With health and wealth in jeopardy, character may be the only saving grace in the face of the recent unprecedented market crash and the virulent Coronavirus. Both of the aforesaid events have caused people and corporates to break promises and act in default under contracts for, arguably, no fault of their own.
Among the many purposes served by the law, maintaining order, instituting standards and resolving disputes in times like the present, are key. While executing contracts, parties often also agree on the course of action to be followed in case the performance of the contract by either party is affected by actions beyond the control of such party, under a force majeure (French for "superior force") clause.
However, where the parties have not allocated the risk in case of unexpected events, the law does not allow courts to revise contracts on behalf of parties (with neither party having defaulted) but provides for the contract to be treated as "frustrated" and allows courts to declare such contracts as void – i.e., neither party is required to perform its obligations under the contract after the occurrence of the unexpected event.
The principle described above is set out in Section 56 of the Indian Contract Act which provides that if the action required to be performed under the contract becomes impossible (literally or practically) or unlawful, such contract becomes void.
While invoking a force majeure clause or in an action to declare the contract void due to frustration, a few challenges may arise.
A successful claim of force majeure or frustration depends to a large extent on the claimant being able to establish that there is no ability to prevent the non-performance of obligations and that performance is, to that extent, outside the control of the claimant.
At the time of the initial outbreak in Wuhan, there may have been no way to foresee the scale of the spread of the virus and the havoc it would cause in supply chain systems and personnel mobility. At the time, therefore, it may have been easier for businesses to claim that they could not have reasonably prevented the impossibility of the performance of the relevant contract.
However, now that the global fallout is apparent and the possible imprint on contractual obligations is reasonably predictable, it is unclear whether companies can still claim (in cases where a disruption in performance could have been avoided by pre-emptive action) that there were no measures that could have been adopted to ensure that the relevant contract was duly performed.
For instance, in case of supply chain disruptions, businesses could perhaps have attempted to source alternative vendors from non-affected areas. So too for workforce erosion, which could perhaps have been mitigated by ensuring adequate spread-prevention measures.
Further, commercial contracts often provide for suspension in cases of force majeure, i.e. that the performance of the contract will be suspended for an agreed period on the occurrence of a force majeure event and if the said event continues for longer than the agreed period, the contract would terminate (with or without consequences).
In cases of contracts not containing a force majeure clause, the impossibility is ordinarily assumed from the time that the defaulting party stops being able to cure the relevant non-performance.
A suspension period or a cure period is ordinarily provided on the basis that the parties would have the ability to take appropriate actions to mitigate the impact of the force majeure or supervening impossibility / illegality within such period.
However, due to the variables that affect the spread of the Coronavirus, the dynamic circumstances and the dependence on government action for mitigation of the impact, a suspension or cure provision may not afford adequate protection.
Therefore, in case a party claims that the force majeure event or supervening impossibility / illegality has continued beyond the agreed suspension / cure period to the detriment of another party and seeks to terminate the contract on this ground, the aggrieved party may not be able to rely on any bright-line test to verify whether the force majeure event or supervening impossibility / illegality had, in fact, continued beyond the agreed suspension / cure period or whether it had ceased to occur before the expiry of the agreed suspension / cure period.
Similar challenges may also impact the invocation of clauses which provide a walk-away right in case of a 'material adverse effect', with such materiality perhaps becoming difficult to prove due to constantly changing circumstances. The flux in market situations worldwide and the overall impact on the economy may also not be definitively determinable until after the spread of the virus has subsided.
The Coronavirus outbreak has been declared a pandemic by the WHO. Certain governments have also declared that the Coronavirus shall be treated as a force majeure event with respect to government contracts. While the aforesaid declarations may be used for persuasive value while interpreting private contracts, the facts of each contract and impact on performance thereof would need to be considered to determine if the circumstances trigger the force majeure clause or if the contract can be declared void under Indian contract law.
While hoping for the best, it may be prudent to prepare for the worst outcome and where possible, proactively analyse contracts to find and deal with vulnerabilities. Parties may also explore the possibility of going back to the negotiating table to come to a viable solution best suited in the given circumstances.
* This article provides an overview of the potential issues in being able to use either a force majeure clause or the doctrine of frustration in case of defaults under contracts attributable to the Coronavirus.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.