Frustration of Contracts
A frustrated contract is a contract that, subsequent to its formation, and without fault of either party, becomes impossible to perform in the manner that was contemplated by the parties to the contract. In other words, ‘frustration of contract’ occurs whenever, without default of either party, a contractual obligation becomes incapable of being performed because the circumstances in which performance is called for would tender it a thing radically different from that which was undertaken by the contract.[1]
The common law principle of frustration of contracts which is embodied in Section 56 of the Indian Contract Act 1872.
Section 56: Contract to do act afterwards becoming impossible or unlawful.—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.
Where a contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself. If, however, frustration is to take place dehors the contract, it will be governed by Section 56 of the Contact Act. In other words, if a contract has an express or implied ‘force majeure’ clause, it will apply over the principles under Sec 56 of the Contract Act. [2]
The doctrine of frustration of contract is not to be lightly invoked; mere incidence of expense or delay or onerousness is not sufficient; and there has to be, a break in identity between the contract and in its performance in the new circumstances, for such doctrine to be applicable.[3] It is clear from the above that the doctrine of frustration cannot apply to the cases where the fundamental basis of the contract remains unaltered[4]
Outbreak of a Global Covid-19 Pandemic
The World Health Organization has declared the novel coronavirus (COVID-19) a global pandemic; a state of public health emergency has been declared in most countries worldwide. There is no doubt that COVID-19 has had, and will continue to have, an adverse impact on the global economy and on performance of contracts.
The Indian Scenario amid the Covid-19 outbreak:
The government of India confirmed India’s first case of Covid-19 on 30 January 2020 in the state of Kerala, when a university student from Wuhan, China traveled back to the state. On 24 March, the Government of India ordered a nationwide lockdown for 21 days, as a preventive measure against the spread of the pandemic in India.
During this 21 day period, all transport services – road, air and rail, educational institutions, industrial establishments and hospitality services stand suspended, with exceptions for transportation of essential goods, fire, police and emergency services, food shops, banks and ATMs, petrol pumps, other essentials and their manufacturing. With disruption in supply chains, domestic and international travel, and business operations, many individuals and businesses are unable to fulfill their existing contractual obligations.
IMPACT OF OUTBREAK AND CONSEQUENT LOCKDOWN:
- Loans
To ease impact of lockdown, the Reserve Bank of India (RBI) has announced a series of measures in the Monetary Policy Committee (MPC) meeting held on 27 March 2020. As part of the measures, the RBI has imposed a 3 month moratorium/temporary halt on all term loans (on home, personal, agriculture, auto, crop loans) outstanding as on 1 March 2020 and allowed banks to defer payment of installments on loans including EMI, credit card dues, principal or interest payments, bullet payments, until 31 May 2020. This means, that the tenure of such loans will be extended by 3 months after the moratorium. However, interest shall continue to accrue on outstanding portion of the term loan during the moratorium period i.e. at the end of three months, the interest will be added to the outstanding term loan and will have to be paid.
In addition to the above, the repo rate and reverse repo rates have been reduced, cash reserve ratio (CRR) of banks and marginal standing facility have also been reduced apart from long term repo auctions to inject liquidity of 3.74 lakh crore into the system.
2. Government Contracts:
i. The Ministry of Finance, Department of Expenditure, Procurement Policy Division on 19 February 2020 issued an Office Memorandum No. F. 18/4/2020-PPD (‘O.M.’) clarifying that disruption of supply chains due to spread of Corona virus in China and other countries shall be regarded as a Force Majeure event i.e. a case of natural calamity and be covered under the Force Majeure clause referred in Para 9.7.7 of the ‘Manual of Procurement of Goods, 2017’ issued by the Department. The OM clarifies that on disruption of supply chain, the force majeure clause in Para 9.7.7 of the Manual of Procurement of Goods, 2017 may be invoked whenever appropriate following due procedure, as prescribed. This will provide relief to those companies actually affected by such disruptions having Central Government contracts. [5].
ii. Para 9.7.7 of the Manual of Procurement of Goods, 2017 inter alia states that a force majeure event does not excuse a party’s non performance entirely, but suspends it for the duration of the force majeure event. The clause requires a party to give notice of the force majeure event as soon as it occurs and cannot be claimed ex post facto/with retrospective effect.
3. Private Contracts
i. In case of private contracts, if the contract has an express or implied Force Majeure Clause, the obligation of the parties will be determined by the consequences specified in the force majeure clause. In such a case, the terms of the contract would have to be examined to determine what events enable parties to invoke the Force Majeure clause and whether outbreak of a pandemic constitutes a force majeure event, subject to compliance of requirements of notice etc., if any, as specified under the contract.
ii. However, if there is no force majeure clause in a contract, or on occurrence of an event dehors the contract, such as the outbreak of Covid-19, the common law principle of ‘frustration of contracts’ which is embodied in Section 56 of the Indian Contract Act 1872 shall govern the contract.
iii. In determining whether a contract is frustrated, an assessment of all relevant factors is necessary i.e. the terms of the contract; factual background to the contract; parties knowledge and expectations about risk when entering into the contract; the parties ability to perform the contract in the circumstances which are said to have frustrated the contract.
4. Lease Agreements
i. The relationship between a Lessor and Lessee are governed by the Lease Agreement. In absence of a force majeure clause in the Lease Agreement, the general law of Contract and Transfer of Property will govern.
ii. Courts in India have generally taken the view that Section 56 of the Contract Act is not applicable when the rights and obligations of the parties arise under a transfer of property under a lease. Under a lease agreement, there is a transfer of right to enjoy that land/property. If any material part of the property be wholly destroyed or rendered substantially and permanently unfit for the purpose for which it was let out, because of fire, tempest, flood, violence of an army or a mob, or other irresistible force, the lease may, at the option of the lessee, be avoided. This rule is incorporated in Section 108(e) of the Transfer of Property Act and applies to leases of land, to which the Transfer of Property Act applies, and the principle thereof to agricultural leases and to leases in areas where, the Transfer of Property Act is not extended. Where the property leased is not destroyed or substantially and permanently unfit, the lessee cannot avoid the lease because he does not or is unable to use the land for purposes for which it is let out to him. 6
iii. The fundamental basis of a lease agreement is possession of the leased premises by the lessee. The question whether the outbreak of Covid-19 can be said to fall within the expression ‘or other irresistible force’ in Section 108(e) is a question to be determined the courts. However, presently, even though an unforeseen event not in contemplation of the parties has occurred i.e. the outbreak of Covid-19, the event being temporary and transitory in nature, till the time it is not shown that the fundamental basis of the contract i.e. the possession of premises of the Lessor, is destroyed, or the leased premises has become permanently unfit for use, the contract cannot be said to be frustrated and the Lessee is bound to pay rent in terms of the Lease Agreement.
5. Employment/ Service/Retainer Agreements
i. In case of employment agreements, in order to determine whether the doctrine of frustration of contracts as embodied in section 56 of Indian Contract Act would apply, in absence of an express or implied clause in the agreement, what has to be considered is whether at the time of entering into the contract, the parties could have reasonably anticipated the occurrence of the force majeure event i.e. in the present scenario- outbreak of Covid-19. Whether, such event is beyond the affected contracting party’s control and whether performance of the contract/service/job becomes ‘impossible’ or ‘unlawful’ due to the occurrence of the event.
ii. Subject to the intention of the parties, term/duration of the employment agreement and the fundamental basis/ foundation of the agreement, the outbreak of Covid-19, being temporary and transitory in nature, is a temporary alteration of circumstances in which the contract was made and even though it may be financially unfavorable or impractical or lead to leading to monetary hardship for the employer it will not amount to frustration of a contract of long term employment.
Neelambika Singh
Associate
Capital Law Chambers LLP
[1] Davis Contractors v. Fareham U.D.C. (1956) AC 16
[2] Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310 : AIR 1954 SC 44
[3] Edwinton Commercial Corporation v. Tsavliris Russ (Worldwide Salvage and Towage) Ltd. (The Sea Angel) (2007) 2 Lloyd’s Rep 517 (CA)
[4] Energy Watchdog v. CERC 2017 SCC OnLine SC 378
[5] NOTE: The ‘Procurement Entities’ who can benefit from the Manual of Procurement of Goods, 2017 include Ministries, Departments, or a unit thereof, or an attached or subordinate offices/units; Central Public Sector Enterprises (CPSEs) or undertakings; any other body (including autonomous bodies) substantially owned or controlled by or receiving substantial financial assistance from the Central Government. The procurement guidelines would continue to apply if these procurement entities outsource the procurement process or bundle the procurement process with other contractual arrangements or utilise the services of procurement support agency or procurement agents to carry out the procurement on their behalf
[6] Raja Dhruv Dev Chand v. Harmohinder Singh & Anr. 1968 AIR 1024; T T. Lakshmipathi v. P. Nithyananda Reddy, (2003) 5 SCC 150
Contributing Advisors
Myles CulmerDirector, BDO Advisory Services