Legal Implication On Parties To A Contract On Account Of COVID-19 Outbreak
7 April 2020 2:53 PM GMT
The current global outbreak of COVID-19 pandemic has led to discussions and deliberations in the business community, supply chain regarding legal implications arising out of Covid-19, the performance of contractual obligations and of parties being released from performance of such contracts as a result of "Force Majeure".
In some cases where parties to a contract have been legitimately prevented from performing their contractual obligations and have been majorly affected due to Covid-19 are exploring options to mitigate further losses. Whereas, some Parties are seeking to use Covid-19 to avoid performance of their contractual obligations or as an excuse to extricate themselves from strenuous contractual arrangements or renegotiating key clauses of the contract.
On account of Covid-19 outbreak and the resultant crisis the situation, parties to a contract are now procrastinating the options available under the clauses expressly written in such contracts and/ or widely known legal principles which includes:
- 1.Force Majeure;
- 2.Doctrine of Supervening Impossibility/ Frustation of contract;
- 3.Material Adverse Event; and
I. FORCE MAJEURE
Many contractual provisions set out a specific list of force majeure events which are deemed to be events of force majeure beyond the control of the parties, such as "war", "terrorism", "earthquakes", "hurricanes", "acts of government", ‟riots", "pandemics", "epidemics" or "diseases". A specific reference to a "pandemic" or "epidemic", if used in the contract, will cover "Covid-19".
In common parlance, a "force majeure" event means unexpected circumstances outside a contracting party's reasonable control that, having arisen, prevent it from performing its contractual obligations. A party affected by such an event of force majeure is relieved from performing the obligation affected for the duration and to the extent affected and may be entitled to compensation.
But to bring a force majeure claim one will still require the other criteria's for a force majeure test to be satisfied.
1. Criteria's for triggering 'Force Majeure':
a. The event must be beyond the reasonable control of the affected party;
b. The affected party's ability to perform its obligations under the contract must have been prevented, impeded or hindered by the event;
c. The affected party must have taken all reasonable steps to seek to avoid or mitigate the event or its consequences.
2. Whether Covid-19 can be treated as a 'Force Majeure event'?
In the current scenario, an act of government body imposing trade embargoes, quarantines, travel restrictions, lockdown could be either recommendatory in nature in the form of advisory or orders which are binding in nature. In the event such impositions are not binding in nature and are mere advisories, such an event cannot be unequivocally interpreted as a "Force Majeure event" and the same shall vary depending on the language of the Force Majeure Clause which forms part of the contract that the parties have entered into. Illustratively in India, the Ministry of Finance, Government of India vide a Notification dated 19th February, 2020 has explicitly notified Covid-19 outbreak as a natural calamity and a "Force Majeure Event" for supply chain Government contracts.
Based on the current Covid-19 crisis, it can be treated as a causal link to qualify as a Force Majeure event, subject to language and provisions of the Force Majeure clause in such Contracts. Also, the affected party must ensure that all reasonable measures are taken and comply with the due process whilst invoking a Force Majeure clause. The right of the affected party to claim relief for Force Majeure under the contract will be conditional upon the issuance of a "Notice" by it to the other party, supported by the required evidence. In addition to that, such a contract may additionally require a "notice" to state the anticipated consequences and duration of the "Force Majeure" event.
II. DOCTRINE OF SUPERVENING IMPOSSIBILITY/ FRUSTRATION
In the absence of an express force majeure provision within a contract, parties may be rely upon the 'Doctrine of Supervening Impossibility' or 'Frustration'.
The Indian Contract Act, 1872, does not define the term "frustration of contract". However, the Doctrine of Supervening Impossibility/ Frustration is enshrined under section 56 of the Act. According to section 56, an agreement to do an impossible act is in itself void. Further, it states that when a contract to do an act becomes impossible, or, by reason of some event which the promisor cannot prevent, it becomes unlawful, the whole contract becomes void when the act becomes impossible or unlawful.
1. Test for doctrine of frustration requires satisfaction of the following criteria's:
a. The underlying event is not the fault of any party to the contract;
b. The event or circumstance occurs after the formation of the contract and was not
foreseen by the parties to the contract; and
c. It becomes physically or commercially impossible to fulfill the contract, or
transforms the obligation to perform into a radically different obligation from that undertaken initially.
2. Doctrine of Frustration on account of Covid-19
When parties decide to apply the doctrine of frustration, such parties need to show that their non-performance, or late performance, was truly outside their control and could not have been prevented or mitigated. Reference may be drawn to such events or circumstances which have caused hindrance or delayed performance of the contract due to Covid-19.
Parties to a contract will need to review and accurately assess the commercial and legal advantages/disadvantages, rights and obligations under the contract whilst invoking frustration.
In light of the aforesaid, one needs to bear in mind that whilst proving the "frustration" in a Court of Law, it is advisable to keep a documentary record of events with specific reference as to why such performance was impossible, hindered or delayed as the case may be, the steps taken to find alternatives and mitigate loss; and the service of notices, if any. The affected party to a contract must collate these documents not only well in advance but also exhaustively as proving the same in a Court of Law is challenging in its absence.
III. MATERIAL ADVERSE EVENT
A "Material adverse event" clause is a term found in some agreements which allows a party to refuse to proceed upon occurrence of certain events after the parties have entered into a contract. A "Material adverse event" clause assigns risks between the contracting parties.
1. Whether events associated to Covid-19 trigger 'Material adverse event' clause in a contract?
This will depend on the language, terms of the clause and the specific circumstances. It
may be possible to invoke a "Material Adverse Event" clause if events have taken an unexpected turn, after the parties have executed the contract.
Taking into consideration the extreme consequences resulting from Covid-19 pandemic in most countries of the World, this could be a line of argument which parties to a contract can exercise, but it will all depend on the specific facts and circumstances.
On account of Covid -19 crisis, if a contract has become uneconomical and undesirable, or otherwise a party may wish to limit its losses by repudiating such a contract. In such circumstances, it is suggested that the party assess the rights and obligations before exiting such a contract and rely upon the "termination" clause, entitlement to terminate or otherwise upon termination, "consequences of termination", "retention", "liquidated damages" clause as may be expressly stipulated in such a contract.