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We all know the outbreak of COVID-19 or Coronavirus has been worldwide disaster that started in late 2019 in Wuhan, China.  It took a horrifying turn by March 2020 when the World Health Organisation (WHO)1 declared COVID-19 as a worldwide ‘pandemic’.


On that very day, the Government of India issued a Revised Travel Advisory inter alia suspending all existing visas until April 15, 2020 (except diplomatic, official, UN/International Organisations, employment, project visas). Many countries took similar precautions.

COVID-19 was officially declared an ‘epidemic’ by the National Disaster Management Authority (NDMA) of India -- one that is certain to severely impact businesses and transactions throughout India and the world. And now, we have entered what we call the second stage of its spread throughout India. The Prime Minister of India has ordered complete lockdown of the country until April 14, 2020 to contain the damage.

What does that have to do with contracts in all nations?  Very much, indeed – for starters, force majeure.  Striking suddenly with worldwide impact, COVID-19 is a force majeure event described as “an event or effect that can be neither anticipated nor controlled, esp., an unexpected event that prevents someone from doing or completing something that he or she had agreed or officially planned to do…”2 India’s law relating to force majeure (‘superior force’) is described under Section 32 and Section 56 of the Indian Contracts Act 1872.3

If a force majeure event occurs, parties to the contract are protected from liability if the parties so affected cannot perform a contractual obligation. A typical force majeure event includes an Act of God or natural disasters, war, or war-like situations, labor unrest or strikes, epidemic, pandemic, etc.

Most Indian contracts have a force majeure clause in them to save a performing party (or parties) from the consequences of anything over which a party has no control. The Government of India has classified COVID-19 as an epidemic and believes that the spread of COVID-19 falls within the definition of ‘Act of God’ as a natural calamity.

In other words, India has clarified vide the Office Memorandum No F. 18/4/2020-PPD dated February 19, 2020 of the Government of India, Ministry of Finance, Department of Expenditure, Procurement Policy Division,4 that in consideration of a disruption of the supply chains due to spread of COVID-19 in China and other countries, this may be considered as a ‘natural calamity’ and  force majeure clauses may thus be invoked.

Whether or not a contractual obligation can be avoided on the grounds of  force majeure is a determination set forth by the specific terms of the contract. The courts would examine, whether, in each case, the impact of a COVID-19 pandemic prevented the party from performing its contractual obligation.

Indian courts have generally recognized this concept and have enforced it where appropriate. Thus, one may argue that the impact of COVID-19 on the ability of the party to perform its obligations under a contract may be identified as a force majeure event. In addition, courts may also require a party to show that the party attempted to perform the contract  -- in spite of the event occurring -- perhaps by finding an alternate source of supply.

Can a force majeure clause be invoked under the contract?

A  force majeure clause cannot be invoked under Indian law. It must be expressly provided for under the contract, and any protection applicable will depend on the language of the clause. If a dispute arises as to the scope of the clause, the courts are likely to apply the usual principles of contractual interpretation.

Can a force majeure clause be successfully invoked in light of COVID-19 being declared a pandemic?

A COVID-19 pandemic could make it more difficult for parties to perform their contractual obligations. Two instances suggest that a force majeure clause covers a pandemic:

  1. If the contractual definition of a force majeure event expressly includes a pandemic. Adding a specific pandemic to the list of force majeure events will provide clarity as to whether COVID-19 outbreak would trigger a force majeure clause in a contract.
  2. If the force majeure clause covers extraordinary events or circumstances beyond the reasonable control of the parties. Such general, catch-all wording may be invoked if it is determined that the factual circumstances caused by the pandemic are beyond reasonable control of the affected party.

Having said that, whether a party can be excused from a contract on account of COVID-19 being declared a pandemic is a fact-specific determination that will depend on the nature of the party’s obligations and the specific terms of the contract.

COVID-19 and the term, “frustration”

The term “frustration” is defined under Section 56 of the Indian Contracts Act of 1872. The leading precedent or judgement with respect to “frustration” is the court case of Satyabrata Ghose v. Mugneeram Bangur and Co. wherein the Honourable Supreme Court of India has referred to Section 56 of the Indian Contracts Act 1872.5

The Honourable Supreme Court of India held that the word “impossible” has not been used in this Section in the sense of physical or literal impossibility. The Performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose of the parties.

The court further states that in situations wherein it is found that the contract itself either implied or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract will take place under the terms of the contract itself and such cases will be dealt with under Section 32 of the Indian Contracts Act 1872.6

WHAT IF YOU FACE ANY OF THE FOLLOWING?

An anticipatory breach

  • A party that demonstrates its intent not to perform under a contract can cause an anticipatory breach of contract which would excuse the other party from its own performance obligations. 
  • For this reason, in addition to considering its own ability to perform, a party should consider whether its counterparties can and/or will meet their obligations under the contract.

 Insurance and indemnity agreements

  • Companies should evaluate which insurance rights might cover losses arising out of a party’s inability to meet its contractual obligations. Depending on the policy and specific facts, business interruption insurance policies may provide coverage.
  • Indemnity rights under contracts may provide relief from claims arising from commercial disruptions.

 Notice and communications to counterparties

  • Parties considering any of the above issues should carefully review the notice requirements in their agreements. Failure to comply with formal notice requirements—which may require prompt notice and regular updates—can prejudice a party’s ability to excuse non-performance or secure indemnification.
  • Beyond the strict letter of an agreement, early communication with counterparties may help avoid disputes and promote coordinated solutions.
  • Organizations facing the possibility that they will be unable to perform under existing contracts, or facing the risk of non-performance by counterparties, will need to proactively and promptly review relevant contracts, and recognize that early communication may be critical. And companies not currently negotiating agreements should consider whether to include provisions expressly allocating and mitigating the commercial risks from COVID-19.

Termination of the agreement

A standard  force majeure clause provides for termination of the agreement if the force majeure event continues for a specific period of time.

If a party serves an initial notice reporting their inability to perform the obligations under an agreement due to an onset of force majeure, then the party can terminate the agreement by serving another notice, in case the force majeure event continues. The Termination clause will not be a risk to the party and the party will be suitably compensated for the work already done.

In addition to the above, the parties may consider invoking other contractual clauses to limit or exclude liability for non-performance – such as price adjustment clauses, material adverse change clauses, or limitation or exclusion clauses. The ability to invoke such clauses will depend on the wording of the relevant clauses and how they are construed by courts.

Furthermore, companies should also consider the ramifications of non-performance clauses under the agreement, such as liquidated damages clauses and penalty clauses under which the extent of non-performance has been predetermined and agreed by the parties .

Conclusion – what is most important to consider?

While it is clear that COVID-19 is an epidemic and qualifies as a force majeure, its implication under a specific contract will depend upon the arrangement and understanding in the applicable contract. India’s sudden lockdown has halted the Indian economy and the contractors have not been allowed at any time to demobilize their personnel or  machinery.

Currently, the lockdown is for 21 days, but if the situation is not brought under control, it is entirely possible the lockdown period may be extended. If this happens, huge claims due to idled resources and costly losses will occur resulting from downtime of contractors’ equipment. These claims will not be settled easily and will result in a large amount of dispute resolution cases and litigations. To avoid this, the Government of India should ask the respective ministries to speak to contractors affected and try to define a common understanding on the situation and its treatment.

Critical considerations – steps toward resolution

  1. If you believe you may not be able to perform a contract due to the coronavirus outbreak, consider when you can realistically resume being in compliance. Review the contract to assess the impact on your organization due to your non-performance.
  1. Communicate early with the other party on a good faith basis in an attempt to resolve the situation. Consider whether part of the contract may still be performed.
  1. If your business partner is the one who may breach a contract, you should review the contract carefully to evaluate available options, and take all reasonable steps to mitigate your losses as far as possible. Consider whether failure of this contract may in turn affect your own performance under your other contracts, in which case you should also take the actions described above.
  1. In any case, document in writing all the circumstances leading up to the current situation. If both parties still want the contract to proceed, explore other options through good faith negotiations, for example time extensions, contractual amendments, or waivers of certain obligations. If you reach agreement going forward, do get it in writing.

Getting results through a good faith negotiation is preferable to a formal dispute resolution process. It is important to preserve long-term business relationships and recognize that all businesses are facing difficulty in this environment. That said, if you recognize signs that the relationship is breaking down, consider whether you need professional advice about your legal rights to better inform your discussions with business partners.

END NOTES

  1. Rolling updates on coronavirus disease (COVID-19) Updated 2 April 2020, World Health Organization (WHO) article
  2. See definition of FORCE MAJEURE in article titled Force Mineure and Contracts That Aren’t Performed Because of Epidemics: The Volokh Conspiracy
  3. Ref: ‘Force Majeure’, ‘Act of God’ & Doctrine of Frustration Under Indian Contract Act [Explainer]: in, 28 Mar 2020
  4. Government of India Office Memorandum dated 19 Feb 2020 update
  5. Section 56 of the Indian Contract Act 1872 explained
  6. See also article titled COVID 19 AND THE SHUT DOWN: THE IMPACT OF FORCE MAJEURE

ABOUT THE AUTHOR

Mohit Khullar Head of Commercial and Contracts with SMEC (India) Private Limited and is a part of the Senior Management in India. He carry along a rich and proven track of more than 19 years in the areas of Contracts Management , Commercial Management, Drafting and negotiations and Business strategies

 

 

Mohit Khullar Head of Commercial and Contracts with SMEC (India) Private Limited


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