Gone are the days wherein ‘Consideration Clause’ under a Contract was used to be the KING. I still remember that during the foundation class of CS Course (now CSEET), under the Indian Contract Act, 1872, we the students, back in those days, were taught that Consideration is the most important clause while writing any Contract. I don’t deny; I agree, but only up to a certain extent, as Consideration, Pricing budget, in a practical field is the sole decision of the management and not the draftsmen.
Having worked majorly in Commercial Contract Assignments from last 5 yrs have made me determined that clauses such as Limitation of Liability, Indemnification, Risk Assessment, Termination, Obligations, Risk assessment, Ownership, Force Majeure, Dispute Resolution, amongst others are the utmost important clauses while framing any Commercial Contract. COVID 19 pandemic today presents unparalleled experiments, challenges, and has caused impairments to businesses in conducting their routine 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”?
Through this article, we hope to help companies re-look at their contracts carefully, and assess the extent to which their performance can either be excused without liability or compelled with the force of law.
In today’s world, Force Majeure has become the talk of the Industry. It is now trending, be it over twitter or LinkedIn. Looks like Force Majeure have achieved success overnight. A clause that was not taken seriously is most debatable as of now. The Companies are not able to fulfill their Contractual Obligations on time and worried whether non-compliance of their Contract with the Parties would be explained as a ‘default committed by the Party or ‘breach of Contract’.
Force Majeure and Material Adverse Effect (MAE) are certain well-accepted principles/practices for dealing with such extraordinary situations in commercial transactions, provided it has been explained in detail and draftsmen have made efforts to rope in all possible situations that can be taken into account, for example, a situation like pandemic as of today.
Section 56 of the Indian Contract Act, 1872 denotes ‘Agreement to do impossible act’ —An agreement to do an act impossible in itself is void. Section 56 of the ICA, 1872 is based on the common law principle known as Doctrine of Frustration and within which it lies the concept of force majeure is a hot topic for debate these days.
Force Majeure, a phrase derived from the French language means a superior force, an express provision of circumstances in which performance under the Contract can be excused or suspended temporarily.
A typical force majeure clause in contract reads as below:
“None of the Parties shall be liable for any delay, failure in performance, loss or damage due to Force Majeure events. During the performance of the Agreement events of Force Majeure may occur, such as, but not limited to, war, fire, flood, earthquake, accident, riot, strike, explosion, lockout, an act of God, an act of Government authority, accidents and/or damage, decisions from the Customer, or any event beyond the reasonable control of any of the Parties, which by their effects render impossible or hinder the performance of any obligation or the exercise of any rights under this Agreement or the normal operation of the Company’s industrial installations, or cause the failure or omission to comply with this Agreement.”
On a detailed note, Force Majeure typically involves events like an Act of God or natural disasters, war or warlike situations, strikes, pandemics, etc. and can be interpreted as an exception to what would otherwise amount to a breach of contract. If we go deep over Section 56 of the Indian Contract Act, 1872, this particular section allows provisional expulsion of obligations on grounds of the impossibility of performance of the contract because of a problematic event or change in circumstances. To invoke such a clause, the prerequisite is as below:
A. The nature of cause must not be brought about by defaulting person’s default;
B. The nature of cause must be inevitable and unforeseeable;
C. The cause has made the execution of the contract impossible.
Now, the Party who claims force majeure is under a compulsion to prove that all-reasonable pains to duck or alleviate the impugned force majeure event and its effects were undertaken on their behalf. This is a case-to-case basis. There are many contracts, which allow Parties to terminate the contract to save them from management difficulties, and cost issues when the period of force majeure is extended.
In light of Covid-19, on February 19, 2020, the Ministry of Finance issued an Office Memorandum on ‘Force Majeure Clause’ providing that “coronavirus should be considered as a case of natural calamity and force majeure may be invoked, wherever considered appropriate, following the due procedure (in the Office Memorandum)”. It provides that “a force majeure clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the force majeure. The firm has to give notice of force majeure as soon as it occurs and it cannot be claimed ex-post facto. If the performance in whole or in part or any obligation under the contract is prevented or delayed by any reason of force majeure for a period exceeding ninety days, either party may at its option terminate the contract without any financial repercussion on either side.
In a situation where force majeure clause has been mentioned, it is advisable to relook into the clause and find Out the details, the language used, whether it covers situations like a pandemic, epidemic, or just Act of God.
In terms of a force majeure clause, the clause could contain words that indicate the extent of the impact on performance to invoke the clause, such as ‘prevent’, ‘hinder’, ‘delay’. Courts have interpreted the words ‘prevent’ and ‘hinder’ differently. Besides, Courts have also construed words which precede or follow words such as ‘hinder’ or ‘prevent’ in the clause, as well as construed the nature and general terms of the contract to determine if the impact as claimed by a party enables it to invoke the agreed force majeure clause. The meaning of these words is critical to understand if a party can invoke the force majeure clause. The ICA provides remedies based on the effect of an unforeseen event on the contractual performance. Impact assessment is therefore essential to better inform the parties about the remedies they can seek under Indian law.
Further, if the parties have used Force Majeure clause in their draft then they also need to provide proof that had they not been “prevented” from performing due to the force majeure, they would have undoubtedly discharged their obligation. Also, it must be proved that there was no possible alternative for the completion of the contract and that all reasonable steps were taken to mitigate or avoid the effects of the force majeure event. However, it is generally a subjective area and is decided on a case-to-case basis thus presenting the parties with a chance to voice out their predicament.
If your contract does not contemplate the occurrence of an event that renders the performance of the contract impossible or illegal, and the event occurs, the remedy might lie in Section 56 of the Contract Act.
Section 56 of the Indian Contract Act, 1872 denotes ‘Agreement to do impossible act’ —An agreement to do an act impossible in itself is void.
In the absence of force majeure Clause, the doctrine of frustration would be applicable to make the contract void because the clause of force majeure if not mentioned explicitly, can never be implied under Indian law.
This doctrine applies when due to an unforeseeable event, the performance of the contract is rendered impossible and even if possible, the outcome would be different from what was envisaged by the parties at the time of entering the contract.
Even though this doctrine comes with a high threshold in terms of standard of proof, it might be possible to include a range of factual circumstances regarding COVID 19 as a frustrating event under this doctrine. In terms of scope, the doctrine of frustration is narrower as compared to force majeure and won’t be allowed to be exercised simply because the event complained of has become more expensive or difficult to perform since the economic constraint is not one of the defenses available under it.
Apart from force majeure and the doctrine of frustration, there is a high possibility of other consequences also such as price adjustment clauses, material adverse change clauses, limitation or exclusion clauses, to limit or exclude liability for non-performance but then again it will all depend on the particular wording of the contract and the discretion of the particular court.
In light of the global pandemic, there are chances that Parties might use the Force Majeure clause as an excuse. Delay, interruption, or all together cancellation of the contract is very likely to be expected and if such a case arises before the Party, then it must be checked that the clauses claimed by the other Party, which leads to non-performance of the Contract are true or not. In the majority of the contracts, the reason cited by the companies will be non-performance of suppliers, and then it is in the best interest of the second party to the contract to try to verify this information. Attempts may be made for renegotiation of price or other key contractual provisions, and for this companies need to be vigilant if they wish to not be deceived since it is very easy under the given circumstances. It is well-advised to do an Assessment of the legal risk involved and proactively manage since at the end of the day, it has to be one party or another who will have to bear the financial loss even without any fault of their own.
We strongly recommend that if possible; execute Addendum to the Contracts during the lockdown period via stamping and e-signing options available over the Internet. Addendum to the Contracts is also advisable to those companies, who now wish to introduce strict/detailed clauses about performance, non-performance, force majeure, limitation of liability, risk assessment, and mitigation, etc.
Disclaimer: The contents of this publication are for general information only and should not be relied upon as a substitute for professional legal advice, which should always be sought concerning any specific matter before acting or reliance upon any such information. The opinions, estimates, and information given herein are made for best judgment, utmost good faith, and as far as possible based on data or sources, which are, believed to be reliable. Notwithstanding we disclaim any liability in respect of any claim, which may arise from any error or omissions or from providing such advice, opinion, judgment, or information.
Author: CS Nikhil Arora, Founder & CEO-LAWgically Yours.
Legal & Secretarial Consultant