Existing contracts will need careful analysis and strategies for renegotiation if needed.
- By Abir Roy
Governments in India have relied on a law more than 120 years old—the Epidemic Diseases Act—to order lockdowns to deal with the Covid 19 crisis. All establishments will be shut down apart from the factories which are producing essential goods/services. Such notifications have been given teeth since criminal prosecution under Section 188 of the IPC awaits violators of the prohibitions.
All contracts where “time is of essence” would be adversely impacted. Firms must now review their contracts to check whether these have force majeure (FM) clauses and how are the latter are worded to safeguard their interests. An office memorandum of the MCA provides that a party may invoke the FM clause. The memorandum makes it clear that invocation of a FM clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the FM. A notice of force majeure must be given as soon as it occurs, and it cannot be claimed later. Further, if the performance, in whole or in part or any obligation under the contract, is prevented or delayed by force majeure for over 90 days, either party may terminate the contract without any financial repercussion on either side.
The preliminary question, of course, is what is the binding nature of such an office memorandum? Let’s look at the situations which may exist in commercial arrangements. There may be arrangements between parties wherein there is no formal written agreement with FM clauses. In such cases, parties unable to perform their obligations under the contract may seek reliance of Section 56 of the Contract Act (CA) on account of impossibility of performance. The party seeking to renege from the contract can argue that, due to the Covid 19 situation, performance of its obligation under the contact became impossible. The key questions now are: What is the yardstick to determine whether an act is impossible, and does the impossibility in performance lead to termination or suspension of the contract/ arrangement?
Say, Party A had entered into a contract with Party B on March 1, 2020, that it would delivery 100 units by April 15, 2020 @ Rs 1,000 per unit. Party A had assumed that input cost would be Rs 800, and the margin would be `200 per unit. If the lockdown duration wasn’t specified and it was lifted on March 31, Party A can start manufacturing from April 1. However, supplying 100 units by April 15 now means a cost of Rs 1,200 per unit since inputs have to be gotten urgently (from sources more expensive or employing more machinery/labourers to deliver). Faced with a huge loss, Party A may seek to renege from its contract.
Does the contract become impossible to perform? In such a situation, where there are no FM clauses, Party A may rely on Section 56 of the CA to claim impossibility to perform. Section 56 only deals with the only possibility of rendering the contract void due to impossibility, there is no option to suspend the contract, unlike FM where a party may delay performance if the clause permits this. Party B may argue that the contract could have been performed: While the commercial rationale for Party A to enter into the contract may have changed, it should not be absolved from performance merely because this has become loss-making. Thus, it is for the courts to determine whether this situation is an event of “impossibility”.
A 1960 Supreme Court judgement, followed again in 1968 by it, is apt in this context, wherein the SC noted that parties to a contract are often faced with a chain of events which they did not anticipate, including an abnormal rise or fall in prices, thus rendering the terms of the contract onerous to one of the parties. This does not in itself mean that the said party can renege from the contract on account of impossibility.
The unprecedented response of government in response to Covid 19 should constitute a FM event; however, the rights and obligation of the parties would depend on the wording of the contract. It is imperative to first analyse the FM clauses in contracts: some may provide only for specific events, while some could include all events beyond the parties’ control. Also, some FM clauses may only be invoked in case of impossibility of performance, while some may be broad enough to include delay in performance. The determining factor now is to establish a direct link of Covid 19 event with the impossibility or delay of performance.
Now, let’s consider the situation discussed earlier. The standard of impossibility of performance would be same as that of Section 56 of CA. It is not enough to show that performance is more expensive, or less profitable, to show impossibility, unless it can be shown that the fundamental basis of entering the contract has been vitiated by Covid. Proving that the performance has been delayed should be less onerous. In such cases, it needs to be shown that adhering to timelines under the contract and other performance is reasonably more challenging.
The parties seeking to invoke FM clauses must follow the procedure mentioned in the contract, i.e., give notices etc without any delay. The parties may also be keen to renegotiate the contracts. Keep in mind, a continued Covid crisis may not be an FM event in renegotiated contracts since a prudent businessman must take into account the crisis’s future implications. Thus, the renegotiation must be done cautiously. Considering the above, a calibrated approach is required wherein a legal and business analysis of the contract is done to protect a party’s interests and formulate a strategy for negotiation.