India: Force Majeure and covid-19

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updated on 6 May 2020 | reading time approx. 9 minutes

  

The current pandemic caused by the covid-19 virus has caused global disruptions in business and commercial operations. It has become difficult to fulfil contractual obligations due to quarantines, lockdowns and work-closures. Due to these circumstances, parties to contracts are increasingly responding with the words “force majeure” in order to be pardoned from penalties that may accrue due to deliveries being missed, project deadlines being exceeded, untimely or non-payments, etc as a result of the pandemic, lockdown and resultant employee shortages, disruptions in supply chains and cash flow problems for businesses. This article aims to offer its readers an insight into the implication of force majeure clause in practical scenario and important factors to consider before the invocation and/or while defending a force majeure claim.

  

  


Force Majeure

In simple words, force majeure events means such causes, which contracting parties cannot prevent and for which they are not held responsible. Force majeure clauses are typically found as a standard or boilerplate clause in all contracts. These clauses generally describe events, which are acts of God, war, government action, terrorism, floods, earthquakes, and other natural calamities, in which the contracting party shall be entitled to suspend the performance agreed under the contract. Though the Indian Contract Act does not particularly define ‘Force Majeure’, it envisages provisions related to force majeure in section 32, which renders a contract void when an event upon which performance of contract is depended, becomes impossible (contingent contracts).

General Force Majeure clauses in contracts

The clause generally describes:
  • the event which shall be considered as force majeure (general examples include act of God, earthquakes, tsunamis, labour strikes, war, act of terrorism, pandemic)
  • the period for which such an event continues (such as 15/30/45/60 days), 
  • the way the notice for such an event has to be sent to the other party (such as by email, fax or registered post and within what time of the event occurring should the notice reach, eg. 7 days) 
  • the next steps involved in resolving the situation (such as suspension or termination of agreement in case force majeure event continues beyond stipulated timeline) and
  • the legal consequences for the parties (in general, the party who claims force majeure will be given the right to not perform the contract at all or at least for a certain time without breaching the contract or possibility of dispute and damages for incorrect invoking of force majeure).
Nonetheless, it should be noted that often uncertainties remain and drafting of the force majeure clauses sometimes are not as detailed or include the requirements as provided above. For example, most of the clauses may not specifically mention ‘pandemic’ as an event of force majeure. Or the condition may be unclear as the pandemic and lockdown scenario was not considered when the clause was being drafted or the clause may not clearly state how long the performance can remain suspended. On this account, it is necessary to analyse the particular force majeure clause incorporated in light of the overall contract and the given circumstances.   

Pandemic being termed as a Force Majeure event in India

On February 19, 2020, the Indian Government issued Office Memorandum, stating that covid-19 pandemic shall be considered as natural calamity and force majeure clause may be invoked wherever necessary. It should be noted however that the memorandum was related to Government contracts. As a result, it would only serve as an indication for private contracts. 

The Supreme Court in 2017 has clarified that economic hardship cannot be considered as a force majeure event. covid-19 would be covered under the terms epidemic, pandemic or even natural calamity, prescribed in a force majeure clause. However, it is important to note that the failure to perform an obligation is primarily due to lockdown implemented by the Government, therefore, the respective force majeure clause should also contain term ‘lockdown’, in order to be invoked.

Thus, whether the force majeure event will rather depend on the nature of the obligations and whether the parties are truly unable to discharge these obligations under the agreement. The pandemic/ lockdown cannot be said to be a force majeure event, if the parties are able to somehow continue operations, either digitally or partially and there is an extended time within which they can complete their obligations, post the lockdowns in the city/country. 

Therefore, calling the pandemic or lockdown a blanket force majeure event can be incorrect depending on the contractual obligations and ways to perform the same and thus, may lead to disputes between contracting parties

Doctrine of Frustration under Indian Law

In India, in the absence of a force majeure clause, the contract will have to be examined in the context of the doctrine of frustration under Section 56 of the Indian Contract Act, 1872 ("Contract Act"). 

The effects of the force majeure event will have to be examined to establish whether it renders the contract impossible, unlawful or impractical to perform and due to which the contract is rendered void automatically. If it is established that the circumstances have materially affected the parties and obligations and there is no way to continue the contract while such circumstances exists, the contract is voided and both contracting parties are discharged of their subsequent obligations and neither party has the right to sue the other party for breach of such contract. It leads to immediate termination of the contract and there are no positive steps taken to try and rectify the situation. 

No damages have to be borne by either party since the doctrine suggests that circumstances have made it impossible for the contract to continue in any manner. If the courts are of the opinion that the doctrine was misused or one party tried to deceive the other party, the court can decide damages to be paid by the party misusing the contract. Thus, this doctrine must be used as a last resort when all other negotiations fail or there is no other recourse available. 

Penalties for improper use of Force Majeure in India

It should be noted that the courts in India follow the contract strictly in terms of force majeure clauses. The burden is on party claiming force majeure clause to prove that contract must be rescinded on account of certain force majeure event. As the courts always favour performance of contracts, the courts do not favour parties resorting to frustration of contracts and termination unless there is compelling evidence that the contracts cannot move forward and there are no other positive steps to be taken except for terminating the contract. The courts do not entertain applications for this merely on the grounds that the contract has now become too expensive, or that there is an inconvenience or difficulty, especially if a valid and practical alternative exists. 

Therefore, the court may dismiss any applications related to frustration of contract if there is the slightest chance to expect that partial obligation is possible or if it seems that the circumstances would change in the very near future or if sub-contracting is possible, if there is only a delay but eventual delivery is possible. Thus, there must be definite reasons to show that the contract has become impossible and it must be terminated in order to invoke the doctrine of frustration. 

In cases where the courts dismiss such claims of force majeure or doctrine of frustration, the courts may order specific performance of the contract or award damages if losses have incurred due to non-performance of delay of the contractual obligations. 

FAQs on force majeure in the times of covid-19

Rental and Leave & License Agreements

  1. Whether force majeure and doctrine of frustration apply in case of lease agreements?
    In case of lease agreements, if force majeure events are not specified in the lease agreement, same shall be governed by the provisions of the Transfer of Property Act, 1882 (T.P. Act) instead of doctrine of frustration (s. 56 of the Indian Contract Act). As per the provisions of the T.P. Act, a lease agreement will be held void if any material part of the property has been wholly destroyed or rendered substantially or permanently unfit for the purposes for which it was let out.

    Certainly, covid-19 has not led to destruction of lease premises or rendered lease premises permanently unfit to use. Therefore, relying upon covid-19 to terminate a lease agreement by either party would essentially depend upon a holistic reading of all the terms of the agreement terms and in the absence of any explicit reason for termination, it would be difficult to successfully contest the force majeure claim. It is important to mention that temporary lockdown of premises amid covid-19 would not render lease premises permanently unfit for use. 
  2. Whether force majeure and doctrine of frustration apply in case of leave and license agreements?
    So far as leave & license agreements are concerned, same are dealt as per the provisions of s. 32 and 56 of the Indian Contract Act as explained earlier in this article.
  3. Whether the lessee can suspend rental payments on account of its inability to access to rental premises amid covid-19 ?
    Answer to this question would essentially depends upon the wordings of the force majeure clause contained in the respective lease agreement. If provisions for suspension of payments are explicitly covered in the lease agreement, lessee may resort to the same while invoking force majeure claim. Therefore, companies will have to look into their lease agreements to ascertain whether – a) covid-19/ pandemic/ locksown is covered under force majeure clause of lease agreement; and b) whether temporary suspension of payment consequent to any force majeure event is allowed.
  4. Are there any relaxations or exemptions available to lessee, besides contractual terms, from making payment of lease rentals ?
    Owing to covid-19 crises, several state governments have come up with notifications thereby allowing the temporary suspension of rent payments, however, this is only in respect of residential premises. No relief has been provided in respect of commercial premises except rental reliefs provided to small software units operating out of software technology parks, etc. 
  5. What recourse(s) a lessor may take against lessee in case of unauthorized suspension of rental payments by lessee?
    Where a lessee suspends the rental payments without authorization, the lessor may invoke eviction proceedings before appropriate rent control authority under the rent control laws of the concerned state. In addition to the eviction proceedings, lessor may also file insolvency proceedings being an operational creditor and where lease agreement permits, lessor may further file proceedings before court or arbitral tribunal as the case may be for claiming damages.

EMployment related queries

  1. Can salaries be reduced? Is it really compulsory to pay wages to workers during the lockdown period?
    Primarily there are two categories of employees – “workmen” (blue-collar) and “non-workmen” (white collar - supervisory / administrative / managerial posts). While the terms of employment of workmen are governed by the provisions of Industrial Disputes Act, 1947, (ID Act) white collar employees are protected either under private contracts or Shop & Establishment Act of state where they are employed. In respect of white collar employees, in the absence of any provisions relating to reduction of wages due to covid-19 under the shop and establishment act of the concerned state (and the Payment of Wages Act, 1936) or in employment agreements of the employees, it will not be possible for companies to reduce its employees’ wages unless it is amicably negotiated with and agreeable to employees.

    In case of workmen, there are provisions available under the ID Act, whereby the employer may reduce wages of its workmen. However, any change in wages would amount to change in conditions of employment for which the employer shall have to give 21 days’ prior notice before effecting such change. Further, any such change can only be implemented if it is agreeable to the employee. Similarly, there are provisions for lockdown available in the ID Act, however, it is difficult to say how much such provisions will actually help the employers.

    The question becomes critical considering the recent Union Government’s Order dated 29.03.2020[2], pursuant to which the state governments have mandated all employers to regularly pay their employees amid lockdown. Though, the government’s move is primarily to safeguard the blue collar employees, courts may adopt a liberal approach and extend its benefits to white collar employees as well. Therefore, a better alternative here could be convincing the employees to accept reduction in wages after appraising them about the financial crisis in the organization. Any such reduction in salary and working hours should be effected only after working out a mutually beneficial agreement between employers and employees. 

    The Union Government’s Order dated 29.03.2020 which has directed all employers to regularly pay their workers, wages without any deduction owing to covid-19 circumstances, has been challenged by some association from Maharashtra and hearing of which is pending before the Supreme Court of India. The petition filed by Mumbai-based textile company Nagreeka Exports Limited states that it had to face major losses to the tune of Rs 1.5 crore due to the lockdown. If they are compelled to pay full salaries, then there would be “far reaching consequences", the plea states. However, a decision has not been reached yet by the Supreme Court on this matter.
  2. Can ‘employees’ be asked to avail earned leave during lockdown?
    As set out in the preceding paragraph, leave provisions for workmen are provided in the ID Act and for white collar employees in their employment agreement as well as shop and establishment act of the concerned state. The above legislations do not prescribe any specific provisions authorising employers to direct their employees to avail earned leaves. It is pertinent to note that, leave is a discretionary right of employees and employers does not have much say in this regard. In respect of white collar employees, it could be possible that their employment agreements contain clauses related to compulsory leaves viz; garden leave clause which could prove useful in this regard. Ultimately, the best strategy would be to discuss the challenges with employees and seek their cooperation. 
  3. Can a company terminate its employees due to loss of business?
    While the termination of employment of white collar employees will be governed by the provisions of their respective employment agreements (and Shop & Establishment Act of the respective state in case termination provisions are provided therein). If employer intends to invoke force majeure clause for termination of the employment agreement, it is essential to consider the factor that employment agreements usually are not for a fixed duration and given that the lockdown is temporary in nature, it will be difficult for employer to prove that covid-19 rendered the performance of the employment agreement ‘impossible’ or that it has frustrated the fundamental object of the agreement.

    In respect of workmen, it is imperative to note that the retrenchment process is very complex and tedious which requires employers to issue 3 months’ notice or pay in lieu to the retrenched employee, in addition to that, the employer may also be required to give some compensation to such employee. Further, retrenchment requires prior permission of government authority which again is a challenging task.

    Considering that companies will need their usual labour force once lockdown is revoked, it is important for the management to reasonably analyse the temporary difficulties in retaining its employees against the financial advantages that the company may derive from terminating the employment of its employees.
  4. Can a company be required to pay contract workers upon failure of contractor to do so, being the principle employer?
    Usually, companies engage contract workers in manufacturing processes. It is now a settled position in law that the principal employer shall be responsible to make payments to its contract workers in case the contractor fails or refuses to pay wages. The extension of lockdown has not only worsened the situation for workers due to lack of job availability in market since last one month but it has also created difficulties for their contractors to make regular payments to them. Consequently, companies being the principal employer are receiving payment demands from these workers. It is pertinent to note that companies are liable to make payments to their contract workers only where services have been received and payments are pending . As the Government Order of 29.03.2020 does not make any distinction in full time and contract workers, it is essential for companies to clear any and/or all existing dues of their contract workers. Any non-compliance of the Order would attract severe penalties in addition to those provided in the labour laws.

Manufacturing & Supply Contracts

  1. In case of material supplies, delivery of products, how long can you claim force majeure?
    Manufacturing concerns are finding it difficult to fulfil their orders amid lockdown and to safeguard themselves from claim of damages. Several companies are invoking the force majeure clause to either postpone the performance or terminate the agreement per se. While claiming ‘impossibility’ is an easier job, proving the same becomes an uphill task, especially when the adjudicating authorities are known to adopt a conservative approach in granting a force majeure claim and tend to lend towards the performance of the contract as against its non-performance. As stated earlier, economic hardship would not render performance impossible. Similarly, unavailability of raw materials or manpower would not be adjudged as force majeure events if though delayed performance may be permitted in the contract.

    Therefore, it is essential for manufacturing companies to consider the factors set out in the beginning of this article before resorting to force majeure claims. Further, governments have come up with several orders to cope up with the circumstances which must be analysed before claiming ‘impossibility’. For instance, no ban has so far been imposed on manufacturing of certain essential commodities, therefore, enterprises engaged in the production of such essential commodities cannot take the defence of lockdown for any failure to fulfil their orders. It will be imperative for manufacturing concerns to fulfil their contractual obligations at the earliest as any unreasonable delay could be construed as negligence and in that case, plea of lockdown would not come to the rescue of manufacturers. Having said that, it will be important to contemplate that whether the delivery post the pandemic serves the purposes of the business transaction on the whole? Thus, the practical solution is for contracting parties to renegotiate or discuss alternative measures to move forward or terminate the contract.
  2. In case of providing services of trained persons to perform professional services at the premises of the client or where services are already completely or partially availed and only payment is required to be made, can force majeure be a reason to delay or terminate? 
    In cases where the contract is still effective after the pandemic, where the pandemic has occurred after the affected party has already delayed contractual performance or where monetary obligations are not being performed post contractual obligation, the force majeure clause cannot be invoked. 
  3. In case of supervisory PE (Permanent Establishment) in India, where it is a requirement of the contract to provide a supervisor to come to India, would this result into suspension or termination of the contract and force majeure can be claimed as the reason for doing so? 
    Whether the contractor can suspend the supervision services, will depend on the contract’s force majeure clause if the clause has travel restrictions as part of it. However, the clause may still not be triggered, if the services can be provided by subcontracting to a third party. Unless the contract stipulates that supervision required shall be rendered by the contractor or a specific employee only, the contractor should not suspend the agreed services, but arrange a substitution.

Material Adverse Changes (MAC) in M&A and Financial Documents

MAE( Material Adverse Effect)/ MAC (Material Adverse Changes) clauses are mostly found in investment and loan agreements, where parties agree to walk away from deals upon occurrence of certain events which have adversely impacts the health of the company. Investors in a M&A deal tend to retain broader terms of MAC to cover almost all foreseeable events which may hamper company’s growth. A MAC/MAE provision kicks in when an unknown event can alter the status of a target’s business, its continued existence, or the enforceability of the documents (in a materially adverse manner) from the time the acquirer has agreed to acquire such business to the time the acquirer actually acquires the business. From a sellers’ perspective, on the other hand, the definition is used as a qualifier to representations and warranties relating to the condition of the business of the target. The burden of proof in this case would be with the acquirer to show that there has been drastic changes in the general economic, financial, legal & political environment which has caused a disproportionate change on the target company’s assets/ operations. If the acquirer can prove these circumstances, he could walk away from the transaction without incurring any damages. 

However, it is an exhausting set of precedents to prove in order to invoke this clause. The acquirer would have to prove financially and operationally how it has been adversely affected during the pandemic and that it is a long term effect which would substantially threaten the acquirer’s earnings in order to terminate the deal. The other options would be to renegotiate and amend the clauses, defer closing or defer the consideration till such time as feasible to complete the transaction. The time considerations in the MAC/ MAE clauses must also be considered. If the pandemic situation has exceeded the timelines of the clause, it may be best to terminate the transaction. 

Force Majeure in Germany – in case of Indian-German transactions 

The German Civil Code (Bürgerliches Gesetzbuch – ‘BGB’) does not provide for a force majeure provision. From the German perspective, force majeure is rather used to determine a party’s fault with regard to damages. Nonetheless, due the globalization, force majeure clauses can be found in many cross-border contracts in which a German party is involved. The German Federal Court of Justice (BGH) has construed the term as an external event which cannot be prevented even by exercising utmost and reasonable care and does not occur from the sphere of risk borne by the contracting parties. 

Similarly to the doctrine of frustration under Indian law, in case the supply of the goods or services agreed becomes impossible, the obliged party will be released from its contractual obligation, as per the German contract law. At the same time the recipient would be exempted from its obligation to make the agreed payment. On the opposite, it should be noted that the payor will never be allowed to assert that the payment became impossible. In case of a temporary impossibility, the party may suspend the performance of the contract. The obligation however revives as soon as the contract can be performed. 

Whether it is a case of impossibility, has to be examined on a case by case basis by examining the agreed performance and conditions, i.e. whether the parties decided on the supply of a specific good or a product out of a product range, or on a particular time when the contract shall be performed or if the performance was guaranteed. It is not possible to merely refer to the pandemic. The burden of proof lies primarily with the defaulting party. In case the contract became impracticable, the party may still refuse the performance under the doctrine of good faith. Other than that, the party may under particular requirements demand the adjustment of the contract conditions, for example by postponing the delivery time, or may withdraw from the contract.

While the contract is impossible or impracticable to perform, damages occurring from the non-performance can theoretically still be claimed. However, the defaulting party is only liable when it can be held responsible. It is worthwhile to mention that the defaulting party would have to prove that the damages are not due to its fault. This may be the case, where the defaulting party could have expected the covid-19 related restrictions, for example, if the contract was concluded during the outbreak of covid-19. Further, the party may be liable in case it has not taken the required precautions or has not made an effort to fulfil the contract. Whether a contracting party is entitled to refuse or suspend the contractual obligations, has to be analysed carefully. In case of a wrongful assumption, the defaulting party would be liable for the losses suffered by the counterparty.   

As a dispute still cannot always be avoided, to prepare for such an event, each party shall document all factors affecting the performance and the correspondence between the contracting parties cautiously. In addition, the German Chamber of Commerce and Industry issues certificates to verify the circumstances. Such a certificate could be used to support the party’s records. However, please note that the German Chamber of Commerce and Industry is not allowed to certify that a case of force majeure occurred under the contract. 

Conclusion and Way forward 

Contracts must be examined carefully for the force majeure clauses and surrounding clauses since the pandemic, which may pose as a force majeure event in some cases cannot automatically be assumed to apply to everyone. Every case will be different in terms of the contract clauses and will also depend largely on how negotiations between the parties take place to control and mitigate the circumstances in order to fulfil their contractual obligations. A presumptuous notice for claiming force majeure under your contract even though it is possible for you to fulfil your obligations, may result in disputes and claims for compensation later on. It is recommended to carefully go through the contract and its clauses or seek professional legal help before sending any notices of force majeure to your contracting party. 

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