While the world continues to battle the novel Coronavirus pandemic, and its dystopian affect on the society, businesses and corporations are in a struggle of their own. Less than four months after its first confirmed case in Wuhan, China, the unprecedented world-wide shutdown of economies and businesses have confirmed what the experts and agencies such as the World Health Organization had already declared, i.e. the Coronavirus pandemic, is unlike any other, in terms of its contagiousness and consequences. For the first time since World War II, the world is witnessing an event which has severely affected almost every major country and economy. It is not surprising, therefore, that businesses, both big and small, could not and would not have contemplated the disruption caused by this pandemic, while entering into transactions and agreements prior to its outbreak. Consequently, several businesses which have been severely affected by this pandemic, are looking to get out of their pre-existing contractual obligations, while others are trying to use this pandemic as an excuse to wiggle out of contracts, they otherwise did not want to perform.
The present article explores the existing Contractual Law in India, for provisions dealing with the affect the present pandemic on existing contractual liabilities, while also suggesting possible legislative interference to balance the principle of sanctity of contracts, with the need to protect parties who are forced to perform their obligations under dire commercial stress.
Sanctity of Contracts
The doctrine of sanctity of contracts is considered to be a critical pre-requisite for economic growth and stability, and is the foundation of the law of contracts. In simple terms, the law of contracts is premised on parties fulfilling promises made to each other, pursuant to a legal agreement entered into between them. The global supply chain runs of millions of transactions and contracts being entered into every day, internationally as well as locally. Protecting the sanctity of contracts, therefore, is necessary for any country that purports to establish confidence in its functioning and the functioning of its businesses and corporations.
However, there are circumstances, such as the present pandemic, when the performance of contracts become impossible. The law of contracts accounts for such circumstances, and releases a party from its obligations to perform a contract where performance has become impossible as a result, of events out of the control of that party. Such release from contractual obligations, can either be the result of a Force Majeure (literally, superior force) clause incorporated within the particular contract sought to be avoided, or it can be based on the doctrine of frustration of contract contemplated within Section 56 of the Indian Contract Act, 1872. Each of these have been separately discussed hereinafter.
Force Majeure Clause
A force majeure clause is a contractual provision that allows a party to suspend or terminate the performance of its obligations when certain circumstances beyond their control arise, making performance inadvisable, commercially impracticable, illegal, or impossible. Although the clause may differ from contract to contract, it generally includes a list of events that may trigger the clause, the obligations of the parties in case the clause is triggered, and the release of the defaulting party from performance and/or payment of damages in case the clause is triggered. Typical force majeure events include war, government intervention, strikes, act of god, natural calamity etc.
Whether or not a force majeure clause in a contract, can be invoked on account of the present pandemic, will be subject to the terms and interpretation of the specific clause incorporated in the contract. Further, even the consequence of the invocation of the force majeure clause may vary from contract to contract. It may include consequences including but not limited to termination rights, suspension of performance of the affected party’s obligations while the effect of the force majeure event continues etc. However, some contracts place a time limit on the suspension and may give the non-affected party (and sometimes also the affected party) the right to source goods or services from elsewhere or to terminate the contract if the affected party remains unable to perform its obligations for a specified period.
Invoking the force majeure clause, more often than not, is subject to certain obligations being carried out by the affected-party. Although some contracts may provide more detailed obligation and procedure, the following basic requirements are incorporated in almost all contracts:
- Notice of invocation of force majeure clause: The affected party ought to notify the other party of its intention to invoke the force majeure clause, as soon as may be possible after the occurrence of the force majeure event. The notice should specify the nature of the event, how the occurrence of the event has impacted the affected party’s ability to perform the contract and the plan of action that the affected party proposes to follow with respect to the contract.
- Mitigation of Damage: The party affected by the force majeure event should, as far as may be possible, attempt to reduce and mitigate the damage and/or impact of the force majeure event on the performance of the contract.
Even if the contract does not require the above-mentioned obligations on part of the affected party, it is advisable to comply with them as a good faith requirement, that may help prove the bonafides of the affected party, in case the non-affected party later sues it for breach of contract.
Pertinently, in India, as in most common law countries, a force majeure clause cannot be read into, or implied to a contract, if it is otherwise not expressly/implicitly included. However, a vast number of transactions in India, are carried out on the basis of boilerplate clauses in the Invoice or the Purchase Order, which more often than not, do not include a force majeure clause. Parties to such transactions, if their performance has been affected by the present pandemic, will have to rely on the Doctrine of Frustration to justify non-performance of their obligations.
Doctrine of Frustration
The doctrine of frustration of contract flows from the Section 56 of the Indian Contract Act, 1872, the relevant part of which is as under:
“Contract to do an act afterwards becoming impossible or unlawful.—A contract to do an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.”
As the section reads, if the performance of the contract is rendered impossible and/or unlawful, on account of circumstances beyond the control of the parties to the contract, the contract becomes void, and need not be performed. Consequently, as an illustration, if the export of certain drugs has been disallowed by the Indian Government on account of Covid-19, a contract for the export of such drugs becomes void, and the purchaser cannot sue the seller for breach of contract or specific performance.
The doctrine of frustration is based on the premise that people enter into a contract on the basis of the facts, circumstances and law existing at the time of the execution of the contract. If such facts, circumstances and/or law is subsequently changed, and such change has the affect of making the contract impossible and/or illegal, the parties cannot be expected to honour their obligations by committing a violation of law, or by doing impossible tasks.
Pertinently, the word “impossible” in the above mentioned section, has not been used in the sense of physical or literal impossibility. The performance of an act may not be literally impossible but it may be impracticable from the point of view of the object and purpose which the parties had in view. If an untoward event or change of circumstances totally upsets the very foundation upon which the parties rested their bargain, it can very well be said that the promisor finds it impossible to do the act which he promised to do. However, what constitutes such impracticability is subject to the interpretation of each contract along with the facts and circumstances of the particular case.
Even though there are no statutory requirements for invocation of doctrine of Frustration, it is advisable that the aforementioned steps of issuing prompt notice to the other party, and mitigation of the impact of the event responsible for frustration, be followed, to prove the bonafides of the party invoking the doctrine of frustration, in case the other party later sues it for breach of contract.
Disputing the Invocation of Force Majeure Clause/ Doctrine of Frustration
Although there will be numerous cases of parties legitimately finding themselves unable to perform their contractual obligations on account of Covid-19 and the consequential lockdown, there will also be numerous cases of parties unaffected by the pandemic, trying to bail out of their contractual obligations under the garb of Covid-19. The courts have time and again held, that the doctrine of impossibility, which is based on equity and common sense, cannot be permitted to become a device for destroying the sanctity of contract.
It is therefore essential to note the circumstances that would not justify the invocation of either the force majeure clause (unless the contract states otherwise) or the doctrine of frustration –
- Commercial Impracticality: Commercial impracticality cannot be the basis for non-performance of a contract. A party cannot avoid its obligations under the contract, simply because performance of the said obligations would be uneconomical or unprofitable.
- Delay in Performance: Mere delay in performance of the contract does not amount to frustration, unless the performance has been so inordinately postponed, that its fulfilment, when the delay is over, will not accomplish the objects which both the parties to the contract had in mind. If the delay is within the commercial risks undertaken by the parties and it does not frustrate the commercial purpose of the contract, there can be no frustration.
- Performance of the Contract has become Onerous: The performance of a contract cannot be avoided merely because it has become difficult, inconvenient or burdensome to perform the contract. In general, the courts have no power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.
- Lease Agreements: A Lease Agreement creates an interest in land, in favour of the lessee. The doctrine of frustration under Section 56 of the Indian Contract Act, therefore, does not have any application in cases of Lease Agreements. The doctrine of frustration can only put an end to purely contractual obligations, but it cannot destroy an estate in land which has already accrued in favour of a contracting party.Where the property leased is not destroyed or substantially and permanently unfit, the lessee cannot avoid the lease because he does not or is unable to use the land for purposes for which it is let to him.
- Leave and License Agreements: Although the law in this regard is not settled in India, it stands to reason that a leave and license agreement is not frustrated merely because the premises given for leave and license cannot be temporarily used by the licensee on account of the Covid-19 lockdown. Payment of rent or license fees, in such circumstances, may be burdensome for the licensee, but as stated above, commercial impracticality cannot be the basis for avoidance of contract. However, a force majeure clause contemplating such circumstances may be invoked to avoid the payment of rent during the persistence of the lockdown.
Need for Legislative Interference
To mitigate the impact of Covid-19 pandemic and to ensure the continuity of viable businesses, the government has already started taking several measures.
The Reserve Bank of India has announced that in respect of all term loans (including agricultural term loans, retail and crop loans), all commercial banks (including regional rural banks, small finance banks and local area banks), co-operative banks, all-India Financial Institutions, and NBFCs (including housing finance companies) are permitted to grant a moratorium of three months on payment of all instalments falling due between 1st March, 2020 and 31st May, 2020. Moreover, in respect of working capital facilities sanctioned in the form of cash credit/overdraft, the lending institutions have been permitted to defer the recovery of interest applied in respect of all such facilities during the period from 1st March, 2020 upto 31st May, 2020. Several other measures have also been taken in this regard, to mitigate the burden of debt servicing brought about by disruptions on account of Covid-19.
The Central Government has also notified a raise in the threshold for invoking insolvency under the Insolvency and Bankruptcy Code to Rs 1 crore from the current Rs 1 lakh with a view to prevent triggering of such proceedings against small and medium enterprises that will be adversely affected by the pandemic.
Although these measures are laudable, they are far from sufficient. The Covid-19 pandemic appears to have presented a rare circumstance, where legislative interference in private contracts may be necessary. Countries like Singapore are deliberating measures such as those provided by the Covid-19 (Temporary Measures) Bill. The Bill, which has been tabled before the legislature of Singapore, contemplates certain reliefs for specific contracts which had to be performed, in full or in part, after 1st February, 2020, but excludes those signed after 25th March, 2020. The reliefs contemplated therein, include giving businesses and individuals 6 months’ relief from legal action, if they are unable to fulfil contractual obligations on account of the pandemic. It also prohibits landlords from terminating a lease due to non-payment because of the Covid-19 outbreak. Measures such as these would not only give much-needed liquidity to commercial parties and allow for the revival of the economy, but will also allow parties to revive their businesses without the impending threat of legal action. It will also give parties time, to settle commercial disputes amicably, instead of rushing to court, thereby relieving the burden off the legal system, which would be anyway caught up in the backlog of cases not heard during the lockdown. Such a temporary buffer period, is being considered as a legal circuit-breaker, necessary to allow the businesses to adjust to the new normal, that has been created by this pandemic. However, it remains to be seen if the Indian Legislature would be willing to adopt such zealous measures.