Force Majeure (A primer for business managers)
Published: Apr 24, 2020
By Nipun Gupta
AS an in-house legal counsel, I've been inserting Force Majeure ("FM") clauses into commercial contracts for a good part of 11 years now. It's one of those things that's often overlooked by parties when negotiating a contract. When you really think about it, can you blame them? why should they have spent time negotiating a clause, which in all probability would never be invoked?
Contracts are negotiated with certain time constraints ever-present in the background, this ensures that energies are focused on issues that matter and only things which are highly likely to occur during the tenure of the contract are debated (for example - delay in the delivery of a turnkey civil project is a highly likely event in India and therefore the 'liquidated damages' clause is one that is heavily negotiated between parties, this can at times become a reason the contract is shelved mid negotiation). Therefore, the prevailing wisdom has been to concentrate on clauses that have a commercial implication, like an indemnity, assigning a limitation of liability, warranties or assigning damages for breach of a contract. Most business and commercial managers feel that these are the scenarios that may come back and hit them in the gut, therefore spending time on negotiating these clauses is worthy of a company's time and resources, all else falls into the sidelines.
However, the outbreak of the COVID-19 pandemic has compelled us to re-visit FM clauses in existing contracts in order to analyse where we stand in terms of fulfilling our contractual obligations. Hopefully, this short primer will give business managers a broad overview of the things to keep in mind when interpreting existing FM clauses or negotiating new ones. It is my prediction that henceforth more scrutiny will be applied to negotiating FM clauses as a result of our learning in these trying times.
The term Force Majeure, literally means a 'superior force'. In a contract, this signifies that a supervening event has occurred which renders the performance of contractual obligations unlikely or seemingly impossible (for a period of time). Normally, an FM event would affect the performance of a single party, however, in some cases it may even affect multiple parties to a contract (for example - an equipment manufacturers inability to supply equipment because his factory is ordered shut by the government due to a pandemic outbreak, similarly, his buyers inability to pay for the equipment if banking channels are frozen too). Once such an event hits, the affected party is excused from performing its obligations for the period the FM event subsists (i.e. contractual obligations are deferred and work is suspended for the affected period). I will come to how this 'temporary suspension' of obligations is different from a 'permanent discharge' of obligations under section 56 of the Indian Contract Act, 1872 ("ICA").
1. Language of an FM clause (exhaustive or inclusive)
Force Majeure traces its roots from the Napoleonic Code and the ancient Roman Law well before that. In India, FM has been customarily used in contracts and there are several judgements which pronounce on its applicability and interpretation. However, the ICA is silent on what is meant by FM, no such narration exists in the draft of the Act. In the absence of any guidance in the ICA, the language deployed in an FM clause assumes paramount importance, as this determines what would qualify as an 'FM event'. Typically, this should cover instances like the invocation of a war, an epidemic, a terrorist strike, flooding, fire, lightening strikes, earthquakes, governmental action & embargoes etc which impede the performance of contractual obligations. In cases where an exhaustive list of FM events cannot be provided in the FM clause (or is undesirable because it may leave exploitable gaps in the clause), parties should ideally incorporate language which is all encompassing and will do away with the need for listing particular events, an example is provided below:
Illustration
"For the purposes of this Agreement, the expression "Force Majeure" shall mean an event which is beyond the reasonable control of an affected Party and which such Party could not anticipate or mitigate by means of insurance, contingency planning or any other prudent business means"
Even after the above exercise, if a particular FM event is somehow not clearly covered in the language of the clause (whether specifically or by using an inclusive all encompassing definition), then parties would run the risk of interpretational disputes arising out of claims by a counter party. In case of such a dispute, the recourse to an aggrieved party is arbitration (if the contract provides for arbitration between parties) or litigation.
2. Misuse of FM clauses by a defaulting party
With due regard to point (1) above, as a customer or a receiving party under a commercial or EPC contract, it is important that one be very wary of wide and comprehensive language in an FM clause which can be interpreted to classify small non-consequential instances as FM events. Jurisprudence is abound with examples where FM clauses have been misused and mis- interpreted by a defaulting party when in hindsight he has no other justification for committing a contractual breach. In such a case, it would be wise to use one's judgement on a case to case basis and include only those FM events / language that would be incapable of misuse by a counterparty.
Illustration:
Excessively heavy rains hit the state of Maharashtra, in some cases, leading to flooding, thereby affecting travel within the state. X who is a service provider to Y claims that his personnel are unable to reach Y's project site in ABC district of Maharashtra to service Y's wind project in the state. X states that 'Flooding' is indicated as an excusable event under the FM clause in their contract. On some due diligence, Y finds out that project site or its adjoining area's were never affected or flooded. Further, X's personnel live in close proximity of Y's project site and should have had no issues commuting to it.
This is an example of a defaulting party couching a contractual breach as an FM event
3. Force Majeure vis-a-vis Frustration of a contract
As 'Force Majeure' is a concept that is not specifically provided in the ICA, therefore it is simply a contractual term which is specifically agreed to between parties whereby one party temporarily excuses the non-performance of the other party on the occurrence of certain preagreed events.
Here, I must point out that the ICA provides for a concept of 'frustration' of a contract under Section 56, whereby if the performance of a contract becomes 'impossible' or 'unlawful' after the execution of a contract, such contract becomes 'void' (i.e. invalid) and the parties are discharged from their obligations under the contract.
It is important to understand the difference between FM and frustration of a contract, as it is observed that in the recent past there has been a great amount of fudging of the two terms. This can be counterproductive and lead to an incorrect understanding and application of either concept.
A nuanced distinction between the two terms is thus the following:
A. In the case of an FM, performance is 'temporarily suspended' during the occurrence of specified events listed in the contract. Parties realise that there maybe events that may occur within the tenure of the contract which may compel parties to excuse the non-performance of the other party, but the same may not necessarily mean the con- tract becomes void. Here, contractual obligations would typically resume once the FM event has concluded.
B. If a party to a contract wishes to claim that a contract is essentially frustrated, the claiming party would have to argue that the central tenet of the contract is now impossible to achieve or has become unlawful.
C. Therefore, Section 56 comes into question when a party believes that performance which is central to the contract is now rendered 'impossible' and cannot be salvaged by suspending the same under a pre-existing FM clause in the contract. Thus, completely discharging the parties from the contract.
4. What if there is no FM clause in the contract?
If no FM clause exists in the contract, this would indicate that parties did not intend (whether knowingly or unknowingly) for there to be excusable suspension of performance under the contract. In this scenario, when faced with a supervening FM event, one may have to substantiate their stand and take shelter under section 56 of the ICA. However, the remedy here would only be a complete discharge from the contract as Section 56 does not provision for delayed / excusable performance.
5. Things to keep in mind to avoid misuse of FM clauses
Ideally an FM clause should cover the following language to mitigate against a potential misuse by a counterpart:
A. An FM claimant should notify the other party when an FM event has begun and the likely duration of the FM event (if the duration is ascertainable). Such a notification should be received by the other party within an agreed number of days, barring which such an event would cease to qualify as an FM event.
B. If the FM event is a natural calamity or a pandemic etc, the FM claimant should have to present proof of its occurrence, either through a published source like a news paper or local Govt etc acknowledging the occurrence of the same.
C. The claimants own breach should not form the basis of an FM claim.
D. When does the affected party have to resume performance of his obligations after the cessation of an FM event? Should it be immediately after cessation of the FM event or will the claimant get a grace period to remobilise resources.
E. The affected party should have to deploy any / all measures at its disposal so as to mitigate the effects of the FM event.
F. Parties should be able to terminate the contract if the FM events continues to subsist for a prolonged period of time i.e. 3, 6 or 12 months etc.
6. Important things one should be aware of when issuing an FM notice / receiving an FM notice
A. Reimbursement / restitution of consideration on contract becoming void (Section 65 of the ICA) - a party deriving a benefit under a contract before it becomes void is bound to reverse the benefit so derived (i.e. cause full restitution of anything so received). For example, B pays an advance to R to secure R's performance, the contract subsequently becomes impossible to perform as the venue of the performance is demolished before the date of the performance, in this case R is bound to replay the advance back to B.
B. Energy Watchdog & Ors. v. Central Electricity Regulatory Commission & Ors (SC): This case builds upon a chain of earlier legal precedents. Here, M/s Adani and other firms won bids to setup and run coal power projects, in the background they had long term coal supply agreements from companies in Indonesia, the coal procurement cost increased substantially within a few years of entering into the contract, the applicants tried to argue that the contract was frustrated due to such an input cost increase. The court held:
- a rise in inputs costs cannot be classified as a frustration event, instead, this is a mere 'business hindrance'.
- a business hindrance cannot be used to invoke section 56 of the ICA
- if an alternative source of procuring coal was available, even at a higher cost, then this line of reasoning cannot be taken by an applicant
C. Governmental pronouncements on FM: If a governmental body issues an advisory that a certain time period should be deemed to be treated as an FM event, one should rely on such a pronouncement only after due consideration. Pronouncements are considered "Law" within the Indian legal framework only when they take the form of an Act of a designated legislature (or the rules formed thereunder) or are issued as notifications in the official gazette of the state or central governments. It may be noted that circulars, standing orders, instructions, office memos etc only have a persuasive effect within the legal framework and do not assume the force of law.
D. Insurance and FM: Insurance contracts are essentially contracts of indemnity whereby the Insurance company indemnifies the insured on the happening of certain pre-agreed events. In some cases insurance contracts are entered into to mitigate the risk of FM events occurring and disrupting business activity (i.e. one can insure against the risk of fire and flooding at a project site). Therefore, When entering into such insurance contracts, due care should be taken to ensure that the language of the insurance contract does not provide the insurer fine print carve-outs / exclusions from fulfilling the indemnity.
The road ahead
Opportunities?
It has been decades since an event with the magnitude of COVID-19 has hit the world. In certain cases it may even allow firms stuck in highly onerous business relationships to exit such relationships, this remains to be seen.
Blackest of Black Swan events - a massive shock to the insurance sector
I'm also eager to find out how insurance companies would treat business interruption insurance (BI) claims in such a crisis - this is interesting, because companies pay into a particular BI policy year on year thinking that they are protected and will receive BI monies on the happening of a black swan event. However, when an event like this arrives, insurance companies may choose to simply disclaim any liability and point to the fine print exclusions in the insurance contract or challenge valid claims in their entirely. This may result in a big hit to the credibility of the insurance sector on the whole. We'll find out more about this in the coming days as well.
The legal profession
Needless to say, no matter who I've spoken to in my fraternity in the last few days, they have been inundated with queries relating to FM, its either sending out FM notices or responding to such notices or simply trying to determine if the company or its vendors / customers are in contractual compliance or default.
I've learnt a great many new things while researching this article and hopefully I've been able to make it easy for everyone reading to understand the issue.
I would be happy to receive any questions. I look forward to debating this further. Please feel free to email me at nipun.mumbai@gmail.com
Disclaimer
This articles highlights the personal views of the author. It is designed for academic debate and general legal awareness.The intention behind the article is not to provide the reader with legal advise, nor should it be implied to be offering such advise.
