C&M e-Alert – COVID – 19: AM I OBLIGATED TO PERFORM MY CONTRACT?

FAQs on force majeure, frustration, and material adverse change
25 April 2020

On 11 March 2020, the World Health Organisation (“WHO”) declared the outbreak of the COVID – 19 disease, to be a pandemic. With each passing day, the number of positive cases in India is on a steady rise. Beginning the midnight of 25 March 2020, the Government of India placed the country in a total lockdown to curb the spread of COVID – 19, until 14 April 2020. The lockdown has now been extended until 03 May 2020[1], with some relaxations being given by State Governments post 20 April 2020.[2] As such, there is limited visibility into what the post lockdown future is going to be.

 

Resultantly, businesses across the board are struggling to perform their contractual obligations. In this context we have attempted to answer some of the most frequently asked questions on contractual rights and obligations in the context of COVID – 19.  

 

 

 

 

 

But, before you jump into these questions, we highly recommend that you consider some practical considerations:

  • First, the COVID-19 pandemic affects all of us. Therefore, an early engagement with your business counter-part is highly recommended over a long-drawn dispute.

  • Second, please also consider other aspects of your contract: whether the contract stipulates arbitration or litigation as a dispute settlement mechanism? Whether the contract is governed by Indian law or laws of another jurisdiction?

  • Third, consider any waivers or actions that may be considered as an estoppel.

  • Fourth, keep records of your decision making, communications, steps taken to mitigate, etc. Disputes can take months and years before courts and tribunal. Therefore, good recording keeping is key to managing risk and proving your case.

  • Finally, keep an eye out for procedures set out in the contract (time period to notify force majeure; notice clauses etc.).

 

For ease of convenience, please click on the FAQs below to go directly to the answer. 

1. Is COVID – 19 a pandemic or an epidemic?

2. Is there a statutory framework to deal with an epidemic disease in India?

3. In view of the outbreak of COVID – 19, can I legally be excused from performing my contractual obligations?

I. Force Majeure

4. What is a “force majeure” clause?

5. Are force majeure provisions statutorily covered in India?

6. What does a force majeure clause typically contain?

7. In what circumstances can a force majeure clause be invoked?

8. Who has to prove the existence of a force majeure event?

9. Is the affected party required to serve a prior notice?

10. What options do I have after invoking the force majeure clause?

11. Can the affected party sit back after issuing the notice?

12. What happens if I am served with a notice of force majeure by the affected party?

13. How should a reply be framed to a notice of force majeure by the affected party?

14. Does the outbreak of COVID – 19 entitle a party to invoke the force majeure clause?

15. In case my contract does not have force majeure clause what other provisions should I look for?

II. Doctrine of Impossibility

16. My contract does not contain any force majeure or similar provisions. Can I suspend my obligations using the doctrine of impossibility or frustration?

17. Can I invoke doctrine of impossibility in case of COVID – 19?

18. What are the procedural steps I need to follow at the time of invoking doctrine of impossibility?

III. Some common themes on force majeure and frustration

19. Can I invoke a force majeure clause or claim frustration in case my contract has become unprofitable on account of COVID-19?

20. Can I rely on the force majeure clause or doctrine of frustration to deny or delay payment under my contract due to COVID – 19?

21. I cannot use my office premises due to the nationwide lockdown. Can I use the defence of force majeure to avoid paying rent?

22. What if my lease/ license is silent? Can I use the defence of impossibility to void the lease (and hence avoid paying rent)?

23. What would be the impact of COVID – 19 on development and construction contracts?

IV. Material Adverse Change

24. What is a material adverse change?

25. What does a typical material adverse change clause in an investment agreement look like?

26. What are the consequences of a material adverse change in an investment agreement?

27. Are material adverse change clauses covered by any statute in India?

28. Can a material adverse change clause be invoked routinely in an investment agreement?

29. Who has to prove the existence of a material adverse change?

30. Can the outbreak of COVID – 19 be considered as a material adverse change?

31. A key managerial person of the acquirer/ buyer dies after contracting COVID – 19. Will that be considered as a material adverse change?

1. Is COVID – 19 a pandemic or an epidemic?

 

The terms pandemic and epidemic should not be confused and used interchangeably. While a pandemic affects a large number of people across the globe, an epidemic is considered to be confined to a region, affecting lesser number of people.  As such, globally, COVID – 19 is declared as a pandemic whereas in India (on account of the terminology used in the relevant statues) COVID – 19 is declared as an epidemic.

 

2. Is there a statutory framework to deal with an epidemic disease in India?

 

Yes, the Epidemic Diseases Act, 1897 (“Epidemic Diseases Act”) and the Disaster Management Act, 2005 (“Disaster Management Act”).

 

Under the Epidemic Diseases Act, a particular State Government can classify a disease as an epidemic and take measures for its containment. The Disaster Management Act allows both Central as well as State Governments to take measures for the purpose of “disaster management”.

 

In the beginning of March 2020, the provisions of Epidemic Diseases Act were individually invoked by select State Governments on a piecemeal basis to enforce the lockdown in some of the districts falling within their ambit. However, keeping in mind the emerging threat of COVID – 19, on 24 March 2020, the National Disaster Management Authority[3] invoked the provisions of Disaster Management Act to direct the State Governments and Union Territories to ensure social distancing. Subsequently, the Home Secretary, Ministry of Home Affairs[4] as chairman of the National Executive Committee constituted under the Disaster Management Act, issued a similar order along with appropriate guidelines[5] to Ministries/ Departments of Government of India, State/ Union Territories with directions for strict implementation with effect from 25 March 2020 for a period of 21 days.

 

3. In view of the outbreak of COVID – 19, can I legally be excused from performing my contractual obligations?

 

That would depend on whether: (i) the contract itself entitles you to suspend or terminate performance on account of COVID-19 (or its consequences); (ii) circumstances exist for invoking the doctrine of “impossibility” or “frustration” under Section 56 of the Indian Contract Act, 1872 (“Contract Act”) de hors the contract.

 

As far as first point is concerned – the contract itself may contain provisions such as “force majeure”, “material adverse change”, “change of law” etc. which will enable suspension, termination or price adjustment on occurrence of an event like COVID-19.  For the purpose of this article, we will examine the “force majeure” clause and the “material adverse change” clause. We will then examine the “doctrine of impossibility” under Section 56 of the Contract Act where the contract itself does not specifically entitle the affected party to excuse its performance.

 

I. Force Majeure

 

4. What is a “force majeure” clause?

 

Force majeure clause is a provision which is commonly found in commercial contracts that frees / excuses a party from its obligation(s), if an extraordinary event (a force majeure) prevents the said party from performing its obligation(s) under the contract. Such extraordinary events must be unforeseeable and unavoidable and must not be the result of a party’s actions.[6]  A force majeure event

would either suspend performance during the continuation of the force majeure or where, such force majeure subsists for a period of time, would terminate such contract or both.

 

The term force majeure originates from the French Code Napoleon (now Code Civil) and as such there is no precise meaning under English law.[7] A force majeure clause may include the phrase “act of god” but, in general, is broader than events or circumstances that can be considered as “acts of god” as it may include riots, strikes etc. which are not, as such, “acts of god”.

 

5. Are force majeure provisions statutorily covered in India?

 

A force majeure clause is essentially a contractual provision – while it is not specifically covered in the Contract Act, case law suggests that they would be dealt with under Section 32 of the Contract Act[8] which deals with contingent contracts or similar other provisions contained in the Act. Where the contract contains a force majeure provision, then the consequences of force majeure is governed by the relevant clauses of the contract.[9]  

 

Where a contract does not contain a force majeure clause, then the provisions of Section 56 of the Contract Act, which deals with impossibility and illegality may come into play (discussed below).

 

6. What does a force majeure clause typically contain?

 

A force majeure clause would differ from contract to contract and the reason such contract was entered into (for e.g. a force majeure clause in a construction contract would be different from a force majeure clause in a sales contract or a force majeure clause as used in an investment contract).

 

However, we have for the purposes of the discussion used a force majeure clause from the ICC Force Majeure Clause 2003,[10]

 

“1. Unless otherwise agreed in the contract between the parties expressly or impliedly, where a party to a contract fails to perform one or more of its contractual duties, the consequences set out in paragraphs 4 to 9 of this Clause will follow if and to the extent that the party proves:

  1. That its failure to perform was caused by an impediment beyond its reasonable control; and

  2. That it could not reasonably have been expected to have taken the occurrence of the impediment into account at the time of the conclusion of the contract; and

  3. That it could not reasonably have avoided or overcome the effects of the impediment...”

 

“3. In the absence of proof to the contrary and unless otherwise agreed in the contract between the parties expressly or impliedly, a party invoking this Clause shall be presumed to have established the conditions in paragraph 1(a) and (b) of this Clause in case of the occurrence of one or more of the following impediments:

  1. War (whether declared or not) armed conflict or the serious threat of same (including but not limited to hostile attack, blockade, military embargo), hostilities, invasion, act of a foreign enemy, extensive military mobilisation;

  2. Civil war, riot rebellion and revolution, military or usurped power, insurrection, civil commotion or disorder, mob violence, act of civil disobedience;

  3. Act of terrorism, sabotage or piracy;

  4. Act of authority whether lawful or unlawful, compliance with any law or governmental order, rule, regulation or direction, curfew restriction, expropriation, compulsory acquisition, seizure of works, requisition, nationalisation;

  5. Act of God, plague, epidemic, natural disaster such as but not limited to violent storm, cyclone, typhoon, hurricane, tornado, blizzard, earthquake, volcanic activity, landslide, tidal wave, tsunami, flood, damage or destruction by lightning, drought;

  6. Explosion, fire, destruction of machines, equipment, factories and of any kind of installation, prolonged break-down of transport, telecommunication or electric current;

  7. General labour disturbance such as but not limited to boycott, strike and lock-out, go-slow, occupation of factories and premises.”

 

While most force majeure clauses in contracts will not tend to be as detailed, they would typically include many aspects from the above.

 

7. In what circumstances can a force majeure clause be invoked?

 

Often overlooked at the time of negotiation, the language used in a force majeure clause in a contract would be critical to determine circumstances in which it can be invoked and the rights and defences parties have in case the same is invoked.

 

In order to invoke a force majeure clause in a contract, firstly, the event (which has affected the performance of contract) should be classified as a force majeure event in terms of the contract.

 

Secondly, simpliciter occurrence of the force majeure event is usually not enough to excuse performance by the affected party. Typically, contracts include a further condition requiring a link between the force majeure event and the affected party’s failure to perform its obligations, as also the impact that the event must have in order to trigger the force majeure clause.

 

For instance, the force majeure clause may state that the affected party will be excused from performance if it is “prevented” and/or “hindered” and/or “adversely affected” and/or “delayed” from performing its obligations as a result of the force majeure event. In such case, the affected party would be able to invoke the force majeure clause only if the force majeure event has “prevented”, “hindered”, “adversely affected” or “delayed” (depending on the terminology used) the performance.

 

Also, the courts may view each of these impacts differently, for e.g. being “prevented” from performing one’s obligation may not necessarily be the same as being “hindered” or being “adversely affected” or “delayed”. Different standards are used by the courts in determining the nature of impact of force majeure that would excuse performance. Further, where such words are used in conjunction with each other, the courts may construe a particular impact with regard to words which precede or follow it, and also with regard to the nature and general terms of the contract.[11]  For instance, in one case, looking at the language used in various clauses of the force majeure provision, the Supreme Court interpreted the expression “hindered” in one provision of the force majeure clause along with the term “partly prevents” in another provision and held that to invoke the clause, there must be something which partly prevents the performance of the obligation under the agreement[12]. Thus, much would depend on the language that is employed in the contract as well as the nature and general terms of the contract.

 

Lastly, a force majeure clause may contain specific exclusions and inclusions – for instance it may entitle only one of the parties (such as only the supplier) to invoke the clause or it may excuse only some obligations (such as obligation to supply) and exclude certain other types of obligation (such as payment obligation) from its ambit. In such circumstances, the excluded party, even if it is affected by the force majeure event, may not be able to invoke it.

 

Typically, the provisions of a force majeure clause in a contract would require the party invoking it to establish that:

 

  • The party invoking it (or the obligation sought to be excused) is not excluded from the ambit of force majeure clause;

  • The event was a force majeure event as contemplated in the contract;

  • The event was not reasonably foreseeable by the affected party;

  • The occurrence of the event was beyond the control of the affected party;

  • The language employed in the contract to check the level of impact that the force majeure event needs to have to excuse performance, e.g. whether the affected party is “prevented” from performing or only “hindered” or “adversely affected” or “delayed” in performing;

  • The impact (i.e. failure to perform) was a result of the force majeure event.

 

It may be noted that since force majeure events are considered to be an exception to contractual obligations, courts in India have generally interpreted these clauses narrowly.[13]

 

8. Who has to prove the existence of a force majeure event? 

 

The affected party. Indian law places a burden on the affected party to prove that the force majeure event prevented it from performing its obligations under the contract.

 

9. Is the affected party required to serve a prior notice?

 

Generally, a force majeure clause requires a party invoking it to issue a prior notice to the counterparty, informing the counterparty about its inability to perform the contract. In case, the contract is silent, it is advisable to serve a notice to the counterparty to show bonafides.

 

10. What options do I have after invoking the force majeure clause?

 

As force majeure clause is governed by the terms of the contract, the remedies available to the affected party would depend upon the express terms of the force majeure clause.

 

Contractual remedies for a force majeure typically include:

  • an extension of time to perform the affected obligations;

  • suspension of contractual performance for the duration of the force majeure event;

  • if force majeure event extends over a longer period, the contract may entitle the parties to terminate the contract.

 

11. Can the affected party sit back after issuing the notice?

 

In order to be excused from the performance of its obligations, an affected party, subject to the terms of the contact, may have to mitigate the effect of its non-performance. If required by the contract, the affected party would have to demonstrate that it undertook best endeavours to mitigate the impact of its non-performance.

 

Thus, depending on the terms of the contract, in case it is proved that the affected party had alternative modes of performance, and it failed to avail them, the defence of force majeure will not be available to the affected party.

 

Similarly, some contracts (especially technology related, data centre related, outsourcing etc.) may, as a pre-condition to invocation of said clause, require the affected party to put into place alternative modes of performance of contractual obligations, including having an effective business continuity plan. In such cases, the affected party must set into motion its business continuity plans.

 

12. What happens if I am served with a notice of force majeure by the affected party?

 

If you receive a force majeure notice from an affected party, you should carefully examine the following:

 

  • Whether the contract contains a force majeure clause?

  • Whether the affected party (or obligation sought to be excused) is covered and not excluded from the ambit of force majeure clause?

  • Whether the event or circumstance claimed by the affected party falls within the scope of a force majeure event under the contract?

  • What is the obligation of the affected party towards you that is claimed to have been impacted by the force majeure event?

  • hat ‘impact’ on the obligation would entitle the affected party to invoke the force majeure clause? Has the force majeure event resulted in such an impact?

  • Whether the process of invoking the force majeure clause has been complied with?

  • Were there any pre-conditions to be met by the affected party before invoking the force majeure clause?

 

13. How should a reply be framed to a notice of force majeure by the affected party?

 

A reply to the force majeure notice is similar to the reply to any other notice, legal or otherwise. However, it is advisable that such reply is framed by the party’s internal or external legal team(s). An important thing to keep in mind while drafting any such reply is whether the event and the actions of the affected party conform to the force majeure clause in the contract:

 

  • If not, then the invocation of the force majeure should be disputed.

  • In case the event is a force majeure event as per the contact, one can insist upon the party claiming force majeure to provide evidence of the circumstances that are allegedly preventing performance and the efforts being undertaken by it to mitigate the impact of non-performance.

 

14. Does the outbreak of COVID – 19 entitle a party to invoke the force majeure clause?

 

This would depend on the terms of the contract. Assuming the contract contains a force majeure clause, following tests (in no particular order) would become important:

 

  • Can COVID-19 be classified as a force majeure event?

 

It would be relevant to see if the contract uses the terms “disaster”, “epidemic”, “pandemic”, “natural calamity”, “act of god” etc. Since COVID – 19 has been declared as a pandemic (globally), as an epidemic in India, where contracts contain the said phrases , COVID – 19 would be covered as a force majeure event.  Similarly, where contracts employ phrases such as “disaster” or “natural calamity” or “act of god” then  it is arguable that the outbreak of COVID-19 would also be covered as such based on the notifications of the Ministry of Home Affairs (Disaster Management Division) dated 14 March 2020 [14] and the office memorandum issued by the Ministry of Finance, Government of India dated 19 February 2020.[15] Do note that these notifications have been issued with respect to particular situations, i.e. supply chains being disrupted in China and other countries in case of public procurement of goods, etc, and only have persuasive value as between private contractual agreement between parties in India.

 

Where the contract does not use such terms – it may still be possible to classify COVID-19 as force majeure event relying on other provisions. For instance, force majeure event may be defined broadly to cover any situation which is unforeseeable and outside the control of parties. Further, since most contracts require not just that the force majeure event to be subsisting but also that it resulted in causing delay or prevented/ affected/ hindered/ the performance, the consequences arising out of COVID – 19, such as embargoes on movement of goods (other than essentials) restricted cargo movement (through air, water, road) are more likely to be considered force majeure events.[16] This is also helpful in cases where contracts do not use the phrases “pandemic”/ “epidemic”/ “natural calamity”/ “disaster” or “act of god”. In such cases, the affected party can rely on other aspects of the force majeure definition such as governmental order, curfew etc.

 

  • Whether COVID-19 has ‘impacted’ the performance of the obligation of the affected party in terms of the force majeure clause?

 

It is equally important to examine what is the obligation of the affected party under the contract and the impact that COVID-19 (or its consequences) has had on such obligation. For instance, whether the affected party’s obligation towards its counterparty has been “prevented” or only “hindered”, “adversely affected” or “delayed” on account of COVID-19 (or its consequences).

 

  • Are there any exclusions - whether the affected party (or obligation sought to be excused) is covered?

 

For instance, if the contract is one sided enabling only a supplier to invoke the force majeure clause, the purchaser may not be able to invoke the clause, even if its purchase obligations are affected by COVID-19.

 

Hence, while COVID – 19 may be considered as a force majeure event in many contracts, however the same may not be enough to trigger the force majeure clause itself. In fact, on 08 April 2020, the High Court of Bombay[17] declined to give relief to steel importers in the form of interim injunction from invocation of letter of credit issued by their bank to the supplier inter alia holding that the force majeure exemption in the underlying contracts with the supplier is applicable only to the supplier and cannot come to the aid of the importer. In this case, the language of the contract excused “Seller” or any of its suppliers or sub-contractors to manufacture and deliver the “Goods”. The Court also noted that:

 

  • the fact that the importers would not be able to perform their obligations so far as their own purchasers are concerned and/or it would suffer damages, is not a factor which can be considered and held against the supplier;

  • distribution of steel is considered as an “essential service”, there are no restrictions on its movement and all ports and port related activities have also been declared as essential services;

  • In any event, the lockdown would be for a limited period and the lockdown cannot come to the rescue of the importer so as to resile from its contractual obligations with the supplier of making payments.

 

On the other hand, by its order dated 20 April 2020, the High Court of Delhi granted ad-interim injunction from invocation of performance bank guarantees by the respondent where the petitioner pleaded inability to complete the project on account of lockdown (resulting from COVID-19). The Court held that the countrywide lockdown was, in its opinion, prima facie in the nature of force majeure. Such a lockdown is unprecedented, and was incapable of having been predicted by the parties. It noted the petitioner’s submission that had the lockdown not be imposed, the project might have been completed. The Court took a prima facie view that ‘special equities’ do exist, as would justify grant of injunction till the expiry of a period of one week from 3 May, 2020 (till lockdown). In respect of the contention that petroleum is exempted from lockdown notifications, the Court prima facie took a view that even if production of petroleum was exempted, the petitioner is not engaged, stricto sensu, in the production but is, rather, engaged in drilling of the wells, which activity is substantially, if not entirely, impeded as the result of the imposition of the lockdown[18]. Interestingly, the contours of the actual force majeure clause (if any) in the agreement between the parties was not discussed. As such, it is unclear if the Court was referring to a particular force majeure clause in the contract or was relying on a general principle of frustration of contract (see below).

 

15. In case my contract does not have force majeure clause what other provisions should I look for?

 

While your contract may not have a clause titled ‘force majeure’, there may be other provisions which entitle you to suspend your obligations upon occurrence or non-occurrence of an event. Look for these provisions – these may be express or implied, they may appear in the form of “material adverse change” clause (see discussion below) or a “change in law” clause, which may entitle you to suspend/ terminate/ renegotiate the contract. Just like a force majeure clause, much will depend on the nature of the contract and the language used in these clauses.

II.Doctrine of Impossibility

 

16. My contract does not contain any force majeure or similar provisions. Can I suspend my obligations using the doctrine of impossibility or frustration?

 

Where the Court finds that the 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 and such cases would be dealt with under Section 32 of the Contract Act (for instance a force majeure clause). On the other hand, if the contract is to be avoided on grounds of frustration, Section 56 of the Contract Act would come into play.[19]

 

Section 56 states that “An agreement to do an act impossible in itself is void; 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

 

There are two parts to Section 56 of the Contract Act. The first part relates to an agreement to do an act which is impossible. Such agreements are void when they are entered into. The second part relates to agreements which are capable of being performed when they were entered into but a subsequent event or circumstance beyond the control of the promisor, makes the agreement either impossible or unlawful. An example of the second part would be where A contracts to take a cargo for B at a foreign port. A’s Government afterwards declares war against the country in which the port is situated. The contract becomes void when the war is declared.

 

Please do note that this doctrine can be invoked either where the performance becomes illegal or where it becomes impossible and both conditions do not need to be satisfied.  The term “impossible” in law does not mean to have a literal meaning attached to it. It is considered as something which may be impracticable from the point of view of the object and purpose of the parties entering into the contact.[20] However, this should also not be interpreted to mean that the doctrine can be invoked if the act becomes “onerous”. A contract is not frustrated merely because the circumstances in which it was made are altered. The Courts have no general power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.[21]

 

This is because the general principal for giving relief under the second part of Section 56 is that on account of a subsequent unforeseeable event, which could not have been contemplated by the parties, the whole purpose or basis of a contract was frustrated. A very strict standard is applied by the Court here and the relief is granted only where the Court considers the change in circumstance be so fundamental as to be regarded by law as striking at the root of the contract as a whole, something that destroys altogether the basis of the adventure and its underlying object.[22] Where the supervening event is of a temporary character, it would generally not affect the fundamental basis of the contract.

 

Importantly, Section 56 does not merely suspend the performance, it strikes at the root of the contract and makes the contract void.

 

17. Can I invoke doctrine of impossibility in case of COVID – 19?

 

The test is whether COVID-19 (or its consequences) have made it impossible or illegal to undertake the act. While at first blush this may appear to be a very easy test in the present situation, as mentioned, a very strict standard is applied by the Court to determine if the act has become impossible or illegal. And to determine this, the Courts will see if the fundamental basis of the contract has altered because of COVID-19 (or its consequences).

 

Where the contracts do not have a time bound nature, it would be challenging to claim impossibility on account of COVID-19 disruptions as the affected party will be able to perform the contract once the temporary supervening event is over.

 

On the other hand, where time is fundamental to the contract and the performance of a material obligation has become impossible or illegal on account of COVID-19 (or its consequences) then such party can invoke the “doctrine of impossibility” to terminate the contract. For instance, a contract with an event planner that provides for organisation of an outdoor concert with over 100 guests on 10 April 2020 became void when lockdown was declared (as the performance of such act impossible and illegal).

 

18. What are the procedural steps I need to follow at the time of invoking doctrine of impossibility?

 

Frustration of a contract due to impossibility or illegality is automatic upon happening of the event. As such, the Contract Act does not provide any specific procedure to be followed. However, since frustration leads to termination, usually, most contracts provide for an obligation of providing an express notice by the affected party. Even if the contract is silent about the notice, it is still advisable to serve a notice to the counterparty to show bonafides.

 

III.Some common themes on force majeure and frustration

 

19. Can I invoke a force majeure clause or claim frustration in case my contract has become unprofitable on account of COVID-19?

 

Generally, no. A disruption that merely impacts the profitability of a contract or makes it more difficult or cumbersome may not be sufficient to constitute a force majeure event under the contract unless there is express contractual provision for such a situation. For instance, it has been held that an expression “hinders the delivery” in a contract would be attracted not if there was merely a question of rise in price, but a serious hindrance in performance of the contract as a whole[23].

 

Similarly, Courts have no general power (under Section 56 of the Contract Act) to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.[24] It is only when a consideration of the terms of the contract, in the light of the circumstances existing when it was made, showed that they never agreed to be bound in a fundamentally different situation which had unexpectedly emerged, that the contract ceases to bind[25]. This is a difficult task to prove.

 

Hence, a more likely outcome in such cases is the parties renegotiating price and other key terms.

 

20. Can I rely on the force majeure clause or doctrine of frustration to deny or delay payment under my contract due to COVID – 19?

 

Payment terms depend on the express provision of contract between the parties. In many cases, parties carve out payment obligations as an exception to force majeure clauses. Further, while the buyers’ own cash flows and business may be impacted by COVID-19, its obligation to pay for the goods or services supplied to it (qua the counterparty supplier) may not be impacted by COVID-19 in terms of the contract. Similarly, doctrine of impossibility cannot be used by a cash strapped company to deny or delay payment for goods/services rendered.

 

However, in certain contracts, a parties’ obligation to pay may depend on specific acts, such as only if the delivery is made at a particular place or during particular time. In such cases, where such specific acts are impacted on account of COVID-19 (and its consequences), then depending on the terms of the contract, the paying party may be able to suspend its obligation to pay.

 

21. I cannot use my office premises due to the nationwide lockdown. Can I use the defence of force majeure to avoid paying rent?

 

While the lessee may be economically impacted by COVID-19 (in terms of generation of income for payment of rent), the same would generally not be enough to avoid payment obligation under the lease/license contract.

 

Firstly, the lease may not have a force majeure clause, or even if it has such a clause, it may have exclusions – for instance, payment obligations are typically carved out as exceptions to the force majeure clause in a lease deed.  Further, the fact that the lessee does not have enough money or is unable to utilize the premises on account of lockdown may not be enough to claim that it has been “prevented” or “hindered” from complying with its ‘payment’ obligation qua the lessor/licensee. We have seen cases where a license (as opposed to a lease) contains a force majeure clause which specifically exempts the licensee from paying the rent/ license fee to the extent it is unable to operate from the premises due to the force majeure event. In such cases, it may be possible to argue that licensee is excused from payment on account of lockdown.

 

22. What if my lease/ license is silent? Can I use the defence of impossibility to void the lease (and hence avoid paying rent)?

 

Where the lease is silent, the lessee cannot have recourse to Section 56 of the Contract Act to void the lease (or to suspend payment of rent) since the doctrine of impossibility is not applicable to leases.[26] This is so because a lease is considered as a “completed contract” i.e. the possession of the premises has been transferred as nothing else remains to be done and is governed by the Transfer of Property Act, 1882. This means, apart from the terms of the lease, the lease can only be terminated in accordance with the Transfer of Property Act, 1882. And till such termination is made, the lessee would need to continue paying the rent.

 

In case of license, apart from the terms of the license, it is unclear whether recourse can be taken to Section 56 of the Contract Act to terminate the license or whether Section 62 of the Easement Act, 1882 (“EA Act”) will apply. Section 62 of the EA Act enumerates circumstances on the existence of which the license is deemed to be revoked. One of such conditions contemplate that where license is granted for a specific purpose and the purpose is attained, or abandoned, or if it becomes impracticable, the license shall be deemed to be revoked. Be as it may, given that COVID-19 disruptions are temporary in nature, it may be difficult to argue that the license has become impossible (under Section 56 of the Contract Act) or impracticable (under Section 62 of the EA Act).

 

23. What would be the impact of COVID – 19 on development and construction contracts?

 

Many, if not all development and construction contracts are time bound with specific liquidated damages and/ or penalty clauses where there is delay in construction and development. Given the lockdown announced by the Indian Government, construction and development in most projects would have likely come to a standstill. In that context, depending on the express terms of such contract, most contractors (such as EPC contractors) may be entitled to invoke the force majeure clause during the lockdown period.

 

Further, the Real Estate (Regulation and Development) Act, 2016 grants the appropriate authority the power to extend the registration of projects granted to promoters by a period which may not exceed one year in case of a force majeure situation. This essentially means that the time period to complete a project stands extended by a maximum of a year.

 

However, post the lockdown it remains to be seen what the actual situation on the ground will be and whether there will be any circumstances that would justify invoking a force majeure.

IV. Material Adverse Change

As stated before, depending on the type of the contract (for instance an investment agreement) a party can terminate a contract / be relieved of its obligation to perform depending on whether it can invoke a material adverse change clause in the contract.

24. What is a material adverse change?

 

A material adverse change is a provision in a contract (especially in investment agreements) that may excuse a party from performing an obligation or entitle a party to exercise certain rights in case of a material and adverse change. In an investment agreement, the material adverse change is typically pegged to a material adverse change to the target entity or its business and (depending on the express terms of the contract) serves two main purposes: one, it is used either as a condition precedent to the transaction (e.g. the buyer’s obligation to invest), or as a termination event (e.g. buyer’s right to terminate), or both; and secondly, it is used as a qualifying factor in the representations and warranties provided by the target entity with respect to its business, state of affairs, financial condition etc.

 

25. What does a typical material adverse change clause in an investment agreement look like?

 

The definition and the consequences of a material adverse change is typically very heavily negotiated. For the purposes of simplicity, we have reproduced below, what the consequences of a material adverse change and a definition may look like based on the ICC Model Mergers and Acquisition Contracts I – Share Purchase Agreement:

 

5.1 As from the date of execution of this Agreement and until Closing, the Seller shall conduct the business of the Company or cause the business of the Company to be conducted in ordinary course.

 

5.2  As from the date of execution of this Agreement and until Closing, the Seller shall notify the Buyer of any material adverse change in the business, operations, properties, prospects, assets or condition, (financial or other) of the Company, or of any event, development or circumstance that may result in such a material adverse change.

 

5.3 In the event of material adverse change, the Buyer shall be excused from his obligation under this Agreement without prejudice to available remedies in the event of the material adverse change being the result of an action or omission on the part of the Seller.

 

5.4  The parties agree that material adverse changes are defined as those changes in the business, operations, properties, prospects, assets or condition (financial or other) of the Company, of a nature to fundamentally alter the economics of this Agreement.[27]

 

26. What are the consequences of a material adverse change in an investment agreement?

 

Subject to the terms of the contract, once an event, circumstance, condition or situation is considered to be a material adverse change, typically, the buyer/ acquirer has the right to terminate the contract, or at its discretion, proceed with the transaction, but may depending on the disclosures made by the target company on the basis of the representations and warranties seek for re-negotiation of the terms of the contract.

 

27. Are material adverse change clauses covered by any statute in India?

 

Similar to a force majeure provision, this is a contractual provision and while it is not specifically covered in the Contract Act, it could be dealt with under Section 32 of the Contract Act which deals with contingent contracts.

 

While there is no codified definition of the term material adverse change in India, the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code, 2011”) contains a comparable provision in Regulation 23(1)(c)[28] which states that a buyer/ acquirer can withdraw an open offer in case any condition stipulated in the agreement for acquisition attracting the obligation to make the open offer is not met for reasons outside the reasonable control of the buyer/ acquirer and such conditions are disclosed in the detailed public statement and the letter of offer.

 

Do however, note that as per Indian jurisprudence the threshold for invoking Regulation 23(1)(c) of the Takeover Code, 2011 are very high. A two year delay in getting an approval from a statutory authority, and during that time the target became a sick company, was not considered material enough to walk away from a takeover.[29] The Supreme Court, while interpreting the erstwhile Regulation 27 of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997, which albeit was far stricter than the present Regulation 23(1)(c), held that economic difficulty cannot be pleaded to walk away from a takeover.[30]

 

28. Can a material adverse change clause be invoked routinely in an investment agreement?

 

Not only are material adverse change clauses negotiated heavily but they are also routinely litigated upon especially in jurisdictions such as United States of America. In India, however, there is limited jurisprudence on the subject and there is no clear bright line test that has been laid down on when such clauses in a contract can be invoked. However, relying on the jurisprudence laid down by courts in India in the context of takeovers and of courts in United States of America, prima-facie there is a high burden of proof on the buyer/ acquirer to prove that the material adverse change clause can be invoked.[31]

 

29. Who has to prove the existence of a material adverse change?

 

The buyer/ acquirer seeking to avoid its obligation to complete the transaction.[32] Usually depending on the clause in the contract, there are two aspects to consider: (a) the adverse change must be consequential to the company’s long-term earning power over a commercially reasonable period, which is measured in years rather than months; and (b) the targets financial results and operations are disproportionately affected in comparison to the industry in which it operates in or its competitors. The second limb typically comes into operation once it is established that a material adverse change has come into force.[33] Many commentators have noted that Delaware courts have never found a material adverse change to have occurred in the context of a merger contract,[34] that is until the 2018 judgment of the Court of Chancery, Delaware[35] which relied on the decision in Hexion, though differentiated the case on the particular facts to hold that a material adverse change had occurred. 

             

30. Can the outbreak of COVID – 19 be considered as a material adverse change?

 

It is important to note that, English courts[36] and courts in the United States of America[37] have not considered that the global financial crisis of 2008 amounted to a material adverse change in contracts.

Therefore, prior to invoking the material adverse change clause, the party should review the terms of the contract carefully and should be aware of the high burden of proof that it requires to discharge.

 

31. A key managerial person of the acquirer/ buyer dies after contracting COVID – 19. Will that be considered as a material adverse change?

 

The Takeover Code, 1997, specifically provided that if the acquirer/ buyer was a sole acquirer, his/ her death would be considered as a reason to walk away from a public takeover. While, the Takeover Code, 2011 has removed the specific provision, the language employed (i.e. “reasons outside the reasonable control of the acquirer”) is still broad enough to include the death of a sole acquirer as a reason to rescind the public offer. However, where the acquisition is that of an unlisted company, then whether the death of the promoter/ key management person would entitle the buyer to terminate the share purchase agreement would depend on the express terms of the contract and the particular facts of the case. Do note that where the acquirer is not an individual person, it would be very difficult to establish that the death of the promoter/ key management person would amount to a material adverse change (of the buyer) to permit a buyer to be able to rescind the contract.

*****

Should you have any queries or comments on this alert or how COVID 19 may affect your business or transactions, please visit our LinkedIn page or drop a line to our COVID – 19 task force at covid19@chandhiok.com.

 

© 2020 Chandhiok & Mahajan, Advocates and Solicitors

This alert is for information purposes only and does not constitute legal advice.

[1] Ministry of Home Affairs Order No. 40-3/2020-DM-I(A) dated 24 March 2020 available here

[2] Ministry of Home Affairs Order No. 40-3/2020-DM-I(A) dated 15 April 2020 available here

[3] National Disaster Management Authority Order No. 1-29/2020-PP (Pt. II) dated 24 March 2020 available here.

[4] Ministry of Home Affairs Order No. 40-3/2020-D dated 24 March 2020 available here.

[5] Annexure to the Ministry of Home Affairs Order No. 40-3/2020-D dated 24 March 2020 available here.

[6] See, Legal Information Institute, Cornell Law School, https://www.law.cornell.edu/wex/force_majeure, last accessed on 01 April 2020.

[7] See, Force Majeure Concept in Construction Contracts under Civil and Common Laws, A. Samerezeldin, AMR ABU HELW, http://www.worldresearchlibrary.org/up_proc/pdf/1059-150848355024-27.pdf, last accessed on 01 April 2020.

[8] Section 32 of the Contract provides that if a contract is contingent on the happening of an event and if such event becomes impossible, then the contract becomes void.

[9] Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310 (Supreme Court) – “In cases therefore, where the court gathers as a matter of construction that the contract itself contained impliedly or expressly a term, according to which it would stand discharged on the happening of certain circumstances, the dissolution of contract would take place under the terms of the contract itself and such cases would be outside the purview of Section 56 of the Indian Contract Act, 1872, altogether. Although in English law these cases are treated as cases of frustration, in India they would be dealt in under Section 32 of the Indian Contract Act, 1872 which deals with contingent contracts or similar other provisions of the Indian Contract Act, 1872.” (Emphasis Supplied)

[10] See, ICC Force Majeure Clause 2003, https://iccwbo.org/content/uploads/sites/3/2017/02/ICC-Force-Majeure-Hardship-Clause.pdf, last accessed on 01 April 2020.  

[11] Chitty on Contracts’, 31st edition at para 14-15

[12] Energy Watchdog v. Central Electricity Regulatory Commission and Ors., C.A. No. 5399 of 2016 (Supreme Court)

[13] Supra Note. 11

[14] Ministry of Home Affairs Letter No. 33-4/2020-NDM-I dated 14 March 2020 available here

[15] Ministry of Finance Office Memorandum No. F. 18/4/2020-PPD dated 19 February 2020 available here

[16] Ministry of Home Affairs Order No. 40-3/2020-D dated 24 March 2020 (available here) read with Addendum dated 25 March 2020 (available here)

[17] Standard Retail Pvt. Ltd. v. M/s M.S. Global Corp and Ors., Commercial Arbitration Petition (L) No. 404 of 2020 (Bombay High Court)

[18] M/s Halliburton Offshore Services Inc. v. Vedanta Limited and Another, O.M.P. (I) (COMM) & I.A. 3697/2020 (Delhi High Court)

[19] Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310 (Supreme Court)

[20] Supra

[21] Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968 (1) SCR 821

[22] Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310 (Supreme Court)

[23] Peter Dixon & Sons Ltd. v. Henderson, Craig & Co. Ltd., 1919(2) KB 778, cited with approval in Energy Watchdog v. Central Electricity Regulatory Commission and Ors., C.A. No. 5399 of 2016 (Supreme Court)

[24] Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968 (1) SCR 821 (Supreme Court)

[25]  M/s Alopi Parshad & Sons Ltd. v. Union of India, 1960 (2) SCR 793 (Supreme Court)

[26] Raja Dhruv Dev Chand v. Harmohinder Singh & Anr., 1968 AIR SC 1024 (Supreme Court)

[27] ICC Model Merge and Acquisition Contract- I Share Purchase Agreement

[28] Regulation 23(1)(c) – “any open offer can be withdrawn in circumstances where any condition stipulated in the agreement for acquisition attracting the obligation to make the open offer is not met for reasons outside the reasonable control of the acquirer, and such agreement is rescinded, subject to such conditions having been specifically disclosed in the detailed public statement and the letter of offer” and erstwhile Regulation 27 of the Takeover Code 1997, (1) No public offer, once made, shall be withdrawn, except under the following circumstances- (d) such circumstances as in the opinion of the Board merit withdrawal.”

[29] Pramod Jain & Ors. v. SEBI, (2017) 1 CompLJ 184 (Securities Appellate Tribunal)

[30] SEBI v. Akshya Infrastructure Pvt. Ltd, C.A. No. 6041 of 2013 (Supreme Court)

[31] Huntsman and In Re IBP, Inc. Shareholders Litigation v. Tyson Foods, 789 A.2d 14 (Delaware Chancery Court); and Hexion Specialty Chems. Inc. v. Huntsman Corp, 965 A.2d 715 (Delaware Chancery Court)

[32] Hexion Specialty Chems. Inc. v. Huntsman Corp, 965 A.2d 715 (Delaware Chancery Court)

[33] Hexion Specialty Chemicals, Inc. v. Huntsman Corp., C.A. No. 3841 (VCL) (Delaware Chancery Court)

[34] Hexion Specialty Chems. Inc. v. Huntsman Corp, 965 A.2d 715 (Delaware Chancery Court).

[35] Akorn Inc. v Fresenius Kabi Ag, Quercus Acquisition, Inc., and Anr., C.A. No. 2018–0300–JTL (Delaware Chancery Court). The court held that, “Fresenius validly terminated the Merger Agreement because Akorn’s representations regarding its compliance with regulatory requirements were not true and correct, and the magnitude of inaccuracies would reasonably be expected to result in a Material Adverse Effect. Second, Fresenius validly terminated because Akorn materially breached its obligation to continue operating in the ordinary course of business between signing and closing. Third, Fresenius properly relied on the fact that Akorn has suffered a Material Adverse Effect as a basis for refusing to close… This case is dramatically different. Fresenius responded to a dramatic, unexpected, and company specific downturn in Akorn’s business that began in the quarter after signing. After consulting with Akorn about the reasons for the decline and receiving unconvincing answers, Fresenius appropriately began evaluating its contractual rights under the Merger Agreement.”

[36] Grupo Hotelero Urvasco SA v. Carey Value Added SL, (2013) Bus LR D45

[37] Hexion Specialty Chemicals, Inc. v. Huntsman Corp., C.A. No. 3841 (VCL) (Delaware Chancery Court)

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

© 2020 Chandhiok & Mahajan