Supply Chain Disruptions Due To COVID-19 - Legal Impact on Contracts
The author, Brindha Balakrishnan, is a BBA-LLB (Hons) student at Alliance University.
Introduction
Apart from the devastating effect that the ongoing pandemic continues to unleash on the normalcy and mere functioning of us human beings, it has also reached and hard hit the commerce and the industry aspects of business. As a result, in an attempt to contain the virus from further spreading, the government imposed lockdowns and restrictions on movement of its citizens. The immediate consequences were supply chain disturbances.
A supply chain is essentially a worldwide system that a business puts together and follows for the manufacture and production purposes of its particular products and services.
Stretches of empty grocery store shelves are what consumers see forefront as implications of the virus on the global supply chains, but on the back end- the stoppage of productions, shortage of raw materials, shutting down of factories, migration of labourers, trade restrictions, and insufficient demand, are a few among the many problems that every country’s government is scrambling to contain. The pandemic has severe implications on the international production networks and will remain so for years to come.
In this unfortunate state of affairs, unintentional delays and incapability of fulfilling obligations are likely to happen. Parties to contracts may seek to delay the performance of their duties under the contract or try to avoid the duties all together either as the COVID-19 situation has legitimately restricted them from performing their obligations or they are trying to use this as an excuse to withdraw themselves from contracts which are unfavorable to them.
Force Majeure
The term that has assumed relevance in business as of today given the ongoing pandemic situation- force majeure.
Force majeure translates literally from French as superior force. In English, the term is often used in line with its literal French meaning, but it has other uses as well, including one that has roots in a principle of French law. In business circles, "force majeure" describes those uncontrollable events (such as war, labor stoppages, or extreme weather) that are not the fault of any party and that make it difficult or impossible to carry out normal business. A company may insert a force majeure clause into a contract to absolve itself from liability in the event it cannot fulfill the terms of a contract (or if attempting to do so will result in loss or damage of goods) for reasons beyond its control.[1]
Blacks law dictionary defines the term force majeure as an event or an effect that could not have been expected, anticipated or further controlled. While force majeure has not been specifically dealt with or come across or even defined in Indian Statutes, you can find its references in Section 32 and Section 56 of The Indian Contract Act, 1872. Section 32 of this act provides that if a contract is contingent on the occurrence of an event that is unlikely, then the contract is void, whereas Section 56 provides that an agreement to do an impossible act in itself is void. Force Majeure, typically spells out circumstances or events which includes an Act of God or events like war, strikes, earthquakes, epidemics, plagues, terrorism, etc.
From a contractual perspective, for this particular force majeure clause to be applicable, firstly, the particular event should be beyond the control of the parties and further, the parties to the contract are required to demonstrate not only that the situation is of the force majeure kind but also that they have made attempts to mitigate through the impact of such an event. A force majeure clause essentially provides a temporary reprieve to a party from performing its obligations agreed upon in a contract upon the occurrence of such a major event.
Depending on the drafting of the clause, this particular clause may have a variety of consequences, such as- excusing the party from performing the contract partly or in whole, excusing the party for delays in performance, giving party right to terminate, entitling them to claim an extension of time, etc.
In unprecedented circumstances like the present situation, the courts are more likely to be generous in their interpretation when faced with parties who are genuinely facing difficulties in performing their obligations.
Further, even if the situation, here being COVID-19, is declared as a type of event covered by the force majeure clause, the next question is to ascertain the level of impact it has had on the affected party’s ability to perform or carry out its obligations.
A party seeking to rely on the force majeure provision has to show that it has taken all reasonable steps to mitigate or avoid the consequences of the event. This provision will not hold if the party simply faces difficulties in carrying out his duty. If there is means to carry out the performance of the obligations but in a different but viable method than what was agreed upon in the contract then the party is bound to do so. However, this may be less profitable due to higher costs but is not sufficient ground to absolve a party in question of liability to perform. This provision only stands when the affected party’s ability to perform its obligations under the contract have been hindered, prevented or impeded.
Doctrine Of Frustration
In the absence of an express force majeure provision, parties to a contract may rely upon the doctrine of frustration. However, if the force majeure clause is present in the contract, then the doctrine of frustration cannot be used as the former by itself is regarded as the agreed form of allocation of risk. The doctrine of frustration comes into play when the obligations under a contract become impossible to perform due to reasons which are beyond the control of both the parties or due to change in circumstances. The court may grant relief on the ground of the subsequent impossibility which has frustrated the whole purpose or the very basis of the contract due to the intrusion of an unexpected event or a change in circumstance which was not contemplated by the parties when the contract was made.
The doctrine of frustration is present in India u/s. 56 of the Indian Contract Act 1852. It says that any act which was to be performed after the contract is made becomes unlawful or impossible to perform, and which the promisor could not prevent, then such an act which becomes impossible or unlawful will become void. It lays down a rule of positive law and does not leave the matter to be determined according to the intention of the parties.[2]
Section 56 first lays down the simple principle that “an agreement to do an impossible act in itself is void”. For example, an agreement to discover gold treasure by means of magic, being impossible to perform, is void. The second paragraph of Section 56 lays down the effect of the subsequent impossibility of performance. This happens when the performance of a contract is quite possible when agreed upon by the parties but due to some event that happens subsequently, the performance becomes impossible or unlawful. In either case mentioned above, the contract becomes void.
For example- in a contract of marriage, if before the event has occurred, one of the parties goes mad, the contract in this case becomes void.
Specific Grounds Of Frustration
1. Destruction of subject matter - If the actual and the very specific subject of the matter of the contract is annihilated, the doctrine of frustration can be applied.
The best example here can be - A decision under Section 56 is that of the Madras High Court in V.L. Narasu v. P.S.V.Iyer[3]- where a contract to exhibit a film in a cinema hall was held to have become impossible of performance when on account of heavy rains the rear wall of the hall collapsed killing three persons and its license was cancelled until the building was reconstructed to the satisfaction of the chief engineer. The owner was under no liability to reconstruct and it took him some time, by that time the film would have lost its appeal.[4]
2. Change of circumstances - When certain situations arise which make the accomplishment of the contract impossible to achieve in the way it was contemplated to be achieved, a contract will frustrate.
Justice Kapur of the Punjab and Haryana High Court in Parmeshwari Das Mehra v. Ram Chand Om Prakash[5] explained the principle thus: It is clear that if there is entirely unanticipated change of circumstances- the question will have to be considered whether this change of circumstances has affected the performance of the contract to such an extent as to make it virtually impossible or extremely difficult or hazardous. If that be the case, the change of circumstances not having been brought about by the fault of either party, the courts will not enforce the contract.[6]
3. Non-occurrence of contemplated event - A situation where, the performance of a contract is entirely possible, but is contingent on the occurrence of a specific event to occur which if fails to occur, affects the core objective of the contract
In the case of Herne Bay Steam Boat Co. v. Hutton[7] which arose from the postponement of the coronation. The Royal Naval Review was proposed to be held on the occasion. The defendant chartered a steamboat for two to take out a party of paying passengers for the purpose of viewing the naval review and for a day's cruise around the fleet. But the review was cancelled and the defendant had no use for the ship. Yet he was held liable to pay the unpaid balance of the hire less the profit which the plaintiff had made by the use of ship in the ordinary course.[8]
4. Death or incapacity of party - A party to a contract is exempted from performing the obligations of a contract if it is contingent on the survival of a specific person and the person dies. Thus, when it is the nature of the contract which requires a performance by a given person, the death of the person puts an end to the contract.
5. Government, Administrative or legislative intervention- The operation of a legislative or an administrative which strikes the very objective of the contract, which further changes the fundamental nature of the contract, the contract is dissolved.
6. Intervention of war - War like situations or the intervention of war has often raised difficult questions in courts.
The closure of the Suez Canal following the Anglo-French war with Egypt, for instance, interrupted the performance of many contracts. One such case is Tsakiroglou & Co Ltd v Noblee Thorl G m b H[9] - The appellants agreed to sell to the respondents three hundred tons of Sudan groundnuts c.i.f. Hamburg. The usual and normal route at the date of the contract was via Suez Canal. Shipment was to be in November/December 1956, but on November 2, 1956, the canal was closed to traffic and it was not reopened until the following April. It is stated that the appellants could have transported the goods via the Cape of Good Hope. The appellants refused to ship goods via the Cape. The question now is whether by reason of the closing of the Suez route, the contract had been ended by frustration. The appellants' argument was that it was an implied term of the contract that shipment should be via Suez. But it was held that such a term could not be implied. The customary or usual route via the Suez Canal being closed, the appellants were bound [by the Sale of Goods Act, 1893, 32(2)] to ship the groundnuts by a reasonable and practical route and, though the appellants might be put to greater expense by shipping the groundnuts via the Cape of Good Hope, that did not render the contract fundamentally or radically different, and there was not, therefore, frustration of the contract.[10]
Frustration must be self-induced and not occur due to the fault of either of the parties. The doctrine of frustration came into existence to serve purpose for when through no fault of the parties, a contract frustrates. The doctrine of frustration is dynamic in nature and takes shape according to the requirements of the society.
Conclusion
Force majeure and The doctrine of frustration have been the only safety net that companies are falling back on amidst the onset of the Covid-19 pandemic which has not only been a humanitarian crisis but also an economic crisis of an unprecedented scale. Uncertainty as to the performance of the obligations of a contract which in turn have led to unintentional breaches, is now driving companies to reassess their rights and remedies in the particular contract. While several contractual parties may seek to retract from their contractual obligations, the aforesaid exceptional circumstances may only result in litigation in a catena of commercial contracts which is then left to the interpretation of the courts.
[1] Definition Of FORCE MAJEURE' (Merriam-webster.com, 2020) <https://www.merriam-webster.com/dictionary/force%20majeure> accessed 21 August 2020. [2] 'Doctrine Of Frustration - Corporate/Commercial Law - India' (Mondaq.com, 2020) <https://www.mondaq.com/india/contracts-and-commercial-law/407868/doctrine-of-frustration#:~:text=The%20doctrine%20of%20frustration%20is,or%20unlawful%20will%20become%20void.> accessed 21 August 2020. [3] AIR 1953 Mad 300, (1952) 2 MLJ 832 [4] Frustration Of Contracts: The Indian Perspective' (Legalserviceindia.com, 2020) <http://www.legalserviceindia.com/legal/article-626-frustration-of-contracts-the-indian-perspective.html> accessed 21 August 2020. [5] AIR 1952 P H 34 [6] Frustration Of Contracts: The Indian Perspective' (Legalserviceindia.com, 2020) <http://www.legalserviceindia.com/legal/article-626-frustration-of-contracts-the-indian-perspective.html> accessed 21 August 2020. [7] Herne Bay Steam Boat Co v Hutton [1903] 2 KB 683 [8] Frustration Of Contracts: The Indian Perspective' (Legalserviceindia.com, 2020) <http://www.legalserviceindia.com/legal/article-626-frustration-of-contracts-the-indian-perspective.html> accessed 21 August 2020. [9] [1961] 2 All ER 179 [10] Frustration Of Contracts: The Indian Perspective' (Legalserviceindia.com, 2020) <http://www.legalserviceindia.com/legal/article-626-frustration-of-contracts-the-indian-perspective.html> accessed 21 August 2020.