Covid-19 has disrupted businesses all over the world. How significant has been its impact on Commercial Contracts? Read this to learn more about the impact of Covid-19 on commercial contracts in India.
Introduction
The impact of covid 19 on commercial contracts has been immense. It would not be amiss to argue that almost everyone and everything in and around us has been deeply affected by the spread of the covid-19 pandemic across the globe.
Commercial contracts too have been badly affected by a sudden disruption in logistics networks, value and supply chains, etc. Many commercial entities plunged into deep losses while some even went bankrupt.
In such a case it becomes pertinent, especially for lawyers and informed citizens to be aware of the enforceability and legal repercussions of the contracts they have entered in the past or are going to enter in the near future.
As law students and informed citizens, we all must be aware of the impact of covid 19 on commercial contracts. We should know what the laws say on this grave contingency and what courts have been holding on to the non-fulfillment of the contractual obligations during the Covid-19 outbreak.
Will Force Majeure or Doctrine of Frustration be applicable to commercial contracts during the time of national lockdown and coronavirus outbreak?
What has been the impact of the covid-19 on Indian commercial contracts and its ramifications (governmental lockdown) on commercial and residential lease agreements in India?
This position paper succinctly attempts to answer all of these with the help of the latest legal developments and case laws analysis. In addition, this paper would also ponder over the commercially viable options ahead for parties during these contentious times.
Impact of Covid 19 on Commercial Contracts
The covid-19 pandemic has no doubt caused a storm in the world of commercial contracts with tenants refusing to pay their rents, individuals declining to honor their contractual obligations, and companies trying hard to renegotiate the contractual terms.
As not many had imagined disruptions and lockdowns at such a scale, they did not pay attention to incorporating sound contingency or force-majeure clauses in their contract agreements.
Courts too, have been overwhelmed by litigations of all sorts during the Pandemic even though they have mostly taken a sympathetic view of this emergency and, hence, have stopped short of imposing any drastic penalties for contractual breaches and non-fulfillment of contractual terms.
In the Halliburton and Vedanta dispute, for instance, the Delhi High Court granted interim relief to the former and stopped the latter from encashing eight bank guarantees for a period of one week after the lockdown.
Later, the court granted interim relief to Indiabulls Housing Finance Ltd. from any coercive action in the event of its failure to make payments to its debenture holders. Similarly, the Bombay High Court stayed pledge invocations by creditors like IDBI Trusteeship and ICICI Home Finance against Future Retail Ltd. and MEP Infrastructure Developers Ltd. respectively.
In the case of Future Retail, the court justified the styling of pledge invocations by IDBI Trusteeship on account of the drastic collapse in the share prices of Future Retail Ltd. since the onset of the nationwide lockdown.
Real estate companies like Anant Raj, Transcon Skycity Pvt. Ltd., and Transcon Iconica Pvt. Ltd., etc too have been granted varying degrees of relief by Indian courts against banks who sought to classify their loans as NPAs (non-performing assets).
On the issue of employers refusing to pay wages to workers, the Supreme Court in Ficus Pax Pvt Ltd v Union of India gave a big relief to the former by holding that the government cannot force them to pay full wages to workers during the lockdown period.
The government on its part has also granted some relief to parties by suspending the operation of several provisions of the Bankruptcy and Insolvency Code 2016 for a period of 1 year in a major relief for corporate borrowers hit hard by the covid-19 pandemic, especially after the declaration of national lockdown in March 2020 which has since been extended several times.
The government did this by promulgating the Insolvency and Bankruptcy Code (Amendment) Ordinance, 2020, which in the newly inserted section 10A in the Insolvency Code provides that no application shall be filed for commencement of corporate insolvency resolution process against a corporate debtor (under section 7, section 8 and section 10 of the Insolvency Code) for any default arising on or after 25th March 2020 for a period of 6 (six) months or such period not exceeding 1 (one) year as may be notified by the Government of India as reported by Mondaq.
In addition, states like Uttar Pradesh came up with ordinances suspending the operation of certain labor law provisions as well for a period of 3 years. Such decisions, however, have been criticized by legal scholars and civil rights activists like Harsh Mander.
Earlier, the Reserve Bank of India vides circulars issued on 27th March 20201 and 23rd May 2020, had permitted lending institutions, commercial banks, and non-banking financial companies to impose a moratorium of 6 months on payment of installments in respect of all term loans outstanding as on March 1, 2020. Further, in respect of working capital facilities, the lending institutions were permitted to defer the recovery of interest for a period of 6 months.
Covid-19 Impact: Applicability of Force Majeure and Doctrine of Frustration
In addition to re-negotiating contractual terms amidst the covid-19 pandemic, parties or entities failing in the performance of their contractual obligations have been relying on various legal tactics to avoid payment of damages or other penalties for non-fulfillment of their contractual obligations.
In this regard, the applicability of the doctrines of “Force Majeure” (Act of God) and “Doctrine of Frustration” to Indian commercial contracts has assumed great significance.
Force Majeure as a concept is not defined anywhere. Its definition is often derived from the Blacks Law Dictionary which defines it in terms of “an event or effect that can be neither anticipated nor controlled.
It is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled”.
Businesses that did not include these clauses in their contractual terms have suffered badly during a covid-19 outbreak. Most contracts even if they have clauses pertaining to “Act of God” are only illustrative and not very explicit and hence, there are disputes regarding interpretation of such clauses as each party concerned focuses on reducing their obligations and minimizing their financial losses.
What is the difference between Force Majeure and Vis Majeure?
Force Majeure has a wider import than Vis Majeure (Act of God). While the former includes both natural and human-made catastrophes like wars, revolutions, riots, labor strikes, geological disasters, etc. the latter is only restricted to natural disasters like hurricanes, tsunamis, earthquakes, etc. An important case that talked about the difference between Force Majeure and Act of God is Dhanrajamal Gobindram vs Shamji Kalidas.
In the words of justice Hidayatullah, the expression “force majeure” is not a mere French version of the Latin expression “vis major”. It is undoubtedly a term of wider import.
Difficulties have arisen in the past as to what could legitimately be included in “force majeure”. Judges have agreed that strikes, breakdown of machinery, which, though normally not included in “vis major” are included in “force majeure”.
He said further that, “an analysis of rulings on the subject into which it is not necessary in this case to go shows that where reference is made to “force majeure”, the intention is to save the performing party from the consequences of anything over which he has no control.
This is the widest meaning that can be given to “force majeure”, and even if this be the meaning, it is obvious that the condition about “force majeure” in the agreement was not vague.
The use of the word “usual” makes all the difference, and the meaning of the condition may be made certain by evidence about a force majeure clause, which was in contemplation of parties”.
Force Majeure and Doctrine of Frustration in Indian statutes
While no Indian statute specifically defines or deals with Force Majeure, S.32 of the Indian Contract Act 1872 that talks about contingent contracts provide some reference and resemblance to it.
As per the provision, “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 [and] if the event becomes impossible, such contracts become void”.
Nonetheless, a contingent contract is drastically different from the Force Majeure Clause (FMC) as in this case, the liability of the breaching party is zero as the contract is void ab initio.
Section 56
Another provision of the Contract Act relevant to this discussion is section 56 that contains the doctrine of frustration. It provides that an agreement to do an act impossible in itself is void.
It provides further that a contract to do an act which, after the contract is made, becomes impossible or unlawful by reason of some event that the promisor could not prevent, becomes void when the act becomes impossible or unlawful.
However, where one person has promised to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promisee for any loss which such promisee sustains through the non-performance of the promise.
Impossibility here will have to be interpreted practically and not literally i.e. even if there has not arisen an absolute impossibility, but the circumstances surrounding the fulfillment of the contract have fundamentally altered and which the parties did not contemplate at the time of the agreement will be governed by section 56 as per the decision of the Supreme Court in Satyabrata Ghose vs Mugneeram Bangur.
Further, illustration (d) to section 56 that talks about a contract becoming void on account of the declaration of war between two countries can be said to cover the Covid-19 kind of contingencies, even though the war is a man-made disaster. In the case of Covid too, various conspiracy theories have blamed China but the WHO has in the past conclusively laid to rest such allegations by publicly absolving China.
That being said, one should note that, the scope of damages or compensation u/s 56 is restricted to cases where one person has promised to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful. One important difference between contingency u/s 32 and impossibility u/s 56 is that impossibility to perform u/s 56 arises after the contract is made.
And more often than not, a Force Majeure clause provides temporary relief. It’s a first-stage relief and usually what looks like an FMC is colored in a contingency clause. For instance, “…in the event that a contingency was to arise, you will be given thirty days to fulfill the contract”.
Most importantly, in order for a force majeure clause to become applicable, the occurrence of such events should be beyond the control of the parties and the party concerned will have to demonstrate that they did their level best to mitigate the impact of such force majeure event.
Effect of Covid-19 on Contractual Obligations: Case Law Analysis
As the covid-19 has resulted in massive contractual failures, courts have been flooded with hosts of litigation issues with most revolving around force majeure clauses and doctrine of frustration of contracts.
Shakuntala Educational & Welfare Society vs Punjab & Sind Bank
This case concerned the Shakuntala Educational and Welfare Society- a Delhi-based charitable institution’s loan account being declared a non-performing asset by the Punjab and Sind Bank after it defaulted on loan repayment which was admittedly payable on or before March 31, 2020.
In its petition to the Delhi High Court, the society argued that out of the six-term loan, it had already paid four and it was not in a position to pay the remaining on time as it was unable to collect fees from its University students in light of an Uttar Pradesh government directive prohibiting the petitioner from coercing the students to pay the fees during the lockdown.
The society also claimed the defense of a moratorium provided by the Reserve Bank of India from April to June to help companies overcome the disruption caused by the Covid-19 pandemic.
The Bank counter-argued that RBI’s moratorium applies only for installments becoming due post-March 1, 2020 and the society cannot claim any protection as it defaulted prior to this date as the loans had become due on Dec. 31, 2019, i.e much before the national lockdown and Uttar Pradesh directive restraining it to collect the fee from students.
It claimed further that RBI’s circular on moratorium cannot override the central bank’s regulatory policy, which does not make any provision for deferment of NPAs due to the Covid-19 outbreak, writes Rohit Jain in Bloomberg.
A single-judge bench of the Delhi High Court, however, granted temporary and conditional relief to the society subject to payment of installments within a week after Uttar Pradesh withdrew its directive.
It is quite evident in the present case, that the court granted the relief to the society not on the basis of either any force majeure clause or doctrine of frustration but on an equitable basis when it observed that a “grave and irreparable damage would be caused to the petitioner” if its accounts are declared as NPA during the continuation of the countrywide lockdown.
Indiabulls Housing Finance vs SEBI
This case concerned a mortgage firm Indiabulls Housing Finance as it failed to pay its dues to the non-convertible debenture holders including the mutual funds. Initially, a single-judge bench of the Delhi High Court had granted the firm an interim relief by granting it permission to withhold the dues during the RBI’s moratorium period. However, later a division bench of the court reversed this order after a petition by the Securities and Exchange Board of India (SEBI), Association of Mutual Funds of India (AMFI), and IDBI trustee.
The Indiabulls group had argued that it was not in a position to meet its payment obligations because it was not receiving money from borrowers during the covid-19 pandemic. The Division Bench was concerned about the MF industry and the fact that any such moratorium could affect the public at large. If the interim order was not set aside, many more borrowers would have asked for similar concessions.
This would have led to panic in the MF industry and resulted in value erosion for investors. The AMFI petition argued before the division bench that the single judge bench has failed to consider the catastrophic impact that the order can have on the MF industry in India.
Irreparable harm will be caused to unitholders, the credit rating of mutual funds, legal liability, and exposure to mutual funds as well as the economy-when the mutual funds are unable to meet their redemption obligations because of lack of funds from Indiabulls.
Here, one can say that the initial order by the single bench granting interim relief to the Indiabulls was based on equitable considerations.
However, the latter division bench reversing this order was clearly based on policy considerations aimed to prevent the opening of “floodgates for the other borrowers of MFs and would seek a postponement of its payment obligations” reports Shrimi Chaudhary in the Business Standard.
M/s Halliburton Offshore Services Inc. vs Vedanta
The case concerned a dispute between Halliburton-an oil rig contractor and Vedanta-an leading Indian mining company. The dispute pertained to a contract involving the construction of integrated oil wells and the development of certain surface facilities by Halliburton.
When the construction could not mature within the stipulated time, Vedanta sought to encash the bank guarantees in addition to a sum of $250 million as liquidated damages arising from the delay in completion of the project as per the agreed terms of the underlying agreement.
Halliburton, however, attributed the delay due to the Covid-19 outbreak and fiercely opposed the invocation of guarantees on grounds of force majeure and some other factors attributable to Vedanta.
It argued that a substantial part of the project was already executed and only 3-5% of the total work remained incomplete. In its defense, it also invoked section 56 of the ICA (frustration of contract) and argued that due to the covid lockdown, its officials were not able to come to India.
The Delhi High court gave an interim relief in favor of Halliburton on the basis of equity but refused to classify the non-compliance due to a Force Majeure event. Most importantly, the court stopped short of laying down any precedent on this issue by holding that similar cases would be decided on a case-to-case basis approach.
A few months later, however, a Delhi High Court bench comprising Justice Pratibha Singh vacated the stay on invocation of bank guarantees by observing that Halliburton had clearly defaulted in performance despite repeated opportunities.
The court also observed that Bank guarantees are unconditional, irrevocable and the bank would have to make the payments simply on demand by a party, the court said. It also directed Vedanta to ascertain the recoverable amount from the oil rig contractor by reconciling the accounts and pending invoices.
The High Court also opined that Halliburton clearly failed to comply with the stipulated deadlines for completion of the project and was already in breach of the agreed terms much before the outbreak of Covid-19. Citing the monthly progress reports, the court held that even before the invocation of the force majeure clause, only a minuscule work was carried out by Halliburton.
As per a Bloomberg report, the court opined further that even though the agreement excused the oil rig contractor from the performance if it was prevented or hindered by a pandemic.
However, every breach or non-performance cannot be justified or excused merely on the invocation of Covid-19. Therefore, past nonperformance by Halliburton cannot be condoned and force majeure cannot be an excuse for nonperformance of the contract, the court held.
NAFED vs Alimenta SA
This was a classic case of section 32 of the Indian Contract Act (contracts contingent on the happening of certain events). Here, the Indian Supreme Court citing section 48 of the Indian Arbitration Act refused to enforce a foreign arbitral award under the public policy exception merely because the award upheld the supply of goods contrary to the export policy of India.
Section 48(2)(b) of the act provides that enforcement of an arbitral award may be refused if the court finds that the enforcement would be contrary to the public policy of India.
The facts of the case involve a trade agreement between NAFED and Alimenta wherein the former agreed to deliver 5000 metric tonnes of select quality groundnut to the latter.
Later a cyclone in India hit the production and supply of groundnuts and the government also imposed some curbs on the export of groundnuts as a result of which NAFED failed to export the required quantity of groundnuts.
The Alimenta regarded it as a breach and initiated arbitration proceedings before FOSFA, London that passed an award in 1989 directing NAFED to pay $4,681,000 as damages to Alimenta. Against this arbitral award, NAFED filed a petition before the Supreme Court.
Even though the SC observed that the defense of public policy under Section 7(1)(b)(ii) of the Act of 1961 should be construed narrowly, it finally concluded that the enforcement of the award would contravene the public policy of India relating to export for which permission of the Indian government was necessary.
Thus, the award was held to be in contravention of the fundamental policy of Indian law and basic concepts of justice and equity. This decision was beneficial to an Indian entity but legal and public policy experts have criticized the decision for setting a bad precedent.
Anu Srivastava, a practicing Supreme Court Advocate, has opined that this decision overlooks fundamental legal principles laid down by Indian courts while considering objections to the enforcement of a foreign arbitral award. It remains to be seen, however, the extent to which a sovereign action like this negating the possibility of delivering on the contract is termed as Force Majeure situation especially in the light of the Covid-19 outbreak.
Commercially viable option ahead for Parties
People hit hard by the outbreak of covid-19 are relying on various tactics to minimize their financial and non-financial losses. Some of the commercially viable options for parties already into a contract or going to enter one during these difficult times may include force majeure or contingency clauses, the doctrine of frustration, public policy arguments, and equitable reliefs.
The first thing one should look into a contract is S.32 of ICA i.e. contingency clause or a force majeure clause covered in a contingency clause. If a contract has an FMC clause that elaborately signifies what qualifies as FMC, then that is an excellent FMC. All courts of Delhi have asked the terminology of the FMC clause whenever the matter went to court. While drafting a force majeure provision, the parties should diligently cover the following aspects-
- Enumerate a list of events that would constitute a force majeure event. The list can be exhaustive or non-exhaustive but it would be better if it is based on the commercial understanding between the parties and the nature of the contract.
- The actions that the parties should take should the force majeure situation stipulated in the agreement were to arise.
- Enumerate the consequence of the occurrence of a force majeure event i.e. requiring parties to the fullest extent possible, to mitigate the losses caused by the force majeure event, excusing the affected party from performing the contract in whole or in part, or excusing a party from delay in performance or entitling them to suspend or claim an extension of time for performance; or giving that party a right to terminate the contract.
Second, if a contingency or force majeure clause cannot be effectively culled out from the impugned agreement, then the parties should seek adjudication by the court on the basis of section 56 of the contract act that talks about the doctrine of frustration.
Parties should, however, note that impossibility under s.56 has been construed practically and not literally by courts. Frustration defense is generally available only if the parties have not contemplated the possibility of an intervening circumstance that might affect the performance of the contract.
Nevertheless, s.56 excuse will still be available to an affected party having unequal bargaining powers between the parties to the contract. To assess whether Covid-19 could trigger the relevant force majeure clause, or frustrate the contract, it will be critical to evaluate the operational aspects of the relevant commercial transaction and the type of force majeure clause in the contract-writes KL Modani and Vyapak Desai.
In case of already executed contracts, if nothing is mentioned on lines of contingency, force majeure clause, the doctrine of frustration, or any provision on liability on account of delays, or price escalations, the affected party may still claim a remedy under justice and equity.
And if past decisions like Shakuntala Educational & Welfare Society, Indiabulls housing finance, Halliburton, and NAFED, etc are to go by, Indian courts take exceptional delight in offering equitable justification in providing reliefs to affected parties.
Covid-19 Impact on Commercial Real Estate and Lease Agreements
Covid-19 has greatly impacted the commercial and residential lease agreements as tenants in both cases have been expressing inability to pay rents due to economic and financial disruptions. While many tenants are requesting rebates and deferment, many have even outrightly not only refused to pay rent but have also refused to vacate the rental premises.
The strict covid-19 lockdown has also resulted in a sudden influx of relatives and family members from all around and consequently many landlords want their rental premises vacated so that they can accommodate their relatives and family members therein.
All of this has resulted in a host of litigation issues thronging different courts all over India and consequently, existing rend deeds and lease agreements have become important for resolving such disputes.
Expert and Judicial Opinion
Many like Anand Desai, partner at DSK Legal, are of the opinion that an equitable solution should be found i.e. the landlords shouldn’t be adversely affected as they may have maintenance, debt servicing, etc on the premises, but equally, they should consider not profiting off tenants during this period, reports Bloomberg Quint.
As far as Judicial opinion on this issue is concerned, the Supreme Court Siri Chand vs Surinder Singh held that when the rent/lease deed does not mention the period of the tenancy or other conditions of the rent/lease deed, in all such cases, it will be assumed that the rent/lease deed is on a monthly basis and the rent/lease deed shall not be compulsorily registrable under the Registration Act, 1908. The decision certainly brought a ray of hope to landlords struggling to recover rents from tenants during the pandemic.
The Delhi High Court on its part, in the case of Ramanand and Ors vs Dr. Girish Soni, while citing an earlier landmark case of Hotel Leela Venture Ltd. vs Airports Authority of India held that in the absence of any contractual provision providing respite from payment of rent or monthly charges, the same would be payable, should the tenant wish to retain the premises. One cannot resile from a contract only because it has become onerous for a party to perform the same.
Can parties invoke S.32 and S.56 of the ICA here?
On the applicability of S.32 (contingent contracts), the Delhi high court in the Ramanand case held that such can be invoked only when the contract explicitly contains or stipulates a force majeure clause.
Section 56 of the Indian Contract Act 1872 contains the Doctrine of Frustration on account of impossibility. Regarding its applicability on executed contracts, the court has reiterated the well-established position that S.56 of the Contract Act is not applicable to arrangements of lease and other similarly situated contracts which are in the nature of executed contracts as opposed to executory contracts.
The court while citing the case of Raja Dhruv Dev Chand vs Raja Harmohinder Singh held that it is well settled that Section 56 of ICA does not apply to cases in which there is a completed transfer.
What if the Contract does not contain any Force Majeure clause?
In such a case, the Delhi high court in the Ramanand case acknowledged that the tenant may invoke equitable jurisdiction of the Court on account of temporary inability to use the premises but facts and circumstances in each case will have to be looked at in determining whether a tenant is entitled to any relief by way of suspension of rent or not.
Conclusion
To conclude, most people hit by the pandemic have been invoking the Force Majeure defense for contractual breaches. People are resorting to frustration defense only if the contract concerned does not contain an explicit force majeure provision.
Courts on their part have refrained from laying out any authoritative rule on disputes arising out of Covid-19 disruptions. Instead, the courts have held that the applicability of Force Majeure defense will depend on the facts and circumstances of each specific case.
Tenancy agreements in India have also faced the heat of the Covid-19 pandemic. Here too, Indian courts have held that invocation of force majeure provisions will have to be assessed on a case-to-case basis depending on the terms of the contract entered into between the parties.
In the Ramanand case, the Delhi High Court, held that in the absence of any contractual provision providing respite from payment of rent or monthly charges, the same would be payable, should the tenant wish to retain the premises.
Clearly, the lack of a proper legal and statutory framework to deal with the eventualities arising out of Covid-19 is quite evident. As Indian laws do not elaborately provide for dealing with such scenarios, the courts have been granting reliefs by relying on creative interpretation of certain provisions like section 32 and section 56 of the Indian Contract Act 1872. The government must bring in suitable and effective amendments to existing laws to cover the radically altered scenario of commercial contracts in the post-covid world.
Till then, some of the commercially viable options for parties already into a contract or going to enter one during these difficult times may only include, contingency clauses like force majeure, the doctrine of frustration, public policy arguments, and seeking equitable reliefs from courts.
