Covid 19 – Frustration of Contracts and Force Majeure
Pandemic of Novel Corona Virus (Covid-19) has caused halt to almost every business activity in India and the world. Some of the countries are virtually shut and the economies have trembled to a grinding halt. Covid-19 has virtually shut each and every market and movement of people and goods. In this challenging time the Governments and other stakeholders are trying to keep pace with the requirements on medical and essential items to the people at large. The basic aim of the government is to keep people safe and only time will tell “were we able to deal with the situation”.
In coming future, the economies will wake up stand on its leg and they will try to recover the injury caused due to this pandemic. Definitely the economies will strive through their business activities but, simultaneously, the claims regarding dishonour of various commitments by respective parties shall also be on rise. These claims will reach to various courts and tribunals and one of the most precious defence shall be “Impossibility of performance” and “Force Majeure”. We wish that respective parties, rather than flooding the Courts with contested claims, mediate with counterparty and negotiate terms of contracts for better good. We all know that contesting a case only leads to development of new jurisprudence and mediation has proved to be a workable solution for all parties. However, the contest in court is also required for development of law and here resides most beautiful part of jurisprudence “Application of legal mind on the emergent situation to deliver justice”.
Performance of Contract:
Under Indian law, Section 2 of Indian Contract Act, 1872 (ICA) defines agreement and contract. Section 2 (e) defines that every promise and every set of promises, forming the consideration for each other, is an agreement and Section 2(h) states that an agreement enforceable by law is a contract. Clauses 2 (g) states that an agreement not enforceable by law is said to be void.
Chapter IV of ICA deals with performance of the contract and Section 37 ICA stipulates that the parties to a contract must either perform, or offer to perform, their respective promises, unless such performance in dispensed with or excused under the provision of this Act, or of any other law. Promises bind the representative of the promisor in case of the death of such promisors before performance, unless a contrary intention appears from the contract. ICA also prescribes that the party in breach of its obligations of non-performance may be fastened with the liability and the party committing the breach may be subjected to the damages and/or compensation under Chapter VI of the ICA or the remedies available under Specific Relief Act, 1963, as the case may be.
CHAPTER III of ICA stipulates a special condition for performance of the contracts and which has been characterised as Contingent Contracts. Section 31 of ICA defines contingent contract as a contract to do or not to do something, if some event, collateral to such contract, does or does not happen and Section 32 prescribes the method for enforcement of Contracts contingent on an event happening. Contingent contracts to do or not to do anything in an uncertain future event happens, cannot be enforced by law unless and until that event has happened. If the event becomes impossible, such contracts become void.
Section 32 ICA provides an excuse against performance of a contract, if an uncertain future event has rendered performance of the contract as impossible. This stipulation must form part of a contract and without specific stipulation to the contingent conditions, resort to Section 32 is not possible. Usually most of the contracts envisage “Force Majeure” as part of general conditions of contract, which exonerates parties from performance of respective obligations on occurrence of specific events and alike.
Under Chapter IV, there is one specific provision dealing with situations where the obligations under a contract become impossible to perform. Section 56 ICA titled as “Agreement to do impossible act” provides answer to most of queries regarding situations in which a contract becomes impossible to perform. Section 56 states that an agreement to do an act impossible in itself is void and contract to do act afterwards becoming impossible or unlawful - 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. Second part of Section 56 gives an answer that a contract becomes void in case due to some external event, which is not in control of promiser, the performance of said promise becomes impossible. Section 56 is a valid defence where there is no stipulation of any uncertain event in the contract. It excuses the party from performing the contract in case the performance becomes impossible due to an uncertain future event.
Doctrine of Frustration:
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 render performance of the contract by one or both parties physically and commercially impossible. English Courts has discussed the doctrine of frustration in many words and summary of same is as below:
The doctrine of frustration which operates to excuse from further performance where:
a. it appears from nature of the contract and the surrounding circumstances that the parties have contracted on the basis of that some fundamental thing or state of things will continue to exist, or that some particular person will continue to be available, or that some future event, which forms the basis of the contract, will take place; and
b. before breach, an event in relation to the matter stipulated in (a) renders the performance impossible or only possible in a very different way from the contemplated, but without default of either party
The doctrine and its operations has been summarised as follows:
i. The doctrine of frustration was evolved to mitigate the rigor of the common law’s insistence on literal performance of absolute promises
ii. The object of the doctrine was to give effect to the demands of justice….as an expedient to escape from injustice where such would result from enforcement of a contract in its literal terms after a significant change in the circumstances.
iii. Since the effect of frustration is to kill the contract and discharge the parties from further liability under it, the doctrine is not to be lightly invoked, must be kept within narrow limits and ought not to be extended
iv. Frustration brings the contract to end forthwith, without more and automatically. The essence of frustration is that it should not be due to the act or election of the party seeking to rely on it
v. The frustrating event must be some outside event or extraneous change in the situation
vi. A frustrating event must take place without blame or fault on the side of the party seeking to rely on it
The theories of the doctrine of frustration evolved by English Courts were discussed by Supreme Court, but were held unimportant in view of the statutory provisions in the Act. In the matter of Satyabrata Ghosh vs Mugneeram Bangur & Co , Supreme Court observed that “In deciding cases in India, the only doctrine we have to go by is that of supervening impossibility or illegality as laid down in Section 56 of the ICA, taking the word impossible in its practical and not literal sense”
Article 7.1.7 of UNIDROIT Principles contains separate provision to cover impossibility of performance (referred to in it as force majeure) and hardship
ARTICLE 7.1.7 (FORCE MAJEURE)
1. Non-performance by a party is excused if that party proves that the non-performance was due to an impediment beyond its control and that it could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.
2. When the impediment is only temporary, the excuse shall have effect for such period as is reasonable having regard to the effect of the impediment on the performance of the contract.
3. The party who fails to perform must give notice to the other party of the impediment and its effect on its ability to perform. If the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, it is liable for damages resulting from such non-receipt.
4. Nothing in this article prevents a party from exercising a right to terminate the contract or to withhold performance or request interest on money due. Where the factual situation can be considered as hardship and of force majeure, the affected party may decide which remedy to pursue. The remedy for hardship will enable it to renegotiate the contract and keep it alive, and the remedy for the later-to have its non-performance excused.
A party is excused of non-performance, if it proves that non-performance was due to an impediment beyond its control, and it could not have reasonably be foreseen by it at the time of making of the contract, nor could it have been avoided or overcome it or its consequences. If the impediment is temporary, the excuse will be had for the reasonable period, during which it has an effect on the performance of the contract. It is necessary that the party failing to perform must give notice to the other party of the impediment and its effect on its ability to perform, failing which, there may be liability for damages for non-receipt of notice.
Impossibility in General:
Generally, a contract which is incapable of performance at the time when it is made, will be void ab initio, but subsequent impossibility ends a valid contract from the moment it becomes impossible of performance, and further performance is excused. The later refers not only to physical or literal impossibility, but also to events occurring, which strike at the basis of the contracts, so as to frustrate the practical purpose of the contract.
The Supreme Court has in Satyabrata Ghosh vs Mugneeram Bangur & Co interpreted Section 56 of ICA thus:
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 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 reset the bargain, it can very well be said that the promisor found it impossible to do he act which he promised to do.
Impossibility and Risk Allocation:
The doctrine of frustration is mainly concerned with the incidence of risk, whether any one or both parties to the contract take the risk of happening of the supervening event.
The question ultimately is always one of risk-allocation. The question to be answered therefore is whether one or other party has expressly assumed the risk of the events which have occurred, or, if not, whether the court thinks
that one or the other party ought reasonably to be treated as having assumed the risk.
If the contract does not expressly allocate the risk, the court has to allocate them. The risk may not be placed on any of the parties, in which case, the contract is discharged for frustration. But if the risk is placed on either party, that party is liable to perform, or be liable for breach. PS Atiyah discusses the following factors as general guide on deciding whether the court will place certain risk on one or other of the parties.
i. A party takes the risk of any change in circumstances, which affect not the common object of both the parties, but only his own purpose 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 renumeration may indicate that the party receiving it has received it to cover the special risks, namely, special insurance premiums
iv. A party to a contract undertakes the risk that performance of his promise may prove more difficult or onerous than expected; or even impossible as a result of normal change in circumstances; but he may not take the risk of performance proving impossible due to abnormal or extra-ordinary occurrences;
v. Even when a party does not normally take the risk of non-performance, in situation where it is rendered impossible due to abnormal or extraordinary circumstances, he can be considered to have taken the risk of non-performance, fi the result of the impossibility is to give him a remedy over or against some other person.
vi. As a rough general rule, if the parties make a contract which is only to be performed as 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 danger of later events.
No discharge despite impossibility:
A contract would not be discharged by impossibility, even though the supervening event makes performance impossible or unlawful if:
a. The contract is absolute in terms and can be held to cover the frustrating event
b. The contract makes full and complete provision for a given contingency
c. It can be reasonably supposed to be within the contemplation of the parties to the contract at the time they made the contract
d. Where the event is such that any of the parties could foresee or could have foreseen with reasonable diligence
e. If only a portion of the contract becomes impossible or difficult to perform
f. If despite the supervening events, the object and purpose of the contract is not rendered useless, and the contract can be performed substantially in accordance with the original intention of the parties, though not literally in accordance with the language of the agreement
Impossibility affecting part of the contract:
Section 12 (4) and explanation to Sec 12 Specific Relief Act 1963, provides that specific performance can be ought to be ordered indivisible contracts of that part, which can and ought to be specifically performed; and that for the purpose of s12 of the Act, a party shall be deemed to be unable to perform the whole of his part, is a portion of its subject matter has ceased to exist at the time pf performance. Section 108 of the Transfer of Property Act, 1882 similarly provides that if by fire, tempest, flood or violence of ay army or of a mob or other irresistible force, any material part of the property leased be wholly destroyed or rendered substantially and permanently unfit for the purpose for which it was let, the lease shall, at the option of the lessee, be void.
Difference between Section 32 and Section 56 of ICA
The main distinguishing feature between ss 32 and 56 is that a contract is dissolved under its own force under s 32, but s 56 applies when the contract becomes impossible of performance and crumbles down due to an outside force. A contract impossible to perform is governed by s 56, and a contract dependent on certain contingencies by s 32 of the Act. In Satyabrata Ghose, the Supreme Court has stated that 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 contract would take place under the terms of the contract itself and such case would be outside purview of s 56 altogether. It has been suggested that the entire field of the rule of frustration under the implied terms comes within the provisions of s 32.
Subsequent Legal Change
Impossibility of performance may arise through subsequent change in the law. Where the performance of the contract has been rendered impossible by an Act of Parliament passed after the contract was made, then the promiser is excused from performing his promise, unless it appears that he intended to bind himself with reference to the future state of law. The impossibility may arise because the law prohibits the doing of the act undertaken under the contract, or restricts it. But the change in law must be such as to strike at the basis of the contract, and not merely to suspend performance under it. Non issuance of permits by the Nizam Government for export of cotton seeds, frustrated a contract as it created a fundamentally different situation bringing about a change in circumstances, which upsets the foundation of the contract; and the price paid could be recovered. Where the commercial and practical purpose of the contract is defeated by restrictions placed by orders of government from exporting foods grains outside the state, the contract is frustrated; although, uncertainties of future existed when the contract was made, but when they become realities, the commercial venture was frustrated. If the obligation is one implied by law, impossibility of performance is good excuse.
A lease in Indian law is not a mere contract, but a transfer of an interest in land and creates a right in rem. The Supreme Court has said that the doctrine of frustration is not applicable to leases; it applied to executory contracts and not to transactions which have created a demise in praesenti.
Force Majeure and Similar Clauses
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. A force majeure clause, as such a stipulation is usually called, must be construed in each case with due regard to the nature and general terms of the contracts, and, in particular, with regard to the precise words of the clause.
Where reference is made to force majeure, the intention is to save the performing party from the consequences of anything of the nature stated above or over which he has no control. A force majeure clause should be construed with close attention towards events which precede or follow it and with due regard to the nature and general terms of the contract.
The expression force majeure has been held to have a more extensive meaning than the act of god and to include things which are not normally included in the expression vis major like strikes and breakdown of machinery, shortage of supply owing to war, wat time difficulty with shipping, refusal of export license.
Act of God:
In the legal sense of the term, an act of God may be defined as an extraordinary occurrence or circumstances, which could not have been foreseen and which could not have been guarded against; or. More accurately, as an accident (a) due to natural causes, directly and exclusively without human intervention; and (b) which could not by any amount of ability have been foreseen, or, if foreseen could not amount of human care and skill have been resisted. The occurrence need not be unique, nor need it be one that happens for the first time; it is enough that it extraordinary, and such as could not reasonably have been anticipated.
Relief under Section 65:
The party who has received any advantage under it is bound to restore it or make compensation for it to the other party under s 65.
Frustration and Compensation:
Paragraph 3 of Section 56 provides for compensation only in regard to per-existing impediment, but it must be taken to govern supervening unlawfulness also, though, it does not do so in terms, as also to supervening impossibility. The principle of compensation have been stated thus:
(1) Section 56 contemplates that a contract may be void under its provisions and yet compensation may be payable by the person who is unable to perform it, weather the impediment is impossibility or unlawfulness, and weather the impediment existed at the time of the contract or supervened;
(2) The question whether compensation is payable or not depends merely on:
i. whether it can, in an abstract manner, be said that the act agreed to be done is impossible (in itself) or unlawful, but upon;
ii. the knowledge as to the act being impossible or unlawful, as well as the promisor using reasonable diligence in obtaining that knowledge; but this knowledge or absence of diligence must be coupled with;
iii. the want of knowledge on the part of the promisee; and finally, it depends also upon;
iv. whether the promisor could have prevented that event which render the act unlawful; in particular, if the promisor knew, or with reasonable diligence might have known and the promisee did not know; that the act promised to be done was (or would become) impossible or unlawful, compensation must be made;
(3) the real question that must be considered, when it has to be determined whether s 56 is applicable or not, in any suit, except whether the contract is sought to be specifically enforced, is not whether the contract was or became void, but whether the promisor has to make compensation for non-performance;
(4) anticipating the result of what I am about to say, I might add a fourth conclusion: that the substance of s 56 (namely the payment of compensation being excused) can only apply when there is no contract to the contrary, and that is but stating in other words that s 56 must be read (when possible) as an implied term in contracts.
Evidence and Burden of Proof
The person alleging that the contract has become impossible must prove it. Moreover, the burden of establishing that the frustration is self-induced, or the neglect or default of the party pleading frustration, lies on the other party.
Energy Watchdog v. Central Electricity Regulatory Commission and Anr
Supreme Court was called upon to decide a peculiar question on “Force Majeure” on that basis that a force majeure event in the agreement takes place the moment performance is hindered and there can be no doubt that an astronomical rise in prices of Indonesian coal, thanks to a change in law, has certainly hindered performance. In any event the change in law clause is very wide and since the agreement deals with imported coal, obviously change in law would cover foreign law. It was also contended that the rise in price of coal consequent to change in Indonesian law would be a force majeure event which would entitle the respondents to claim compensatory tariff.
Supreme Court observed that:
• Force majeure is governed by the Indian Contract Act, 1872. In so far as it is relatable to an express or implied clause in a contract, such as the PPAs before us, it is governed by Chapter III dealing with the contingent contracts, and more particularly, Section 32 thereof. In so far as a force majeure event occurs de hors the contract, it is dealt with by a rule of positive law under Section 56 of the Contract. Sections 32 and 56 are set out herein.
• Prior to the decision in Taylor vs. Caldwell, (1861-73) All ER Rep 24, the law in England was extremely rigid. A contract had to be performed, notwithstanding the fact that it had become impossible of performance, owing to some unforeseen event, after it was made, which was not the fault of either of the parties to the contract. This rigidity of the common law in which the absolute sanctity of contract was upheld was loosened somewhat by the decision in Taylor vs. Caldwell in which it was held that if some unforeseen event occurs during the performance of a contract which makes it impossible of performance, in the sense that the fundamental basis of the contract goes, it need not be further performed, as insisting upon such performance would be unjust.
• The law in India has been laid down in the seminal decision of Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310. The second paragraph of Section 56 has been adverted to, and it was stated that this is exhaustive of the law as it stands in India. What was held was that the word impossible has not been used in the Section 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 purpose of the parties. 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. It was further held that where the Court finds that the contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself and such cases would be dealt with under Section 32 of the Act. If, however, frustration is to take place de hors the contract, it will be governed by Section 56.
• In M/s Alopi Parshad & Sons Ltd. v. Union of India, 1960 (2) SCR 793, this Court, after setting out Section 56 of the Contract Act, held that the Act does not enable a party to a contract to ignore the express covenants thereof and to claim payment of consideration, for performance of the contract at rates different from the stipulated rates, on a vague plea of equity. Parties to an executable contract are often faced, in the course of carrying it out, with a turn of events which they did not at all anticipate, for example, a wholly abnormal rise or fall in prices which is an unexpected obstacle to execution. This does not in itself get rid of the bargain they have made. It is only when a consideration of the terms of the contract, in the light of the circumstances existing when it was made, showed that they never agreed to be bound in a fundamentally different situation which had unexpectedly emerged, that the contract ceases to bind. It was further held that the performance of a contract is never discharged merely because it may become onerous to one of the parties.
• Similarly, in Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968 (1) SCR 821, this Court went into the English law on frustration in some detail, and then cited the celebrated judgment of Satyabrata Ghose v. Mugneeram Bangur & Co. Ultimately, this Court concluded that a contract is not frustrated merely because the circumstances in which it was made are altered. The Courts have no general power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.
• 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.
• This view of the law has been echoed in Chitty on Contracts, 31st edition. In paragraph 14-151 a rise in cost or expense has been stated not to frustrate a contract. Similarly, in Treitel on Frustration and Force Majeure, 3rd edition, the learned author has opined, at paragraph 12-034, that the cases provide many illustrations of the principle that a force majeure clause will not normally be construed to apply where the contract provides for an alternative mode of performance. It is clear that a more onerous method of performance by itself would not amount to an frustrating event. The same learned author also states that a mere rise in price rendering the contract more expensive to perform does not constitute frustration. (See paragraph 15-158)
• Indeed, in England, in the celebrated Sea Angel case, 2013 (1) Lloyds Law Report 569, the modern approach to frustration is well put, and the same reads as under:
• In my judgment, the application of the doctrine of frustration requires a multi-factorial approach. Among the factors which have to be considered are the terms of the contract itself, its matrix or context, the parties knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed mutually and objectively, and then the nature of the supervening event, and the parties reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances. Since the subject matter of the doctrine of frustration is contract, and contracts are about the allocation of risk, and since the allocation and assumption of risk is not simply a matter of express or implied provision but may also depend on less easily defined matters such as the contemplation of the parties, the application of the doctrine can often be a difficult one. In such circumstances, the test of radically different is important: it tells us that the doctrine is not to be lightly invoked; that mere incidence of expense or delay or onerousness is not sufficient; and that there has to be as it were a break in identity between the contract as provided for and contemplated and its performance in the new circumstances.
Basis the provision of Indian Contract Act, Specific Relief Act and available legal precedents, it can be said that the performance of contacts can be avoided invoking the “force majeure” and the liability can be avoided. As mandated under law, notice is must for invocation of a force majeure event and the facts have to be pleaded in a manner connecting terms of performance directly with impossibility.