On March 11, 2020, the World Health Organization (WHO) declared the novel coronavirus disease a pandemic. On the same day, the Government of India imposed visa and other travel restrictions. Soon thereafter, many states in India declared a ‘lockdown’, an emergency measure [under the Epidemic Diseases Act, 1897 and the Disaster Management Act, 2005 (“Disaster Management Act”)] to prevent and contain the spread of SARS-CoV-2, and also issued prohibitory order(s) under Section 144 of the Code of Criminal Procedure, 1973. A stricter lockdown was then imposed by the Central Government, which will presently remain in effect till May 3, 2020. During the lockdown, whilst certain commercial activities have been classified as essential and are permitted to continue operations, subject to following preventive measures (including social distancing), several others remain stalled and suspended.
Disruption of trade and commerce on account of such measures has already spiraled. The measures will prevent (and may have already prevented) several businesses from fulfilling their obligations under contracts and could lead to termination/cancellation of the same, as well as expose businesses to the risk of litigation. Undoubtedly, there will be a spate of litigation by promisees seeking enforcement of contractual obligations or compensation for non-performance of contractual obligations, and possibly even by promisors seeking recovery of dues withheld by promisees or compensation for termination of contracts.
Contractual jurisprudence is founded upon the commandment that contractual terms are supreme and parties must be held to their bargain. The parties may, as part of their pact, also identify certain events or occurrences (including price fluctuation), which would not affect the obligations of the parties under the contract. Parties would also normally include certain exceptions or exclusions in the contract, which they believe would affect the performance of their obligations under the contract, recognising that the performance of certain aspects of the agreement may not always be within their contemplation or control. Such clauses, like force majeure clauses, have garnered a lot of importance over time, and have been brought into focus during the present epidemic. Depending on the terminology adopted by the parties, a force majeure clause may be all-encompassing or restricted to only certain situations beyond the control of the promisor and/or the promisee. The occurrence of an identified or ‘covered’ event/circumstance may suspend the performance of the contract, or render it void. Historically, force majeure clauses, also referred to as act of God clauses, include within their fold circumstances such as floods, natural calamities, war, strikes, riots, etc. However, as a matter of law, force majeure clauses are also to be narrowly construed.[1]
Contracts with widely worded force majeure clauses, are also usually eloquent in relation to the steps to be taken and the rights and obligations of the parties in that situation. In the absence of a force majeure clause (or one which is not widely worded/all-encompassing), parties will be required to examine whether the outbreak of SARS-CoV-2 or the restrictions imposed in view thereof, make it “impossible” for them to perform their obligations. If so, and depending on the facts and circumstances, such parties who are unable to perform their contractual obligations, may have no option but to invoke the doctrine of frustration (i.e. that such obligations have become impossible to perform) to defend any action initiated against them.
In a crisis of this nature, many will try to ride on the force majeure/frustration wave. Some will float, others may sink. Courts may or may not be inclined to take a lenient view, but this will most likely be based on the facts and circumstances of each case, given that the determination of whether a contract is frustrated (or impossible to perform) is quite subjective. This may include determining the nature of the obligation to be performed (including whether the same is part of the fundamental bargain between the parties), whether the outbreak or state measures were the direct or substantial cause of the inability to perform such obligation, whether the promisor was diligent and explored all alternatives, etc. It is entirely possible that courts may not consider the lockdown to ipso facto be an event that renders the performance of obligations under a contract impossible, given that the lockdown is temporary.
The Bombay High Court recently refused to restrain encashment of letters of credit on applications by purchasers of steel products, who contended that their contracts with a South Korean supplier were unenforceable on account of frustration, impossibility, and impracticability. Pertinently, the seller had already shipped the goods from South Korea and the relevant force majeure clause provided protection only to the seller and not to the buyers. The Bombay High Court rejected the applications by the buyers on the grounds that (a) the letters of credit are an independent transaction with the bank and the bank is not concerned with the underlying disputes between the parties, (b) the force majeure clause is applicable only to the seller and not the buyers, (c) the fact that the buyers would not be able to perform their obligations as far as their own purchasers are concerned and/or would suffer damages are not factors that can be held against the supplier, (d) steel, ports, warehouses, etc., have been declared as an essential service and there are no restrictions on the movement of steel and (e) the lockdown is only for a limited period and cannot come to the rescue of the buyers so as to enable them to resile from their obligation of making payment to the supplier.[2]
The advantage of a force majeure clause is essentially that it provides agreed alternatives for the parties to consider in such a situation, including suspension of obligations under the contract, extension of time for performing obligations or even renegotiation of the terms of the contract. This also means that the underlying project or transaction can still be salvaged, and parties can agree as to the best way to do this. However, the aforesaid options may not be available as a matter of course in the absence of a force majeure clause, unless the parties can agree to exercise them, nonetheless. Frustration can be used only as a defence in an action brought against a party for non-performance of contractual obligations, and whether the contract stands frustrated is subject to determination by a court or arbitral tribunal ex post facto. If the contract is found to be frustrated, then it is automatically void. In such a case, the party invoking the doctrine will be found to be released from the performance of its contractual obligations and will not be penalised. However, if the contract is found to have become void, then any party who has received any advantage under the contract is bound to restore it or to compensate the party from whom such advantage was received.[3]
The doctrine of frustration of contract allows parties to cease performing contractual obligations where it becomes impossible to do so in circumstances beyond the control of the parties. Section 56 of the Indian Contract Act, 1872 (“Contract Act”) provides that a contract to do an act, which becomes impossible after the contract is made, becomes void when the act becomes impossible. Naturally, the threshold to prove that a contract stands frustrated is very high, and parties will have to prove that the contract is impossible to perform i.e., not literal impossibility, but that it is impracticable and useless from the point of view of the object and purpose of the parties.
Some key takeaways from Indian precedents on frustration of contract are as follows:
The English position on frustration,[16] which has been recognised by the Indian Supreme Court,[17] also recognises the following:
It is clear that a high threshold exists for establishing that a contract is frustrated. In order to (a) avoid going down this road and (b) be able to make out a case for frustration of contract, if required, it becomes important to be as pro-active and cautious as possible, at the outset. The present crisis is unprecedented, and whilst companies in many sectors may be given relief by relaxation of certain obligations, this cannot be presumed on an inter-party contractual level as parties at the receiving end of force majeure or frustration invocations are also going to be severely impacted. Therefore, we proceed to set out certain indicative measures, which parties can consider taking in case they foresee delay in their ability to perform contractual obligations, or that they are not going to be able to perform such obligations at all.
For instance, the Ministry of New and Renewable Energy inter alia directed all renewable energy implementing agencies to (a) treat delay on account of disruption of supply chain due to outbreak of SARS-CoV-2 in China and other countries as force majeure and (b) consider applications for extension of time in such situations objectively and grant such applications based on the facts therein. Thereafter, the Ministry also directed that agencies may treat the lockdown as force majeure and grant extension of time for renewable energy projects equivalent to the period of the lockdown, and an additional 30 days for normalisation after the end of such lockdown. Several Indian ports have also declared force majeure in anticipation of difficulties in movement of labour, personnel, vehicles, etc., even though ports have been categorised as essential services in order to ensure normal functioning of supply chains.
[1] Energy Watchdog v. Central Electricity Regulatory Commission & Ors. (2017) 14 SCC 80
[2] Standard Retail Private Limited v. G.S. Global Corp. (Order dated 8th April 2020 passed by the Bombay High Court in Comm. Arbitration Petition (L) No. 404 of 2020)
[3] Section 65 of the Indian Contract Act, 1872
[4] Satyabrata Ghose v. Mugneeram Bangur & Co. 1954 SCR 310
[5] Ibid
[6] Ibid
[7] Ibid.
[8] Energy Watchdog v. Central Electricity Regulatory Commission & Ors. (2017) 14 SCC 80
[9] National Agricultural Cooperative Marketing Federation of India v. Alimenta S.A. (Judgement dated 22nd April 2020 passed by the Supreme Court in C.A. No. 667 of 2012)
[10] Satyabrata Ghose v. Mugneeram Bangur & Co. 1954 SCR 310
[11] Naihati Jute Mills Ltd. v. Khyaliram Jagannath (1968) 1 SCR 821
[12] Ibid
[13] Alopi Parshad & Sons Ltd. v. Union of India 1960 (2) SCR 793
[14] Ibid
[15] Boothalinga Agencies v. V.T.C. Poriaswami Nadar AIR 1969 SC 110
[16] Sea Angel case, 2013 (1) Lloyds Law Report 569 (paragraph 111.)
[17] Energy Watchdog v. Central Electricity Regulatory Commission & Ors (2017) 14 SCC 80