Akshata Timmapur & Shriraj Khambete
Undeniably, the COVID-19 pandemic has created quite a semblance of a pandemonium in the world. Impact on the collective human health aside, it has also effortlessly managed to disrupt the world economy; bringing most workplaces to a standstill. Supply chains, recovery and payment cycles and other aspects of commercial transactions stand effectively damaged.
The lockdown announced by the Prime Minister of India on the 25th of March 2020, has brought the country and consequently its economy to a virtual standstill; making cash flow within the country incredibly restricted. The diabolical effect of the pandemic has ensured a heavy financial burden upon various sectors of the economy such as infrastructure, banking, housing, to name a few.
Naturally, with financial strain on the businesses of many, there is an urgent need to contain the far reaching financial repercussions of the pandemic on the economy. Legally speaking, there is a surge in businesses and individuals seeking to suspend or revoke any ongoing contractual obligations, in order to not go bankrupt.
Not only this, the lockdown has also in effect made the performance of various contractual obligations, practically impossible. Consider an EPC contract wherein a contractor is obligated to complete a project within a specific period of time. Obviously, considering the lockdown, the contractor would most likely not be able to adhere to the completion period clause of the contract; unintentionally causing a breach.
To protect themselves, parties to a commercial transaction are increasingly seeking to suspend their obligations for a limited period of time, in the wake of COVID-19. Much has been said and discussed about invoking the Force Majeure clause present in most contracts, which remained an overlooked standard contract clause up until now.
However, this article seeks to provide information on the remedies available to the parties under the Indian Contract Act, 1872, (“ICA”) in a situation where contracts have failed to incorporate a force majeure clause.
Doctrine of Frustration
Where the force majeure clause is absent, English Common Law Doctrine of Frustration can be availed in certain situations. The doctrine provides that in a situation where the performance of a contract is rendered entirely impossible, due to events not reasonably foreseen by the parties, and for no fault of the parties, then the contract can be made voidable or void as from the date of such event. The doctrine of frustration is an English Law principle derived from the latin maxim “les non cogit ad impossibilia” which means that the law will not compel someone to do something which he cannot possibly perform.
In Indian law, Section 56 of the ICA imbibes the doctrine of frustration of contract. The provision states that any act which is to be performed after the contract is made becomes unlawful or impossible to perform, and which the promisor could not prevent, then such an act which becomes impossible or unlawful will become void. Therefore, Section 56 of the ICA is a plausible surrogate to the invocation of a force majeure clause.
The Apex Court in various landmark judgements has shed light on the true import and purpose of Section 56. In Satyabrata Ghose v. Mugneeram Bangur & Co., the Supreme Court has clarified that the word “impossible” appearing in the Section, is not merely indicative of physical or literal impossibility but rather of impracticability of the contract which renders the objective and purpose of the contract obsolete. If an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement, it can be said that the promisor finds it impossible to do the act which he had promised to do.
Additionally, Section 32 of the ICA is also important. Section 32 states that where the contract itself provides for an event which is contingent to the fulfillment of the contract and such event becomes impossible due to an external factor, the contract may be made void. The distinguishing factor between Section 32 and Section 56 is that the former encapsulates contracts which provide for an event, the happening (or not happening) of which, is a contingent event to the successful completion/fulfillment of the contract, whereas, if any event occurs which is de hors the contract, the frustration would be covered by Section 56.
Therefore, parties to a contract which does not contain a force majeure clause, and are facing difficulty in executing the contract, have Section 56 and 32 of the ICA at their disposal. Given the above, it is immediately important to mention that these sections do not provide a guaranteed escape route from all contractual obligations en masse.
When may relief of a frustrated contract be sought?
Interestingly, in M/s Alopi Parshad & Sons Ltd. v. Union of India, the Supreme Court had held that merely because a contract becomes more onerous to perform due to an external event, Section 56 would not come into play. Mere alteration in the circumstances under which a contract was executed would not frustrate the contract. In Energy Watchdog & Ors. v. Central Electricity Regulatory Commission & Ors. the Supreme Court refused to apply Section 56 to a contract where the contractor claimed that due to the increase in the price of supply of coal due to a change in law, the contract was frustrated as that was not an event envisaged by the parties. It was held that because the contractor was free to get coal from other suppliers, the performance of the contract was not impossible.
Legal jurisprudence has made it abundantly clear that the threshold to be able to seek recourse of doctrine of frustration is quite high. That being said, contractual rights are heavily dependent on the implied and express terms within the contract, the object and purpose of the contract and the circumstances surrounding the contract. What would be the resulting outcome is unique to each case depending on the above factors.
Accordingly, the contracting parties may consider the following factors in ascertaining whether to seek resource to Section 56:
Whether the objective is to completely get out of the contractual bounds, rendering the contract void; or to merely suspend certain obligations such as payments to be made? If the answer is the latter, it must be kept in mind that Section 56 completely relieves both contracting parties from their obligations and renders the contract void. There is no provision under Section 56 for suspension of contract for the duration of the external event. Therefore, if parties still wish to continue with the contract but one party wants certain obligations to be kept in abeyance, Section 56 is not the way to go.
If the objective is to be relieved from the contract altogether, the parties must understand that as a consequence of being free, the party that gained benefits from the contract is legally bound to restore the benefit it received during the existence of the contract. This is also mandated by Section 65 of the ICA. Neither party can be allowed to be unjustly enriched. In this regard, the party who is entitled to receive the benefit back, must bear in mind that trying to regain its position as prior to the execution of the contract might be a long drawn out process.
Does the contract envisage either in express or implied terms that the contract would only subsist so long as the events continue on an as is basis and do not change? If the answer is in the affirmative, then the contract may be frustrated by the current events.
Does a contractual obligation become incapable of being performed because if performed, it would render the contract “radically different” from what was originally envisaged? If yes, frustration would apply.
Does the current lockdown render the performance contract impossible? This may be relevant to contracts for renting of a venue, supply of raw materials which are in short supply and so on.
Section 55 of the Indian Contract Act, 1872
In the current scenario, people are affected most by a delay in the execution of the contract. Most contracts might not be “impossible” to perform (so as to seek recourse under Section 56), but rather are affected by a delay in the performance due to the lockdown situation.
In such circumstances Section 55 of the ICA may be looked at. It provides that in case of a delay by a party, the other party can hold a contract void, but only if the intention of the parties is that the time is of the essence. It also provides that where time is not of the essence, but there is a delay, compensation must be made for the delay caused.
Therefore, parties will have to consider whether the contract provides a “time is of the essence” clause or the same can be inferred from the contract. Then, it would be prudent to consider that if such timeline prescribed is not met, would it go to the root of the contract? However, this will have to be seen in juxtaposition with liquidated damages clause, or extension of time clause. If these are incorporated into the contract, it would most likely vitiate the effect of time of the essence clause.
The current socio-economic scenario, ushered in by the phenomenon that is COVID-19, is unprecedented. Legal jurisdictions all over the world are seeking out ways to manage the situation. While there are a few methods available to contract parties to try and minimise losses and circumvent the adverse effects, the truth of the matter is that many contracting parties will be left struggling. This situation must serve as a harsh reminder to always incorporate a force majeure clause into contracts, which must have a wide enough import to include pandemics and their effects. Perhaps, for future contracts, parties may also consider incorporating material adverse change (“MAC”) clauses, the full potential of which remains largely untapped in the Indian legal sphere. For now, force majeure clauses, Section 56, 32 and 55 of the ICA remain the strongest weapons. That being said, one may also consider simply requesting the other contracting party to suspend certain contractual obligations. For e.g. a tenant may request his landlord to suspend the payment of rent for a couple of months, employers may request employees to agree to deferred payments of variables and so. The effects of the pandemic may perhaps be able to be combated with real human compassion, albeit to a very limited extent.