This article is written by Arun Nair, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho, and Vishesh Gupta, from Institute of Law, Nirma University, Ahmedabad. This article discusses the importance of renegotiations of contracts in the times of COVID-19.
The whole world is currently facing one of the biggest crises in the modern era. COVID-19 has spread all around the globe. The World Health Organisation has declared it to be a pandemic and many countries including India, United States of America, Singapore have imposed extreme measures of “Lockdown”.
The novel coronavirus has severely affected the global economy and commercial market. International trade including export and import, the international movement of people from one country to another and businesses have been effectively stopped for an indefinite time.
In these challenging times, one has to think about the impact of the lockdown on his previously entered contractual obligations. Therefore, this article discusses whether a contract could be renegotiated during this COVID-19 crisis. This article also puts light on the importance of renegotiations of contracts during COVID-19.
Why is there a need for renegotiation of contracts?
The highest law in any commercial contract is the principle of Pacta Sunt Servanda which means that agreements must be kept and must be performed in good faith. However, because of the COVID-19, the world is in a state of lockdown and supply chains have been disrupted and the demand and supply curve has also been reduced. Any import or export is not allowed.
Businesses have been exposed to heightened risks of legal implications which impacts the small companies and manufactures more severely than the large Multinational Corporations. Even these MNCs are not entirely unaffected.
Global trade and the world economy are in shambles and it has a direct consequence on every individual. In these circumstances, it is difficult to conduct business and fulfil any previously entered contractual obligations.
Therefore, parties to the contract seek to absolve, delay, or alter the terms of their contractual obligations so as to minimise any unjust costs and legal implication.
Can a contract be renegotiated in the light of COVID-19?
A contract could be renegotiated when the subject matter of the contract becomes impossible to perform. This is a common law principle also known as the frustration of contraction. Further, parties can invoke the clause of Force Majeure (if it is drafted in a contract).
Generally, a well-drafted contract always contains the Force Majeure Clause so as to save the parties from any unforeseeable loss or liability which involves no fault from the parties.
Force Majeure Clause
Black’s Law Dictionary defines the term as “an event or effect that can neither be anticipated nor controlled. Force Majeure is commonly understood to encompass both acts of nature, such as floods and hurricanes, and acts of man, such as riots, strikes, and wars.”
Black’s Law Dictionary further defines ‘‘Force Majeure’’ clauses as “contractual provisions that address circumstances in which contractual performance becomes impossible or impracticable due to events that could not have been foreseen, and are not within a party’s control. It is important to note ‘‘Force Majeure’’ clauses do not generally provide for termination of an agreement; rather, they generally suspend a party’s obligation to perform under the agreement for the duration of the ‘‘Force Majeure’’ event. It is therefore a key tool in managing such events.”
Important principles while invoking the ‘‘Force Majeure’’ clause are:
- Whether or not you can prove the impossibility of performance of the contract;
- The temporary test of the event triggering the ‘‘Force Majeure’’ clause in the contract;
- Alternative means of performance of the contractual obligations since the courts will hold the contracting parties to their obligation.
Force Majeure is one of the essential clauses in a contract which protects a party from liability for the failure of performance of the contractual obligations because of unforeseeable events which are beyond the control of the parties.
For instance, In the case of Peter Dixon and Sons, Ltd. v. Henderson Craig and Co. Ltd. (1919) 2 K.B. 778, British ships were no longer available because of the war for carriage of wood pulp from Canada to Grimsby in England. It was held to be a hindrance to the performance of a contract for delivery of pulp and came within the meaning of the force majeure clause in the contract under consideration in that case. It was held that the boilers were not liable for non performance of shipping pulp.
It has not been expressly mentioned in the Indian Contract Act but it derives its authority from the doctrine of frustration which is mentioned in Section 32 and Section 56 of the Indian Contract Act.
In the case of Energy Watchdog v CERC, (2017) 14 SCC 80, it was clearly stated that force majeure is governed by the Indian Contract Act. If the force majeure clause is mentioned in a contract, it is governed by Section 32 of the Indian Contract Act. However even in the cases where force majeure event is outside the scope of the contract, it will be governed by Sec 56 of the Indian Contract Act. The latter is known as the doctrine of frustration and will be discussed in the next section of the article.
Force Majeure includes the Act of God, war or war-like situations, labour unrest or strikes.
It is pertinent to note that force majeure and Act of God cannot be used interchangeably. Force Majeure is a broader concept than the Act of God as force majeure includes an act of god and any event which involves human agency unlike events in the Act of God. The rationale behind the Force majeure provision is to protect a party from the consequences of a breach of contract on which the party has no control.
What constitutes ‘‘Force Majeure’’
Contracts can and usually do include terms as to what qualifies as a ‘‘Force Majeure’’ event and what notice requirements must be met to obtain relief from the required performance. Therefore, contracting parties must anticipate and specify the circumstances that will be covered by the ‘‘Force Majeure’’ clause in the agreement.
In general what constitutes a ‘‘Force Majeure’’ event is – natural disasters like hurricanes, floods, earthquakes, and weather disturbances (collectively referred to as “acts of God”), war, plague, terrorism or threats of terrorism, civil disorder, labour strikes or disruptions, fire, disease or medical epidemics, pandemics, outbreaks, and curtailment of logistics and transportation facilities preventing or delaying commercial activities.
Absence of the ‘‘Force Majeure’’ Clause
In the absence of a ‘‘Force Majeure’’ clause, parties to a contract are left to the mercy of the narrow common law contract doctrines of “impracticability” and “frustration of purpose,” which rarely result in excuse of performance. Instead of relying on the common law, meeting planners can better achieve flexibility during times of crisis through a carefully negotiated ‘‘Force Majeure’’ clause.
An improperly drafted, generic ‘‘Force Majeure’’ clause can leave the parties with fewer protections than they would have under the law without it. In addition, the Indian Contract act, 1872 itself being more than 100 years old does not have specific conditions relating to suspensions and terminations of contract owing to such ‘‘Force Majeure’’ events.
If your contract does not have such a clause or has limited scope then the parties rely on Section 56 of the Contract Act, which deals with agreement to do an impossible act.
Section 56 says –
“An agreement to do an act impossible in itself is void. — An agreement to do an act impossible in itself is void. Contract to do act afterwards becomes impossible or unlawful.—A contract to do an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.”
Section 56 deals with a situation where:
(a) Either there is an agreement to do an act which is itself impossible,
(b) There is an agreement to do an act, which becomes impossible or unlawful and resultantly void,
(c) Allows compensation to the promisee from the promisor who enters into an agreement that the act promised is impossible or unlawful while the promiser does not know this.
However, if your contract does have a ‘‘Force Majeure’’ clause then Section 32 of the Indian Contract Act becomes applicable. This is because the contract itself depends on the happening or non-happening of the contingency.
Section 32 states that – “Enforcement of contracts contingent on an event happening.—Contingent contracts to do or not to do anything if an uncertain future event happens, cannot be enforced by law unless and until that event has happened. —Contingent contracts to do or not to do anything if an uncertain future event happens, cannot be enforced by law unless and until that event has happened.” If the event becomes impossible, such contracts become void.”
There can also be instances in contracts where the term – “Pandemic” is not specifically provided for in the ‘‘Force Majeure’’ clause and reliance may then be given on other clauses such as “Act of God” or “Natural Calamity”. While such an act may not be universally applicable it may still seem a compelling and convincing argument while interpreting the contract.
In such situations, there can be an argument that the inability of a party to perform their obligations under a contract are covered under the ‘‘Force Majeure’’ even if the specific event is not mentioned under the contract.
However, the consequences of invoking such a clause, how long it can be invoked and upon whom the risks and losses lie would depend upon the contract.
Whether COVID-19 is covered under Force Majeure?
There is no universal answer to this, but Indian and Chinese governments have answered this in affirmative. The legislative body and the judiciary of China have effectively categorized COVID-19 outbreak Corona under Force Majeure. The China Council for the Promotion of International Trade issued over 1,600 ‘force majeure certificates’ to Chinese companies in February.
In India, the Department of Expenditure, Procurement Policy Division, Ministry of Finance issued an Office Memorandum on Feb. 20, 2020, in relation to the Government’s ‘Manual for Procurement of Goods, 2017’. The Memorandum has effectively stated that the COVID-19 outbreak could be covered by a force majeure clause.
Also, in some cases, the question of whether pandemics, in general, could be covered in force majeure can be answered by expressly including pandemic in Force Majeure clause of the contract. In cases of contract law, a well-drafted contract is essential. Every liability and responsibility is determined based on what is written in the contract.
It may be general in nature where the Force Majeure clause is included in the contract but has not been defined in specific terms. On the other hand, the exact scope of Force Majeure has been expressly written. Proving pandemic as a force majeure event is more difficult in the case where the clause of Force majeure is not defined in specific terms.
Government legislation on ‘‘Force Majeure’’
In India, the Government has recently issued an office memorandum in relation to the ‘‘Force Majeure’’ event which aimed at bestowing some relaxations to the parties who have entered into a contract with the Government of India.
For this purpose the Government had earlier regarded this pandemic as a natural calamity to invoke the ‘‘Force Majeure’’ clause under different contracts. It was also lucid in its approach of the applicability of ‘‘Force Majeure’’ event on account of disruption in manufacturing distribution and supply chain activities of goods and services in India including the restrictions placed by the Central Government as well as the respective State Governments and Union Territories.
Therefore, it can be implied that the Government seeks to cure the impact of ‘extraordinary events and circumstances which are way past human control which in turn lead to impairment in fulfilment of contractual obligations for parties.
How to negotiate a Force Majeure Clause
A contract can be re-negotiated when the subject matter of the contract becomes impossible to perform and parties can invoke the force majeure clause if it is included in the contract.
In any agreement or contract the parties should negotiate with probity and the parties are expected to cooperate with each other not just at the time of drafting the contract but also at the time of a force majeure event occurring. Contracting parties should be willing to consider the interests of the other party and in all earnest attempts at saving the parties from any unforeseeable loss or liability, which arises due to no fault of the contracting parties.
When such an event arises, and, a renegotiation of contract is warranted then such process should place the parties in the initial economic position and parties should endeavour to reach an agreement within the set framework and in consideration of the prevailing conditions.
Doctrine of Frustration
Even if a contract does not contain the Force Majeure clause, parties to the contract can rely on the common law doctrine of frustration as Force majeure derives its authority from this doctrine.
The doctrine of frustration is embodied in Section 56 of the Indian Contract Act which states that if an act becomes impossible to perform the contract shall be deemed void.
The court, in the case of Satyabrata Ghose v. Mugneeram Bangur and Co., stated that if the event was outside the anticipation of the contract, Section 56 of the Indian Contract Act would apply and render the contract void even if no implied or express provision regarding Force Majeure was present. In this case, Satyabrata(plaintiff) sued the defendant for wrongfully repudiating the contract of developing the land. Defendant took the defence of frustration as the land which needed to be developed were temporarily requisitioned by the Government under the defence rules for an unspecified period of time. The court declared that the contract had not become impossible to perform as the circumstances of war were known to the parties and the reasonable time in which the contract was to be completed was not mentioned.
What things are to be taken care of before enforcing force majeure?
- Duty to Mitigate- The provision of Force Majeure has been misused in a plethora of cases as a means to escape the contractual obligations. The party invoking the exception of Force majeure has the burden of proof to show that there were no reasonable measures to mitigate or avoid the consequences of the force majeure event.
- Notification requirement- Force Majeure clause contains a time-bound notification requirement. Such provisions are enforceable, and so complying fully with all notice requirements will be important for parties seeking to invoke the exception of force majeure.
- In cases of the renewable energy sector, companies claiming for time extension shall submit an application to Solar Energy Corporation of India Ltd (SECI) or other implementing agencies. Companies also have to provide all evidence in support of their claim and on reviewing all the evidence, agencies may grant Extension of Time.
- Defence of economic hardship is not adequate to invoke frustration of the contract. The doctrine of frustration does not relieve a party from performing their contractual obligation simply because the force majeure event has made the performance more difficult or expensive.
Benefits of Renegotiations
The circumstances at the time of the formation of the contract are always fluctuating and sometimes the unexpected events change these circumstances in such a way that the execution of the contract in the new conditions, without the adjustment/renegotiation of contract, makes the performance extremely difficult and unbearable.
The rapid spread of COVID- 19 around the world was not reasonably foreseeable by anyone. So, any contractual obligation or performance of a contract that seemed possible in December 2019 and January 2020, is now almost impossible to perform because of the complete lockdown.
Breach of contract is justiciable in a court of law and may cause unjust losses to the parties. Renegotiation is an effective way of modifying various aspects of a contract which is more suitable to the prevailing situation of the market and the world in general.
Looking at the current developments of COVID-19 in India and the rest of the world, there remains huge uncertainty about when the normalcy will prevail again. So any contract, whose performance is due now or in a foreseeable future should be considered for renegotiation of the terms of the contracts.
Remedies for Force Majeure Event
The wordings of the contract would determine the future course of Action when the Force Majeure event takes place.
- Termination of Contract: Parties may terminate the contract in toto or suspend only a few clauses of an agreement.
- Freezing of contract: Some parties may decide to put on hold the contractual obligations until the force majeure event is over.
- If the force majeure event is prolonged, a clause of termination will be enforced in a certain period of time as prescribed in the contract.
However, this is not applicable in all cases. For instance, for a contract in which perishable goods are the subject matter, freezing or prolonging the contracts is not reasonable.
Scope of Re-negotiation clause in contracts
The concept of renegotiation tries to uphold the principle of pacta sunt servanda. Scope of Renegotiation can be found in the terms of the contract itself. There may be a clause of renegotiation which specifies in which circumstances can the contract be renegotiated. Renegotiation clauses include cancelling/absolving the contract, delaying the obligations till future notice when the contract could be enforced.
Renegotiation may also exist in different clauses like material adverse change clauses, to limit or exclude liability for non-performance, price adjustment clauses, limitation or exclusion clauses etc.
Material adverse change clauses state that if the status of the subject matter or the status of the parties has adversely changed since the time when the contract was entered, the contract will be deemed to be void. This clause is commonly found in acquisition, merger and lending agreements.
These clauses provide flexibility to a contract and the main reason for the inclusion of these provisions is to ensure that parties do not face losses and that the contract could be performed, not as originally agreed, but in such a manner as to reduce risk of losses and legal implications.
Renegotiation for different subject matters
In the current scenario, renegotiation shall differ for contracts involving different subject matter. It is important for a party to a contract to decide whether they want to absolve the contract altogether or they want to prepone or postpone the commitment.
- Essential commodities: As we all are in the state of lockdown, the supply of essential commodities like groceries and medicines are very important and therefore, the contracts of supply of these commodities shall not be absolved. The terms of the contract regarding the time period, jurisdiction covered, mode of performance and consideration can be altered. This is more applicable to those vendors who don’t have a huge supply chain.
- Renewable Energy: The government is offering leniency in the renewable energy sector as the renewable energy sector can cite COVID-19 as the force majeure to delay the projects. This is because this sector may face project delays because of COVID-19, which could prove fatal to the country’s flagship 175GW target for 2022.
Absolving the contract in toto should be used in those cases only where the performance cannot be possible for a foreseeable future and in the cases where the time of performance of the contract is of the essence and non-performance at the stipulated time will lead to non-recoverable losses.
Effects of force majeure certificates issued by Chinese government
The certificates will no doubt be beneficial to chinese companies in the domestic market, but these certificates might not hold up at the global stage as other countries have strict terms for claiming Force Majeure.
Further, many companies in China have contracts that call either for disputes to be adjudicated in jurisdictions other than the Chinese courts or arbitration forums or to apply laws other than China’s. Outside China, the legal value of those certificates is unknown.
The crisis that humanity is currently facing has no end date confirmed. No vaccine has been created and the virus is spreading like wildfire. Determining the date when the world will return to normalcy seems implausible. This puts uncertainty in most of the contracts which are currently impossible to perform and this ultimately affects the parties as non-performance leads to losses for the parties involved in a contract.
However, a well-drafted contract can save a party from losses. A well-drafted contract is a contract that anticipates any loss that parties might incur and also don’t put any additional burden on the parties.
Contracts should have the force majeure and renegotiation clause as it provides more flexibility to the contract. In these uncertain times, a contract should be renegotiated in such a way that it becomes possible to perform in these uncertain times.
The role of advocates is of great importance for renegotiating contracts. The intricacies of a contract could be understood by an advocate and he can guide the parties towards amicable discussions for renegotiations. It is advisable to keep an open mind during renegotiations so that parties could make the best of the worst situations.
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An interesting read!