COVID-19 and Liability of Parties in Contracts

This article is written by Yash Dodani, a student of NALSAR University, Hyderabad .

The law has impact on every aspect of the society and essentially in every issue which comes in a society. It shapes itself as and when the issue comes up in the picture of the society. We are going now through one such issue which has disrupted the daily economic, legal, social working of the people. The COVID 19 whose first case was reported in the month of December 2019 in China, has now spread in almost all parts of the world. It has come up with lots of deaths, fear amongst the people, so much so that the people are not able to do their daily activities and are sitting in homes. But it makes certain things either delayed or impossible if the time is of essence. It is when the Law of Contracts and the COVID-19 crisis intersect and it is to be determined whether a situation like COVID-19 is a Force Majure and thus discharge the parties form their obligation or suspends their obligation until the situation is in control? This has become important so as to dodge the breach of contracts.

The contractual obligations of the parties can be discharged in two ways in lights of novel Coronavirus [COVID-19]. Now-a-days, the parties make a provision [clause] in their respective contracts namely ‘Force Majeure Clause’. In general terms, it is known as ‘Act of God’. But the term Force Majeure not only covers Act of God but also covers some supervening situations like Strikes, Epidemic etc. The term ‘force Majeure’ has been defined by the Supreme Court of India in the case of Dhanrajmal Gobindram v Shamji Kalidas and Co[1]. The Court said thus:

“The expression “force majeure” is not a mere French version of the Latin expression “vis major”. It is undoubtedly a term of wider import. Difficulties have arisen in the past as to what could legitimately be included in “force majeure”. Judges have agreed that strikes, breakdown of machinery, which, though normally not included in “vis major” are included in “force majeure”. An analysis of rulings on the subject into which it is not necessary in this case to go, shows that where reference is made to “force majeure”, the intention is to save the performing party from the consequences of anything over which he has no control.[2]”

We can see the force majeure clause in different forms in the Contracts drafted. Some contracts contain a broad meaning of the term ‘force majeure’ which says the term ‘beyond reasonable control of the parties’ like Act of God, war, labor dispute, strikes etc. Whereas in some other agreement, a long list of events is given, occurrence of one of such events will attract the force majeure clause.

The courts had in early times, provided a very narrow interpretation to the term ‘Force Majeure’. [3] This can also be seen in the case of Md Sirajuddin v State of Orissa[4] where the court said thus:

“Therefore the words “any other happening” must be given Ejusdem generis construction so as to engulf within its fold only such happenings and eventualities which are of the nature and type illustrated above in the same clause with close attention to the nature and terms of the lease, and would not reasonably be within the power and control of the lessee.”

It means that if a general term follows a specific term, that general term will be seen in the context of that specific terms used in the contract which are beyond the control of parties. Thus, the COVID-19 outbreak would be interpreted on case to case basis.

The COVID-19 outbreak can be considered as an event which might trigger the force majeure clause. The next thing to do is to invoke the clause which was explained by the Supreme Court in the case of Satyabrata Ghose v Mugneeram Bangur and Company[5] where the Supreme Court said the following lines;

“According to the Indian Contract Act, a promise may be express or implied (vide Section 9.). In cases, therefore, where the Court gathers as a matter of construction that the contract itself contained impliedly or expressly a term, according to which it would stand discharged on the happening of certain circumstances the dissolution of the contract would take place under the terms of the contract itself and such cases would be outside the purview of Section 56 altogether. Although in English law these cases are treated as cases of frustration in India they would be dealt with under, Section 32 of the Indian Contract Act which deals with contingent contracts or similar other provisions contained in the Act.” (emphasis supplied)

The Supreme Court in the same case further said that:

“It must be pointed out here that if the parties do contemplate the possibility of an intervening circumstance which might affect the performance of the contract, but expressly stipulate that the contract would stand despite such circumstance, there can be no case of frustration because the basis of the contract being to demand performance despite the happening of a particular event, it cannot disappear when that event happens.”

If the force majeure event occurs, the parties have an obligation to work in the same manner as specified in the contract. The manner may include but is not limited to a reasonable notice, alternative way to perform the contract and any other way which may be agreed by the parties. However if the contract has already a force majeure clause, that clause will be dealt under section 32 of the Indian Contract Act[6][see Satyabrata Ghose v Mugeeniram Bangur and Company] but if there is no such clause, the party who is alleging that the contract has been frustrated because of the force majeure event, they have to justify the same. However, there is no existed list of the events which can come under the preview of the force majeure events. It has and will be decided by the Indian Courts on case to case basis.

Frustration as a Way to discharge

Having discussed the meaning of the force majeure and the enforceability of the same, it is the time to discuss what other ways which are available to the parties if there is no express provision of a Force Majeure event. The contracts which are not made on company level basis have very general terms and are not often focused on the specific terms like that of force majeure. In that case it is important to discuss the alternate remedies which the parties have.

A perusal of the Act provides a legal principle in such situations, which is postulated in Section 56 of the Act evincing the doctrine of frustration.[7] The contract which the parties have entered into can be classified into two broad categories where the parties can file a plea of frustration. First is when the contract is impossible from the beginning when the parties have entered into an agreement. The second situation is where the agreement can not be performed due to some event which took place after the drafting of the contract. This is called ‘subsequent impossibility’ where the event can be anything which can stop the parties from performing the contract where that event can’t be controlled by the parties who are responsible to perform such act.

The Supreme Court has very beautifully analyzed Section 56 of the Indian Contracts Act, 1872 in the following lines in the case of Satyabrata Ghose v Mugneeram Bangur and Co[8]

“The first paragraph of the section lays down the law in the same way as in England. It speaks of something which is impossible inherently or by its very nature, and no one can obviously be directed to perform such an act. The second paragraph enunciates the law relating to discharge of contract by reason of supervening impossibility or illegality of the act agreed to be done. The wording of this paragraph is quite general, and though the illustrations attached to it are not at all happy, they cannot derogate from the general words used in the enactment. 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 unless from the point of view of the object and purpose 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 finds it impossible to do the act which he promised to do.”

Now in order to analyze that the COVID-19 outbreak will be in the ambit of Section 56, we need to first understand the essentials of the Doctrine of Frustration. The remedy which is generally filed is the remedy of ‘Restitution’.

Essentials of Doctrine of Frustration

Fundamental Change in Circumstance

In order to succeed in a plea under Section 56 of the Act, the underlying event causing the impossibility or illegality should be an intervening event or change in circumstance which is so fundamental as to be regarded by law striking at the root of the agreement and beyond what was considered by the parties when they entered into the agreement.[9] The party needs to prove that the change in situation is such that there can’t be any option but to cancel the contract under the plea of frustration. If that very event doesn’t hit the fundamentals of those contracts, the plea of frustration will not succeed.

Let’s now take the current COVID case. Currently the governments of various countries have announced a nation-wide lockdown. The contracts of construction where time is of essence will be hit by the doctrine of frustration. The contracts of manufacturing will also be hit by the frustration because of the lockdown [a fundamental change], the manufacturing of units of products will not be possible because of absence of labors. But at the same time, a work which can be easily done from home, that contract will not be hit by the Doctrine of Frustration for the very simple reason that this change will not be a fundamental change in situation and can be performed. Similarly, the supply contracts may also be hit by frustration because of the lockdown and the non-availability of the transport.

The events which are unforeseeable by the parties can also come under the frustration. If the parties, at the creation of the contract, have contemplated the happening of the event, or could have foreseen the event [as a reasonable person would do], the doctrine of frustration can’t be allowed. Also, events such as an abnormal rise or fall in prices or a sudden depreciation of currency, do not by themselves affect the bargain made by the parties.[10] It is because the parties are expected that they have contemplated on it and these are those risks which are assumed by the parties that they need to take those risks.

Alternate means Available

When there is more than one way to perform that contract and that alternate way can be used in the case when some unforeseen event occurs, the plea of frustration can’t be allowed. If in the COVID condition, any contract can be performed by any alternate way, the contract will not be set aside just because any unforeseen event has occurred. This essential was explained by the Supreme Court of India in the recent case of Energy Watchdog and Ors. v. Central Electricity Regulatory Commission & Ors.[11] Where the court has used an English decision to very beautifully explain the essential in the following lines-

“37. It has also been held that applying the doctrine of frustration must always be within narrow limits. In an instructive English judgment namely, Tsakiroglou & Co. Ltd. v. Noblee Thorl GmbH 1961 (2) All ER 179, despite the closure of the Suez canal, and despite the fact that the customary route for shipping the goods was only through the Suez canal, it was held that the contract of sale of groundnuts in that case was not frustrated, even though it would have to be performed by an alternative mode of performance which was much more expensive, namely, that the ship would now have to go around the Cape of Good Hope, which is three times the distance from Hamburg to Port Sudan. The freight for such journey was also double. Despite this, the House of Lords held that even though the contract had become more onerous to perform, it was not fundamentally altered. Where performance is otherwise possible, it is clear that a mere rise in freight price would not allow one of the parties to say that the contract was discharged by impossibility of performance.”

Act of the Parties

When the performance becomes impossible due to the act of the party itself, in that case frustration can’t be allowed and the defaulting party may be directed to pay the damages to the other party. In a very earlier case under the line of frustration, it was said as under:

“the essence of “frustration” is that it should not be due to the act or election of the party and it should be without any default of either party and if it was a party’s own default which frustrated the adventure, he could not rely on his own default to excuse him from liability under the contract”.[12]

So when the contract can’t be performed due to the self-induced event, the plea of frustration will be rejected.

To recap, the parties in the current COVID condition needs to prove that there has been a fundamental change in the condition, but for that change the contract would have been performed, they also need to prove that the contract can’t be performed by any alternative way. If the court by any chance, found that the contract can be performed by any way, let it a more expensive way, they will ask the party to perform the contracts. The court has said in many cases that if the contract can be performed by any chance, they will direct the parties to perform the contract. The court also need to be satisfied that the contract was nor self-induced.

This is now important to understand the difference between frustration and Force Majeure. The Force Majeure event does not directly place the contract under the preview of section 56. When the parties have a force majeure clause in the contract, it can’t come under the ambit of section 56 but under section 32 in Indian law. The rationale behind this position is that, the parties should not be absolved from performing their obligations in entirety on the happening of an event that was contemplated by them in the contract, and the recourse to be adopted by them on the happening of such event has been expressly stipulated therein.[13] To explain this lets take a case where the force majeure clause says that in the happening of that event, the parties will be suspended from performance and not termination, the parties can’t now take the plea of frustration because it will render the contract void and that was not the very intention of the parties when the contract was made.

If a force majeure event occurs and the party is filing a plea of frustration, they need to be care full that if the party is doing so, the contract will be void altogether when such a plea will be accepted. But when a party is taking the defense of force majeure event, there is an option with him or the courts can also direct that the performance can be done once the event is done.

Bank Guarantees in COVID-19

When the parties enter into some very long-term supply or constructions, it requires the parties to have performance security. One such security is bank security. If the performance has not been done by either of the party, the other party can ask the bank who has guaranteed on the behalf of the defaulting party. The Bank HAS to give the money and then the bank may collect that money from the party who has guaranteed. In the case of COVID, many contracts are being canceled, and if the Bank is asked to pay that amounts, that will be highly unjust. As said the bank HAS to pay, but it can lift from paying under two cases. Firstly, if the guarantee has been taken by fraud, and secondly when there are some special circumstances. In the COVID situation, there is very less liquidity in the market as all the businesses are closed due to lockdown. If the banks are asked to pay in these special cases, it will be highly just and the banks will fall down. Therefore, the banks should not be directed to pay in these cases.

To sum up, COVID 19 has made the world stop at the place where it is. When the contracts have a force majeure clause, the Courts will deal it under section 32 of the Act and when there is no force majeure clause, the parties can file a plea of frustration which will render the contract void. However, the COVID has stopped the working of the whole commercial world and there is a huge uncertainty until when it will go like this and it’s affecting the working of a large number of Contracts which could go good if these conditions would not have arrived.

[1]AIR 1961 SC 1285.

[2] Id.

[3] Energy Watchdog and Ors. v. Central Electricity Regulatory Commission & Ors. [(2017) 14 SCC 80].

[4] AIR 1969 Ori 152. Also see TGV Projects & Investments Pvt. Ltd. v. National Highways Authority of India [2019 (173) DRJ 717].

[5] AIR 1954 SC 44.

[6] The Indian Contract Act, 1872 [Act 9 of 1872].

[7] Halsbury’s Laws of England, Vol. 7, page 213.

[8] Supra n, 5.

[9] Energy Watchdog and Ors. v. Central Electricity Regulatory Commission & Ors. [(2017) 14 SCC 80].

[10] Alopi Parshad and Sons v. Union of India [AIR 1960 SC 588].

[11] (2017) 14 SCC 80.

[12] Maritime National Fish Ltd. v. Ocean Trawlers Ltd. [AIR 1935 PC 128 (A)].

[13] NTPC Limited v. Voith Hydro Joint Venture [2019 (176) DRJ 241] and Bharat Heavy Electricals Limited v. G+H Schallschutz GMBH, decided on July 9, 2018 by the High Court of Delhi.

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