Impossibility of Performance of Contracts during a Pandemic

Indian Government issued a memorandum clarifying that the disruption of supply chains due to the spread of the Covid-19 should be considered as a case of ‘natural calamity’ and ‘Force Majeure’ clauses must be invoked, wherever considered appropriate.

The COVID-19 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. In regards with the contractual obligations of the businesses, 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 contract or are 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.

Doctrine of Frustration:

Section 56 of the Indian Contract Act, 1872 talks about the Doctrine of Frustration which states that “an agreement to do an act impossible in itself is void”.

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.

Where a person has promised to do something which they 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 non-performance of the promise.

The Ministry of Finance, Department of Expenditure. Procurement and Policy Division issued an Office Memorandum dated 19th February, 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:

Central Bank of India Staff v. Dulipalla Ramachandra Koteswara Rao: 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.

Hamara Radio and General Industries Ltd. Co. v. State of Rajasthan: 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.

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.

Satyabrata Ghose v. Mugneeram Bangur & Co.: 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.

Energy Watchdog v CERC: 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.

Interpreting of ‘Force Majeure’ Clause by The Indian Judiciary During Lockdown:

On 8th April, 2020, The Bombay High in the case of Standard Retail Pvt. Ltd. v. G. S. Global Corp. refused to grant 'Force Majeure' exemption to the Petitioners.
 
The petitioner filed a petition was filed under Section 9 of the Arbitration and Conciliation Act seeking directions restraining the Respondent from negotiating/ encashing the Letters of Credit.

The Petitioner had argued that in view of the COVID-19 pandemic and the lockdown declared by the Central/State Government, its contracts with the Respondent 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 said Contract, the Respondent 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.

However, the Court denied any ad-interim relief to the Petitioner stating the following reasons:-
  • The Force Majeure clause in the present contract is applicable only to the Respondent, and was not present for the Petitioner.
  • The Respondent was able to comply with its obligations and performed its part of the contract and the goods were already shipped from South Korea. The fact that the Petitioners were not able to perform its obligations due to which they suffered damages, is not a factor which can be considered and held against the Respondent.
  • The distribution of steel was declared as an essential service during the lockdown. There were 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 were declared as essential services. The Notification of the Director General of Shipping, Mumbai, even stated that there would be no container detention charges on import and export shipments during the lockdown period.
  • 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 of making payments.
On 20th April, 2020, the Delhi High Court in the case of Halliburton Offshore Services Inc. v. Vedanta Limited allowed the prayer of the Petitioner and injunct the Respondent from invoking the bank guarantees.

This petition was also filed under Section 9 of the Arbitration and Conciliation Act, 1996 seeking restraint against the Respondent from invoking or encashing eight bank guarantees issued by the ICICI Bank, in favour of the first Respondent, 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 unable to perform the contract. 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.

The Respondent argued 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 prima facie in the nature of force majeure. Such a lockdown was unprecedented, and was incapable of having been predicted either by the respondent or by the petitioner.
  • The devastation, human, economic, social and political, that has resulted as a consequence of the pandemic was unprecedented. 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.
  • The interests of justice would justify an ad interim injunction, restraining invocation or encashment of the bank guarantees till the date of the last lockdown extention.

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.