This article is written by Darshit Vora of the Narsee Monjee Institute of Management Studies, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article discusses the application of doctrines of force majeure and frustration to supply chain contracts in light of COVID-19.
It has been published by Rachit Garg.
Table of Contents
Introduction
Supply chain refers to a chain of events that are involved from producing the goods to distributing a product to the final customer. The supply chain contains various factors such as, sourcing raw materials, refining those fundamental parts, creating a product from the existing raw materials, sales, product delivery, and customer support. COVID led to supply chain disruptions. Due to multiple national lockdowns, the flow of goods from manufacturing to delivery to the final consumer was affected. The manufacturers and distributors found it difficult to replenish their inventory, equipment, or machinery. As many international ports were shut down, importers and exporters found it challenging to deliver goods across international borders. This led to massive disruption in all the supply chain agreements, and companies and individuals tried to renegotiate their contracts.
Disruption of the supply chain brought to the limelight numerous commercial and contractual issues. The contractual issues arose due to delays in the execution of contracts or non-performance of contracts due to unforeseen events. The contracts that included the “Force Majeure” have been relieved from the execution of the contract without paying any liability to the affected party. Force majeure can be defined under Black’s Law Dictionary as an event or an effect that can be neither anticipated nor controlled. However, if the parties have failed to insert a force majeure clause, the party can claim relief under Section 56 of the Indian Contract Act, 1872 where the party will have to prove that due to the unforeseen event it has become impossible for the party to perform, leading to frustration of the contract.
This article will discuss in relative detail the impact of Covid-19 on supply chain contracts and its interplay with the doctrines of force majeure and frustration.
Impact of force majeure clause on supply chain contracts during COVID-19
In March 2020, the World Health Organization declared Covid-19 as a “global pandemic.” By the third week of March, there was a total lockdown in India. The imposition of the lockdown made it impossible for the people engaged in the supply chain to execute their contracts. Parties seeking to avoid execution of the contract relied on the force majeure clause. A “force majeure” clause’ is not expressly mentioned in the Indian Contract Act but its essence can be seen in Section 32 of the Act.
Section 32 of the Act states that while performing the contract, if an unforeseen event happens that makes the contract impossible to perform, then the contract shall be termed void. Due to the unforeseen situation, the parties have the liberty to negotiate and shift the contract to a future date mutually agreed upon. However, if a contract cannot be shifted to a future date, it shall be deemed void under Section 32 and release the parties from their liability to perform the contract.
Force Majeure did not release parties from making efforts to mitigate the probable loss that can be suffered by the affected party. In Halliburton vs Vedanta Limited (2020) after the bidding process, Halliburton was selected to execute a project that included drilling and completion. The court, in this case, observed that there should be a real or justified reason to apply the force majeure clause. Halliburton was not allowed to claim an exemption under the realm of force majeure as a breach was committed by the party before the uncertain event of Covid-19 and the aggrieved party cautioned Halliburton about the breach. Opportunities were given to cure the same, but they were being neglected. However, a few days before the deadline, Halliburton invoked force majeure. The same was not allowed by the court, and the party was obligated to discharge its obligation as per the terms of the contract.
In a contract in which time is of the essence, a force majeure clause shall terminate the contract due to the impossibility of performing the obligations that are present in the contract. In other words, the party claiming relief under the Force Majeure clause has to prove that time is of the essence of the contract.
However, if there is no force majeure clause present in the contract, the party who is unable to perform the contract due to constant lockdowns can claim relief under the doctrine of frustration, which is provided under the Indian Contract Act.
Relief for parties under the Doctrine of Frustration
The presence of a force majeure clause under the Indian Contract Act is not mandatory to terminate the contract between parties. The party can claim relief under the doctrine of frustration, which is covered under Section 56 of the Indian Contract Act.
According to Section 56 of the Act, a contract becomes void when it is for the performance of an act that has become impossible or unlawful (without the fault of the promisor) after the contract was made. Basically, there needs to be a supervening or subsequent impossibility or unlawfulness of the act that was to be otherwise performed through the contract.
The Supreme Court in the 1953 case of Satyabrata Ghose v. Mugneeram Bangur & Co. elaborated on the word “impossible.” The court stated that the performance of the act does not become impossible unless it is impossible from the point of view of the object and purpose of the contract in a practical sense.
In a situation of commercial hardship, relief cannot be granted to the parties under this doctrine. In other words, if the act of the contract becomes (commercially) hard but not impossible, this doctrine cannot be used. Thus, the doctrine of frustration does not apply in situations where the performance is not practically cut off but merely rendered more difficult or costly. In the case of Sanchandra Nath vs Gopal Chandra (2020), Justice Henderson held that the difficulty of the higher rental cocost,hich led to a reduction in prprofit,oes not frustrate the contract. In M/s Alopi Parshad and Sons vs Union of India(1960), due to the outbreak of the world war, there was a price increase. However, the contract stated a specific price. The contractor claimed relief under the doctrine of frustration. However, it was rejected by the Supreme Court, which held that the parties cannot escape their liability just because the performance of the contract has become onerous.
Essential requirements for a party to terminate their obligations under the contract
The party that wants to terminate their obligations or duties that are present in the agreement needs to satisfy the following conditions:
- A notice needs to be issued to the other party providing them details about the Force Majeure event which has made it impossible to execute the contract.
- If the agreement where time is not essential, information needs to be provided when the agreement shall be resumed and the party shall execute their obligations.
- The event should be beyond the reasonable control of the parties and the affected parties should take reasonable steps to mitigate the consequence of the event.
The US Supreme Court relied on these conditions in the case of Lakeman vs Pollard (1857) and allowed the termination of the contract during the outbreak of the cholera epidemic, which made it impossible for the laborer to complete the contract. The Supreme Court considered the epidemic as an ‘act of God’ and was beyond human control to complete the performance of the act.
Protection of parties is emphasized in the legal maxim of Impotentia Excusat Legem which means that the law does not compel a man to do what is impossible to be performed. Relief under this maxim can only be claimed by the party if the essential conditions listed above are complied with.
Distinctions between the Doctrine of Frustration and the Doctrine of Force Majeure
The doctrines eventually make the contract void. Therefore, many believe that they are one and the same. However, there are differences between the two, which are stated as follows:
- The doctrine of Force Majeure is not a legal concept per se and becomes legally enforceable when it is embodied in the contract. However, the Doctrine of Frustration is enlisted in the contract law and per se, a legal concept.
- When a contract does not contain a Force Majeure clause, then parties might claim frustration with the contract.
- In the Force Majeure, parties expressly agree on a list of unforeseeable occurrences that would trigger the clause. However, frustration is triggered when an external event makes the contract impossible to perform.
Difficulties caused to the supply chain sectors due to Covid-19
Various sectors of the supply chain had a direct impact due to Covid-19 which negatively impacted the economy of the country. To name a few such sectors that were affected by Covid-19 were:
- Manufacturing: Manufacturers due to the emergence of Covid-19 found it difficult to distribute the products. There is an inventory build-up that has increased the cost of storage. Losses have been suffered by those manufacturers that manufactured perishable goods. Due to restrictions, the distribution cost is high and this affected profitability.
- Export and Import: Due to border restrictions there was a tremendous reduction in the percentage of imports and exports. Though the ports were overwhelmed with imports and exports, however, they couldn’t be cleared due to staff restrictions.
- Retail trade: Due to internal and external restrictions it was difficult to sell their products which negatively impacted their overall sales. Retailers that built inventory before Covid-19 due to frequent lockdowns suffered huge losses. During Covid, there were times when sellers were selling below the market price to reduce the margin of loss.
- Food services: During the lockdown, there was a substantial reduction in the sale of food services especially when people were working from their homes. Many food service providers found it difficult to shift to the online platform eventually forcing them to exit the market.
- Logistics and transports: The consumers had to bear an increase in delivery costs as there was a drop in the volume of sales. Airlines and the shipping company were forced to lay off a certain number of employees as they couldn’t bear the high operational expense.
Possible solutions to minimise the impact of COVID-19 on supply chain agreements
After numerous lockdowns, companies had been healing from the shockwaves that they received on their profitability due to COVID-19. To further minimize the impact on sales the companies must perform the following functions:
- Educate employees about Covid-19 and ensure that they are complying with all the safety protocols.
- It is necessary to reimagine the supply chain strategy, new trade agreements and country incentives.
- Improve disruption response with real-time visibility and monitoring of your end-to-end supply chain, as well as performing scenario planning and simulations.
- Work towards implementing the digital and end-to-end supply chain across planning, procurement, manufacturing, and logistics. This can drive efficiencies and also open new revenue streams.
Conclusion
Supply chain contracts play a vital role in providing goods to the final consumer. If there is a failure on the part of any key component of the supply chain to execute its part, it would lead to disruption of the supply chain contract. However, liability is extinguished due to the inclusion of a force majeure clause in the contract if all the essentials are being complied with. Many people consider the doctrines of force majeure and frustration as synonymous which is not the case and there are differences between the two. Other than the supply business, various other sectors had to bear the brunt of Covid-19 and there was non-performance on the part of the parties and termination of contracts. Therefore, the situation in COVID-19 reflects the importance of the force majeure clause, which erases liability in situations of unforeseen and impossible events.
References
- https://www.ibanet.org/Covid-19-supply-chain-disruption-rips-up-contractual-rulebook.
- https://www.ey.com/en_gl/supply-chain/how-Covid-19-impacted-supply-chains-and-what-comes
- https://blog.ipleaders.in/force-majeure-clause-contracts-phase-Covid-19/.
- https://blog.ipleaders.in/how-the-coronavirus-pandemic-impacts-commercial-contracts/.
- https://www.inspirajournals.com/uploads/Issues/461892297.pdf.
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