations with non-compliance of terms neither being regarded as a "default committed by any party" nor a "breach of contract"?

There are certain well-accepted practices for dealing with such extraordinary situations in commercial transactions by the inclusion of force majeure & material adverse effect (MAE) clauses.

Also Read: Firms to seek protection under 'force majeure' as coronavirus disrupts businesses

Determination of the types of circumstances so covered by the force majeure clause contained in a contract is essential. Provisions of force majeure often cover natural disasters like hurricanes, floods, and earthquakes as "acts of God." Other covered events may include war, terrorism, civil disorder, fire, disease medical epidemics or by reasons of applicable laws or regulations. Broadly, the courts have interpreted the term "Force Majeure" as an event that can neither be anticipated nor controlled by either of the contracting parties.

A force majeure clause applies in the context of ongoing contractual arrangements, whereas, an MAE or material adverse change (MAC) clause applies to the allocation of risk in transactions before their closure or completion. For instance, a contract to acquire, invest in, or lend money to a company often contains a clause that allows the acquirer, investor, or lender to cancel the transaction if a material adverse change occurs.

Pandemic and related consequences such as government action is a type of event covered by a force majeure clause, however, its impact on the affected party's ability to perform its contractual obligations may vary depending upon contractual terms.

It is common for force majeure clauses to specify the impact that the event or circumstances in question must have, in order for the clause to be triggered. References may be made, for example, to the event or circumstances having "prevented", "hindered" or "delayed" performance. These terms require different levels of impact on performance before a party can claim recourse to these clauses.

In other words, the force majeure and MAC clauses act as an exception to what would otherwise be treated as a breach of contract. Certain contracts may state that, if a force majeure clause is applied, the contract may automatically be terminated.

Also Read: Covid-19 impact: Ashoka Buildcon, IRB Infra to invoke 'force majeure', seek moratorium on loans

On the other hand, some contracts may even state that the duty to fulfill the contractual obligation may be suspended for a certain period of time and if the force majeure event is not curbed or treated even after such time, then eventually the contract may be terminated.

In India, the nationwide lockdown has gravely affected businesses. Though there cannot be a one-size-fits-all solution to this question, and it depends upon how the force majeure clause is worded in a specific contract; and in the absence of the same, applicable laws related to the same will be required to be taken into consideration.

The Indian Contract Act, 1872, despite being a rather old statute, contains specific provisions to combat situations of force majeure or similar circumstances. In this regard, reference can be made to Sections 32 (Enforcement of Contracts contingent on an event happening) and 56 (Agreement to do impossible act) of the Indian Contract Act 1872.

As long 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 of the Indian Contract Act. In so far as a force majeure event occurs which are outside the scope of the contract, it is dealt with by a rule of positive law under Section 56 of the Indian Contract Act.

The Supreme Court, way back in 1954  had adverted to Section 32 &  56 of the Indian Contract Act, in SatyabrataGhose v. Mugneeram Bangur& Co case, wherein it was held that the word "impossible" has not been used in the Section in the sense of physical or literal impossibility. However, certain exceptions have been carved into the applicability of force majeure by Indian Courts.

More recently, after the break out of COVID-19, while reinforcing the settled position in law that letters of credit are independent transactions and the banks are not concerned with underlying disputes between the parties, the High Court of Bombay in its decision dated 8 April 2020, in the matter of Standard Retail Private Ltd Vs GS Corp & Others held that force majeure cannot be invoked by the purchaser in making payments when the seller has performed its part of the contract.

Counterparties may argue that COVID-19 is a force majeure event that excludes them from their contractual obligations. However, the impact of the force majeure event cannot be generalised and shall vary depending on the nature of the transaction and its impact on the same.

There exists a fine line of difference between cases of force majeure and those of hardship. In order to correctly identify an individual instance and its possible legal implications, therefore, it is necessary to undertake a case by case analysis.

The Indian government and its organisations have recognised the event of COVID-19 as a force majeure and have taken possible steps to ensure the minimum possible hardships to the common people.

  • The Finance Ministry had on February 19, 2020, clarified that the meaning of force majeure shall include the present pandemic as a case of natural calamity and hence if the contract mentions natural calamity in the force majeure clause then non-performance of contract can be exercised by the contracting parties stating COVID-19 as a force majeure event.
  • The Reserve Bank of India (RBI), on March 27, 2020, announced that all commercial banks, co-operative banks, all-India financial institutions, and NBFCs are permitted to grant a moratorium of three months on payment of all installments falling due between March 1, 2020, and May 31, 2020.
  • The Securities and Exchange Board of India (SEBI) has considered the present situation fit to introduce various relaxations in compliance for listed companies.
  • Even the courts and judicial forums have been constrained to either completely close their operations during the lockdown in India or are operating on an extremely limited scale via video conferencing, exclusively for extraordinarily urgent matters. This is also why the Supreme Court (SC) thought it was advisable to notify an extension of the statutory period of limitation for approaching courts to protect litigants from the technical difficulty of time bar. Additionally, the High Courts notified the extension of interim orders for this period of lockdown.
  • Various ministries and government authorities including the Ministry of Corporate Affairs, Ministry of Finance, Department of direct and indirect Tax have also notified extension for mandatory compliances.
  • Considering the worsening impact of COVID-19 on the economy, on March 23, 2020, Finance Minister Nirmala Sitharaman announced that the government is considering the suspension of Sections 7, 9 and 10 of the Insolvency and Bankruptcy Code, 2016, to prevent mass insolvency proceedings if disruption of economic life due to COVID-19 continues beyond April 30, 2020.
  • India's biggest container terminal, run by Maersk at Mumbai port, as well as Adani Ports in Gujarat has already declared force majeure, joining oil refiners Indian Oil and Mangalore Refineries. It is also learnt that several big Indian corporate houses have begun sending notices to their business associates, threatening to discharge themselves of contractual obligations claiming force majeure.

For contracting parties, there is no definitive rule to follow. Every commercial entity which has been impacted by the spread of the COVID-19 must first begin to examine the specific provisions of their contracts with the goal of establishing if there is a precise definition of the circumstances of force majeure (or hardship) and their relative consequences.

Only on following such an evaluation, can one determine the effects of failure to perform certain services, as well as the actual impact of a series of events on the contractual balance, be concretely ascertained.

(The author is the founder and Managing Partner of corporate law firm RRG & Associates.)

Published on: Apr 17, 2020, 11:14 PM IST
Posted by: Manali, Apr 17, 2020, 11:14 PM IST