Contracts Enforceability and COVID-19- A Review of Extant Legal Opinion
Dr. (CS) Parimala Veluvali
The author is Assistant Professor, SCMS, Pune, Symbiosis International University. She can be reached at veluvaliparimala@gmail.com and eboard@icai.in.
Background
Consenting parties enter into contracts to bring definiteness and certainty into their business transactions. One of the essential features of a contract is its enforceability and the courts will seek to enforce the terms of the contract in a suit for its performance. Failure of a party to live up to their contractual obligations amounts to a breach and it would invite the consequences of such breach. Performance of a contract is a smooth way of extinguishing mutual obligations arising from the contract.
However, it is common knowledge that the performance of a contract may at times be hampered by supervening impossibility that is beyond the control the parties. Sec 56 of the Indian Contract Act, 1872 states that when the performance of the contract is impossible, such contracts need not be performed. Law provides relief in such cases where the contract is frustrated for reasons that are external to the contract, either unforeseen or unanticipated. The relief under the ‘doctrine of frustration’ is invoked when the essence or purpose of the agreement is frustrated or rendered impossible or even illegal to perform. Under such eventualities that upset the very foundation of the contract, the contract is discharged and the party is excused from non-performance.
Uncertainty is an integral part of life and is mostly factored by the parties while signing contracts.
The Contract Act, 1872 provides for contingent contracts under section 32, where a contract may be contingent upon the happening or non-happening of an uncertain event. Parties to contingent contract make provision for anticipated uncertainties and such contracts come to their natural ending when the said contingency strikes. Parties may protect themselves from the incidence of breach by explicit inclusion of a clause to that effect, absolving themselves from performance. This clause termed as ‘Force majeure Clause’ is incorporated in contracts to cater to events which are unanticipated or uncontrollable. While the Indian contract Act 1872 does not make a specific mention of the term ‘Force majeure’, it is defined as an event that can neither be anticipated nor controlled (The Black’s Law Dictionary, 2019).
Since 2020, the global economy is witnessing unprecedented crises affecting lives and livelihoods due to the COVID-19 pandemic. The Indian government has classified COVID-19 as a disaster under the Disaster Management Act, 2005 to make way for uniform lockdown regulations all over the country to spread the control of the pandemic (Chauhan Chetan, 2020). Owning to disruptions in the production, manufacture, distribution, delivery of goods and services, a bulk of business transactions are being suspended, delayed or terminated, with parties defaulting in adhering to the contract terms. This large-scale disruption that hampered business continuity has also compelled businesses to relook into their contracts, to assess the impact of the pandemic on their dealings. There has also been a renewed interest in academia regarding issues of enforceability of contracts and the remedies available under the statutes. Sections 32 and 56 of the Indian Contract Act, 1872 have been the most visited provisions in this context. Recent works have studied the concepts of force majeure and the doctrine of frustration. Drawing from these existing works and recent case judgements, this paper studies the jurisprudence that has evolved from COVID induced litigation. The nature of the study is doctrinal, analysis of legal propositions and extant case laws being the primary source of information for the study.
Doctrine of Frustration
Doctrine of frustration could be invoked when, subsequent to the contract, the performance has been rendered impossible, illegal or impractical.
Fundamentally, all contracts need to be performed. Non-performance of a contract amounts to breach and will invite legal action. Under the common law underpinnings, the enforceability of contracts was stringent and absolute. The possibility of non-performance of the contract due to supervening events rendering it impossible to perform was first acknowledged in the case of Taylor v. Caldwell (1863). As a departure from the extant doctrine of absolute obligations, the doctrine of frustration that emerged from the case of Taylor v. Caldwell (1863), enabled parties to seek refuge from the consequences of non-performance, if their case so merits.
Doctrine of frustration could be invoked when, subsequent to the contract, the performance has been rendered impossible, illegal or impractical (Sen, G. 1972). A fit case under this doctrine is one when, the contract is frustrated by occurrence of a events or a change in the circumstances subsequent to formation of the contract as has been reiterated in the case of Krell v. Henry (1903). The essence of the contract is lost in such cases. Courts have also held that mere difficulty in performance cannot be pleaded as an excuse and the change in the circumstances owing to the subsequent eventuality, must bring about a radical or fundamental change in the circumstances shaking the premise on which the contract rests, as held in Davis Contractors v. Fareham (1956).
The maxim “Non haec in foedera veni” which means “This was not what I promised to do” explains the parties’ inability to perform the contract owing to changed circumstances rendering the contract radically different from what has been undertaken by the contract. The rationale behind doctrine of frustration was applied to cases involving ‘destruction of subject matter’, failure of the implied condition in the contract and in cases where it was just and equitable to excuse the performance. It applied to cases where the parties did not contemplate such eventualities and have not expressly addressed them in their contracts. Studies (M. P et al, 2020) explain that the evolution of such theories was the result of the courts’ endeavour to take a realistic stance in such cases.
Section 56 of the Indian Contract Act, 1872, states—when the performance of the contract becomes impossible, it need not be performed. Studies explain that the decisive wording and the express provision of section 56 under the Act have made it easier for courts to apply this in cases involving supervening impossibility. The doctrine of frustration comes under the ambit of section 56. In the landmark case of Satyabrata Ghose v. Mugneeram Bangur and Co. (1954), it was held that, for section 56 to apply, the subsequent event must render the performance of the contract impossible.
Impossibility can be physical or legal. Events that render the contract impracticable or upset the foundations of the contract are also considered impossible to perform under Section 56.
Section 56 would apply in cases when the performance of an existing contract has been interrupted by an event that has occurred subsequently frustrating the contract. This is a natural outcome of the event which is involuntary. As has been held in the case of Satyabrata Ghose v. Mugneeram Bangur and Co. (1954), for application of section 56, a substantial portion of the contract must be impacted, changing its basic premise. Cases where the performance is rendered burdensome or commercially impossible in view of additional costs or inconvenience do not merit consideration under this doctrine as has been held in the case of Tsakiroglou & Co. Ltd v. Nablee Thorl Gmbl (1962).
The construction of the contract is primarily looked at by the courts before deciding whether the contract is frustrated or not. Contracts that provide for subsequent eventualities as an express clause in the contract also called ‘Force majeure’ are decided as per the terms of the contract. Section 56 would apply when there is no such express provision in the contract. Section 56 is invoked when the subject matter of the contract is destroyed or the performance has become illegal or the purpose for which the contract has been entered is lost. However, when the risk is inherent in the contract, then it is self-induced and held to be in contemplation of the parties. Therefore, it does not merit consideration under section 56 as has been held in the case of Maritime National Fish Limited v. Ocean Trawlers Ltd (1935).
Impossibility of performance cannot be used as a defence in all cases. If the party knew of the facts that made the performance impossible when the contract is executed, or assumed, the risk of impossibility or could have acted to prevent its occurrence, the defence would not hold well.
Force Majeure Clause in Contracts
“The construction of the contract is primarily looked at by the courts before deciding whether the contract is frustrated or not. Contracts that provide for subsequent eventualities as an express clause in the contract also called ‘Force majeure’ are decided as per the terms of the contract.”
A contract emerges out of consensus after a careful consideration of all the terms and conditions by the parties. It is common practice for parties to define the limits of their obligations and absolve themselves from performance, in view of external unforeseen events beyond their control. A force majeure clause is incorporated in contracts catering to unforeseen events such as war, epidemics or natural disasters also termed as ‘acts of god’. Force majeure, a French term that means “Superior force” covers unusual or extra ordinary events that may unexpectedly occur. Force majeure clauses are inserted in the contract to provide for externalities that are unforeseeable or uncontrollable by the parties. While the occurrence of the force majeure event may not completely release the parties of all liabilities arising from the contract, they offer relief from absolute adherence to the terms of the contract.
Force majeure clauses may be exhaustive or inclusive (Batas and Shah, 2020). The exhaustive clauses expressly spell out specific events which will excuse the performance of the contract. The language of the inclusive clauses is broad and is intended to cover any circumstances that are beyond reasonable control of the parties. Studies (International Bar Association, 2020) explain that parties that have gone ahead with an inclusive approach may stand a strong chance of accommodating COVID-19 as a Force Majeure event.
Section 32 (Contingent Contracts) vs. Section 56 (Frustration of Contract)
Force majeure clause in contract is covered under section 32 of the Contract Act dealing with contingent contracts, the performance of which is dependent on the happening or non-happening of an event. Section 32 states that “Contingent contracts to do or not to do anything if an uncertain future event happens, cannot be enforced by law unless and until that event has happened. If the event becomes impossible, such contracts become void”.
On the face of it, while section 32 and section 56 both appear to be similar, the difference lies in the conditions when they can be invoked:
- Section 32: Invoked when the said contingency occurs and would be decided strictly as per the terms of the contract.
- Section 56: Comes into play when the contract becomes impossible to perform and relies on the positive rule laid out by the law for want of an express or implied provision in the contract to that effect.
In the Satyabrata Ghose v. Mugneeram Bangur case, the Supreme Court cleared the difference between the two, stating that a case under section 56 will hold good only when a force majeure is not inserted in the contract. For section 56 to apply, the nature of the contact must be executory.
Essential Requirements for a Successful Force Majeure Claim:
- Due Notice: An essential requirement of the force majeure is to give due notice to the other party regarding the circumstances that have rendered the contract impossible to perform.
- Burden of Proof: The burden lies with the party seeking to be relieved from performance, to establish that the excluded event actually prevented it from performing its obligations under the contract.
- No Alternate Modes of Performance: For a claim to be successful under force majeure, there ought to be no alternate ways of performance of the contract. Relief under force majeure can be sought as a matter of last resort after exhausting all the means of performance.
Energy Watchdog v. Central Electricity Regulatory Commissions & Ors (2017)
In this case, the petitioner invoked force majeure on account of increase in coal prices. The plea was dismissed by apex court stating that price increase did not render the contract unforeseeable, only commercially difficult. Force majeure cannot be invoked when alternate means of performance are available and the initial premise of the contract is intact subsequent to the event. The Contract Act, 1872 explicitly states under section 56, that commercial impossibility is not an excuse for non-performance.
National Agricultural Cooperative Marketing Federation of India v. Alimenta S.A (2020)
The apex court clarified on the scope of applicability of section 56 and section 32 of the Indian Contract Act, 1872. It observed that: “If a contract contains impliedly or expressly stipulation according to which it would stand discharged on happening of particular circumstances. The dissolution of the agreement would take place under the terms of the contract itself. Such cases would be outside the purview of section 56 of the Indian Contract Act altogether. They would be dealt with under section 32 of the Contract Act, which deals with contingent contracts.”
Analysis of Case Judgements
The question whether COVID-19 is a fit case of force majeure or not has been the most debated issue since the pandemic. Reports state that the earliest mention of COVID-19 as a case of force majeure in India, was the Office Memorandum issued by Ministry of Finance, Government of India that recognised ‘the pandemic’ as a force majeure event in relation to a procurement of goods manual (Bandyopadhyay and Ray, 2021) and subsequently granted certain reliefs and extension of time in that regards. Government departments and market regulators including RBI and SEBI also provided relief measures in view of the large scale disruption caused due to the pandemic. While these initiatives have set the ground, the judicial decisions by the courts helped to develop the jurisprudence on the issue.
| Case / Forum | Key Legal Pronouncement & Judicial Principle |
|---|---|
|
Standard Retail Pvt Ltd. v. Global Corp (2020) Bombay High Court |
The earliest legal stand on the pandemic. The court held that the lockdown caused due to the pandemic could be treated as a case of Force Majeure only if one could establish a direct nexus between the occurrence of the event and the non-performance of the contract. While dismissing to treat the case under Force Majeure, the court examined the nature of the contract in question which involved delivery of an essential service. Movement of essential services not being restricted during the pandemic, the court held that the contract was not substantially impacted by the lockdown. |
|
South Delhi Municipal Corporation v. MEP Infrastructure Developers Ltd. (2020) Delhi High Court |
The Delhi High Court granted relief with respect to toll collection from the contractor to SDMC, until such time that 90% traffic stands resumed, thereby acknowledging the effect of the pandemic on business functioning. |
|
Indrajit Power Pvt. Ltd. v. Union of India (2020) Delhi High Court |
The court held that despite an extension of 12 months granted to the petitioner, it was unable to fulfil the contractual obligations and therefore cannot seek refuge under force majeure. The pandemic cannot be used as a shield to cover up for the pre-existing negligence of the defaulting party. |
|
Halliburton Offshore Services Ltd v. Vedanta Ltd (2020) Delhi High Court |
The court held that breach of any contract has to be examined on the basis of the facts and circumstances of the case. A mere inclusion of the force majeure clause in the contract does not automatically guarantee relief from performing the contract. Past non-performance of the party cannot be condoned due to the COVID pandemic. Force majeure has to be interpreted narrowly and not liberally. The court did not intervene in the invocation of a bank guarantee in response to non-performance of the contract, thereby maintaining the sanctity of a contract. |
|
Ramanand and others v. Dr Girish Soni and others Delhi High Court (Commercial Leases) |
The economic consequences of the COVID-19 pandemic have been felt across sectors. With the slowdown in the business, retail outlets and commercial establishments faced the challenge of paying rent under commercial lease agreements albeit loss of earnings. The question whether tenants could seek a waiver or exemption from rent was clarified by the Delhi High Court: “In contracts where there is a profit-sharing arrangement or an arrangement for monthly payment on the basis of sales turnover, the tenant/lessee may be entitled to seek waiver/suspension, strictly in terms of the clause. Such cases would be purely governed by the terms of the contract itself, and the tenant’s claim could be that there were no sales and no profits and thus the monthly payment is not liable to be made. Thus, the entitlement of the client in such a situation is not governed by any overriding force majeure event but by the consequence of the said event, being that there were no sales or profits.” The terms of the lease contract are the determining factors to decide on the admissibility of the pandemic as a force majeure event. |
Conclusion
The applicability of COVID-19 as a force majeure event is dependent on the terms of the contract, with the specific language of the contract being the single most important factor. If expressly provided in the exclusion clause of the contract, the plea for relief has been considered by the courts favourably. Contractual breaches that have occurred prior to the COVID-19 pandemic have not been condoned by the courts.
While COVID-19 has disrupted the normal course of business functioning, sheer difficulty in the performance of the contract or additional burden in terms of increased costs owing to the pandemic situation do not merit invocation of force majeure or relief under section 56.
The disruption to the contract ought to be the direct result of the pandemic situation. In other words, disruptions to the contracts which cannot be directly and substantial attributed to the pandemic do not merit consideration section 56 and section 32. The parties need to establish that, but for the supervening event, they would have performed the contract. The impossibility to perform must be not self-induced or attributed to any negligence of the party. Duty to mitigate losses ought to have been taken. Courts have also considered the degree of hardship imposed on a party due to the pandemic.
An analysis of case judgements arising from the COVID-19 induced litigation reveals that relief under the doctrine of frustration is provided after due consideration of the terms of the contract, the past behaviour of the parties, the construct of the contract, and as a matter of last resort. The courts have applied this in a narrow sense, thus reinforcing the absolute obligations the contract imposes.
References
- Ambica Batas and Meet Shah (2020), ‘The Effect of Outbreak of COVID-19 on Force Majeure Clause in Commercial Contracts: An Indian Perspective’ International Journal of Law Management & Humanities, Vol. 3, Issue 2, pp. 490–497.
- Chauhan Chetan (2020 March 26th), ‘India under Covid-19 lockdown: All about the disaster management law’, Hindustan Times.
- https://www.hindustantimes.com/india-news/india-under-covid-19-lockdown-all-about-the-disaster-management-law/story-i7cjfZrUZcbOxamlEOAoPO.html (last accessed 11.05.2021).
- M. P., Ram Mohan and Murugavelu, Promode and Ray, Gaurav and Parakh, Kritika, The Doctrine of Frustration Under Section 56 of the Indian Contract Act (January 1, 2020). Indian Law Review (DOI: 10.1080/24730580.2019.1709774); IIMA W. P. No. 2020-10-01.
- Satyabrata Ghose v. Mugneeram Bangur and Co, AIR 1954 SC 44 [14].
- Sen, G. (1972). Doctrine of Frustration in The Law of Contract. Journal of the Indian Law Institute, pp. 132–177. Retrieved May 11, 2021, from http://www.jstor.org/stable/43950178.