Coronavirus – Act of ???: Effect on existing agreements and their performance

By: Srikaanth S. Iyyer*

‘Force majeure’, French for ‘superior force’ is a standard clause found in most commercial agreements. Force majeure means an event that is completely out of the control of the parties to the agreement, and such an event prevents either of the parties or both the parties from discharging their contractual obligations. The intent behind such a clause is to absolve a party of blame for non-fulfilment of an obligation due to an event that was beyond their control.

Typically, ‘force majeure’ in an agreement includes and defines particular events that subsist beyond a certain period of time, then either the parties may explore any alternative remedies or either of the parties may terminate the agreement and such non-performance would not be considered as a breach of contract. The events that a force majeure clause may include would depend on the nature of transaction, the sector in which the transaction is being carried out and the territorial extent of the transaction.

It is for the party to the agreement claiming for discharge from performing its contractual obligations on account of force majeure to demonstrate that the event (as defined in the agreement) has occurred and that the event is not in control of the party. A party affected by such an event may be discharged from performing its obligation for the duration of the agreement and to the extent that it may be affected and the other party may be entitled to compensation, depending on the terms of the agreement.

For an event to be considered as force majeure, it needs to satisfy the following criteria:

  • The event is beyond reasonable control of the affected party;
  • The event has prevented the affected party from discharging its contractual obligations; and
  • The party seeking for discharge has taken all necessary steps, as a prudent party would do, to avoid or mitigate the event or its consequences.

The consequence of triggering force majeure may result either in extension of time for performance of the obligation or the agreement being in abeyance, which means that the performance of the agreement would be suspended until the parties agree to continue the performance subsequent to the event coming to an end. This may result in cost escalation or losses due to non-performance within a stipulated time. In certain scenarios, force majeure clauses may entitle a party or parties to terminate the agreement.

Can COVID-19 be considered as force majeure?

An agreement contains the terms and conditions that are mutually agreed upon by both the parties, therefore, it can be presumed that any term in a commercial agreement is inserted in the agreement only after the parties have understood and agreed upon the same.

A force majeure clause generally contains two aspects, the event and the duration of the event beyond which the obligations cannot be performed. It is common for agreements to contain “Acts of God”, which mean natural disasters, and “Government Action”, which may result in sanctions or changes through legislations or executive orders. However, more often than not, pandemics or epidemics are not considered as a force majeure event while negotiating the terms of an agreement.

An outbreak of a pandemic is beyond the control of the parties, and even though a specific reference to “pandemic”, “epidemic” or “an outbreak” may not be mentioned, the impact of such an event will be felt especially in cases where human resources are involved. Any action taken under the agreement to fulfil the obligations of a party that involves human interaction and physical presence during an outbreak might pose a health hazard and risk to life.

Most of the force majeure clauses contain a “catch-all” phrase that would include ‘any event that occurs outside the reasonable control of a party’. It is essential to understand that even if an agreement does not provide expressly for disruptions due to pandemics, any event connected to the pandemic may fall within the scope of the force majeure clause. For example, if a party is required to be physically present at a particular site during the period of the agreement, but due to the pandemic outbreak the government has imposed a lockdown and restricted movement, the event to trigger the force majeure clause can be considered as a “government action”.

In order to trigger the force majeure clause it is important to assess the degree of impairment that prevents any from performing its obligations. As mentioned earlier, if an agreement requires a party to be physically present at a site and due to outbreak the site is health hazard, the party will not be able to perform its obligations. It is necessary to establish the link between the event and the inability to perform the obligations. However, if a party is not required to be physically present and can still perform its obligations from a safe environment, force majeure does not get triggered since the party is not prevented from performing its obligations. A change in cost or profitability due to the pandemic may not be considered as a sufficient reason to trigger force majeure.

While claiming for discharge from performing the contractual obligation, a party is required to demonstrate that it acted prudently to mitigate the event and its consequences, and that there was no other option but to trigger force majeure. The mitigating factors would depend on the nature of the transaction and the obligation that is required to be performed.

Therefore, the question whether a party can claim force majeure due to COVID-19 will have to be assessed according to the circumstances that surround the performance of the obligation. The current scenario may give rise to disputes between parties for non-performance of contractual obligations due to the outbreak; however, it is for the courts to apply the principles of law to each of the cases to determine whether the non-performance can be considered as a breach or not.

Doctrine of Frustration

If an agreement does not provide for events that may be considered as force majeure, which is a rare case, or the force majeure clause does not foresee an event as a disruptor to the performance of the contractual obligation, a party or parties may rely upon doctrine of frustration as provided under Section 56 of The Indian Contract Act, 1872.

Doctrine of Frustration is applied on subsequent impossibility of an agreement when due to an unexpected event, which was not contemplated while entering into an agreement, the entire purpose of the agreement is frustrated and makes the performance of the agreement impossible. When such an event or change of circumstances occurs which is fundamental and strikes at the roots of the agreement, the court may hold such agreements to be frustrated. However, the court is bound to examine the facts and circumstances and decide upon the merits of the case.

For a party to rely upon the doctrine of frustration, it is essential to satisfy the following conditions:

  1. There is a valid and subsisting agreement between the parties.
  2. The agreement or a part of the agreement is yet to be performed.
  3. The event that renders the agreement impossible to be performed or radically changes the nature of obligation occurs subsequent to entering into the agreement.
  4. The event is not due to fault of any of the parties.
  5. The event was not foreseen by any of the parties.

The resultant of the doctrine would automatically put an end to the agreement and discharge the parties to the agreement from performing their contractual obligations. However, a party that suffers losses due to application of the doctrine may claim for compensation if due to the termination the other party has benefited at the cost of the party.

Claiming force majeure due to COVID-19

The first step is to send a formal written notice to the other party triggering force majeure supported by evidence within the time frame prescribed by the agreement. In case the agreement does not contain force majeure clause, a party can send a formal written notice for either for frustration of agreement or claiming for extension of time. In any case, the relief sought for and the available options would depend on the terms of the agreement. The notice should also detail the impact of the pandemic on the performance of the agreement as well as steps taken to mitigate the impact.

The party claiming for discharge will have to demonstrate in clear terms that despite taking all necessary measures as a prudent person, the impact of the pandemic has resulted in the inability to perform the contractual obligation.

It is vital that a party frames the notice in an unambiguous and precise manner that conveys the event and its impact, because it is upon this document that the court relies upon while deciding whether the event triggers the force majeure clause in case of any dispute. If a claim is decided to be wrong claim and the event is not considered as force majeure, the consequences of such a claim would result in wrongful termination of the agreement and breach of agreement, which would impose a liability on the party making the claim to compensate the other party for damages.

Receiving notice for triggering force majeure clause due to COVID-19

When a party receives a notice from the other party seeking for discharge from performing its obligations due to the impact of COVID-19, it is necessary to examine the claim and the measures taken to mitigate the impact. There may be certain transactions that are adversely impacted by the outbreak while certain transactions may not be affected to an extent that might disrupt the performance. It is for the party to evaluate the circumstances and the contents of the notice to arrive at a decision. However, any decision that may be contrary to the terms of the agreement or to the law in force would result in a suit against the party. Therefore, it is vital to respond to the notice in accordance with the terms of the agreement and provisions of law.

*The author is a practicing advocate based in New Delhi. The views expressed here are personal and does not amount to any legal advice or solicitation.

Related Posts

Leave a Reply