Respite to India Inc. – Novel Corona Virus Declared a Force Majeure Event

In December 2019 the world watched in concern as scenes of chaos, misery and rapidly mounting death tolls emerged from China. Covid -19 was first detected in the Hubai province of China, however by January 2020, the World Health Organization had declared the outbreak of the Novel Corona Virus as a ‘public health emergency.’ Such was the viral spread of this potent virus, that as of February 2020, Covid -19 has been detected in at least 29 countries. In few places such as South America or Africa the absence of evidence more likely reflects lack of testing and detection rather than absence of the virus. This fast-moving alien pathogen has overwhelmed health systems, making the provision of even basic care impossible – a fact which is ascertained by the ever-increasing death tolls.

Covid-19 has quickly developed from a local to a global threat with tragic human losses that take priority over its economic impact. However widespread economic disruptions have been caused as a result of the unprecedented measures taken to control the viral outbreak: workplace shutdowns, disruption of production, port closures, and suspension of air travel.The disease and the societal conditions it creates thus have a profound impact on business and underlying contractual relationships.It has often been highlighted that historically in the current socio-economic scenario we are witnessing, the concept of force majeure has been brought into play.

The Great Financial Crisis, natural disasters, and political turmoil in various regions around the world have in the past represented the significant importance of force majeure clauses. Medical epidemics is the latest entry into this growing list.

Force Majeure

Force Majeure clauses are commonly included in commercial contracts in case certain defined circumstances prevent performance of contractual obligations. The term “Force Majeure” synonymous with the Latin term “Vis Major”means “superior force”, and includes “acts of god” (such as earthquakes or tsunamis) and certain acts of man of a disruptive and unforeseeable nature, such as industrial action.

While civil law systems recognize the concept of force majeure statutorily or in their jurisprudence, force majeure, under common law especially English law is a creature of contracts. Force majeure is not implied as a matter of law, and express clauses are interpreted strictly. In India, absence of a force majeure clause may result in the reliance on the Doctrine of Frustration as set forth in the Indian Contract Act, 1872, which states that an agreement to do an impossible act is void. The provision also relieves a party from the discharge of their duties in event of an intervening act which renders the performance of the contract impossible or unlawful.

Force majeure clauses in contracts may allow parties to avoid their performance of obligations in certain extreme circumstances, as defined by the contract.If one of the events listed in a force majeure clause occurs, the clause will usually prescribe what the parties must do next, e.g. a party claiming force majeure may have to notify its counter party and take reasonable steps to mitigate the effect of the event impacting performance. For this reason, in most cases, the requirements for invoking force majeure and the consequences of so doing will depend upon the precise terms of the contract in question.

Outbreak of Covid-19 a Force Majeure Situation

As a vital mechanism to excuse a party’s non-performance or justify termination of a contract, a key question on India Inc’s mind lately has been: does the corona virus constitute force majeure?

On February 17, 2020 more than 200 representatives from sectors such as pharmaceuticals, textiles,electronics, solar power, automobiles, surgical equipment, paints, fertilizers, telecom, metals, mobile manufacturing, edible oils, health, tourism and shipping met with the Finance Ministry to discuss the impact of the Covid-19 outbreak on Government contractors especially due to the disruption in the supply of raw materials.

A report by the Confederation of Indian Industry (CII) said “45% of total electronics imports in India come from China.””One-third of the machinery and almost two-fifths of organic chemicals that India purchases from the world comes from China,” the report said.It further added that China’s share in imports is more than 25% for automotive parts and fertilizers, while 60-70% of pharmaceuticals in India are also sourced from China, according to the report.India imports goods worth more than $1 billion from China in pharma, fertilizers, medical devices, inorganic chemicals and textiles sectors[1].

The Manual for Procurement of Goods, 2017,released by the Ministry of Finance contains guidelines set forth for government organizations; i.e. ministries, departments and other entities substantially owned or controlled by or receiving substantial financial assistance from the Central Government,that procure a wide variety of goods and services. The Force Majeure Clause of this manual states that:

‘A Force Majeure (FM) means extraordinary events or circumstances beyond human control such as an event described as an act of God (like a natural calamity) or events such as a war, strike, riots, crimes (but not including negligence or wrong-doing, predictable/seasonal rain and any other events specifically excluded in the clause). An FM clause in the contract frees both parties from contractual liability or obligation when prevented by such events from fulfilling their obligations under the contract. An FM clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the FM. The firm has to give notice of FM as soon as it occurs and it cannot be claimed ex-post facto. There may be a FM situation affecting the purchase organisation only. In such a situation, the purchase organisation is to communicate with the supplier along similar lines as above for further necessary action. If the performance in whole or in part or any obligation under this contract is prevented or delayed by any reason of FM for a period exceeding 90 (Ninety) days, either party may at its option terminate the contract without any financial repercussion on either side. Notwithstanding the punitive provisions contained in the contract for delay or breach of contract, the supplier would not be liable for imposition of any such sanction so long as the delay and/ or failure of the supplier in fulfilling its obligations under the contract is the result of an event covered in the FM clause.

There has been growing concern and ambiguity surrounding whether disruption to supply chains due to the Covid-19 outbreak in China or any other country would be considered a force majeure situation.On February 19, 2020, amid such increasing doubt, the Ministry of Finance, Government of India, notified that corona virus will be covered under the above force majeure clause (FMC) and should be considered as a case of natural calamity. Further, the ministry has stated that this clause can be invoked wherever appropriate, subject to due procedure being followed.It is to be noted, the clause does not excuse a party’s non-performance entirely but only suspends it for the duration of a period.One of the conditions for this clause is that during any such extraordinary event, the entity must notify force majeure as soon as it occurs and the same cannot be claimed retrospectively.

For non-government and other contracts, where a contract contains a force majeure clause, the yardstick is whether the Covid-19 outbreak would fall within the scope of the clause. If the contract does not include a force majeure clause or if the Covid-19 out break falls outside the scope of that clause, the parties may have to ascertain whether the common law doctrine of frustration is applicable to discharge them from their contractual obligations.

Steps to Mitigate Risk

It is amply clear now that the epidemic was never going to be contained. At most, its spread has been perhaps slowed by the lock down imposed in China and local as well as global government efforts to identify infected people and anyone they might have been in contact with. With the outbreak showing no signs of abating, the corona virus disruption is set to continue. In such socio-economic conditions, companies should review all contracts in which force majeure (or frustration) may be a factor and consider which existing contracts may be impacted by closures or delays, or where a counter party may seek to terminate or suspend the contract. Additionally, if you are able to invoke a force majeure clause, time limits and notice for doing so should be considered. If there are any alternative ways of performing contractual obligations and taking appropriate mitigation steps (whether by you or your counter party) these should also be thought of. All evidence of disruption, including documents proving delay / cancellation should also be retained. Furthermore, if entering into new contracts, draft clauses sufficiently clearly to cover eventualities such as the corona virus outbreak.