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COVID-19: ANALYSIS OF CONTRACTUAL OBLIGATIONS AND FORCE MAJEURE

By Rajat Prakash

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COVID-19 pandemic has caused a lockdown in many countries in order to prevent the spread. This has resulted in a stoppage of work and further, created problems in delivering on the contractual obligations. The Indian government also announced a lockdown from the 24th of March till 14th of April. This has resulted in corporates and individuals reviewing their contracts in order to invoke Force Majeure for suspending the obligations in the contracts.

FORCE MAJEURE

The term has originated from the French language and finds its roots in ‘Code Napoleon’. Over the years and in theusage of the same in the contractual sphere, it has been defined as ‘an irresistible force or compulsion such as will excuse a party from performing their part of the contract’. A Force Majeure clause is usually put in all contracts in orderto prevent termination of the same due to unforeseeable circumstances that render performance of contractual obligations as impossible and/or difficult to perform. The Hon’ble Supreme Court in the case of DhanrajmalGobindram vs. Shamji Kalidas, (1961) 3 SCR 1020 has held that the term force majeure is of wider import. Judges in the past have agreed that where the reference is made to force majeure, the intention is to save the performing party from the consequences from the anything over which he has no control.

The COVID-19 pandemic is a Force Majeure event that can be covered under contracts but, not all contracts have the same clause. For the coverage of this pandemic in the Force Majeure clause, it should encompass within its ambit, ‘prevention of fulfilment of obligations due to governmental restrictions’, ‘any unforeseen circumstance that prevents the fulfilment of obligations’ or specifically mentioning a ‘pandemic/epidemic’ as an event that would come within the ambit of Force Majeure. But some clauses do not have the same wording and are limited to a few circumstances only, in which case invoking the clause would not do much good unless both the parties to the contract mutually decide to suspend the operation of the contract for a specific period of time. In the absence of such mutual understanding the party which is not able to fulfil the terms of the contract can invoke the ‘Doctrine of Frustration’, which has been dealt with herein-below.

DOCTRINE OF FRUSTRATION

This is a common law doctrine used to set aside contracts where an unforeseen event either renders contractual obligations impossible or radically changes the party’s principal purpose for entering into a contract. It was established by the English Courts in Taylor v. Caldwell [EWHC QBJ1]. This doctrine is usually relied upon for termination of the contract unlike the concept of Force Majeure which is for suspension of the obligations.

This doctrine has been embodied in the Indian Contract Act, 1872 (‘Act’) by way of Section 56 which states – A contract to do an act which, after the contract is made, becomes impossible or become unlawful by reason of some event which the promisor could not prevent, becomes void when the act becomes impossible or unlawful. As such, certaincontracts under which the obligations have become impossible to perform due to the lockdown imposed by the Government can be terminated through section 56 of the Act.

Propounding the law of frustration, the Hon’ble Supreme Court of India in Satyabrata Ghosh Vs. Mugneeram Bangur & Co. [1954 SCR 310(12)], held that the word “impossible” has not been used with respect to physical or literal impossibility. To determine whether the contract is frustrated, it is not necessary that the performance of an act should literally become impossible, a mere impracticality of performance, from the point of view of the parties, and considering the object of the agreement, will also be covered. Where an unexpected occurrence or change in circumstances decimates the very objective of the contract the same may be considered as “impossibility” to do as agreed.

GOVERNMENTAL NOTIFICATION

In view of the aforesaid discussion, it is imperative to ascertain the effect of the Government notifications issued in lieuof the COVID-19 pandemic. The Government has taken note of the effect this pandemic is causing across various industrial sectors as well as upon the economy of India and has released various notifications and advisories to helpstabilize the market. With respect to force Majeure as well, certain departments of the Government have clarified their respective stance on the same.

The Ministry of Finance has come out with a notification dated February 19, 2020. It has been clarified that Force Majeure under Manual of Procurement of Goods 2017 would be applicable in this pandemic due to disruption of supply chains. It has also been stated that it should be considered as a natural calamity and the Force Majeure clause should be invoked following the due procedure. The Ministry of New & Renewable Energy with respect to solar project developers, vide office memorandum dated March 20, 2020 has declared that parties can invoke the Force Majeure clause to avoid financial penalties if they miss the contractual obligations on account of COVID-19. Similarly, other ministries have issued respective notifications pertaining to invoking of Force Majeure clause. However due to the widespread impact on the economy, caused by the pandemic, it is imperative to discuss the effect of the Force Majeure clause and the doctrine of frustration on certain sectors whose exposure is more profound than others under the prevailing circumstances.

IMPACT ON AUTOMOBILE SECTOR

The disruption in global automotive supply chain has caused heavy losses for the automotive industry. It is estimated that there will be an overall revenue impact of at least $1.5 billion per month across the industry. Even after the lockdown ends, it is expected that there will be a decline in purchase of new automobiles due to increased cost from BS-VI and decreased spending from the public. The pandemic is expected to impact all stakeholders from the suppliers to the dealers. The Hon’ble Supreme Court of India has given a respite to the sector whereby granting permission to the companies to sell 10% of its stock coming under the ambit of BS-IV to be sold within 10 days of the end of the 21 day lockdown imposed by the government, except within the National Capital Territory of Delhi, owing to the immense pollution levels in the area. With an unsold inventory of more than Rs. 7,000 Crores, the automobile sector was bound to experience immense losses owing to the order of the Hon’ble Supreme Court wherein it had directed the companies to sell all its stock falling within the ambit of ‘BS-IV’ level of emissions before the 31st of March, 2020, however, with the respite that has been granted by the top court, the automobile sector may be able to cover some of the losses that it is bound to incur in the near future.

To minimize the impact of the pandemic, it is essential to review the contracts. Usually all commercial contracts in the automobile industry contain a Force Majeure clause that is fairly wide in its application. As such, corporates should  proceed with sending a notice of invocation of Force Majeure in accordance with their agreements to suspend operation of the running obligations under the contracts. The government has already provided clarification with respect to invocation of Force Majeure for supply chain disruption and as such, parties cannot deny the same. Apart from this the automobile industry can be relieved from the other measures such as in taxation provided by the government.

IMPACT ON REAL ESTATE SECTOR

Another sector which is heavily impacted by the COVID-19 pandemic is the Real Estate sector. All stakeholders from the builders to the lessees, are affected from the pandemic and the resultant lockdown. The Builder Agreements usually contain such Force Majeure clauses and the same can easily be invoked but the same is not the case with lease agreements. In case there is no Force Majeure clause in the lease agreements, then Section 56 of Indian Contract Act does not come to the aid of the parties either. The Hon’ble Supreme Court of India, in Raja Dhruv v. Raja HarmohinderSingh [1968 AIR 1024] has made this clear by stating that Section 56 has limited application to covenants under a lease and does not apply to cases where there is a completed transfer. The court further observed that a lessee cannot avoid the lease because he does not or is unable to utilize the land for the purpose for which it is let to him if the land is fit for usage and as such, section 56 of the Indian Contract Act does not apply in that scenario.

IMPACT ON AVIATION SECTOR

The outbreak of the pandemic Covid-19 has had a major impact on the already loss-making Aviation Sector. The Aviation Sector in India has been amongst the biggest loss-making sectors in the country, with Airlines barely managing to break-even. With existing low-availability of credit to maintain day to day operations, the lockdown that has been imposed is going to have a magnanimous destructive effect on the aviation sector. The government’s decision of listing the state carrier Air India for sale to private entities clearly enunciates the prevailing condition of the Aviation sector in the country, and with the travel ban that has been imposed by the government, the Aviation sector is bound to suffer further immense losses. Air Deccan, a regional carrier has already put all its employees on a sabbatical without pay which indicates the losses that the sector is bound to suffer in the days to come.

In such a situation, the airlines can seek invocation of Force Majeure clauses to defer payment of taxes, oil charges, and salary to workers amongst other payments, since it is evident that if the current situation exists, most of the airlines would have wiped out their cash reserves. In the current scenario, the airlines should invoke the Force Majeure clause forming part of the Civil Aviation agreement executed between the said Airline and the Airports Authority of India. The agreement consists of a Force Majeure clause which gives the Airline the right to suspend performance of its obligations to the extent that it is prevented to do so by an event of Force Majeure. The Force Majeure clauses in the said agreements are amply wide so as to encompass an epidemic or plague as is the current situation within the Force Majeure clause. Airlines should send notices to the concerned parties seeking invocation of the Force Majeure clause whereby suspending performance of its obligations. With the current prevalent scenario, it is highly likely that the Aviation sector is bound to suffer magnanimous losses in the near future, and the Airlines can considerably reduce their losses by invoking the said clause.

The Central Government has issued an ordinance namely Taxation and Other Laws (Relaxation of Certain Provisions) Ordinance, 2020 on 31st March, 2020 wherein an amendment has been brought to the CGST Act by inserting a new section 168A which provides for power of government for extension of time limit in force majeure cases. The ordinance has included epidemic so as to deal with the situation of COVID-19. Even otherwise, this ordinance has been brought in to relieve many companies from legal burden and to prevent their collapse in these extraordinary times, which shall further be helpful for the Aviation sector which has already been undergoing a severely tumultuous period in the recent times.

IMPACT ON HOSPITALITY SECTOR

The outbreak of Covid-19 is going to have an unprecedented effect on the Hospitality sector, such that has not been seen in Modern History. With the travel ban having been imposed and tourism shut, the Hospitality sector has experienced a complete shutdown in its economic activities whereby leading to magnanimous losses in its revenue. Oyo Homes and Hotels, one of the country’s largest chains in the Hospitality sector has already suspended payments to its partners owing to unprecedented losses in its revenue. In the current scenario it is advisable that the entities forming part of the sector invoke the Force Majeure clauses in their agreements seeking suspension of payments and other obligations arising out of contracts. It has been predicted that the Hospitality sector alone in India is looking at losses to the tune of almost Rs. 500 Crores in the next 6 months owing to the outbreak of this global pandemic. Hotel operators, owners and franchisors should consider carrying out a review of key contracts to determine whether the impact of the outbreak constitutes a Force Majeure event. With an absolute bar having been implemented across the nation, hotels have had to shut their operations, owing to which it is advisable that depending on the wordings of the contract, the sector should invoke the Force Majeure clause comprising part of its agreements, seeking exemption from payments andother liabilities. Albeit, regardless of whether Force Majeure provisions apply to a specific agreement or not, the Hospitality sector should further apply the Doctrine of Frustration of contract, which although narrow in its scope, may further be helpful in the current scenario inasmuch as owing to the prevalent conditions and the magnanimous losses that the sector is going to be burdened with, the entities comprising of the sector may be in a situation to plead impossibility to perform its obligations arising out of the contract.

OTHER CONSIDERATION

Any party to a contract can either invoke the Force Majeure clause or the Doctrine of Frustration under Section 56 ofthe Indian Contract Act. However, in situations where the same cannot be done and an obligation is required to be fulfilled, the same can be suspended by mutual consent of the parties.

Section 3 of the Epidemic Disease Act, 1897 states that any person who disobeys any regulation made under it would be punishable under the Indian Penal Code, 1860 and Section 4 of the same also provided that no suit or legal proceedings can be made against any person for anything done by them under the Epidemic Disease Act. Furthermore, Section 73 of the Disaster Management Act, 2005 states that no proceedings can be initiated against any person acting in good faith in pursuance of the regulations framed under it.

Hence, non-fulfilment of obligations under the contracts cannot lead to legal proceedings if the same were affected by the lockdown imposed by the government or owing to any hindrances caused by COVID-19, in performance of obligations arising out of a contract by either part, as long as it is sufficiently established that the situation that had arisen was such that it was impossible for the party seeking exemption from performance, to perform its part of the contract.

Stakeholders of all industries should immediately review their contracts and invoke any Force Majeure or similar clauses to suspend their obligations. Further they should undertake all acts to maintain liquidity and readiness for the period after the end of the lockdown. They should explore all legal solutions to avoid economic problems that may follow this pandemic.

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