This article has been written by Semantika Ghosh pursuing the Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article has been edited by Ruchika Mohapatra (Associate, Lawsikho).
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Contracts are an essential part of our daily lives, especially for individuals in the corporate world. The primary goal of entering into a formal, legal contract with another party is to legally bind them and obligate them to complete the agreed-upon work. The failure to perform a contract results in a contractual liability being imposed on the party who fails to perform the contract. To solve this issue, the Indian Contract Act, 1872 defines the essential nature of a contract and outlines the rights and obligations that bind a party after they engage in a contract with one another. Due to the ongoing pandemic, every sector of the economy has suffered a significant setback in terms of commitments, completion, and performance stemming from contracts. There are normally two parties involved in the performance of a contract: one who receives the money upon successful completion of the work assigned, and the other who pays the money upon due performance. “A promise to execute an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not avoid, unlawful, becomes void when the act becomes impossible or unlawful,” says Section 56 of the Indian Contract Act of 1872.
Performance of contracts
If two parties have formed a contract, the contract’s performance, or the fulfillment of the work or the aim for which the contract was formed, must be accomplished. There would be a breach of contract if the performing party failed to perform the contract, and in such an instance, the defaulting party would be required to pay a specified amount of compensation to compensate for the loss suffered as a result of the breach. Non-performance of a contract is addressed in two parts of the Indian Contract Act, 1872, namely Section 56 (Impossibility of performing the contract after its execution) and Section 32 (Impossibility of performing the contract after its execution) (Contingent contract). The Act’s Section 37 deals with the obligations of contracting parties, each party is obligated to fulfill his contractual obligations unless the performance is waived or excused by the Contract Act or any other law. A performance under section 37, for example, may be waived by the agreement under Section 62.
Force Majeure Clause
The basic foundation of this section is the term ‘impossibility,’ and it can be determined from a simple reading of the section that the current pandemic scenario is related to this section and that it can also be invoked on our contractual responsibilities. Force majeure clauses in a contract, on the other hand, do not excuse a party’s non-performance in its entirety; rather, they suspend it for the period of the force majeure. As a result, there may not be a total termination of the force majeure clause; instead, the agreement may be cancelled or temporarily suspended due to the existence of a force majeure clause.
In the recent case Standard Retail vs. G.S. Global Corp., steel was being brought into the country and it was contended that steel, as an important item, had to be excluded from the use of the force majeure clause. Because it is a private contract, the Bombay High Court’s single bench has said unequivocally that force majeure will not be considered in that specific case. In this context, the Government of India declared the outbreak of the Covid-19 pandemic to be a force majeure with respect to contract performance in February 2020, but it did not include private commercial contracts within its purview. However, it clarified that it may have assuasive value by stating that “coronavirus should be considered as a case of naturopathy.” “A force majeure clause does not totally exonerate a party’s non-performance, but rather suspends it for the duration of the force majeure,” it says. Force majeure must be declared as soon as it arises, and it cannot be claimed after the fact. If any reason of force majeure prevents or delays the execution in whole or in part of any duty under the contract for more than ninety days, any party may cancel the contract at its discretion without any financial repercussions.”
However, in circumstances where the contract’s performance cannot be excused due to force majeure, the contract can still be absolved under Section 56 of the Indian Contract Act, 1872, which deals with the doctrine of frustration. There is, however, a distinction to be made between philosophy of frustration and force majeure. One of these is the doctrine of frustration, which applies in circumstances where the contract was silent on any such unlikely event, whereas a force majeure provision in a contract identifies all such events that will excuse the contract’s execution for the time being. The occurrence of a force majeure event is merely the first stage in deciding whether a contracting party is entitled to some relief in carrying out their obligations. The required measures to invoke a provision will depend on the exact wording of the contract itself, as is the nature of a force majeure incident. The following are the most prevalent conditions for invoking a force majeure clause:
i) Demonstrating that the force majeure event has a sufficient impact on an actual contractual obligation – force majeure provisions will often specify the level of impact required on a party’s capacity to perform its contractual commitments – a challenging business environment will often not suffice;
ii) When a contract’s provision is triggered, the parties are usually required to give written notice; and
iii) Mitigation – Parties are normally expected to mitigate the force majeure event’s impact.
There is minimal common law redressal available where parties do not have or do not apply force majeure contractual terms. Protections or excuses under common law for parties who are unable to perform their contractual obligations are few, and those that do exist are narrowly defined and enforced. Parties affected by COVID-19 who are unable to rely on contractual terms for non-performance are restricted to common law defences such as frustration. Frustration happens when an incident occurs that causes contractual responsibilities to differ radically, substantially, or fundamentally from those anticipated by the parties due to circumstances beyond their control. Frustration is contrasted from situations where execution has become merely onerous, difficult, or unreasonably expensive, as in the case of force majeure events.
While COVID-19 may cause frustration or impossibility, asserting that a contract is frustrated or impossible is a high bar to clear. It’s also worth noting that, unlike most force majeure provisions, common law remedies call for the entire contract to be terminated, rather than a more customised solution like allowing a delay or relieving a party of certain obligations. Given how the nationwide lockdown has disrupted business in every sector, as evidenced by the quarterly GDP report, it will come as no surprise if there is an increase in the number of cases relating to contractual rights enforcement in a desperate attempt to eliminate the enforcement of force majeure clauses.
In the absence of a force majeure clause, the parties may seek to enforce the doctrine of frustration under Section 56 of the Act, and it may be a challenge for the court and the tribunal to determine whether this situation qualifies for temporary suspension of contract performance by invoking the force majeure clause or rendering the contract void with the enforcement of Section 56 in its entirety.
Contracts are agreements that are made voluntarily. Similarly, contract enforcement is a voluntary act. It is possible to opt not to insist on rigorous adherence. This can raise difficulties about whether and to what degree rights have been waived. Depending on the conditions, contractual rights can be surrendered “totally or partially.” A decision to refrain from enforcing a contractual right can be a beneficial concession that serves as the foundation for a new agreement, but the new agreement should preferably be carefully structured. Otherwise, the decision might easily devolve into a squabble. Waiver of contractual rights is a question of intent, and intent is often difficult to show. Because the purpose to waive is frequently a matter of fact, failing to make one’s intention clear and unequivocal might result in the worst kind of dispute: a protracted one.
Contract measures intended to prevent conflicts over potential waivers and contract amendments may not be effective. Many written contracts, for example, have a clause indicating that contractual amendments must be made in writing. The state of New York has enacted a legislation requiring that such provisions be followed. However, the highest court in New York has ruled that the statute’s protection against oral alterations can be rendered ineffective in two situations. The first is when “the oral agreement to modify has been carried out to completion”; the second would be when “partial performance” is “unequivocally referable to the oral modification.” Furthermore, even if neither of the statute’s exceptions apply, a party may still be precluded from enforcing the original, written agreement if a judge determines that doing so would be unfair.
When one party to a written agreement induces another to rely on an oral change in a significant and substantial way, the first party may be estopped from invoking the legislation to prevent proof of the oral modification. Despite the fact that events are unfolding swiftly, parties to commercial contracts are recommended to take the time to make their objectives about contract modification as clear as possible.
Defence of impossibility
The statute refers to situations in which performance as agreed has been made impracticable by the occurrence of a contingency whose non-occurrence was a common assumption on which the agreement was made, or by adherence in good faith with any relevant foreign or domestic government oversight or order, whether or not it later demonstrates to be invalid. The majority of the time, impossible defences fail. Financial hardship, for example, is rarely sufficient on its own. However, an impossibility argument can be supported by a government directive that interferes with the contract. Even if the government direction is informal, the impossibility defence can succeed. A US company had a contract with a Swedish company to send radio parts to Iran and other nations, according to a decision ruled by a Federal Appeals Court interpreting New York law. After that, the US Company reached an arrangement with the US government to stop exporting parts to Iran. When the Swedish company sued for breach of contract, the court decided that the US company’s good faith compliance with the government’s informal rules constituted an impossible defence.
Emergency orders and related government instructions are being issued at an alarming rate these days. Restaurants, entertainment venues, and commercial gyms in New York City have been told to shut down their main operations. Most organisations in New York State have been directed to ensure that at least 50% of their personnel work remotely. Recently, the Governor of New York State stated that this figure will be raised to 75%, and that interior areas of retail shopping malls throughout New York and neighbouring states will be required to close. Certain contract claims may benefit from an impossibility defence based on these government directives.
Other contractual obligations
Aside from force majeure clauses, many contracts will address temporary disruptions, such as allowing a supplier to skip a commodities supply on notice and with compensation if applicable. Depending on the circumstances, a disruption like this may or may not be considered a material breach of termination conditions. Every contract will be unique in this regard, and contracts should be thoroughly scrutinised for any temporary “out” provisions.
Business interruption insurance
Organisations having business interruption insurance should check their policy to see if business losses caused by an outbreak or pandemic are covered or excluded. Business interruption insurance often covers income losses caused by physical damage to property, but it may also cover disruption caused by pandemics or government-ordered closures. Examine the notification periods and any procedures that must be followed in order to file a claim.
Despite the hardships created by the epidemic, most contracts will still be enforceable. Wherever possible, force majeure clauses shall be construed by the courts to give temporary reliefs, but these temporary reliefs will not render the contract unenforceable in its entirety. Even fewer contractual connections will be harmed as a result of the epidemic, given the government’s lockdown is only temporary and will be removed soon. If a contract is deemed to be frustrated as a result of the epidemic, the party that got the benefit is required to refund it to the other party under Section 65 read with Section 56 of the Act. Increased costs and delays in fulfilling obligations as a result of the lockdown are matters that the courts should address. The Supreme Court’s precedents plainly show that these considerations alone would not be enough to cause a contract to be frustrated. A party utilising a contract’s force majeure provision must show the courts that it has taken genuine steps toward fulfilling its commitments. The COVID-19 lockout will exacerbate the challenges that already exist in overburdened court institutions, potentially leading to a lengthier case pending times. As a result, wherever possible, parties should explore renegotiation and settle disagreements by reaching a mutual agreement. To resolve and find out-of-the-box solutions for these difficulties, expert mediators are recommended. It may be more practical for parties to avoid lengthy and expensive litigation. The COVID-19 pandemic has underlined the significance of cooperation among individual citizens of the country in limiting the pandemic’s spread, and now parties must work together to successfully transition into the post-COVID-19 world.
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