By: Arpit Lahoti and Sherry Shukla
The world is going through a social, economic and medical crisis right now. COVID-19 has rampantly shivered the world at large. Be it the health of the citizens or the economy of states, everything has been affected by this pandemic, but there exists more to what is evident right now; the primary concern, without any doubt, is the health of the citizens and to strive out of this outbreak by controlling it as soon as possible. The legal dimensions, however, remain unanswered.
The fact whether this outbreak was anticipated or not is still a question for debate, however, what is evident is that the commercial world, at large, must not have anticipated it. There exists no logistics to find out the exact number of contracts that were entered into or where performance was required in this time phase, however, it can be assumed that the damage done is quite huge.
In this situation, the major doubt which exits is regarding what happens to such contracts that are affected due to this pandemic. To answer this, the law of contracts has to be looked into. The current dilemma is whether to treat this pandemic as a force majeure, or simply to consider it as frustration of contract, or neither of them. This article attempts to answer this legal dilemma by relying on the principles of contract law and also on the recent decisions of various countries and courts worldwide on answering this dilemma.
To classify as a force majeure, there must be an unforeseen event or a circumstance that wholly or partly prevents the affected party from performing its obligations under the agreement. The courts have defined force majeure as an event or effect that can neither be anticipated nor be controlled.
A force majeure clause can broadly be divided into two types:
- Natural force majeure event – It includes natural disasters like drought, fire, earthquake, volcanic eruption, landslide, typhoon, adverse weather conditions etc. which could never be predicted given the statistics of the last hundred years.
- Non-natural force majeure event – It includes acts which are not natural force majeure events. It can further be divided into further types:
- Direct non-natural force majeure event – It includes nationalisation or mandatory acquisition by the government, refusal of consent required by the sellers or the unlawful, unreasonable or discriminatory revocation of, or refusal to renew, any consent required by the seller or any of the sellers’ contractors to perform their obligations, or any unlawful, unreasonable or discriminatory refusal to grant any other consent required for the development or operation of the project, provided that an appropriate court of law declares the revocation or refusal to be unlawful, unreasonable and discriminatory and strikes the same down or any other unlawful, unreasonable or discriminatory action on the part of the Government of India.
- Indirect non-natural force majeure event – It includes any act of war (whether declared or not), invasion, armed conflict or an act of a foreign enemy, blockade, embargo, revolution, riot, insurrection, terrorist or military action, or radio-active contamination or ionising radiation originating from a source in India, or industry-wide strikes and labour disturbances having a nationwide impact in India.
A force majeure clause, however, must exist in the contract. It is an express provision in the contract providing for the circumstances in which the parties may be excused from performance under the contract. The motive behind such clause being to save the performing party from the consequences of any such thing over which the party had no control. To claim force majeure, a requirement is that it should primarily exist in the contract. The second requirement which stands is that such an event due to which the performance cannot be done must be covered by such force majeure clause. Though ‘act of nature’ and ‘Act of God’ are often used in contracts worldwide, the authority as to whether an epidemic falls within either category, particularly when the force majeure clause does not specifically refer to it, is very limited.
To analyse the force majeure clause, courts worldwide have often considered various other secondary factors along with the primary factor, i.e., the force majeure clause itself. For example, the courts refuse to consider adverse market conditions (even if sudden and unpredictable), a party’s financial situation, or other circumstances that may have made it difficult but not unforeseeably impossible for a party to perform under the contract. Even in cases of severe economic downturn, such as the economic crisis in 2008, or natural disasters, such as Hurricane Sandy, New York courts had refused to apply a force majeure clause because of financial difficulty or economic hardship on the ground that the contracting parties bear this risk in commerce. Further, a breakdown in commercial negotiations does not constitute a force majeure event. In Wuhan Airlines v Air Alaska, Inc., Air Alaska denied performance relying on the lease’s force majeure clause. However, the court held that the dispute between the parties did not constitute an event specifically listed in, or even one similar to those listed in, the force majeure clause, and thus, Air Alaska was not exempted from the performance of the contract as the same wasn’t covered by the force majeure clause. Further, the cases provide many illustrations of the principle that a force majeure clause will not normally be construed to apply where the contract provides for an alternative mode of performance.
China has categorically adopted a different approach in this situation. The China Council for the Promotion of International Trade has encouraged businesses that have failed to perform on time, or failed to fulfill an obligation in an international trade contract due to the coronavirus outbreak, to apply for a ‘force majeure certificate’ excusing their performance. Recently, it issued such a certificate to a manufacturing company in Zhejiang province, potentially stalling a damages claim of approximately USD 4.27 million against the same.
It can be reasonably concluded that the courts have to make an effective interpretation of such force majeure clauses in contracts and find whether such clauses include pandemics or not. Another alternative to fit this pandemic in the force majeure clause can be to consider it as a direct non-natural force majeure event as the pandemic was followed by compulsory lockdown in most of the states, thus rendering it beyond the control of parties and is something which the parties could not have anticipated. However, realising that this epidemic has already caused huge damage to the world economy, the courts should adopt a liberal approach in interpreting such force majeure clauses, and thus, prevent further damage to the contracting parties; if possible, the courts should rather focus on the fulfillment of the contract by giving time to perform the contract.
FRUSTRATION OF CONTRACT
To claim force majeure, the clause must expressly exist in the contract. However, in cases where such a clause does not exist, the contract law provides for another mode to discharge the liability of the performing party. The English courts had first used this doctrine in Taylor v Caldwell, wherein the destruction of an opera house by fire was treated as frustration of the contract as the primary thing on which the contract was dependent ceased to exist. The doctrine got its name in the case of Krell v Henry, wherein the cancellation of a procession (for which an apartment was rented) led to the frustration of the contract.
The Indian Contract Act also provides for the doctrine of frustration of contract, wherein the performance of the contract becomes impossible because the event in place becomes impossible or unlawful, and the parties could do nothing to render its possibility.
The Indian courts have made extensive use of this doctrine making its application very clear. In the Satyabrata Ghose case, the court held that the performance of an act may not be impossible but it may be impracticable and useless from the object and purpose of the parties revealing that the term ‘impossible’ is not to be strictly construed in its physical or literal sense. Additionally, if an untoward event or change of circumstance affects the foundation of the contract, it can be deduced that it has led to the impossibility of performance by the parties.
Further, it is only in case a situation arises which is fundamentally different than what was negotiated, that the contract ceases to bind the parties. The performance of a contract is never discharged merely because it becomes onerous to one of the parties. However, there have been contrary judgments as well. For instance, when the original mode of transportation was Suez Canal, and on its subsequent closure, the parties claimed impossibility of performance, the court held that the contract of sale of groundnuts, in that case, was not frustrated, even though it would have to be performed by an alternative mode of performance which was much more expensive and that such increase in the expense did not fundamentally alter the contract. A rise in expenses cannot be held as a ground for the frustration of a contract.
There exists a multi-factorial approach that has to be applied while dealing with the doctrine of frustration; the intention and knowledge of the parties, their expectations, the terms of the contract, nature of risk anticipated, supervening risk etc. have to be considered. The effect of the frustration of a contract is that it renders the contract void, thus discharging the parties of their contractual obligations. However, if in case there is any advantage to any of the parties forming such a contract, the party with the advantage has to compensate for the same.
The Indian Approach
Recently, the Bombay High Court made an important observation while answering this dilemma wherein one of the parties had claimed force majeure due to the coronavirus pandemic. They rejected it on the ground that steel, which was the material the company was dealing in, was declared as an essential service and the contract could have been performed. Emphasis also has to be made on the court’s observation that the lockdown would continue for a limited period and the parties cannot use it as an escape from its contractual obligations.
The Delhi High Court, however, while dealing with a petition for interim relief under the Arbitration and Conciliation Act, 1996, for restraining the respondent from invoking bank guarantees, held otherwise. The respondent had argued that due to nationwide lockdown, it was not able to perform the contract, and thus, invoked the force majeure clause. The petitioner, however, argued that the respondent was dealing with petroleum which was an exempted commodity; the court clarified that the respondent was dealing with petroleum drilling and not petroleum per se. The court further held that it was convinced that this lockdown fitted as a force majeure, and thus, granted the interim relief.
The Singapore Approach
The Singapore Parliament, on 7 April 2020, passed the COVID-19 Temporary Measures Act, which provides for relief, such as freezing any kind of legal action for the breach of contract for the period of the next six months. The parties can claim relief under this Act if the performance of the contract was to be completed on or after 1 February 2020. The parties will have to show that the inability of performance was due to a national or international law that was passed in this time of the pandemic. However, the Act applies only to the following type of contracts:
- Loan or Finance Contracts (where the producing unit office is in Singapore).
- Construction and Supply Contracts.
- Hire Purchase Agreements about commercial vehicles or fixed assets or plant machinery located in Singapore itself.
- Event Contracts.
- Tourism-related Contracts.
- Lease or License Contracts relating to non-residential immovable property.
The Act further provides for various reliefs like restraining arbitral proceedings, bankruptcy proceedings, termination of the said hire-purchase agreements etc. Further, non-compliance of the Act could result in a criminal conviction and a fine amounting to USD 1,000. Thus it can be said that this temporary Act is comprehensive enough to help the sectors of the economy in a time when many of them are bleeding.
It has to be emphasised that in this situation of crisis due to the coronavirus, the frustration of contracts will be a more feasible option with the parties as compared to the force majeure clause since the frustration of a contract requires no explicit mention in the contract whereas claiming force majeure does. The principle of compensating the party at loss should further be applied to maintain the status quo between the parties. The parties who claim force majeure will have to prove before the court that such a pandemic was not anticipated by them. Further, the courts will have to see that such frustration is due to the absolute impossibility of performance and there exists no other alternative to fulfil the performance of the contract. If a liberal interpretation is adopted in this case, it will lead to a situation where the parties will try to simply claim the impossibility of performance and get rid of performing the contract. Thus, the courts have to adopt a strict interpretation in cases involving claims of the frustration of contracts, and if there exists any alternative mode of performing the contract, the court should look into it rather than simply striking all the options by adopting a liberal approach.
With the world already adopting methods to curb the issues faced due to this pandemic, there is surely a lot to see as to how effective these methods will be. The Indian High Courts’ approach towards this pandemic seems to be different and diverging, however, the reasoning applied by both the courts, as discussed before, is satisfactory, as the courts are neither adopting a liberal nor a strict approach in dealing with this pandemic and are rather applying the law on a case-to-case basis. Also, the recent enactment of the COVID-19 Temporary Measures Act by the Singapore Parliament acts as a great example to the world in overcoming, or at least, reducing some harm caused to the economy due to the COVID-19 pandemic. The nations worldwide would have to apply such an approach to save their economies and also to curb the financial loss faced by parties, thus acting as saviours to fight this pandemic.
(Arpit and Sherry are currently law undergraduates at Maharashtra National Law University, Nagpur. They may be contacted via LinkedIn here and here, respectively.)
Cite as: Arpit Lahoti and Sherry Shukla, ‘Coronavirus: Answering the Legal Dilemma’ (The RMLNLU Law Review Blog, 13 May 2020) <https://rmlnlulawreview.wordpress.com/2020/05/13/coronavirus-answering-the-legal-dilemma > date of access.