Whatever be the fate of COVID-19 and the ensuing nationwide lockdown, companies face the harsh reality of receiving little to no revenue in the foreseeable future. Cruel decisions become inevitable: where is the money to honour contracts with employees, vendors or third parties? In this climate, every organisation urgently needs to answer the question: does the law allow them to avoid their contractual commitments?
At the level of reality check, the law does not matter. If you have no money, you can’t pay anyone no matter what the law says. You would then expect that companies who have taken the trouble to actually have written contracts would scramble to hunt for ‘act of God’ type clauses in their existing documentation. The problem is that these ‘act of God’ clauses contemplate events such as tsunamis and earthquakes but rarely disease. Commercial contracts are after all products of human experience and who in living memory recalls being hit by a pandemic? But stretch and fit to event we must and so, already, countless companies have rightly or wrongly used existing force majeure clauses in their templated standard documentation to refuse payment. Whether such self-serving distortion is defensible depends largely on the precise language used in these clauses and this will doubtless be the subject of much dispute in courts in the years to come.
What about those who weren’t savvy enough to include these legal obscurities in the paperwork? Fortunately for them, there is a glimmer of light out there in the legal fine print: Indian contract law has embedded within it a ‘doctrine of frustration’.
Section 56 of the Indian Contract Act states that “A contract to do an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful”.
The law is a living organic thing
On the face of it, the language of the law creates glorious complexity. A canny lawyer would argue that there is nothing impossible about performance if a business faces cash flow delays as a result of a temporary albeit nationwide lockdown. Businesses will inevitably resume work eventually so what is ‘impossible’ here? How would the court react to such an argument?
The seminal 1954 Supreme Court case of Satyabrata Ghose v. Mugneeram Bangur & Co has so far stood the test of time and states the principle thus: “The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose which the parties had in view and if an untoward event or change of circumstances totally upset the very foundation upon which the parties rested their bargain, it can very well be said that the promisor found it impossible to do the act which he promised to do”.
Intriguingly, in this case, land which was to be developed by the petitioner on behalf of the owners was seized by the government for military purposes. The court was not sympathetic. The government’s requisition order was held to be temporary and the petitioner’s argument in favour of applying the doctrine of frustration rejected.
In 2017, in the case of Energy Watchdog v. Central Electricity Regulatory Commission, the Supreme Court advanced the discourse by stating that “mere incidence of expense or delay or onerousness is not sufficient; and that here has to be as it were a break in identity between the contract as provided for and contemplated and its performance in the new circumstances”. The court again refused to apply the doctrine of frustration on the facts before it.
Recently, in Standard Retail Pvt. Ltd. v. M/s G.S. Global Corp & Ors., the Bombay High Court had the opportunity to adjudicate upon a contractual dispute to determine whether the COVID-19 outbreak constitutes a force majeure event. The petitioner requested the court to prevent encashment of letters of credit given to its Korean-based suppliers for non-receipt of goods as a result of the lockdown in India. In a short and terse judgment, the High Court dismissed the petitioner’s prayer without examining previous judicial cases.
Against the grain of these judgments, on April 20, 2020, the Delhi High Court granted interim relief to Halliburton Offshore Services Inc., an energy company, restraining Vedanta Ltd. from encashing bank guarantees secured for the performance of a contract to drill petroleum wells. The court held that “the countrywide lockdown, which came into place on 24th March, 2020 was, in my opinion, prima facie in the nature of force majeure”. Since the order was passed at an interim stage without going into merits, the outcome of the dispute may still change.
Following the logic of these cases, it then becomes clear that courts have a tendency to ask parties to honour their contractual commitments as far as possible regardless of any supervening events. If a party wants a court to interfere, the ‘impossibility’ of performance has to be severe and permanent. Mere inability to use premises for a commercial purpose for a period of a few weeks for instance, would not qualify as legal frustration allowing a tenant to refuse to pay rent.
Still, the law is a living organic thing and there are at least two reasons why those who have no money to honour their bills can remain optimistic. First, laws evolve as human experience widens. There is a fine line between ‘onerous performance’ and ‘impossibility’. The Supreme Court hasn’t had much opportunity to test this distinction against real-world events. Perhaps a court will decide in the future that a party should not be allowed to descend into bankruptcy because a pandemic made it impossible for it to pay its bills.
Second, we must bear in mind that there is no force majeure law in relation to pandemics. As experienced lawyers will tell you, traumatic events lead to the development of laws you could not have anticipated. If a shutdown ‘stops the clock’ for everything and everyone, why would a tenant, for instance, continue to face a ticking clock? A lawyer could argue that unforeseen risk must be absorbed by whoever it hits first: it’s not the law’s job to then apportion its impact after the fact. Doubtless, this is speculation and creative thinking, but then, what is jurisprudential evolution if not contrived argument turned dogma?
Pandemic a ‘natural calamity’
It helps that the Indian government thinks this pandemic is a force majeure event. On February 19, 2020, the Ministry of Finance issued a memorandum which allowed the invocation of force majeure clauses in government contracts if there was “disruption in supply chain due to spread of coronavirus in China or any other country” and that COVID-19 is a “natural calamity“. On March 20, 2020, the Ministry of New and Renewable Energy came out with a similar memorandum. It remains to be seen if the spirit of this executive action would apply equally to the government if they are at the receiving end of it. Who doesn’t want to avoid paying some taxes today?
I am not suggesting that COVID-19 constitutes a force majeure event only because the government thinks so. As the Bombay High Court has recently shown, the courts may not necessarily agree. Nevertheless, international businesses have reason to be sanguine. Contrary to common-law judge-centric systems like India, the legal standard to classify a macro event as one of force majeure is generally lower in civil law systems like China and much of Europe. Thus, companies with cross-border contracts will likely get a sympathetic hearing from these judicial systems. Where any company ends up in relation to this pandemic may well come down to where it does its business.