Of gods and governments

Natural calamities and lockdowns are examples of force majeure, but the status of COVID-19 is moot

June 17, 2020 12:15 am | Updated 12:15 am IST

The COVID-19 pandemic is unleashing a flurry of contractual disputes. Due to the lockdowns, a large number of companies and individually owned enterprises find their contractual obligations impossible to meet or economically ruinous, especially in the aviation, automobile, construction, hospitality and entertainment, retail, and insurance sectors. Consequently, they have refused the promised employment and suspended supplies of goods or services, triggering legal claims of compensation from the counterparties.

Reducing scope of dispute

Many parties have invoked COVID-19 as force majeure (FM) — an event that is beyond the control of the parties and renders contractual performance impossible. Most contracts contain a FM clause to catalogue events like wars, riots or strikes in which the parties would prefer to terminate the contract or put it on hold. Acts of the government (such as lockdowns) and acts of god (such as floods, cyclones) are typically listed under a FM clause.

This provision reduces the scope of dispute between parties in case a FM event occurs. Plus, it helps them allocate contract risks efficiently. The problem is, many a times the clause contains ambiguous and catch-all phrases like, ‘events including but not limited to the ones listed herein’. Such ambiguities are being exploited by many contracting parties. They are seeking termination or suspension of business deals by claiming that COVID-19 is a FM event. Moreover, ambivalent statements by government agencies regarding the pandemic have added to the confusion.

How the courts and the regulators adjudicate contractual disputes will determine the distribution of losses among the disputants and, more importantly, the quantum of economic cost of the pandemic. Delayed or ambiguous rulings will aggravate the economic costs of the disease by disrupting supply chains beyond the lockdown period. By contrast, clear and consistent judgments will discourage opportunistic behaviour and encourage pre-trial negotiations thereby avoiding unnecessary litigation and attendant social costs. Issues of individual welfare are better addressed through public policy and not court rulings.

As to the status of COVID-19 or the lockdowns as FM, courts should interpret ambiguous or catch-all terms on the principle of ejusdem generis – ‘when general words follow an enumeration of things, they apply to things of the same general kind specifically mentioned.’

COVID-19 is not FM per se. It is the lockdowns, not the virus, that has made it impossible for the airlines, hotels and caterers to deliver as promised and contractors to complete projects on schedule. Under such contexts, it is justified to use the lockdowns as FM for non-performance or delayed performance, as the case may be.

In other contexts, however, the clause has been used for dubious reasons. Discoms have invoked it under power purchase agreements. They have withheld monthly payments and have asked some power producers to stop the project. True, due to lockdown of industries and commercial establishments the demand for electricity has fallen. However, the virus and the lockdowns have not affected the generation-capacity of power producers, nor have they rendered it impossible for discoms to off-take electricity, an essential service. In any case, a reduced demand or the agreement becoming commercially onerous does not qualify as a FM event.

If the contract does not have a FM clause, parties can seek termination of the contract on grounds of frustration. Section 56 of the Indian Contract Act, 1872, along with its interpretations by the Supreme Court ( Satyabrata Ghose v. Mugneeram Bangur ) renders a contract void if a subsequent event makes performance impossible or useless for one or the other party. Accordingly, claims by wedding caterers regarding frustration of contract can hold ground for events that were pre-scheduled but could not take place during the lockdown.

Lockdown as force majeure

A justifiable use of COVID-19-induced lockdown as FM or an event causing frustration of contract is subject to context and facts. In Standard Retail Pvt. Ltd. v G.S Global Corp. & Ors. (2020), the Bombay High Court rejected the claims of the petitioner, who argued that the lockdowns had led to frustration of his contract for supply of steel by the respondent G.S Global Corp. The Court aptly observed that the lockdowns did not apply to the steel sector, an essential item as per the government notification. Moreover, the relief under FM was applicable only to the seller (if supply became impossible). But the seller had already dispatched the supplies.

Moreover, restitution goes hand-in-hand with the use of FM and frustration of purpose to terminate the contract. A seller seeking to terminate the contract should return the payment received for the yet-to-be-fulfilled part of the promise. This principle has been grossly violated by the airlines. Thousands of prior bookings had to be cancelled due to ban of flights during the lockdown (a FM event in this case). What is troublesome is that rather than refunding the cancelled tickets, airlines have sought to convert them into credit shells usable only for buying future tickets from the same carrier. This is an opportunistic move.

Riskiness of returns is an integral part of most business and commercial activities. The Supreme Court in Naihati Jute Mills Ltd v. Hyaliram Jagannath (1967) held that a contractual obligation becoming economically arduous is not a ground for absolving a party of its commitment. Therefore, OYO’s decision to suspend payments to client hotels citing commercial unprofitability is not a ground for frustration of contract.

Similarly, the demands of multiplexes, retailers and restaurants are untenable. They are seeking rental waivers from premise owners citing the lockdowns as FM. Government notifications declaring COVID-19 as FM has encouraged such demands. Lease agreements typically allow rental waivers only if a FM event causes physical damage to the property rendering it unfit for commercial use. This is not the case with COVID-19. Besides, lessee cannot claim frustration of contracts as the lockdowns and concomitant losses are temporary.

Insurance contracts are intricate. Property insurance claims require physical damage to the property. As the lockdown has caused no physical harm, claims for loss of business income are not tenable. Moreover, courts should realise that the losses on account of the lockdown are quite different from those meant to be covered by individual policies. Business losses caused by epidemics and lockdowns tend to be numerous and highly correlated. That is why standard insurance policies do not allow compensation for such losses. Allowing a single claim will set a precedent for all, potentially bankrupting the insurance industry.

Courts and regulators should encourage litigants to go for negotiations or mediation to settle disputes. In most cases, a middle ground exists within the contract letter.

Ram Singh is Professor, Delhi School of Economics, and Utkarsh Leo is Assistant Professor, NALSAR University of Law

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