Insights

COVID-19: CAN A FORCE MAJEURE CLAUSE SAVE THE DAY IN INDIA?

March 31, 2020 | Kritika Agarwal (Corporate/M&A, Restructuring)

Since December 2019, the impact of the Novel Coronavirus (COVID-19) has, gradually, but incrementally, been felt in almost every country in the world. As a consequence of COVID-19, businesses have had to limit, if not completely restrict, their operations in various countries in the world, either voluntarily or under instructions from local authorities or governments. In India, the central government has imposed a lockdown from March 24 until April 14 (both days inclusive), and everyone has been ordered to stay at home. In these circumstances, the performance of contractual obligations has been delayed, disrupted or become impossible.

In this update, we analyze the impact of the COVID-19 lockdown on contractual relations in India and the remedies available to contracting parties.

Is time the essence of a contract?

Under Indian law, there is no general presumption that time is of the essence of a contract. In the absence of an express clause providing for strict timelines in the contract, courts in India have held that contractual obligations must be completed within a “reasonable period of time.” However, if parties have agreed on a specific schedule for the performance of a contract and have acknowledged the materiality of the schedule to the performance of their mutual obligations, time will be a material term of such a contract. In such a contract, unless a specific force majeure carve-out is included, a delay in the performance by one party may give the other party a right to initiate an action for damages or relieve such inconvenienced party from performing its own obligations.

Force Majeure

The concept of Force Majeure, which originated under French civil law, has found its way to common law jurisdictions like India over time. Unlike civil law countries where the force majeure exemption is often captured within the law itself, in India, a force majeure exception has not been statutorily provided. Indian courts have held that a force majeure exception must be specifically incorporated within the contract, and have relied on Section 32 of the Indian Contract Act, 1872, to enforce this exception. Section 32 provides for the discharge of contingent contractual obligations, and a force majeure event has been regarded as a contingency.

Force majeure clauses

As a force majeure exemption has not been provided for under Indian law, parties are bound by the contours of the force majeure clauses in their contracts. Typically, such clauses excuse the non-performance or delayed performance by a party of its obligations when such failure or delay is caused by a pre-defined force majeure event.

In this context, the definition of a force majeure event in a particular contract becomes crucial in determining the applicability of such a clause to any given situation. In its broadest ambit, force majeure events are defined as events that are not foreseeable and outside the control of the breaching party. However, this definition is usually either limited by providing an exclusive list of force majeure events or further clarified by providing for an inclusive list of force majeure events.

Additionally, force majeure exemptions usually mandate a notice requirement and impose an obligation to provide sufficient evidence and a duty to mitigate. In such cases, parties seeking to claim the exemption are required to promptly notify the other party of the existence of the force majeure event, establish the manner in which such event has hindered their performance, and take all reasonable steps necessary to ensure that the impact of such an event is limited. Therefore, parties cannot rely on a force majeure event to excuse their own negligence in performing a contract.

Give the foregoing, the applicability of a force majeure clause to a particular event is a factual determination and each such clause must be analyzed on a stand-alone basis, both, to ascertain the extent of the exemption available and to determine the specific requirements for successfully invoking the exemption.

Impact of the COVID-19 pandemic

As mentioned above, the impact of the COVID-19 outbreak has been gradually, but incrementally, felt across the globe. The Indian government has also periodically revised its perception of the threat and scaled-up the measures being taken to control the spread of the outbreak.

On February 19, 2020, the Ministry of Finance issued an office memorandum in relation to the public procurement of goods in India, and directed public procurement entities to consider the disruption of supply chains due to COVID-19 as a natural calamity for the purposes of force majeure clauses in procurement contracts. Thereafter, on March 20, 2020, the Ministry of New and Renewable Energy directed its renewable energy implementing agencies to treat delay on account of COVID-19 as an event of force majeure. While these notifications dealt with public procurement contracts, the measures taken in the past week have had a more significant impact on the likelihood of invocation of force majeure clauses in private contracts.

On March 24, 2020, the Indian government imposed a nationwide lockdown effective until April 14, 2020. Pursuant to this order, state governments have issued separate guidelines for the enforcement of the lockdown in each state. In general, these guidelines require all establishments not involved in providing certain prescribed essential services to temporarily suspend all operations until April 14, 2020. In light of this lockdown, clauses specifically providing exclusions for force majeure events such as epidemics, pandemics, natural calamities and/or government orders/directives are likely to be invoked by private parties affected by the government order. However, as stated above, each force majeure clause must be analyzed on a stand-alone basis to factually determine its applicability.

Alternative remedies – Frustration of the contract

Apart from specific force majeure exclusions, parties affected by the outbreak may also seek to rely on the doctrine of frustration under Section 56 of the Indian Contract Act, 1872. Section 56 provides that a contract is frustrated when the act promised by a contracting party becomes impossible or illegal due to the occurrence of an event which could not be prevented. Therefore, parties that have not incorporated a specific force majeure exclusion can seek to rely on Section 56, given that the outbreak in India has led to a legal requirement to close establishments and restrict the movement of individuals.

In 2017, India’s Supreme Court held that Section 56 will have no applicability to contracts that specifically contain a force majeure exclusion, and such contracts will be governed by the language specifically provided therein.

In the past, Indian courts have allowed parties to rely on Section 56 only when the performance of the obligations becomes completely impossible and not when the performance is unduly hindered. Therefore, the extent of COVID-19’s impact on the performance of a contract will need to be factually analyzed to determine whether Section 56 will apply to it.

Commonly affected contracts

Supply Contracts: The most apparent impact of the outbreak and the measures undertaken to control its spread will be on international and domestic supply chains. Suppliers are likely to rely on force majeure clauses to claim exemptions from liabilities arising from the delayed or non-performance of their obligations given the national lockdown. On the other hand, buyers may also be interested in invoking these clauses and delaying the acceptance of the delivery due to weakened demand in their downstream markets.

M&A Agreements: The impact of the COVID-19 outbreak may also be felt in ongoing mergers and acquisitions, as the outbreak may lead to the occurrence of a materially adverse effect/change on the business of the target entity. Again, as in the case of force majeure clauses, each clause dealing with materially adverse effect or change will have to be individually analyzed to assess whether a pandemic can be considered as such a change that impacts the performance of the parties’ obligations.

Lease, Construction, Finance and Employment Contracts: In addition to the foregoing, the impact of COVID-19 is likely to be felt in various other transactions including, inter alia, leasing arrangements, construction contracts, financing and employment agreements. The full extent of the impact on contracting parties, however, is likely to only become clear in the aftermath of this pandemic once the business impact can be properly assessed.

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