Covid-19 and failure to perform contracts: ‘Force majeure’ event or impossibility of performance?

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Covid-19 and failure to perform contracts: ‘Force majeure’ event or impossibility of performance?

Introduction

The recent outbreak of Covid-19 has resulted in a global pandemic. In order to contain the spread of the disease, governments in nation states across the globe have restricted the movement of people, goods and services at an unprecedented scale.

In addition to the severe social costs that have resulted from the spread of Covid-19, the restrictions imposed to contain the disease have led to a breakdown of supply chains around the globe and across industries. While the degree of severity of impact will range from sector to sector, there is no doubt that businesses operating in almost every sector will be (and in most cases, already are) severely impacted.

The economic impact of Covid-19 extends to a delay or failure by a party to perform or to receive the performance of, obligations under contracts. Whether parties would be absolved from performance of contracts or whether performance would be permitted to be suspended for a stipulated period, is required to be examined on a case-to-case basis. We examine in brief the effect of ‘force majeure’ clauses in commercial contracts and the doctrine of frustration laid down in section 56 of the Indian Contract Act, 1872 in the context of the Covid-19.

Force Majeure

(a) The term ‘force majeure event’ when used in relation to contracts, usually refers to the occurrence of an event that is beyond the reasonable control of a party to the contract and which prevents such party from performing its obligations under the contract.

(b) It is important to note that a ‘force majeure’ clause is not implicitly existent in a contract. As such, the doctrine of ‘force majeure’ is a creature of contract and can only be relied upon if expressly provided in the contract. A party’s ability to claim relief for a force majeure event therefore depends upon the terms of the contract, and the force majeure provision in particular.

(c) Additionally, it is important to note here that a party’s ability to delay or avoid the performance of a contract would depend on the duration for which and to the extent a party is affected due to the relevant ‘force majeure’ event.

(d) The duration and extent to which a party’s ability to discharge its’ obligations under a contract are impeded due to the effects of the spread of Covid-19, would vary from case-to-case. Further, any relief is dependent upon the terms of the contract which must necessarily be considered on its precise terms and in its specific context. The relief obtained under ‘force majeure’ provisions may entitle a party to suspend performance of its obligations for a limited duration or lead to termination in certain circumstances. A few generally common features of ‘force majeure’ clauses are considered below.

Event and performance

(a) The relevant contract would usually include certain events that would be deemed to constitute a ‘force majeure event’ along with a generic inclusive sentence such as ‘any other event beyond the control of the party affected’. However, the mere spread of Covid-19 would not be considered as a ‘force majeure’ event in itself under a contract, unless it can be demonstrated that it affected the ability of a party to perform its obligations under the contract. Further, unless expressly provided for, it is unlikely that an impact on the profitability of a party to the contract would be considered as a ‘force majeure event’.

(b) It is pertinent to note that the Government of India, Ministry of Finance, Department of Expenditure, Procurement Policy Division issued Office Memorandum No. F.18/4/2020-PPD dated 19 February 2020 to the Secretaries of all Central Government Ministries/ Departments, whereby it stated as follows:

“2. A doubt has arisen if the disruption of the supply chains due to spread of corona virus in China or any other country will be covered in the Force Majeure Clause (FMC). In this regard it is clarified that it should be considered as a case of natural calamity and FMC may be invoked, wherever considered appropriate, following the due procedure as above.”

(c) While the clarification only pertains to the contracts in respect of which the circular was issued, we understand that several industry bodies are lobbying the government to issue similar circulars in respect of industries that they represent.

Notice

(a) Several ‘force majeure’ clauses in contracts would include an express duty on the party whose performance is impeded, to notify the other party(ies) to the contract, of the circumstances that have caused the failure to perform and the anticipated extent and duration for which the performance is expected to be impeded. Further, given the dynamic nature of the effects of the spread of the Covid-19 disease, it is important that notices with updates within reasonable intervals, and in any event, in accordance with the terms of the relevant clause of the contract, be issued by the affected party to the parties concerned.

Duty to mitigate

(a) A party that seeks to delay or avoid performance of its’ obligations usually has an implicit obligation to mitigate the Covid-19 and failure to perform contracts. Force majeure event or impossibility of performance? 3 adverse effect. This means that a party should take reasonable steps to mitigate the adverse effect caused due to the ‘force majeure event’.

(b) The duty to mitigate would be implied, unless the contract expressly provides otherwise. What constitutes a reasonable mitigation measure is fact-specific and depends upon the nature and subject matter of the contract in question. Further, considering that the Covid-19 pandemic has affected almost all industries across the globe, the extent to which a party can effectively mitigate the adverse effect could be called into question.

(c) In the event of a few resources being available, businesses may be called upon to elect between performing one contract over another. In these situations, it is important to analyze the terms and conditions of each contract and the scope of any ‘force majeure’ clauses or contingency provisions therein.

Frustration of contracts – Section 56 of the Indian Contract Act, 1872

(a) There may be circumstances where contracts do not contain a ‘force majeure’ clause. In these circumstances, performance of a contract may become impossible on account of circumstances beyond the control of parties that arise as a result of the impact of Covid-19.

(b) Such situations may be covered under Section 56 of the Indian Contract Act, 1872 (“Contract Act”), which deals with circumstances where on account of a subsequent impossibility it is found that the whole purpose or basis of a contract was frustrated by the intrusion or occurrence of an unexpected event or change of circumstances which was beyond what was contemplated by the parties at the time when the agreement was executed. If it is so held by a court, a contract may be rendered void. This is generally known as the doctrine of frustration of contracts and whether a contract would be deemed to be frustrated, will have to be examined based on the terms thereof and the impact of the spread of the Covid-19 disease on the performance of such contract.

(c) While the doctrine of frustration is similar to the doctrine of ‘force majeure’, insofar as they both deal with situations beyond the reasonable control of a party, the doctrine of frustration has been held to apply in narrow limits and subject to rigid conditions.

(d) For instance, it is important to note that a contract would not be discharged by impossibility, even though the supervening event/ subsequent event makes performance impossible, if:

(i) the contract makes full and complete provision for a given contingency;

(ii) only a portion of the contract becomes impossible or difficult to perform;

(iii) the frustrating event is such that any of the parties could foresee or could have foreseen with reasonable diligence; or

(iv) if despite the supervening events, the object and purpose of the contract is not rendered useless, and the contract can be performed substantially in accordance with the original intention of the parties, though not literally in accordance with the language of the agreement.

(e) Courts have repeatedly held that the doctrine of frustration cannot become a device for destroying the sanctity of the contract and cannot be applied to assist a party that does not want to fulfil its obligations under the contract.

Commercial impossibility

(a) In certain situations, it has been held that the impossibility referred to in Section 56 of the Contract Act does not include what is called commercial impossibility, namely, extreme or unforeseen cost or difficulty of performance.

(b) However, given that the disruption caused due to present pandemic is unprecedented in terms of the restrictions imposed and Covid-19 and failure to perform contracts. Force majeure event or impossibility of performance? 4 supply chains disrupted, the applicability of the doctrine of frustration will have to be examined on a case-to-case basis having due regard to the circumstances in which the contract was executed, the terms thereof, any contingency provided therein and the nature of the industry in which the parties operate.

Conclusion

It is important that parties undertake a review of their contracts in both cases, i.e. where performance is due to be made, or where performance is due to be received; and assess the probable impact on such performance due to the present pandemic.

It is important to note that other sector specific laws or laws governing certain transactions (for example, the Sale of Goods Act, 1930) may contain additional provisions that would assist in reviewing the legal impact on a delay or failure to perform obligations in certain cases.