Amongst other objectives, contracts are about the allocation of risks between contracting parties. Risks that may hinder or absolutely obviate the possibility performance are therefore addressed, either by parties themselves in the contract, or by the legal rule of frustration of contracts. In this note, we present an overview of how the law deals with the contractual impact of risks occurring from viruses such as the Novel Coronavirus Disease 2019 (COVID-19).
Interestingly, the impact of viruses is not alien to the Law of Contracts. Almost a hundred and thirty years ago, the English decision in 1892 in Carlill v. Carbolic Smokeball Co. (a case based on a Company’s promise to prevent Influenza)led to the restatement of celebrated ideas of ‘offer’, ‘acceptance’, ‘consideration’ and ‘the intent to create legal relations’ – considered to be the very basic principles of Contracts until this day.
The English theories of absolute contracts and discharge
The courts in England originally favored a doctrine of ‘absolute contracts’ – i.e. contracts where performance could not be excused for any reason whatsoever. In 1863, an English Court, in Taylor v. Caldwell accordingly stated:
“there seems no doubt that where there is a positive contract to do a thing, not in itself unlawful, the contractor must perform it or pay damages for not doing it, although in consequence of unforeseen accidents, the performance of his contract has become unexpectedly burdensome or even impossible.”
However, recognizing that the results of such a rule may not always be just, J. Blackburn crafted an exception to the above rule. He held that the Contract could however, be discharged (put to an end), where it was demonstrated that the Contract contained either an express or an implied condition which presumed a certain state of affairs, which had materially changed subsequently. That case involved a contract for the hire of a garden and music hall by the plaintiff-performer. The music hall caught fire and the Plaintiff had to cancel its performances. It sought damages from the Defendant-owners of the hall, which was rejected by the Court. The Court held:
“The principle seems to us to be that, in contracts in which the performance depends on the continues existence of a given person or thing, a condition is implied that the impossibility of performance arising for the perishing of the person or thing shall excuse the performance.”
Implied terms, although rarer in modern day Contracts, still form a credible source of legal obligations between parties, since they are ultimately geared towards giving efficacy to the intent of parties. The Court thus created a theory of discharge or excuse, by implying a term into the Contract. It therefore did not displace the original rule of absolute contracts but found a way to hold that the Parties contractually provided for such risks by impliedly agreeing to be excused from performance if the conditions on which performance had been dependent, had altered drastically or had become impossible to meet.
The Court in Taylor v. Caldwellaccordingly concluded that “the music hall having ceased to exist, without fault of either party, both parties are excused, the plaintiffs from taking the gardens and paying the money, the defendants from performing their promise to give the use of the Hall and Gardens and other things.” The Plaintiff lost its claim for damages by this holding.
In the first edition of his treatise on Frustration and Force Majeure (1994), Treitel explains that the modern theory of discharge more satisfactory ‘splits’ the risk and loss between contracting parties. For instance, where a contract involved payment by one party and performance of something by another party, the former will bear the ‘payment-risk’ and the latter will bear the ‘performance-risk’.
This effectively ‘splits’ the loss occurring from these risks having materialized, leaving both parties to bear their own loss. In a situation such as Taylor v. Caldwell, these risks will thus fall on the parties and each will be excused from his/her performance, i.e. the Plaintiff need not pay, and the Defendant need not perform, with both parties being left to bear the losses of their own expenses already incurred.
This may not, however, be stated as a universal proposition, since in some circumstances, both risks, i.e. payment-risk and performance-risk may be borne by one party. As explained by Treitel, where, for instance, the title in goods has already passed upon placing it in a carrier, the purchaser bears both, the performance-risk (risk of non-delivery on account of destruction in transit) and the payment risk (obligation to pay the seller).
The Indian Law on frustration and force majeure
The Indian Contract Act deals with the principle of frustration in Section 56, the effect of which is to nullify a contract if it becomes ‘impossible’. Four important aspects as to the character of this provision were made by the Indian Supreme Court in its renowned decision in 1952 in Satyabrata Ghose v MugneeramBangur and Company and Ors (‘Mugneeram’).
First, that Section 56 was exhaustive of the law on frustration in India, and thus English law principles could not be so readily applied to Indian cases. Consequently, an analysis of ‘implied terms’ as was done in Taylor v. Caldwell is unnecessary in Indian law. This was supported by the fact that Section 56 is a mandatory provision in the Indian Contract Act, as opposed to other default provisions in the Act that only apply if there is no contrary intent of parties in the contract.
Second, that while English Courts would construe express or implied terms taking account of contingencies and risks, as part of the overall body of frustration, this would not be the situation under Indian law. Under the Indian Contract Act, such terms, if found within the contract would be addressable under Section 32 of the Act, which deals with contingencies agreed upon by Parties. Accordingly, force majeure and similar clauses will be determined in accordance with Section 32 of the Act, and not under Section 56, thereby rendering both situations mutually exclusive.
This second element has been furthered by the Indian Supreme Court’s subsequent decisions, includingin its recent decision in 2017 in Energy Watchdog v. Central Electricity Regulatory Commission (‘Energy Watchdog’). The court held that parties will never be able to take simultaneous alternative defences under Section 32 (based on contractual clauses) and Section 56 (based purely on the Contract Act). In other words, the contractual concepts of force majeure and frustration in India operate in mutually exclusive spheres. The Court held
“As has been held in particular in (Mugneeram) Satyabrata Ghose Case, when a contract contains a force majeure clause which on construction by the Court is held attracted to the facts of the case, Section 56 can have no application”.
It is important to note that the court only looks at whether Section 32 or force majeure clause was ‘attracted’ and not whether it was in fact applied. In fact, in Energy Watchdog, the Court found that the force majeure clause did not excuse the contracting party therein.
Third, that the word ‘impossible’ used in Section 56, does not only refer to physical impossibility but also practical unviability in the context of the contractual circumstances. The court in Mugneeramthus held
“The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose which the parties had in view; and if an untoward event or change or circumstances totally upsets the very foundation upon which the parties rested their bargain, it can very well be said that the promisor finds it impossible to do the act which he promised to do.”
Fourth, on the facts of the case of Mugneeram, a requisition order issued under the Defence of India Rules, during World War II, was found to have not frustrated the contract. The requisition order had led to a temporary dispossession of the lands meant to be developed into a residential project. The developer was not allowed to take the defence of frustration on claims by the purchasers of the residential units, after the requisition was withdrawn. The Court found that on the facts of the case, among other contextual surroundings of the contract, “the total absence of any definite period of time agreed to by the parties within which the work was to be completed, it cannot be said that the requisition order vitally affected the contract or made its performance impossible.”
Therefore, where there is no time fixed for performance, (unlike most modern-day construction contracts), it will be difficult to argue that a temporary lapse/delay in, can frustrate the contract and bring it to an end.
The Contractual impact of Coronavirus
The COVID19 has caused significant alterations in global, regional and local economic conditions. Beginning with precautionary voluntary measures being taken by companies, to the mandatory lock-outs, causing an absolute prevention of any physical industrial activity requiring a congregation of persons – it is clear to see how this would in many cases fundamentally alter the conditions of performance of contracts, especially those that are time sensitive.
Parties will usually have three broad categories of options when assessing the economic impact of COVID19 to their contracts and consider remedies if possible.
Where contracts contain force majeure and similar clauses
In this scenario (which is the more prevalent state of affairs), Parties have to look to the solution provided for in the wording of the relevant clauses under the Contract. These clauses in themselves are contingent contracts under Section 32 of the Act. Once the contingency can be established as having been triggered, any losses incurred during this period will have to be split as per the allocation of such risks between the parties, as provided in the relevant clauses.
Usually, risks for events such as COVID19, not being attributable to either party, will be contractually split in the manner that neither party can be held to be in breach of their respective obligations. This would thus be an exercise similar to loss-splitting, (in the words of Trietel) as was done in Taylor v Caldwell. For instance, in construction projects which are quite likely to be delayed – a possible result could perhaps be that neither will the Contractor be liable to an Employer for its delayed performance, nor will the Employer be made liable to pay the Contractor for the additional sums incurred onlabour, etc. during the delayed period. Of course, generalizations such as these cannot be made without a keen analysis of the contract, its nature and context.
Further – as a general policy, force majeure clauses are construed narrowly. Thus, where the clauses use the words ‘prevent’ or ‘hinder’ performance, the court will look to whether alternative methods of performance were possible. For instance, in Energy Watchdog, the significant increase in price of Coal being imported from Indonesia was not considered as a Force majeure event that prevented or hindered performance, as the Contract did not mandate that coal had to only be procured from Indonesia.
From the perspective of the effects of COVID19, these effects may be characterized as direct or indirect. For instance, mandatory lockdown measures, may directly impact or prevent or hinder performance to some extent. Here, the narrow or wide construction of force majeure clauses is likely to be irrelevant, as there will possibly be no alternative way of performance. Of course, it could be argued that the effect of lockdown measures must also account for the nature of the industry in which the Contract operates, and the ability for the relevant contracting party to be able to perform its services remotely, without being necessarily impacted by the lock-down, for example securities broking services (given that stock markets have not suspended trading during the lockdown).
However, where the impact of COVID19 is more indirect, such as through increase in procurement prices or through indirect delays, the narrow interpretation of ‘Force majeure’ clauses will become a very relevant and fact-intensive exercise. Such an exercise will usually need to demonstrate prevention and/or hindrance more than merely rendering performance more onerous, for the party relying on force majeure.
Where contracts do not contain force majeure and similar clauses
Where contracts do not contain clauses that can be taken as contingencies agreed between parties – parties are relegated to the sole remedy under Section 56 – that of frustration which brings the Contract to an end. However, this remedy does not give parties an option to continue with the Contract and adjust the obligations to account for the risk of COVID19.
In Contracts that contemplate long-term performance, parties will usually not want to put an end to the Contract as a whole, making Section 56 an unviable option. Further, at the threshold level, Section 56 will not be available where performance, however more onerous, is still possible after the (hopefully) temporary measures in relation to COVID19 are brought to an end.
However, in those situations where one party does indeed want the contract to come to an end – and it can be established that the delay or other impact caused by COVID19 affects the root of the contract – the Section 56 remedy of frustration will be available. In the words of the Supreme Court in Mugneeram:
“If there was a definite time limit agreed to by the parties within which the construction work was to be finished, it could be said with perfect propriety that delay for an indefinite period would make the performance of the Contract impossible within the specified time and this would seriously affect the object and purpose of the venture”.
Therefore, if circumstantial changes (including delays) occurring as a result of COVID19 are so substantial and indefinitethat their impact goes to the object and purpose of the contract – frustration will be available as a mode of putting the contract to an end.
Where Contracts contain Change in law clauses
Arising in an entirely different context than force majeure or frustration – long term contracts, especially in the infrastructure and construction industries usually provide for ‘change in law’ clauses. Courts have consistently held that the purpose of such clauses is restitutionary, in order to ensure that the parties do not suffer or benefit on account of any change in cost occurring due to a change in law.
In Energy Watchdog, the Supreme Court in fact did grant that a change in law clause could be triggered, despite the failure of the force majeure clause – to claim additional costs.
To the extent that COVID19 measures have been statutorily imposed by the Governments of India, or of various states in India – a direct cost impact of these measures may be claimed as a change in law event. For example, the Government of the National Capital Territory of Delhi recently mandated that despite mandatory lockdown/’work-from-home’orders, employers will be mandated to treat employees as being ‘on duty’ and remunerate them in the usual manner. If this is treated as a mandatory rule, this could trigger a change in law clause having a cost impact, where for instance, daily wage labourers would not have otherwise been paid by contractors during the lockdown period.
Thus, some of the gaps in the use of the option of force majeure, i.e. the likely situations where both Parties will be excused from their obligations and left to bear their own expenses, (as in the cost-splitting result achieved in Taylor v Caldwell) could be addressed by Change in Law clauses. Such clauses could thus perhaps, despite the force majeure result in Taylor, provide for a way for contractors to claim at least some of the costs directly incurred as a result of statutory measures in relation to COVID19, from their respective employers.
Contracting Parties’ Exposure for Tort liability for failure to engage in preventive measures
Tort Law, which is an uncodified body of ‘Civil Wrongs’ works on the principle that any person owes a duty of care, not to cause harm to persons who can be directly impacted the actions of the former. Once this duty of care is breached, damages for foreseeable consequences of the breach are payable by the breaching party.
Although Tort liability usually has little direct bearing in contractual situations, it will be relevant for contracting parties to consider their individual exposure to tortious litigation when taking respective unilateral actions in dealing with COVID19. Reasonable potential tortious exposure could then be a circumstance to take into account when applying the terms and clauses of the Contract, in a dispute between the contracting parties regarding the impact of COVID19.
A helpful statement of principle in this regard, was laid down by the English Court in 1966 in Weller & Co. v. Foot and Mouth Disease Research Institute. In this case, the Plaintiffs, the owners of an auction house situated in a market sought damages from the Defendants on account of an outbreak of foot and mouth disease in the market caused by the escape of the virus from the Defendant’s premises. This had resulted in closure of the market and the Plaintiffs accordingly claimed the economic loss of profits caused due to the closure, from the Defendants.
In Weller, the Court held that the duty of care was to be limited to persons on whom a direct impact could be foreseen and there was no duty of care to the general world at large (that would be indirectly impacted). The court held that holding otherwise would have an astounding impact on businesses and that:
“The world of commerce would come to a halt and ordinary life would become intolerable if the law imposed a duty on all persons at all times to refrain from any conduct which might foreseeably cause detriment to another, but, where an absence of reasonable care may foreseeably cause direct injury to the person or property of another, a duty of such care exists.”
On this principle, all persons (including contracting parties) have a duty of care to other persons who can foreseeably be directly impacted by the former. This would mean that although such person may not be held liable for the indirectly foreseeable consequences of ‘escape’ of a virus as against the world at large, it could be exposed to tortious suit by persons it owes a duty of care to. For example, customers being affected by the COVID19, on account of lack of precaution taken by the service provider could form basis for tortious liability.
Principles of law that will decide contractual situations arising out of COVID19 may be readily culled-out from the existing body of law. Yet, the most important characteristic of COVID19 - occurring in times when perhaps, the human race has seen its highest-level of ability to travel, work and conduct business across the globe – is that its nature as well as spread is unprecedented. Such unprecedented state of affairs, whether seen as contractual risks, or a fundamental change in circumstances - will inevitably have an impact on contracts, as well as on life in general. The solutions to contractual problems that are likely to arise will therefore, functionally have to be geared towards equity by stretching existing principles, where current legal rules do not, on the face, provide satisfactory results.
[The authors are Partner and Principal Associate, respectively, at Lakshmikumaran & Sridharan, New Delhi]