Covid-19 and the resulting lockdowns across countries have caused a lot of confusion and there is a lack of clarity on the impact of this unprecedented event on commerce and business.
The impact may span across contractual obligations, capital market transactions (IPOs, rights issue, etc), listed company transactions (such as takeover open offers, preferential issues, buy back of shares, etc), private equity exits, regulatory compliances, real estate transactions, employment matters, etc.
From a corporate transactional perspective, force majeure could be in the form of a "material adverse effect" or a "material adverse change".
In this article, we have attempted to anticipate the major issues and considerations around Covid-19 as a "force majeure event" from the perspective of contractual obligations.
What is force majeure?
The Indian Contract Act, 1872 (Contract Act) does not define the term "force majeure". This term is usually defined in contracts and has also been interpreted by various Indian courts from time to time.
A force majeure clause is a contractual provision which alters the rights and obligations of parties to the contract due to the occurrence of extraordinary events or circumstances beyond their control which prevents one or all of them from fulfilling their obligations.
Section 32 of Contract Act, which deals, amongst other things, with contingent contracts provides the legal basis for a force majeure clause. If a contract includes a force majeure clause, that will apply strictly and if an event such as Covid-19 is envisaged as a force majeure event, the consequences envisaged in the contract will apply.
Section 56 of Contract Act incorporates the Common Law doctrine of frustration and provides that contractual obligations which become impossible or unlawful to perform by virtue of an event which could not be prevented by the affected party, will become void once such obligations become impossible or unlawful to perform. The stringent threshold of establishing impossibility or unlawfulness under Section 56 has to be met.
Types of force majeure clauses in contracts
Force majeure clauses in contracts typically adopt three broad approaches to defining what type of event may excuse a party from its contractual obligations:
(a) Specific language: These may include specific events such as war, terrorism, acts of government, act of god, etc.
(b) General or residuary language: Such clauses usually end with words like 'beyond the reasonable control of parties' to be a force majeure event.
(c) Combination of specific and general language: More common type of clauses would contain both the specific as well as the general or residuary language as set out in (a) and (b) above.
What do contracts provide on the occurrence of a force majeure event?
Usually, force majeure clauses provide that upon the occurrence of a force majeure event, the party affected by such an event would be entitled suspend the performance of its obligations during the continuance of the force majeure event. Further, if the force majeure event continues for a certain period, the other unaffected party would be entitled to terminate the agreement. Some contracts may go into further details and provide for other specific consequences.
What you should consider while deciding to opt out of your contractual obligations?
1 Are you restricted or prevented or unable to perform the contract as a direct result of the lockdown and/ or Covid-19?
2 Does your contract have a force majeure clause? If so, does your clause include non-performance of the contract due to the lockdown and/ or Covid-19?
3 If your contract does not have a force majeure clause, has it become impossible or unlawful for you to perform your obligations under the contract due to the lockdown and/ or Covid-19?
4 Are your obligations under the contract dependent on the happening of the event which event has become impossible due to the lockdown and/ or Covid-19?
5 Does your contract contemplate any alternative means of performing your obligations even if such alternatives involves a higher cost?
6 Are you required to invoke the force majeure clause by communicating it in a timely manner? Ensure that your communication invoking force majeure is in line with the contract?
Some important principles derived from judicial precedents
Please also understand some of the following important principles which have been derived from Indian case laws:
1 When a contract contains a force majeure clause which is applies to the facts of the case by the Court, Section 56 (which refers to the contract becoming impossible or unlawful to perform) will not apply.
2 For Section 56 to apply, "impossibility" would not necessarily mean physically or literally impossible. It may be shown that it is impracticable and useless to perform considering the object and purpose for which the parties executed the contract.
3 A party to the contract cannot be relieved from the performance of a contract merely because performance may become onerous to such party due to an unforeseen turn of events. In other words, merely because performance of the contract involves higher costs or is more difficult, does not relieve a party from its obligations.
4 The language in the force majeure clause will be reviewed carefully or narrowly. When the clause contains general or the residuary language, it will be read with the words which precede and follow it. The overall nature and general terms of the contract will also be considered in interpreting.
Some general observations
Based on the legal provisions and judicial precedents discussed above, it is important to understand that both, a force majeure clause in the agreement as well as the application of Section 32 and Section 56 of the Contract Act, are typically narrowly interpreted by courts.
If you would like to claim relief under Section 56 of the Contract Act, impossibility or unlawfulness of performance of obligation will need to be proved. To claim relief under the force majeure clause, the occurrence of one of the events set out in the force majeure clause will need to be proved.
Although Covid-19 has been declared as a pandemic by the World Health Organisation and various governments including the Indian central and state governments, such a declaration would not by itself prove force majeure or impossibility or unlawfulness for all contracts.
If you are seeking to avoid your obligations under the contract you will need to prove that you are not able to perform your obligations due to the current lockdown as contemplated in the force majeure clause or that it has become impossible or unlawful for you to perform your obligations. Additionally, you will also need to show that you have taken all reasonable steps that could have taken by you to avoid or mitigate the event or its consequences.
Typically, an increased economic cost for, or an increased difficulty in, performance is an insufficient basis to claim force majeure would highlight that there is an alternative way to perform your obligations and therefore, it is not impossible or unlawful to perform your obligations.
Having said the above, considering the unprecedented nature of Covid-19 pandemic, the Courts may be generous in their interpretation of the resulting unanticipated circumstances and wordings of a force majeure clause (if any) when faced with parties who are facing genuine obstacles in performance of the contract.
In this context, an ad-interim order was passed by the Bombay High Court on 30 March 2020 in the case of Rural Fairpice Wholesale Limited and Anr vs IDBI Trusteeship Services Limited and Ors. In this order, the Bombay High Court took notice of Covid-19 and provided ad interim relief to the plaintiffs. This was a financing transaction and IDBI Trusteeship Services Limited wanted to sell the pledged shares as the share price substantially fell. It does not appear that the relevant contract had a force majeure clause, however, the Bombay High Court granted the ad interim relief citing Covid-19. While this was only an ad interim order, this does give an indication that Courts may take an approach based on fairness and equity rather than a technical approach.
However, given that the Court would assess the circumstances presented to it on a case-to-case basis, it is crucial for you to review the terms of your contract and understand your rights and obligations and plan accordingly.
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