COVID 19- FORCE MAJEURE AND LEGAL IMPLICATIONS ON COMMERCIAL CONTRACTS

The outbreak of COVID-19 has led to unprecedented challenges to be faced by business organizations majorly the ones’ indulged in public spirited projects with the government due to the nationwide lockdown.

It is extremely essential to mention that such an outbreak of pandemic has widely been reported to have impact not only on global manufacturing, shipping, cross border supply chains but has also warped the local commercial dealings, thereby undermining many aspects of trade and commerce.

In this regard, given the supply chain disruption caused by the Covid-19 pandemic, it is most likely that performances under many contract will be delayed, interrupted, or even cancelled.

Therefore, those Companies indulged in Agreement with the government agencies are in a predicament considering the present-like situation wherein all the public- interested projects are stalled mid-way after incurring huge expenditure already and therefore a need arises to focus upon the legal perspective and to consider the possible legal avenues concerning the future implementation such as a) seeking extension for adequate time period necessary for the full completion by invoking force majeure conditions and with a view to commensurate the losses incurred and b) seek for compensation for the operational cost, capital expenditure incurred and other unrecovered losses in order to continue the implementation without any hindrances.

Furthermore, the Companies are now attacked with a common query which is: Whether under any commercial contract such as concession agreement etc. can they be entitled to invoke the force majeure conditions and seek for appropriate extension from the concerned government department along with the requisite compensation to commensurate the operational and capital expenditure incurred prior to the lockdown orders in order to carry out the obligations under the agreement?

The aforementioned query arises due to the following considerations:

1. The activities being completely stalled since 24th of March, 2020 owing to lockdown orders issued by the Central Government and continuing till date without any certainty of its ending therefore rendering the impossibility to perform the contractual obligations within the decided timelines. Hence, the extension sought..!!

2. Humongous expenditure incurred with respect to the implementation of the projects which still remains unrecovered and after being apprised of the Company’s financial position owing to the paralyzed state of activities without any scope of revenue generation makes it utterly difficult to carry out the future implementation under the agreement without being adequately compensated.

Hence, it is utmost essential to deliberate upon the tenability of the aforementioned proposed actions that are under contemplation.

IMPACT AND REPERCUSSION OF THE CALAMITOUS CORONAVIRUS

Where the world is distressed by the daunting situation created due to the catastrophic outbreak of COVID-19, Companies/Industries/Associations and their workforces are also facing frantic challenges during such period of disruption owing to the nationwide lockdown orders by the Central government in pursuance of powers under the Disaster Management Act, 2005

Therefore, As a consequence of lockdown nearly all business activities have come to halt due to the restricted movement and shutting down off all non- essential services which have impacted the business entities and economy at large.

Furthermore, in the present scenario where the world is at standstill axis due to coronavirus pandemic, it is most likely that the performances of certain  contracts may get delayed, interrupted or even terminated on account of partial or complete frustration of such contracts.

Significantly, the most horrific consequence is the contractual performance under the commercial agreements engaged with the government i.e. the obligations to carry out certain activities in the interest of public, the performance of which is severely affected due to the lockdown measures ordered by the Central Government for containment of COVID-19.  

COVID-19 PANDEMIC- A FORCE MAJEURE CONDITION

In the situation like the present it is crucial to emphasize upon the concept of “frustration of contract” “force majeure”

“Frustration is an act outside the contract owing to which the completion of contract becomes impossible.” The doctrine of frustration is an aspect or part of law of discharge of contract due to supervening impossibility or illegality of the act agreed to be done and hence comes within the purview of Section 56 of the Indian Contract Act.

Section 56. “Agreement to do impossible act.—An agreement to do an act impossible in itself is void.”

A contract maybe frustrated due to various reasons such as destruction of subject matter, unforeseen circumstances (i.e. Act of God which includes natural disasters, war or war- like situations, labour unrest or strikes, epidemics, pandemics etc. These unforeseen or intervening circumstances are typically known as “force majeure”

For a contract to be impracticable three factors must be present:

1) Circumstances existing at the contracting date and foreseeability of the impracticable situations. If the circumstance that causes performance to be impracticable was foreseeable when the contract was executed, then the contract will likely be enforceable. But in the case, where the parties were completely unaware of an event that made it impossible for them to perform its obligations then it is force majeure.

2) The frustration must be substantial.

3) The non-occurrence of the frustrating event must have been a basic assumption on which the contract was made

It is pertinent to state that in all contractual agreements parties usually include “force majeure clause” in order to absolve the parties from performing party from the consequences of something over which it has no control Hence, force majeure is an exception to what otherwise amount to a breach of contract as under force majeure, the performing party is excused from the performance or discharge, as an supervening circumstance has made the performance of the obligation temporarily or permanently or wholly or partially impossible or is entitled to suspend performance or to claim extension of time to performance.

In this regard, mostly all Public Private Partnership (PPP) concession contracts explicitly include “force-majeure clauses” which defines the circumstances beyond a contracting party’s control in which a party’s nonperformance may be excused. Furthermore, such clauses typically also allow an extension of time for performance or relief from liability for nonperformance by the party timely invoking it and sometimes considering the situations provide for adequate compensation.

OFFICE MEMORANDUM ISSUED BY THE MINISTRY OF FINANCE THEREBY CLARIYING THE INTERPRETATION OF FORCE MAJEURE CLAUSE

While placing reliance upon para 9.7.7 of the “Manual for Procurement of Goods 2017” which are the guidelines issued by the Government concerning public procurement. Para 9.7.7 clearly focusses on the “Force Majeure clauses” To quote

“A Force Majeure (FM) means extraordinary events or circumstance beyond human control such as an event described as an act of God (like a natural calamity) or events such as a war, strike, riots, crimes (but not including negligence or wrong-doing, predictable/seasonal rain and any other events specifically excluded in the clause). An FM clause in the contract frees both parties from contractual liability or obligation when prevented by such events from fulfilling their obligations under the contract. An FM clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the FM……………………………….. Notwithstanding the punitive provisions contained in the contract for delay or breach of contract, the supplier would not be liable for imposition of any such sanction so long as the delay and/ or failure of the supplier in fulfilling its obligations under the contract is the result of an event covered in the FM clause.”

Emphasizing the aforementioned clause the Ministry of Finance vide No. F. 18/04/2020-PPD dated 19.02.2020 clarified that the spread of coronavirus be considered as a case of natural calamity and force majeure may be invoked, wherever considered appropriate following the due procedure.

Furthermore, the Ministry vide No. F.18/4/2020-PPD dated 13.05.2020 released an office memorandum wherein it acknowledged that the current situation has affected the transportation, manufacturing and distribution of goods and services. The limitations placed on the movement of men and material have severely impaired the fulfillment of contractual obligations for supply of goods, works and consultancy services (including other services). Therefore, the Government also rightly acknowledged that with respect to Public Private Partnership (PPP) concession contracts, a part of contract may have become unremunerated and therefore, in such event the parties may extend the contract after following due procedure i.e. compliances with issuance of notice to other party for invoking the FM  clause.

The bottom line as to whether a party can have the advantage of force majeure or not shall majorly depend on the contractual provisions. The events constituting force majeure stipulated in the contract shall be considered to determine whether the performance of the contract may be extended or suspended or will stand frustrated.

Renegotiation:

However, in cases where the performance has merely become commercially more difficult but not impossible, parties could consider whether it would be commercially viable to suspend the contract, or use this opportunity to renegotiate the contract. Significantly, in projects where the beneficiary is the general public it is advisable to renegotiate the contractual terms without causing any hardships to either of the parties.

HON’BLE SUPREME COURT’S INTERPRETATION AND JUDGMENTS THAT ARE BINDING PRECENDENTS AND ENTAIN THE FORCE OF RULE OF LAW

The Supreme Court in a landmark judgment of Satyabrata Ghose Vs Mugneeram Bangur & Co (AIR 1954 SC 44) held that the doctrine of frustration is applied and relief is given only on the ground of subsequent impossibility when it finds that the whole purpose or basis of a contract was frustrated by the intrusion or occurrence of an unexpected event of change of circumstances which was beyond what was contemplated by the parties at the time when the parties entered into a contract. 

It was further upheld that when the contract itself contained implied or express term for discharging the obligations, then the parties would be governed by such contractual terms and it would be outside the purview of Section 56 of the Indian Contract Act.

In the case of Naihati Jute Mills Ltd. v. Hyaliram Jaganath MANU/SC/0348/1967 the Supreme Court clearly held that “The Courts have no general power to absolve a party from the performance of his part of the contract merely because its performance has becomes onerous on account of an unforeseen turn of events.”

 It could therefore be inferred that the performance under the Contract should be endeavored and every best effort should be made by the parties to fulfill the obligations under the Contract. For the reasons stated, the Company in good faith to fulfill its obligations can seek for extension after considering the provisions of the contractual agreement.

UNRAVELING THE LEGAL PERSPECTIVE TO THE TENABILITY OF THE ACTIONS VIS-A VIS EXTENSION AND COMPENSATION

From a legal perspective, unanticipated events which could not be reasonably contemplated by anyone at the time of entering into a commercial contract can be enumerated as follows:

a) Force majeure which includes Act of God such as natural calamities (floods, hurricanes, catastrophe, fires etc), war like conditions, strikes etc.

b) Change in law

c) Material Adverse Effect

As it is clear that a Force Majeure clause under a Commercial Contract primarily excuses a party from their obligations and therefore, non-performance would not attract liability or penalty under breach of agreement. In order to assess rightly that whether the proposed actions such as extension of the contract or compensation for the incurred expenditure should be taken or not depends on the threshold inquiry that “Whether the force majeure condition” in fact operated as a substantial impairment of the contractual obligations and if the response to the same is in the affirmative, then the private contractor is entitled to what extent?

The exercise is essentially a valuation of loss and legitimate time period necessary to complete a particular project further to commensurate the losses.

Having said this, in situation like the present, could be termed as a force majeure condition and can be said to be made applicable with respect to the Companies involved in executing the public interested projects which may invoke the same and thereby seek legal extensions and adequate compensation in order to fulfill the obligations under the agreement in good faith. Considering the financial crunches which the Company is undergoing due to the sudden halt in business activities and losses sustained due to inactivity, the Company after bringing forth the losses, the capital expenditure already incurred and operational expenditure which would be incurred when the activities resumes and which the Company is not in a position to bear, it may seek for compensation in order to maintain the state of preparedness whenever required for executing the project.

After considering the provision of law which act as guiding basis, notifications released by the Central Government and the Hon’ble Supreme Court’s interpretation on “force majeure’, it is thus pertinent to state that the Company may resort to the below mentioned:

1. After bringing forth the losses of the Company while clearly demonstrating that such losses are not attributable to its own fault and wherein the Company took all reasonable steps to mitigate the losses, it may seek for compensation from the government to enable it to maintain a state of preparedness whenever called for executing the scope of work under the agreement.

2. Considering the Company to have been competitively awarded the contract and after being conversant with the depressed state of affairs, the Company may legally seek for adequate extension on the basis of losses incurred to commensurate the losses that can be compensated. Therefore, the Company may accordingly seek for renegotiation of the contractual terms whereby the period would be extended to make good the losses incurred by the Company and in order to fulfill the obligations under the contract in public interest and further no hardships are caused to either of the parties.

Written by: Samiksha Gupta, Associate Advocate at SUO