Force Majeure: Coronavirus pandemic is crucial time for businesses to review contracts

Published: May 8, 2020 5:21:09 PM

Force majeure in contracts typically allow parties to avoid performing their contractual obligations when inevitable, unforeseen, and uncontrollable circumstances arise, rendering the performance of the contract impossible.

This is a crucial time for management, including general counsels, legal heads, chief financial officers, chief executive officers and key managerial personnel to prepare for the COVID-19 pandemic. (Image: Reuters)
  • Arpinder Singh

In the wake of the global economic slowdown and disruption in the movement of goods and services through international borders because of the COVID-19 pandemic, the Ministry of Finance, Government of India recently issued an office memorandum (thereafter referred to as ‘memo’) allowing entities to invoke the “force majeure” clause in contracts executed under the Manual for Procurement of Goods, 2017. This has been on the grounds of supply chain disruption to mitigate the spread of COVID-19 in China or any other country. The memo clarifies that such instances should be considered as a case of natural calamity and the force majeure clause may be invoked wherever appropriate in accordance with the procedures laid down in the procurement manual. Force majeure in contracts typically allow parties to avoid performing their contractual obligations when inevitable, unforeseen, and uncontrollable circumstances arise, rendering the performance of the contract impossible. As an illustration, if an Indian party enters into a contract with a foreign party to purchase a certain quantity of dairy products and at a later stage, Indian laws prohibit import of dairy products into India, then such contract becomes impossible and thereby void.

Pursuant to the memo, the Ministry of New and Renewable Energy (MNRE) issued another office memorandum dated 20 March 2020 1 relying on the Ministry of Finance’s clarification. This intimated that all renewable energy implementing agencies of the MNRE (and all State Renewable Energy Departments) must treat all situations of supply chain disruption, as force majeure and may grant suitable extension of time for projects accordingly.

While the memo only applies to contracts executed under the procurement manual with government entities, the reasoning applied here may also be adopted and claimed in private contracts, as applicable. However, the chances of successfully invoking the force majeure clause would be determined based on specific facts and circumstances of each case. The argument is yet to be tested in the court of law.

Preparing for impending economic issues amidst the COVID-19 pandemic

From an organizational standpoint, this is a crucial time for management, including general counsels,
legal heads, chief financial officers, chief executive officers and key managerial personnel to prepare for the COVID-19 pandemic. Organizations need to consider whether they can successfully claim impossibility of performing their contractual obligations and invoke force majeure clauses in their contracts. Only foresight and careful planning will lead to a scenario where any upcoming losses can be mitigated. Some of the actions to be taken into consideration are:

  • All contractual obligations should be reviewed for deadlines, governing law, possibility of
    extensions and commitments which may not be fulfilled due to any direct or indirect impact of COVID-19. Organizations can conduct valuation studies to highlight the major contractual relations which have a greater risk of causing losses and the losses should be quantified.
  • All organizational contracts entered into should be reviewed to highlight the force majeure clauses and their applicability in the current crisis. This should include all forms of contracts including but not limited to contracts entered with suppliers, vendors, customers, etc. A special interest on this point should be taken by banks and other financial institutions due to the increased risk to the sector. Some other areas which should be considered relevant are commodity contracts, building contracts, supply of material contracts which require material to be obtained cross country and manufacturing contracts.
  • In cases where impossibility of completing contracts has already been achieved, and force majeure clause can be invoked, organizations must act immediately and inform and start a dialogue with the other party as soon as practically possible.
  • Assess the impact of force majeure clauses on insurance arrangements to assess viability.

Considering we are in a time where uncertainty is reigning supreme, it is challenging to speculate on all areas of business which will be impacted due to COVID-19. However, trends witnessed in past pandemics highlight that all businesses must plan properly and assess the situation at hand to prepare for the unknown and maintain continued business and economic viability.

  • Arpinder Singh, Partner and Head – India and Emerging Markets, Forensic & Integrity Services, EY. Views expressed are the author’s own.

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