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Covid-19 Lockdown: Can You Use Change Of Law Clause To Seek Exemption?

Preethika Pilinja
20 May 2020 6:37 AM GMT
Covid-19 Lockdown: Can You Use Change Of Law Clause To Seek Exemption?
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Introduction

When a contract is entered into, both the parties are expected to factor in all legal requirements in arriving at mutually agreeable rights and obligations. However, since laws can alter over the course of execution of the contract and this in turn can swing the contractual equilibrium, change of law clause is incorporated to set right the undue burden created by such change of law on a party.

The implications of such a change may be increased costs, altered timelines, change in technical capacity of supplier etc. Now, in the light of various notifications of the Government of India including the one leading to complete lockdown, one pertinent question is, whether change of law clause can be invoked in the case of a contract, where timelines are affected due to lockdown.

To validate the utility of this clause, we analyse NAFED v. Alimenta S.A.[i] delivered by the Supreme Court on 22.04.2020, where the Hon'ble Court deliberated this clause in length and shed light on the use and interpretation of this clause.

In Oil India Limited v. South East Asia Marine Engineering and Constructions Limited.,[ii] another decision delivered on 11.05.2020, Apex Court decided the question of whether the increase in price of High Speed Diesel, one of the essential materials for drilling operations undertaken to be carried out by the Appellant Company triggered the change of law clause since, the increase in price was brought about by issue of government circular. Both these decisions are discussed in the course of this article.

NAFED v. Alimenta S.A: Formal recognition of Change of law as an excuse?

In what can be a formal recognition of reliance on, what is akin to a 'Change of law' clause the Supreme Court in NAFED v. Alimenta S.A. held that NAFED is excused for inability to supply groundnut to Alimenta S.A. as agreed, since this failure was attributable to the refusal of the Government to permit export.

In arriving at this conclusion, Supreme Court relied on clause 14 of the Agreement, which stated as follows:

14. PROHIBITION: In the event, during the shipment period of prohibition of export of any other executive or legislative act by or on behalf of the Government of the country of origin or of the territory where the port/s or shipment named herein is/are situate, or of blockade or hostilities, restricting export, whether partially or otherwise, any such restriction shall be deemed by both parties to apply to this contract and to the extent of such total or partial restriction to prevent fulfilment whether by shipment or by any other means whatsoever and to that extent this contract of any unfulfilled portion thereof shall be extended by 30 days. In the event of shipment during the extended period still proving impossible by reason of any of the causes in this Clause, the contract or any unfulfilled part thereof shall be cancelled.

Relying on clause 14, Supreme Court deduced that the Parties had contemplated in advance that obligations under the contract were contingent on the absence of restrictions on transport mentioned in the clause and therefore it was a contingent contract as per section 32 of the Indian Contract Act, 1872 (hereinafter "Indian Contract Act").

As per clause 32 of the Indian Contract Act, 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. Applying section 32 of the Indian Contract Act, Supreme Court held that the contingency envisaged in the agreement had occurred and the contract has therefore, become void.

Application of Change of Law clause: Factors to be considered

In a general situation, the following factors are to be considered in a change of law clause in the context of a contract under consideration:

  • What is the definition of 'law'/'applicable law' as per contract?
  • What amounts to change (of law)?
  • What are the implications of such change of law for a contract?

Each of these factors are discussed in detail below:

Definition of Law:

First aspect to be examined to be able to place reliance on this clause is the definition of law/applicable law. The clause has to be examined to see if the law which has impacted the contractual obligations is covered under the definition of 'law' in the change of law clause.

For example, in Energy Watchdog and Ors. v. Central Electricity Regulatory Commission and Ors.,[iii] , when Adani Power Ltd., sought to be excused from a Power Purchase Agreement(PPA) due to astronomical rise in the cost of fuel due to change of law in Indonesia, on which it has highly dependant, Court resorted to the study of definition of 'Law' provided in the PPA, which stated as follows:

"Law" means, in relation to this Agreement, all laws including Electricity Laws in force in India and any statute, ordinance, Regulation, notification or code, rule, or any interpretation of any of them by an Indian Government Instrumentality and having force of law and shall further include all applicable rules, Regulations, orders, notifications by an Indian Governmental Instrumentality pursuant to or under any of them and shall include all rules, Regulations, decisions and orders of the Appropriate Commission.

Since, the definition of law given in the agreement referred only to Indian Law, the Supreme Court refused to discharge Adani Power from the Contract due to change in Indonesian law. Hence, in order for lockdown measures to be an excuse, essentially, law in the change of law clause should include 'Indian law'.

What amounts to Change (of law)?

In Oil India Limited v, South East Asia Marine Engineering and Constructions Limited., the Apex Court looked into the question of whether increase in price of High Speed Diesel one of the essential components of drilling operations contracted between the Parties, by a government circular amounted to Change of Law. The relevant clause dealing with Change of Law read as follows:

Subsequent to the date of price of Bid Opening if there is a change in or enactment of any law or interpretation of existing law, which results in additional cost/reduction on cost to Contractor on account of the operation under the Contract, the Company/Contractor shall reimburse/pay Contractor/Company for such additional/reduced cost actually incurred.

Supreme Court after perusing the clause held that, a liberal interpretation cannot be given to this clause to include any change brought by government circular as law. On reading the contract as a whole there are terms in the contract which indicate that, rates, conditions and terms shall be in force till the completion or abandonment of drilling operations and hence, claim of reimbursement for change in price of HSD cannot be brought under the purview of this clause.

Now, the question is whether Supreme Court would have looked at the clause differently if term 'law' was defined in the Contract. The answer would probably be yes, if 'law' was defined to include all thinkable forms of sub-ordinate legislation. Hence, in well-drafted contracts 'law' or 'applicable law' is widely defined to include, laws passed by the legislature of the respective jurisdiction, a wide gamut of executive law making, including amendment and repeal of rules, bye-laws, notifications, circulars, ordinances, decrees, and codes, as well as clearances, permits, taxes, duties, and cesses, change in interpretations due to judicial pronouncements.

Now applying this clause to the current situation, the Central Government in India has issued Guidelines dated 24.03.2020[iv], modified on 25.03.2020[v], 27.03.2020[vi] etc., instructing the State Governments on the measures to be taken by them to ensure shutting down of interalia, all industrial and commercial units. The authority for this guideline can be traced to section 6(2)(i) and section 10 of the Disaster Management Act, 2005 (hereinafter "Disaster Management Act") where the National Disaster Management Authority under the chairmanship of the Prime Minister has the authority to take measures for prevention or mitigation of a disaster. Since, the guidelines stated above rely on the authority under the Disaster Management Act, these notifications can positively qualify as law for the purposes of Change of Law clause, if the word 'law' is defined wide enough.

What are the implications of such change of law for a Contract?

The next aspect to be examined is what is the redressal mechanism provided in the contract for addressing a change of law phenomenon. Generally, this is a right to the affected party to give notice to the other party, seeking compensation, to the extent required to put the affected party in the same position as before. In a lockdown scenario, the expected remedy is most likely to be a request for an extension of time for execution of contractual obligations.

While looking at the remedies, focus should not be lost on the threshold required for triggering a change of law recourse. For example, in a 2003 SARS epidemic-related case Li Ching Wing v Xuan Yi Xiong[vii], a Hong Kong court rejected a tenant's claim for termination of tenancy agreement because the premises were affected by an isolation order by the Department of Health due to the outbreak of SARS, which meant that it could not be inhabited for 10 days. The court held that a 10 day period was insignificant in view of the two-year duration of the lease, and that whilst SARS was arguably an unforeseeable event, it did not "significantly change the nature of the outstanding contractual rights or obligations" of the parties in the case.

Change of law v. Force Majeure:

One important commonality between these clauses is that, both these clauses can be triggered by a specific clause in the contract, unlike frustration. Supreme Court in its various judgements including, the rent judgement of Nabha Power Limited ("NPL") vs Punjab State Power Corporation Limited ("PSPCL") & another[viii] has held that, a contract should be read as it reads, as per its express terms. Commercial courts ought to be mindful of the contemporary technical expertise of legal drafting and must not endeavour to imply terms into a contract. Hence, both force majeure and change of law would come to play only when there are express terms in the contract providing for such clauses and as per the contours laid down by such express terms.

The one possible occasion when change of law and force majeure can both be invoked is when, say, act of government or similar occasions trigger a force majeure clause as well. Since, the lockdown notification has triggered a force majeure situation as well, both the clauses would be applicable. In such cases both the clauses and its implications should be analysed in toto and a decision has to be taken on which clause has to be relied upon.

Change of Law v. Doctrine of Frustration

Whether change of law and doctrine of frustration are simultaneously applicable or are they mutually exclusive? Supreme Court in NAFED v. Alimenta S.A. discussed the scope of applicability of doctrine of frustration provided in section 56 of the Indian Contract Act. In case an act becomes impossible at a future date, and that exigency is not provided in the agreement on the happening of which exigency, impossible or unlawful, the promisor had no control which he could not have prevented, the contract becomes void as provided in section 56.However, in the case of NAFED v. Alimenta, since, clause 14(Change of law clause) clearly provided for a contingency which eventually occurred, the contract cannot be said to be frustrated. Hence, it is clear that, if a contract contains a change of law clause, it will be seen as an envisaged contingency and applicability of doctrine of frustration becomes automatically excluded.

Conclusion

Change of law clause is often overlooked in a jumble of contractual text we deal with, but can potentially wriggle one out of the rigours of contractual obligations, excruciated by lockdown. However, it has to be kept in mind that, like force majeure, change of law clause can be triggered only if there is a specific provision in the contract, which provides for comfort in case of a 'temporary'contingency triggered by a government notification.

Views are Personal.

Preethika is an in-house Legal Counsel based in Bangalore. The writer acknowledges the guidance of Badrinath Srinivasan, an in-house Legal Counsel in shaping this article.

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