[A] Introduction:
A few weeks ago, The Economist carried an article entitled “A force to be reckoned with” in which it highlighted – stemming from the lockdown in China, in general, and around Wuhan, in particular, as a result of the “viral outbreak” as it called it – the worry that the trickle of Chinese enterprises using an “obscure legal manoeuvre” of declaring “force majeure”, would soon turn into a “tidal wave”, enabling such firms to “get out of contracts”. The article went on to describe how, as a result primarily of large-scale disruptions in global supply chains stemming from the negative economic impact of the virus in China, “China Inc is panicking”. The Economist continued:
“Firms are starting to invoke [force majeure] to avoid paying non-performance penalties on contracts. On February 17th, the China Council for the Promotion of International Trade (CCIPT), an official body, revealed that it has already issued over 1,600 “force majeure certificates” to firms in 30 sectors covering contracts worth over $15bn. These [certificates] give official support to [force majeure’s] invocation. More are likely to come.” [1] (emphasis supplied)
Whether coincidentally or not, just a couple of days after the CCIPT’s revelation, the Government of India (GoI), through its Ministry of Finance’s Procurement Policy Division – limited as regards GoI’s regime governing the public procurement of goods (i.e. the State’s purchase of goods and services, while undertaking the execution of public works) – seemingly hurried to clarify to all its departments as follows (Office Memorandum No.F.18/4/2020-PPD, dated 19-2-2020):
“A doubt has arisen if the disruption of the supply chains due to spread of corona virus in China or any other country will be covered in the Force Majeure Clause (FMC). In this regard it is clarified that it should be considered as a case of natural calamity and FMC may be invoked, wherever considered appropriate, following due procedure.” (emphasis supplied)
Since then, in barely five weeks, that “viral outbreak” has become a global pandemic – COVID-19 – which, in a breath-taking, blink of an eye, looks set to unleash the generation’s, if not the century’s, principal economic destructive force globally, and for which daresay, the world at large was unprepared. And, all in the backdrop – as the International Association for Contract & Commercial Management (IACCM) notes (in its Research Report on the Impact on World Trade, Corona virus: Business Disruption Escalates, 23-3-2020) – of complete uncertainty, as it appears no one can actually and accurately predict what is going to happen; the extent, range, scale and length of time of the damage, especially to the global economy, as a result of COVID-19. And, those are important factors to be borne in mind while considering the extent of the application of the principles of frustration of contracts, as a result of intervening impossibility.
In the midst of all the mayhem in domestic and cross-border economies and markets around the world, as well as the deleterious impact on businesses and commerce in India, in particular, this article focuses its examination on the key question of whether this “obscure legal manoeuvre” (or as IACCM calls it, “little used”) – force majeure – can indeed in some cases, come to the rescue of enterprises wracked by the pummelling effects of the economic downturn brought about by COVID-19.
The answer, as we shall see in this article to that question, is neither as straight forward as GoI would have us believe (as regards public procurement contracts), despite GoI’s seemingly categoric response above; nor indeed, one that will really and entirely work, on which as The Economist rightly notes, “legal opinion is divided”. This article will seek to untangle some of those divisive knots and attempt to seek clarity on the applicability and consequences, under Indian Law, of the concepts and principles of frustration of contracts by reason of impossibility on the one hand, and force majeure clauses, on the other. The conclusion is, as we shall see, a rather narrow and limited framework within which, in India, both principles of contractual frustration by reason of impossibility and force majeure clauses, operate.
[B] Background, Essential Threshold Differences:
Force majeure literally translates from the French as “superior force”. Immediately apparent is its continental roots within the civil law systems of the world – the foundational basis of the principle is one crystallised in the Napoleonic Code in the 1800s, although its origins can be traced to Roman Law. [2]
This is to be contrasted with the Anglo-Saxon common law systems of the world – of which India, the UK (including the Commonwealth) and the USA amongst others, are a part (the fascinating study of the differences between the two systems of law are for another time and place). Suffice it to say that the common law notion with which we are most concerned is the principle of “frustration of contracts” arising from the impossibility of performance of such contracts.
Two important threshold distinctions arising straight away between frustration of contracts by reason of impossibility, on the one hand; and, force majeure clauses, on the other. Firstly, the civil law systems’ concept of force majeure largely consists in the contractual prescription by the parties of such a clause; it being present specifically in their contracts – whereas in common law jurisdictions, including India, the principle of frustration of contracts by reason of impossibility lies as a matter of law beyond a contractual prescription (although the latter force majeure clause may also exist in the contract in dispute, as we shall examine later). Many common law jurisdictions, more used to the rigidity and narrow applicability of their concept of ‘frustration of contracts’ due to impossibility (a critical point discussed in some detail below), are less friendly to claims based on such force majeure contractual clauses, being as they are for instance, “not overly impressed by force majeure certificates” as in China, as The Economist wryly notes.
The second distinction flowing from the first, is clearly how important the governing law of the contract in question is as regards the treatment of any attempt by the affected party or parties to a contract to disclaim such contract – whether by the principle of frustration for reason of impossibility, or the application of a force majeure exception clause in the contract itself. For instance, local Chinese firms, anyways likely to get a “more sympathetic hearing in mainland courts” (The Economist’s words), are also probably far favourably insulated than their Indian counterparts for instance, in these times of COVID-19, since Chinese courts are likely to rule in favour of the Chinese entities when seeing a force majeure certificate, when foreign counterparts of Chinese parties seek enforcement in China of their overseas judgments or arbitral awards – something as examined below, is likely not to be the case in India against Indian enterprises, given the state of the Indian Law in this regard.
If there ever was an opportune time during contractual negotiations to weigh-up the parties’ proper exercise of their freedom to choose the governing law of a contract, rather than give such discussions the usual short shrift (the lawyer’s job alone, as some may say), this is perhaps that time. That said, in some cases, the choice of governing law may effectively be pre-determined on the basis of applying the principles of the proper law of the contract – such as for example, in shareholders’ agreements involving Indian companies – or, the issue transforms itself into one of bringing overseas judgments or arbitral awards into the jurisdiction of the country of the affected party or parties to that contract; and thereby anyways encountering that jurisdiction’s existing treatment of force majeure clauses or principles of frustration of contracts due to impossibility.
One thing though is certain: parties (especially in China given its favourable regime) are using the viral outbreak to try to renegotiate terms under the threat of seeking sanctuary in force majeure exemption clauses – a tactic The Economist describes as “price majeure”. Interestingly, the GoI’s public procurement manual for 2017 (which is the current version applicable) states that “price variation clauses” may be allowed beyond the original scheduled delivery date, by specific alteration of that date through amendments to the contract as a result of force majeure – the GoI’s above mentioned Office Memorandum triggering force majeure in the face of COVID-19 is a step in that direction of re-negotiation, clearly. It appears that the GoI as regards its public procurement regime at least, also wishes to adopt the rather rigid approach of the Chinese in these cases – and, given the expected severity of the impact of COVID-19, one perhaps cannot begrudge GoI in these circumstances. The same approach may be true of, or adopted by, private parties in India.
[C] Essential/Key Principles of Indian Law – Frustration:
Indian Law in this regard, has a quirk of our colonial legal history – an approach arising from the British Colonial State’s eagerness to use India as a testing ground to crystallise in statutory law, principles of common law and thereby the hope of cementing or freezing its contours (crucially, seeking to remove anomalies or grey areas). Unlike in England where the principles relating to what constitutes frustration of contracts as a result of the impossibility of their performance, are subject to the vagaries of judicial pronouncements (and, as a result, can often be notoriously difficult to apply in any given fact situation), Indian law stands crystallised in Section 56 of the Contract Act, 1872 (“the 1872 Act”) – and to that extent ought to be easier of interpretation and application (or at least, capable of crisper definition). However, that said, the one thing common though to both legal systems is that these principles can in their interpretation and application, vary significantly given the facts and circumstances of each matter. As a result, extrapolating the key strands of the applicable principles is essential, as follows:
1. Section 56; first paragraph: An agreement to do an act impossible in itself is void – in other words, if the event or action forming part of the contract is incapable intrinsically of performance at the time of entry into the contract, then that contract is void from the very inception. The 1872 Act itself provides an illustration of this first principle: A agrees with B to discover treasure by magic; the agreement is void.
2. Section 56; second paragraph: A contract to do an act which, after the contract is made: (i) becomes impossible; or (ii) by reason of some event which the promissor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful – in other words, where events have occurred after the making of the contract which constitute an intrusion or occurrence of an unexpected event or change of circumstances which was beyond the control of the parties, the contract may be discharged on the ground of frustration (or, as the 1872 Act says, ‘becomes void when the act becomes impossible or unlawful’). A contract which has become impossible of performance is said to be frustrated. (emphasis supplied)
A strict reading or interpretation of the wording of this second paragraph of Section 56 of the 1872 Act would seem to suggest that the inability of the party in question to prevent such intervening frustrating circumstance or event would only arise for determination in cases where such intervention has resulted in the act or contract itself becoming unlawful, not when it becomes impossible – the second illustration to the provision is illuminating in this behalf: A and B contract to marry each other. Before the time fixed for the marriage, A goes mad. The contract becomes void.
However, the Indian Supreme Court (principally, in Mugneeram Bangur case [3], and several other judgments, such as Raja Dhruv Dev Chand [4], Naihati Jute Mills [5] and Ganga Saran [6]) has construed this provision to include three critical aspects:
(a) Section 56 is a complete or exhaustive code to the extent that the 1872 Act deals with this subject, laying down a positive rule of law; an aspect of what constitutes a permissible discharge of, or an acceptable exception to, the subsequent performance of the contract – as a result, it is not permissible to import the principles of English Law without reference to the statutory provisions in Indian Law, and the Indian courts cannot travel outside the terms of Section 56, including as regards bringing in the concept of whether or not the event under consideration was or was not within the contemplation of the parties at the time of execution of the contract. That said, to the extent of similarities in treatment of these subject-matters between English and Indian Law, the former’s authorities can indeed be very persuasive and relevant guides.
(b) The doctrine in Indian Law is that of “supervening impossibility or illegality”, with the word “impossible” to be taken in its practical, and not in its literal, sense and does not leave the matter to be determined in accordance with the intention of the parties.
(c) The Supreme Court has expounded on a third principle (see also, Pollock & Mulla’s Indian Contract and Specific Relief Acts): when an event of change in circumstances occurs, which is so fundamental as to be regarded by law as striking at the root of the contract, it is the Indian court which can pronounce the contract to be frustrated and at an end. In that regard, the court has to examine the contract; the circumstances under which it was made; and the belief, knowledge and intention of the parties, being evidence of whether the changed circumstances destroyed altogether the basis of the contract and its underlying object – while reaching its conclusion on the basis of the facts and circumstances of each and every such contract, whether the contractual bargain was indeed at an end as a result of the significantly altered conditions.
[D] Application of Principles of Frustration:
The foregoing analysis leads us to the crux of the matter in India: Indian courts a la their English counterparts are reluctant to invoke the doctrine of frustration because they do not want to allow the doctrine to act as an escape route for a party for whom the contract has simply become a bad bargain (a point stressed by the leading English authority on this subject, Prof. Ewan McKendrick, QC, Professor of English Private Law, Oxford University). Courts are anxious to preserve intact the sanctity of the contract, only providing relief when the harshness of the situation becomes so fundamental and apparent in that the performance becomes impossible by causes which could not have been foreseen and which are beyond the control of the parties – establishing such “impossibility” is therefore in most cases, a tall order. The threshold is undeniably high, in the words of the Indian Supreme Court itself (Mugneeram Bangur case [3], AIR 1954 SC 44 at p. 46):
“This much is clear that the word “impossible” has not been used here in the sense of physical or literal impossibility. The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purposes which the parties had in view; and if an untoward event or change of circumstances totally upsets the very foundation upon which the parties rested their bargain, it can very well be said that the promisor found it impossible to do the act which he promised to do.”
(emphasis supplied)
Indeed, in none of the Indian cases referred to above, even while drawing out the key principles mentioned above, did the Supreme Court actually permit the contract in question to be regarded as having been or become frustrated by impossibility – in Mugneeram Bangur case [3], for instance, after re-iterating that the test depends or turns on the “effect of what has actually happened on the possibility of performing the contract”, the Supreme Court regarded the total absence of any definite period of time agreed to by the parties within which the work was to be completed (the case involved admittedly, temporary requisition orders passed during war time intervening against the contract), as justifying the ultimate holding that the supervening events did not vitally affect the contract or make its performance impossible.
Further, in Naihati Jute Mills case [5], for instance, the Supreme Court emphasised that a contract is not frustrated merely because the circumstances in which it is made are altered – the courts having no general power to absolve a party from the performance of his or her part of the contract, merely because its performance has become more onerous on account of an unforeseen turn of events. The question in that case was whether the contract which the party claiming frustration had entered into provided that such party would make their best endeavours to get the licence in question; or, whether the contract was that they would indeed obtain such license or else be liable for the breach of that stipulation. The Court on facts found in favour of the latter proposition, and denied frustration, indeed holding that party liable for breach in accordance with the terms of the contract.
Where then does this leave us on the key issue of frustration of contracts by subsequent impossibility? The Indian Law and its principles are undeniably rigid (some would say at a much higher threshold) in terms of its interpretation; and narrow or limited in its applicability. Outcomes in favour of reaching a conclusion of frustration by reason of impossibility need to satisfy a very high threshold in most cases – and turn on a plethora of factors, two of which are relevant for our current purposes. First, the issue of the length of time impacting the reaching of a conclusion of “impossibility” and the second, the extent or range/scope – in other words, the severity – of the intervening “impossibility”. What may in some cases be only a temporary or incomplete bar (for instance, in Mugneeram Bangur case [3]), but which in other instances tend towards either a delay in decision making or an unambiguous conclusion of the impossibility of performance (especially where the parties could not and did not have that supervening circumstance in mind), can result in the finding of “impossibility” within the meaning of Section 56 and the consequent discharge of the parties from that contract. This was the position reached for instance, in DDA v. Kenneth Builders case [7].
Whether COVID-19 is such an intervening event beyond parties’ control that extends to “impossibility” of performance in such circumstances is a moot question, turning largely on facts and circumstances of each case where the deleterious effects of COVID-19 is to be considered on the subject-matter of the contract; but also importantly, on the length of time and the extent or range of its deleterious consequences – all to be viewed from the prism of the legal system’s undeniable preference to hold parties to their bargain.
There is at least one area where such “impossibility” would almost always be a given – and that is in executory contracts, namely, contingent contracts whose performance is dependent on the happening or otherwise of an uncertain future event, which then gets so frustrated. One example is share purchase or subscription agreements, where the completion of the share sale or issuance rests on certain contractually stipulated conditions precedent; the contract being capable potentially of being avoided, if such conditions precedent are not met typically to the satisfaction of the buyer or subscriber as the case may be. A contractually stipulated clause that such “material adverse effects” arising from a COVID-19 like situation can derail such completion, may stand up to the higher threshold of “impossibility” on the basis at least, of a complete vitiation of the very foundation of the contractual bargain.
On the other hand, contracts with a company’s promoters that their non-satisfaction of certain contractually prescribed metrics would result in “significant non-performance” enabling investors to eject them from the executive management of the company in question, may need to satisfy the higher threshold tests of impossibility before being genuinely capable of being triggered in a COVID-19 like situation. This is especially true where the affected party (in such cases the company promoter) may legitimately claim that his or her ability to satisfy the metrics are now materially prejudiced as a result of factors beyond his or her control; although whether those metrics can be said to be unambiguously impossible of achievement (in situations where the severity of the impact can be obviated; or, the length of time of its negative impacts subject to a determinate period visible, or capable of being perceived, on the horizon) are moot questions that may frustrate the very finding of frustration due to “impossibility”.
Another twist in the tale is the legal system’s principle stipulating a duty of mitigation – a non-affected party is under a duty to take all reasonable steps to mitigate any loss consequent upon a breach by the other party. Of course, in order to apply the duty of mitigation, it must first be concluded that the act claimed to be one of frustration is actually “impossibility” masquerading as a breach – which goes back to the fundamental determination: whether the supervening acts constitute an “impossibility” of performance within the three-pronged test described above.
[E] Indian Law & Force Majeure Clauses:
Force majeure clauses come in all shapes and sizes – of what constitutes such force majeure; as well as the contractual consequences thereof. Typically, such a clause defines a set of events that are supervening ones from beyond the contractual sphere of control – for example: acts of God, strikes, lock-outs, fires, war, terrorist attacks (the list can be endless and one can never hope to be exhaustive – in one English case, Channel Island Ferries [8], it covered “disease”), and is typically concluded by generic language seeking to include by reference, any incident or event beyond the control of the relevant affected party or parties.
While such clauses bring about a degree of certainty (as Prof. McKendrick notes), the touchstone remains under Indian Law, the meeting of the test of frustration by “impossibility” as earlier described. Importantly, since the general principle of frustration by reason of “impossibility” operates within very narrow limits (both in terms of the events which constitute frustrating events and the rigour with which discharge from contractual liability arises as a result of such impossibility), force majeure clauses enable parties to contractually provide a wider class of events on which to hang a hook for frustration as a result of such “impossibility” – as Prof. McKendrick notes, while in Davis Contractors case [9], an unexpected increase in prices did not constitute a frustrating event, a commercial contract may state that an “abnormal increase in prices and wages” shall constitute a force majeure event and thereby bring it expressly within the concept of frustration at the threshold at the very least – whether such an event would meet the concept of “impossibility” as legally defined, is of course another matter.
Two important, and sometimes alternative, considerations may be borne in mind, arising from the foregoing discussion – firstly, it is important to bear in mind that the generic language included in a force majeure clause to capture such other incidents or events beyond the control of the relevant affected party, will be limited by the rule of interpretation that stipulates that the subsequent generic words are confined in their scope to the same or similar genus of items as earlier listed (namely, the rule of ejusdem generis – of or as the same kind). The proper drafting of such force majeure clauses is therefore vital – for instance, the use of the generic word “similar” may destroy a more extensive coverage sought to be placed on a force majeure clause. Secondly, and naturally flowing from the first, the approach to be adopted while drafting the language of such force majeure clauses, materially depends on whether the party will be the one most affected by the other party avoiding the contract under principles of frustration by reason of impossibility – in that case, one would want the force majeure clause to be naturally limiting in its definition.
Finally, by providing a force majeure clause the parties have the advantage themselves to make provision for the consequences of the occurrence of such force majeure events leading to contractually defined frustration of the contract. As Prof. McKendrick notes, frustration operates too drastically because it terminates the contract, irrespective of the wishes of the parties – very often the parties may want to continue their relationship but to adapt the terms to meet the new situation (adverted to somewhat earlier as above, while describing ‘price majeure’). As Prof. McKendrick succinctly puts it:
“The remedial rigidity of the doctrine of frustration contrasts unfavourable with the flexibility which can be obtained by drafting an appropriate force majeure clause.”
Oftentimes, the contractually mandated consequences of force majeure clauses are a “stand-still” obligation for a defined period of time, where parties attempt to remedy the deleterious effects of the supervening events, coupled with a subsequent non-recourse, no-liability termination of the contract for convenience – importantly in that latter case, though another principle of Indian contract law appears to be applicable, namely, that where one person has promised to do something which he knew or with reasonable diligence might have known, and which the other party did not know to be impossible, such promissor must compensate that other for any loss which that other sustains as a result of the non-performance of the promise (even in cases of frustration).
In conclusion on this subject, Prof. McKendrick mentions an English case (Super Servant Two [10]) as an interesting and important one because it provides us with an excellent example both of the narrow confines within which the doctrine of frustration operates and of the advantages which can be obtained by the incorporation of a suitably drafted force majeure clause in a contract – a contracting party who wishes to be released from his or her obligations to perform in a wider range of circumstances that may constitute frustrating events, must bargain for the inclusion of a force majeure clause if he or she seeks to benefit from the “narrow confines” of frustration as generally defined.
Interestingly, The Economist asked whether the “viral outbreak” would be covered in typical force majeure clauses; especially, as regards the term “acts of God” – it kept the question open: “does [‘act of God’] really apply to an epidemic probably caused by humans eating exotic animals and to the heavy-handed government response to it?”. The jury we believe is still out on that question as regards whether COVID-19 can be treated as a “natural calamity” or an “act of God” – but greater visibility in India is at hand: seek force majeure clauses properly drafted as to its scope and extent of its applicability, and the consequences that would stem upon it being triggered, especially as regards those matters beyond the control of the parties and which may have a fundamental contract altering effect, so as to have greater certainty that such contracts in such circumstances, may well be regarded as being discharged on the ground of frustration due to impossibility, via the operation of such force majeure clauses.
[E] Conclusion:
Ultimately, the general guiding points in a court deciding on whether to trigger frustration by reason of “impossibility” of performance, whether with or without a force majeure clause, rests on a few important factors (as succinctly described and summarised by the English jurist, P.S. Atiyah, in his An Introduction to the Law of Contract, and worth quoting here in full as there is nothing in Indian Law to show that its provisions run counter to these principles):
(i) a party takes the risk of any changes in circumstances, which affect not the common object of both the parties, but only his or her own purposes in contracting;
(ii) a change in circumstances, which only affects the manner in which one of the parties is to carry out the obligations does not normally frustrate the contract;
(iii) an abnormally large remuneration may indicate that the party receiving it has received it to cover the special risks, for instance, special insurance premiums;
(iv) a party to a contract undertakes the risk that performance of his or her promise may prove more difficult or onerous than expected; or even impossible because of normal changes in circumstances – but he or she may not take that risk of performance proving impossible due to abnormal or extra-ordinary occurrences;
(v) even where a party does not normally take the risk of non-performance, in situations where it is rendered impossible due to abnormal or extra-ordinary circumstances, he or she can be considered to have taken the risk of non-performance if the result of the impossibility is to give him a remedy over or against some other person; and
(vi) as a rough general rule, if the parties make a contract which is only to be performed at some distant future date, one or the other of them will be held to have assumed the risk of performance, whatever the future may bring; the object of such contract may be to eliminate the dangers of later events.
COVID-19 is a game changer in many respects – whether it will upend the prevailing principles of force majeure and frustration of contracts due to “impossibility” remains to be seen. The existing legal provisions and the Indian legal jurisprudence surrounding the same appear robust enough to address the large and wide-ranging legal consequences of the viral pandemic. Whether in particular cases, such consequences will actually lead to parties being able to successfully avoid their obligations, still continues to depend on the time-tested benchmarks of each case – namely, whether the changed circumstances destroyed altogether the basis of the contract and its underlying object, and whether the contractual bargain was indeed at an end as a result of the significantly altered conditions.
That is until the fullness of the COVID-19 disaster unfolds.
*Siddharth Raja, Partner, Saakshya Law. Saakshya Law is a premier, full-service Indian Law Firm headquartered in Bangalore, India (www.saakshyalaw.com). The author can be reached at siddharth@saakshyalaw.com.
[1]. The Economist, “A force to be reckoned with: Chinese firms use obscure legal tactics to stem virus losses”, dated 22-2-2020.
[2]. See Laurence Lieberman & Abhimanyu Bhandari, “The forgotten Force Majeure clause and its relevance today under Indian and English Law”, Bar & Bench, dated 27-3-2020.
[3]. Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310 : AIR 1954 SC 44.
[4]. Raja Dhruv Dev Chand v. Raja Harmohinder Singh, (1968) 3 SCR 339 : AIR 1968 SC 1024.
[5]. Naihati Jute Mills Ltd. v. Khyaliram Jagannath, (1968) 1 SCR 821 : AIR 1968 SC 522.
[6]. Ganga Saran v. Firm Ram Charan Ram Gopal, 1952 SCR 36 : AIR 1952 SC 9.
[7]. DDA v. Kenneth Builders & Developers (P) Ltd., (2016) 13 SCC 561 : AIR 2016 SC 3026.
[8]. Channel Island Ferries Ltd. v. Sealink UK Ltd. [1988] 1 Lloyd’s Rep. 323.
[9]. Davis Contractors Ltd. v. Fareham Urban District Council, [1955] 1 QB 302 : [1955] 2 WLR 388 : [1956] A.C. 696 : [1956] 3 WLR 37.
[10]. J. Lauritzen A.S. v. Wijsmüller B.V., [1990] 1 Lloyd’s Rep. 1.