Frustration of Contract
Covid-19: An event of force majeure or frustration affecting contractual obligations?
- Contractual Disputes due to COVID-19
Can COVID-19 be the Force Majure Clause?
The coronavirus pandemic has witnessed unprecedented lockdowns across the world, including in India. Current lockdowns are extraordinarily impacting businesses and supply chains. Manufacturing processes are in halt, the supply of goods and services are being delayed, construction and infrastructure projects are going to be delayed, and the list goes on. In other words, parties to legal agreements will inevitably be in default of contractual obligations, financing prerequisites and timelines for performance. Consequently, they will seek to renegotiate, suspend or even end their contractual arrangements. As a result, what we will most certainly witness is a plethora of legal disputes culminating in thousands of litigations and arbitrations resulting solely from this coronavirus-triggered standstill situation and its aftermath. In this context, an understanding of legal implications is vital for corporations and entrepreneurs.
The rule of thumb is that a contract once formed is meant to be performed. Mere inconvenience or hardship is not sufficient to avoid fulfilling contractual obligations, and the court will enforce the bargain that parties have struck. The exception to this is – if parties to a contract are dispensed with such performance or otherwise excused under any provisions of law. In the present context, parties must consider whether the Covid-19 is a force majeure event under their respective contract, and if not, whether the contract otherwise stands frustrated due to impossibility of performance.
Force Majeure Events:
Force majeure is a legal concept referring to an event or circumstance that can be neither anticipated nor controlled, which prevents or impedes a party’s ability to perform its contractual obligations. In such an event, the affected party may invoke the force majeure clause to be relieved from its obligations and avoid liability for the non-performances. This may excitingly appear to be what the coronavirus pandemic is all about. However, it may not necessarily be the case. A party is entitled to seek relief arising out of a force majeure event only if the contract incorporates a force majeure clause and the event in question also falls within the purview of such clause. It is therefore purely a contractual remedy, and there is no automatic right to assert a force majeure under the law. As a result, before a party can rely upon it, the force majeure clause so incorporated must have been drafted in a manner so that the current Covid-19 situation or associated lockdowns fall within the contractual definition of circumstances or occurrences capable of triggering the force majeure clause
A specific reference to epidemics or pandemics will certainly remove any doubt but there need not necessarily be such a specific reference. It may suffice if the list of force majeure events is left open to include acts of God or nature or lockdowns outside the control of the parties. However, what may give rise to complications is that draftsmen of contracts sometimes put down an exhaustive list of few specific events to eradicate uncertainties of interpretation. This may give rise to problems if a reference to natural calamities or lockdowns are not amongst such events in the said exhaustive list. In such a case, a party may not be able to rely on such provisions if the Covid-19 event in question has no connection with those which are expressly listed in the contract as force majeure event. The counterparty will, in that case, effectively attempt to resist a force majeure claim and may succeed in doing so.
In any event, the party’s ability to perform its contractual obligations must have been prevented, impeded or hindered, by the Covid-19 pandemic or associated lockdown. The exact degree of impediment or hindrance depends on the exact contractual wording. The party attempting to rely upon a force majeure will also have to demonstrate a link between the pandemic or associated lockdown and its inability to perform contractual obligations.
A force majeure event may result in the mutual suspension of all contractual obligations until the specified event ends or termination of the contract often extinguishing contractual obligations. The precise outcome depends on how the contract is drafted and the facts of each case. The parties should nonetheless closely adhere to contractual protocols if any.
Frustration of contracts
If a contract did not incorporate force majeure clause or did not otherwise stipulate epidemic, pandemic or natural calamities beyond the control of the parties or unforeseen lockdowns as a force majeure event, parties may still have legal remedies amid the Covid-19 pandemic. A contract may be discharged on the ground of frustration when something occurs after the formation of the contract which renders it physically or commercially impossible to fulfil the contract or otherwise transforms the obligation to perform into a radically different obligation from that undertaken at the moment of entering in the contract. Under the Contract Act, an agreement to do an act impossible or which subsequently becomes impossible because of some event which the promisor could not prevent becomes void when the act becomes impossible.
While some contracts may genuinely fall within the purview of the law of frustration, Covid-19 shall not be presumed to be a readily available escape door to avert contractual obligations. The courts do not wish to allow a party to rely upon the doctrine of frustration in an effort to escape from what has proved to be a bad bargain or hard task. The doctrine will not come into aid merely because performance under a contract has become difficult, onerous or expensive, and is no longer commercially viable for one of the parties. It has to reach the degree of rendering performance impossible. One should carefully note that once found to be frustrated, a contract stands as void and permanently set aside. The parties are excused from all further performance and not liable for damages for non-performance. This is, therefore, a rare occasion.
What should be the approach for businesses?
It would be prudent for parties to consider whether the event was within the parties’ contemplation when the contract was entered into. Was it before the virus was declared by WHO a pandemic on 12 March 2020? For India, the lockdown from 23 March 2020 onwards has to be considered. Parties should ask what the true cause of their inability to perform is and exactly what obligation(s) cannot be fulfilled due to this situation. They should also consider whether there are multiple causes for non-performance. Parties are recommended to explore alternative ways in which the relevant obligation can be fulfilled and to prudently consider steps that can be taken to mitigate the effects of the pandemic. If contractual provision allows and the situation so demands, parties should give notice following the relevant contractual clauses.
Most cross-border and international contracts in the region adopt laws of England as its governing law. Moreover, courts in India and neighbouring countries also follow common law traditions. One should, therefore, note that English or common law approach to force majeure and the doctrine of frustration is quite restrictive. In no case should the parties attempt to put forward Covid-19 or its lockdown as an outright excuse to not perform contractual obligations or avoid less profitable bargains or inconvenient deals. Instead, conduct in good faith and best effort actions must be demonstrated and also evidenced, which will be of high relevance should matter ultimately end up in dispute resolution proceedings.
Increased engagement and correspondences in writing, by email under the present scenario, is of utmost importance. Parties should seek legal advice and also use the best endeavour to perform before taking any kind of decision as to abandoning or otherwise limiting contractual performance.