Impossibility of Performance of Contracts - Covid 19

The COVID-19 or the Corona Virus outbreak has affected the entire world. In India, the Central Government along with the respective State Governments are continuously taking necessary steps in order to control the spread of COVID-19.

The COVID-19 or the Corona Virus outbreak has affected the entire world. In India, the Central Government along with the respective State Governments are continuously taking necessary steps in order to control the spread of COVID-19. One of such measures is the announcement of the lockdown within the entire country. With the lockdown, everything has come to a halt except for the manufacture, supply and distribution of essential commodities and services.

There is hardly any sector/ service which hasn’t taken a hit under the present scenario. This Financial slowdown is glooming and businesses are striving to survive under the pressure. As regards contractual obligations of the businesses, obviously, the circumstances which existed when the contracts were entered into as opposed to the circumstances which exist today have changed.

Under such changed circumstances, businesses are either not able to perform their obligations under the contracts or finding it hard to perform the same, which has resulted in several delayed projects. Therefore, there is a need for the contracting parties to look into the ‘Force-Majeure’ clause in their contracts, if there is any, in order to ascertain its impact under such changed circumstances.

The contracts which do not contain a ‘Force-Majeure’ clause or any such similar provision, shall still be governed by Section 56 (Doctrine of Frustration) of the Indian Contract Act, 1872 which reads as follows:-

Section 56: Agreement to do impossible act.

An agreement to do an act impossible in itself is void.

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.

Compensation for loss through non-performance of act known to be impossible or unlawful.—Where one person has promised to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promisee for any loss which such promisee sustains through the nonperformance of the promise.

The Ministry of Finance, Department of Expenditure. Procurement and Policy Division issued an Office Memorandum dated 19.02.2020 clarifying that the disruption of supply chains due to the spread of the corona virus should be considered as a case of natural calamity and Force Majeure clauses must be invoked, wherever considered appropriate, following the due procedure.

This memorandum essentially means that COVID-19 could effectively be covered under force majeure clauses because it is a 'natural calamity'. However, this interpretation is not true for every contract.

The Force Majeure clause in any contract and whether it frees the parties from their liabilities  or obligations depends upon the specific language of the Force Majeure clause, the governing law, the facts and circumstances surrounding the dispute etc.

Doctrine of Frustration and Indian Judgments

Frustration signifies a certain set of circumstances arising after the formation of the contract, the occurrence of which is due to no fault of either party and which renders the performance of the contract by one or both parties physically and commercially impossible. Where the entire performance of a contract becomes substantially impossible without any fault on either side, the contract is prima facie dissolved by the doctrine of frustration. (Dulipalla Ramachandra Koteswara Rao: AIR 2004 AP 18)

The essential principle upon which the doctrine of frustration, embodied in Section 56 of the contract Act, is based is the impossibility or rather the impracticability in law or fact of the performance of a contract brought about by an unforeseen and unforeseeable sweeping change under the circumstances intervening after the contract was made. In other words while the contract was properly entered into, in the context of certain circumstances which existed at the time it fell to be made, the situation has so radically changed subsequently that the very foundation which subsisted underneath the contract as it were, gets shaken, nay, the change of circumstances is so fundamental that it strikes at the very root of the contract, then the principle of frustration steps in and the parties are excused from or relieved off the responsibility of performing the contract which otherwise lay upon them. (Hamara Radio and General Industries Ltd., Co., Delhi v. State of Rajasthan: AIR 1964 Rajastan 205).

Where one party claims that there has been frustration and the other party contests it, the Court has to decide the issue 'ex post facto' on the actual circumstances of the case. The question of  whether the frustration has occurred or not depends upon the nature of the contract, the surrounding circumstances and the events which have occurred. (Twentsche Overseas Trading Co. Ltd. MANU/PR/0072/1944: 1945-1 MLJ 417:AIR (1945) P.C. 144; Ram Kumar MANU/WB/0326/1950: AIR 1952 Calcutta 335).

In every case where there  is a dispute between the parties as to the frustration of a contract, the Court must ascertain the substance of the contract and then examine whether the contract can be substantially performed notwithstanding the supervening event. In cases where the performance of the contract gets so frustrated, that neither party can get the relief it expects or claims because no party is really to blame for what has happened, the law imputes blame or responsibility to neither of them. (Hamara Radio and General Industries Ltd., Co., Delhi AIR 1964 Rajasthan 205; Satyabrata Ghosh MANU/SC/0131/1953 : AIR 1954 SC 44; State of Rajasthan v. Madanswarup MANU/RH/0033/1960 : (1959) 9 Raj 1217 : (AIR 1960 Raj 138).

The word "impossible" under Section 56 does not mean physical or literal impossibility. The contract can be held to be frustrated if its performance is "impracticable" and "useless" from the point of view of the object and purpose of the parties, though the performance is not literally impossible. If the untoward event totally upsets the very foundation upon which the parties entered their agreement, the contract can be held to be frustrated. (Satyabrata Ghose v. Mugneeram Bangur & Co.,: 1954 SCR 310).

If the contract has an express or implied 'force majeure' clause, it will apply over the principles embodied under Sec 56. Application of the doctrine of frustration must always be within narrow limits. A rise in the cost or expense will not frustrate a contract. Doctrine of frustration will not apply so long as the fundamental basis of the contract remains the same. Force majeure clause will not apply if alternative modes of performances are available. (Energy Watchdog v CERC: (2017) 14 SCC 80)

LET US ALSO LOOK AT THE DECISIONS RENDERED BY BOMBAY HC AND DELHI HC INTERPRETING ‘FORCE MAJEURE’ CLAUSE DURING LOCKDOWN:-

  1. Standard Retail Pvt. Ltd. V/s M/s. G. S. Global Corp & Ors. – decided by Bombay HC on 08.04.2020

This petition was filed under section 9 of the Arbitration and Conciliation Act seeking directions restraining the Respondent–Bank from negotiating/ encashing the Letters of Credit.

It is the case of the Petitioners that in view of the COVID-19 pandemic and the lockdown declared by the Central/State Government, its contracts with Respondent No. 1 were terminated as unenforceable on account of frustration, impossibility and impracticability. The Petitioners relied upon Section 56 of the Indian Contract Act, 1972.

Under the Contracts the Respondent No. 1 which has its head office at South Korea was to supply certain steel products, the shipments of which were to be dispatched from South Korea, to the Petitioners in Mumbai. There was a Force Majeure clause in the contract which read as follows:

“Article 11. Force Majeure: In the event of an Act of God (including but not limited to floods, earthquake, typhoons, epidemics and other natural calamities), war or armed conflict or serious threat of the same, government order or regulation, labor dispute or any other similar cause beyond the control of “Seller” or any of its suppliers or sub-contractors which seriously affects the ability of “Seller” or any of its suppliers or sub-contractors to manufacture and deliver the “Goods”, “Seller” may, at its sole discretion and upon written notice to “Buyer” either terminate the Contract or any portion affected thereof by such event(s), or delay performance of the Contract, in whole or in part, for a reasonable period of time. Any such delay of performance by “Seller” shall not preclude “Seller’s” later right to terminate the Contract or any portion affected thereof by such event(s). In no event shall “Seller” be liable to “Buyer” or to any third party for any costs or damages arising indirectly or consequentially from such non-fulfillment of or delay in the performance of all or part of the Contract”

The Court denied any ad-interim relief to the Petitioner stating the following reasons:-

  1. The Letters of Credit are an independent transaction with the Bank and the Bank is not concerned with underlying disputes between the Petitioners who are buyers and the Respondent No. 1 who is the seller.
  2. The Force Majeure clause in the present contracts is applicable only to the Respondent No. 1 and cannot come to the aid of the Petitioners.
  3. The contract terms are on Cost and Freight basis (CFR) and the Respondent No. 1 has complied with its obligations and performed its part of the contracts and the goods have been already shipped from South Korea. The fact that the Petitioners would not be able to perform its obligations so far as its own purchasers are concerned and/or it would suffer damages, is not a factor which can be considered and held against the Respondent No. 1.
  4. The Notifications/Advisories relied upon by the learned Senior Counsel for the Respondent No. 1 does suggest that the distribution of steel has been declared as an essential service. There are no restrictions on its movement and all ports and port related activities including the movement of vehicles and manpower, operations of Container Freight Station and warehouses and offices of Custom Houses Agents have also been declared as essential services. The Notification of the Director General of Shipping, Mumbai, states that there would be no container detention charges on import and export shipments during the lockdown period.
  5. In any event, the lockdown would be for a limited period and the lockdown cannot come to the rescue of the Petitioners so as to resile from its contractual obligations with the Respondent No. 1 of making payments.
  6. The Judgments relied upon by the learned Counsel for the Petitioner in Energy Watchdog Verus CERC (2017) 14 SCC 80 and Satyabrata Ghose Versus Mugneeram Bangure & Co. (1954) SCR 310 do not assist the case of the Petitioners and are distinguishable on facts.

In short, the Bombay HC refused to grant 'Force Majeure' exemption to the Petitioners.

  1. M/s Halliburton Offshore Services Inc. versus Vedanta Limited & Anr. – decided by Delhi HC on 20.04.2020

This petition was also filed under Section 9 of the Arbitration and Conciliation Act, 1996 seeking restraint against the Respondent No. 1 from invoking or encashing eight bank guarantees issued by the ICICI Bank (Respondent No 2), in favour of Respondent No. 1, under instructions of the Petitioner.

It is the case of the Petitioner that though a substantial part of the project was completed, however, owing to a complete lockdown, on industrial activities as well as on movement of persons in the country, consequent to the novel COVID-2019 pandemic, the petitioner was unavoidably handicapped in performing the contract. It is emphasised in the petition, that performance of the contract required the travel of persons from overseas, as well as workmen from various parts of the country. The Petition sought to invoke the Force Majeure clause in the contract.

On the other hand, counsel for the Respondent no.1 submitted that in law, the only ground upon which invocation of a bank guarantee can be stayed, is the existence of egregious fraud. It was further submitted that the plea of force majeure is an afterthought and cannot constitute a justifiable basis to grant an injunction, as sought by the petitioner.

The Court allowed the prayer of the Petitioner and injunct the respondent from invoking the bank guarantees by observing that:-

  • The countrywide lockdown, which came into place on 24th March, 2020 was, in my opinion, prima facie in the nature of force majeure. Such a lockdown is unprecedented, and was incapable of having been predicted either by the respondent or by the petitioner. Prima facie, in my view, special equities do exist, as would justify grant of the prayer, of the petitioner, to injunct the respondent from invoking the bank guarantees of the petitioner, forming subject matter of these proceedings, till the expiry of a period of one week from 3rd May, 2020, till which date the lockdown has been imposed.
  • We are placed, today, in uncomfortably peculiar circumstances. A pandemic, of the nature which affects the world today, has not visited us during the lifetime of any of us and, hopefully, would not visit us hereinafter either. The devastation, human, economic, social and political, that has resulted as a consequence thereof, is unprecedented. The measures, to which the executive administration has had to resort, to somehow contain the fury of the pandemic, are equally unprecedented. The situation of nationwide lockdown, in which we find ourselves today, has never, earlier, been imposed on the country. The imposition of the lockdown was by way of a sudden and emergent measure, of which no advance knowledge could be credited to the petitioner – or, indeed, to anyone else.
  • For the present, I am convinced, prima facie, that, in view of the submission, of the petitioner, that it was actually working on the project till the imposition of lockdown on 22nd March, 2020, or at least shortly prior thereto, and in view of the sudden and emergent imposition of lockdown, the interests of justice would justify an ad interim injunction, restraining invocation or encashment of the aforesaid eight bank guarantees, till the expiry of exactly one week from 3rd May, 2020, till which date the lockdown stands presently extended. As to whether this interim injunction merits continuance, thereafter, or not, would be examined on the next date of hearing, consequent to pleadings being completed and all requisite material, including all relevant Governmental instructions, being placed on record.

CONCLUSION

Presence of a Force Majeure clause in a contract will not free the parties from their liabilities and obligations automatically in the current COVID-19. Every clause needs to be studied and then interpreted to see whether a party can take shelter under the said clause or not. From the above decisions it is also clear that the application of the doctrine of frustration or force majeure clause would be narrow as its consequence on the party affected by non-performance could be huge.

If the performance of a contract is possible through an alternate mode or if such a performance is possible with some inconvenience to the performing party, even though with some delays that would not frustrate the contract.

Each case will be judged on its own facts and circumstances.