What does Force Majeure Mean?
The term ‘force majeure’ as defined in Black’s Law Dictionary as ‘an event or effect that can be neither anticipated nor controlled’. The term ‘Force Majeure’ in Law originated in England. In the case of Taylor v. Caldwell(1863), the court laid down that, ‘performance under the contract is excused if, circumstances are beyond the control or fault of two contracting parties’.
In this particular case, an event organizer had contracted with a venue owner to rent a music hall and gardens for four days during the summer of 1861. Before the first event could take place, an accidental fire destroyed the music hall. The parties’ contract did not include a clause governing such a situation. After evaluating the contract, the court decided that the purpose of the contract was to authorize the event organizer to use the music hall which is an integral part of his summer events. Without the concert hall, the purpose of the contract was null and void.
Further, the term appeared in the case of Lebeaupin v Crispin(1920), although its origins can also be traced back to Roman law. It is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled.’ To put it differently, any event or circumstance which is within the reasonable control of the contracting parties does not qualify as force majeure.
Under Indian law, the concept of ‘Force majeure’ was first discussed in the case of Edmund Bendit And Anr. vs Edgar Raphael Prudhomme(1925). In this case, a contract was made out and the respondent (Mr. Prudhomme) was to ship groundnuts to the appellant through the use of steamer called Sea-pool. However, the steamer was commandeered for war purposes and the respondent was unable to ship the tonnage on time even after the best of his endeavors. Edmund (plaintiff) sought damages for non-performance of the contract.
The contract between the parties had an explicit clause of force majeure that could absolve parties to the contract from performance in certain scenarios. The force majeure clause included unforeseen causes and events such as war, epidemics, strikes, political unstability, etc. The question before the court was ‘whether the inability of the defendant to obtain tonnage is within the scope of force majeure or not’?. The Madras High Court discharged the defendant from the performance of the contract by applying the ‘Force majeure’ clause.
The Court cited the passage from Matsoukis v. Priestman and Co(1915), wherein the definition is given by an eminent Belgian lawyer, who explained the meaning of ‘Force Majeure’ as, “causes you cannot prevent and for which you are not responsible”.
Broadly, therefore, the event of force majeure must pass the following tests:-
1. Externality- the cause is not created by the defaulting party’s fault;
2. Unpredictability- The cause must be inevitable and unforeseeable; and
3. Irresistibility- The cause must make the execution of the contract wholly impossible.
While force majeure has neither been defined nor specifically dealt with in Indian statutes, however, the term attracts the provisions of Section 32 of the Indian Contract Act. This section pertains to contingent contracts. It states that, if a contract is contingent on the happening of an event in which an event becomes impossible, then the contract becomes void.
From a contractual point of view, a force majeure clause provides reprieve to parties from performing their obligations under a contract, upon the happening of a force majeure event.
For force majeure to be applicable, the occurrence of such events must be beyond the control of the parties, and the parties must show that they have made efforts to diminish the impact of such force majeure event. If the circumstances come within the realm of a force majeure event and thereby fulfill the conditions for applicability of the clause, then the parties would be discharged from performing their respective obligations that are required to be completed under the contract during the period of such force majeure events. If a contract does not include a force majeure clause, Section 56 of the Contract Act is attracted.
What do you mean By ‘Frustration’ of contract and why is this concept important?
Section 56 of the Indian Contract Act, 1872 talks about Frustration of contract. If the performance of an act becomes impossible or unlawful after a contract has been executed due to an event that the party undertaking the performance could not prevent, then such a contract itself becomes void or one can say that the contract becomes ‘frustrated’.
Hence, in layman’s terms, ‘Frustration’ is the happening of an act outside the contract making the completion of the performance of a contract impossible. The doctrine of frustration of contract states that ‘an agreement to do an act impossible in itself is void’. The section envisages some impossibility or unlawfulness of the performance of the act, which the parties had not contemplated at the time when they entered into the contract.
In the case of Industrial Finance Corporation of India Ltd v The Cannanore Spinning and Weaving Mills Ltd(2002), the court laid down the three ingredients of section 56-
1. There must be a subsisting contract;
The existence of a valid contract is the foremost condition for the application of Section 56. The valid contract includes a contract entered between competent persons and which is followed by some consideration.
2. Some part of the contract is yet to be performed and;
Section 56 will be applicable only if there is some part of the contract which is still to be performed and without performing it the ultimate purpose of the contract is not fulfilled.
3. The contract after it is entered into becomes impossible to perform due to fact or the law.
This is the most important condition for the application of section 56. After the contract has been entered into and has become impossible to perform, it, therefore, becomes void.
These are three sine qua non for invocation of Section 56. Section 56 is instituted on the maxim “les non cogit ad impossibilia” which means that the law will not compel a man to do what he cannot possibly perform.
Justice Mukherjee briefly explained the Doctrine of Frustration in the case of Satyabrata Ghose v. Mugneeram(1953) and held that the basic idea upon which doctrine of frustration is based is that of the impossibility of performance of the contract and the expression frustration and impossibility can also be used as synonyms.
What is the difference between force majeure and frustration of a contract?
Under the Doctrine of frustration, the contract becomes void and consequently, all contractual obligations of the parties cease to exist.
However, Force Majeure is contractual provision contemplating an event, which can result in deferment of performance of contractual, obligations and therefore rights of parties thereunder until such event continues and typically does not excuse parties from performing their obligations. It’s important to note that, force majeure cannot be invoked only because the contract has become financially or commercially more difficult to perform.
Force Majeure in times Of Covid-19
In view of the COVID-19 pandemic, the much forgotten Force Majeure clause will now come under great scrutiny, especially concerning commercial contracts. Recently, in February 2020, the Government of India issued an Office Memorandum regarding the disruption of supply chains because of coronavirus and whether such an extraordinary event will be covered in force majeure clauses or not. The notification further stipulates that “coronavirus should be considered as a case of natural calamity and force majeure may be invoked, wherever considered appropriate, following the due procedure.
However, the government clarified on the event on Force Majeure and stated that the Force majeure clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the force majeure.
To invoke Force Majeure clause notices must be served promptly showing that the contract has become impossible to perform or that a force majeure event has occurred. For parties ‘receiving’ notices of force majeure, they must determine whether such notice holds consistency with the protections contemplated by the clause, if due process has been followed and whether supporting documents are available. Parties claiming force majeure should be very careful about the evidence of such impossibility, what steps they are taking to prevent such impossibility, and the magnitude of that event, since parties making claims are always at a risk of making a wrongful claim.
Lastly, if the performance in whole or in part or any obligation under the contract is prevented or delayed by any reason of force majeure for a period exceeding 90 days, either party may terminate the contract without any financial repercussion on either side.”
The most general clause under most force majeure clauses is the ‘Act of God’, and the COVID- 19 can be brought under the domain of the same. However, a judgment from Hong Kong points out that it may not be that straightforward. In Li Ching Wing v Xuan Yi Xiong(2004), popularly known as the “SARS” case, the court found that a 10-day isolation order by the department of health did not allow a tenant who had taken premises for two years to terminate the tenancy agreement by arguing that it had been frustrated by the unexpected outbreak of such a deadly virus.
However, each case will depend on the facts. The scenario would have possibly been different if the tenancy agreement was for 6 months and the isolation order for 3 months.
Generally, the failure of a third party in the supply chain (such as a sub-contractor) to abide by the contract to which they are a party will not be treated as a force majeure happening unless the situation is contemplated in the clause.
If a contract does not include a force majeure clause, the courts will apply the common law principles laid out by the U.S. Supreme Court in The Tornado (1883), and modify by more recent decisions to determine whether COVID-19 related disruptions have resulted in the frustration of a contract’s purpose to the extent the parties to the contract are excused from performance.
Force Majeure Events shall mean an event which prevents either party from performing its obligations under this Agreement due to circumstances beyond the Party’s reasonable control, including without limitation, acts of any Governmental Authority, war, armed conflict, acts of terrorism, a counter-attack by security forces against such disturbances, hostile attack, insurrections, riot, sabotage, blockage, embargo, fire, flood, earthquake, typhoon, epidemic or another natural calamity, change of law, change in Government policy, withdrawal or suspension of operating licenses or permissions, changes in surrounding environments due to construction by Government of roads or flyovers, which affects the operations, etc.
Force Majeure and IBC
After the Government of India declared Covid-19 as a natural calamity. To mitigate the devastating effect of economic slowdown, the government has increased the default amount of one lakh rupees to one crore rupees as the minimum amount of default for initiation of proceedings under the Insolvency and Bankruptcy Code. This step is taken to prevent the companies especially micro, medium, and small enterprises (MSME) from facing the threat of insolvency.
It is also mulling at the suspension of the rights of creditors to file an insolvency application under the Code. Suspension of Sections 7, 9, and 10 of Code may also help further in this regard and may be called for if the situation further aggravates.
However, a question pops up in the mind that, whether a resolution applicant can invoke Force Majeure?
A resolution applicant may be able to invoke rights of suspension or termination under Force Majeure if the clause specifies disease, epidemics, pandemics, quarantines, or government intervention/declaration as force majeure events. Then the Resolution Applicant may approach the Adjudicating Authority and seek termination of its obligations to implement the Resolution Plan, which in turn, will push the Corporate Debtor towards the liquidation, as CIRP gets terminated on approval of Resolution Plan by the Adjudicating Authority and the same cannot be re-initiated / re-opened.
However, the availability of the relief of Force Majeure would depend on the ability of the resolution applicant to satisfy the test laid down under Section 56 of the Indian Contract Act, 1872. The essential element for a claim of frustration is the impossibility of performance of its obligations and the party claiming frustration carries the burden of proof.
Disruption of business would attract strict implementation of the approved Resolution Plan and the Implementation Schedule. In the event of such defaults or contravention of the Resolution Plan, the Corporate Debtor will be pushed to liquidation under Sub-Section (4) of Section 33 of the Code.
The Legislature has not contemplated this real-time scenario and therefore, there is no mechanism provided for protection of a Corporate Debtor from liquidation, due to contravention/deviation from the approved ‘Resolution Plan’ during an event of ‘force majeure’ like the present Global Pandemic of Covid-19.
Regulation 40C has also been inserted whereunder the period of lockdown imposed by the Central Government in the wake of the Covid-19 outbreak shall be excluded from the prescribed ‘timelines’ concerning a Corporate Insolvency Resolution Process (CIRP). Therefore, this amendment, though will come handy to those Corporate Debtors against whom CIRP is not concluded, but will be of no help to those where Resolution Plan is already approved and is in the process of implementation.
Force Majeure and Due diligence
Covid-19 has caused havoc in the world. There is no gainsaying that the behemoth of COVID-19 has inter alia virtually brought economic activity to a halt and has disturbed the chain of production, supply, and distribution. Companies are, therefore, advised to manage the related legal risk and carefully review which party must ultimately bear the financial losses caused by COVID-19. Parties claiming force Majeure clause have to exercise reasonable diligence to overcome the Force Majeure event and to mitigate the effects thereof on the performance of its obligations under this contract.
Businesses having ongoing contracts with customers/clients having “force majeure” provisions should revisit the provisions of such clauses and evaluate whether they can indeed seek protection under Contract Act or provisions of the contract by the onset of COVID 19.
In addition to standard due diligence inquiries regarding compliance with material contracts, diligence review have to focus on whether any material contracts have been modified or material terms waived in light of COVID-19 that might affect future enforcement, force majeure and other termination provisions, defenses to contract breach, practical ability to enforce contracts, minimum guaranteed financial commitments, and consequences of breach and termination.
The strain of this crisis may also cause a higher risk of third-party liability, eg, product recalls, and damages from product defects. Diligence may, therefore, include a careful review of indemnification provisions in material contracts and insurance coverage for any such claims.
The termination and force majeure provisions in the target’s commercial contracts will require heightened scrutiny in light of current events. As a result of COVID-19, we also need to look for the of target’s insurance policies for losses attributable to COVID-19 and actions being taken to preserve target’s rights under those policies, supply chain disruptions arising from mandated quarantines and facility closures, and steps being taken by the target to ensure business continuity in the face of potential disruptions.
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