Would invoking Force Majeure be economically efficient amidst the economic crisis in the backdrop of COVID-19?

-Rishab Aggarwal

Amidst humanity’s darkest hour since World War II,[1] countries around globe are enforcing social distancing measures. Some are even distributing force majeure certificates[2]  like China so as to excuse parties in commercial contracts from performance. [3]  Amidst such economic crisis, it would be interesting to know whether parties can efficiently take the benefit of force majeure clauses.

Economic Crisis due to COVID – 19

An economic hibernation model is suggested wherein depletion of organisational capital and accumulation of debt in private sector would be prevented.[4] It is because; severe recession is predicted to follow[5] which would see high unemployment rates.[6] Around half a trillion US dollars in the form of 300 merger deals are lying to be closed.[7] But, coming to India, supply chain was already with a “downslide effect on businesses”.[8] The informal sector constituting 45% of its GDP[9]  is in peril as witnessed from the crisis of migrant labourers. [10]

What is force majeure?

Etymologically, it means a superior event, one beyond human control, like an Act of God.[11] The origin is from French Civil Code or Napoleonic Code of 1804.[12] Article 1218 of the code defines a force majeure event as-

“In contractual matters, there is force majeure where an event beyond the control of the debtor, which could not reasonably have been foreseen at the time of the conclusion of the contract and whose effects could not be avoided by appropriate measures, prevents performance of his obligation by the debtor.” [13]

Indian Supreme Court holds that such contract saves the performing party from the consequences of anything over which the parties have no control.[14] Four essential requirements are externality, unavoidability, unforseeability and causation with the external event.[15]

Essentially the intervening event has to beyond parties’ control.[16]  The consequences must also be unavoidable[17]  leading to impossibility. [18] Force majeure clauses in the contracts tend to allocate the risks of misprediction among the parties.[19] Parties are free to negotiate upon what may constitute unpredictable in future. [20]

Impossibility and Efficiency – Economic Analysis

In a contract, uncertainty exists since the performance is to take place in future. If default takes place, it is construed as a breach. Thus, the risk gets allocated to the promisor. But if doctrine of impossibility is successfully invoked, risk shifts to the promisee. Hence, one has to find the superior risk bearer in order to allocate the risk efficiently.[21]

The two factors for finding superior risk bearer are prevention of risk from materialising and insurance from probable harm. The first may not be sufficient since the event would mostly be unavoidable. To find cheaper insurer, risk appraisal (probability * magnitude of loss) and transaction costs (buying insurance policy) are considered. Posner accordingly holds that in case promisee is the superior risk bearer (cheaper insurer), impossibility can be invoked and discharge should accordingly be allowed.[22]

Let us take illustration of manufacturing printing machinery. If printer (promisor) asks for the machine from a manufacturer (promisee) to be sold and installed at his premises, which later catches fire, question arises as who should bear the risk? Since fire broke in the printer’s premises, he was in better position to prevent it. But, since it was unforeseen and supposing there was no fault on his part, it is prudent to move to the second test.

Though printer can fathom the probability of fire occurrence better, it is the manufacturer who is better suited to calculate the magnitude of the cost since he has more knowledge about the stages of production. Thus, manufacturer is better suited to self insure against any possible loss in future. Hence, discharge can be allowed since promise is the superior risk bearer.  Similar manufacturing contracts have been discharged on the ground of impossibility when stores got destroyed by fire unforeseen and without fault of either party.[23]

The famous shutting down of Suez Canal case was resolved with similar economic analysis. Transatlantic argued for discharge from transporting wheat to Iran. Applying economic analysis, court found the shipping company was superior risk bearer since it could estimate magnitude of loss better and could have insured against possible risks in future. The consignment could still be transported through Cape of Good Hope. [24]

Hence the interpretation of contract terms would depend on the risk bearing capacities of the parties as well as the surrounding circumstances.[25]

Problem with Enforcing Force Majeure

Common law courts have been reticent in excusing performance due to unclear evidentiary basis.[26] The phraseology used in contracts is also different as in US, 42% of the deals concluded in 2019 used the expression of “act of God” compared to 23% using specifically “pandemic” word.[27] Since the event is interpreted within the contours of the clause, [28] its effect would differ case to case[29] depending on how the clause has been negotiated. [30]

The opposite party demanding breach can always argue upon lack of unforseeability in a pandemic which comes every 10 or 100 years. When we talk about those dealings entered into after the COVID- 19 cases started erupting in India, especially in the beginning of the month of March, it would be difficult to prove for the party claiming discharge how the event is unavoidable.

Difficulty lies in establishing the causality with the triggering event as suggested by International Chamber of Commerce.[31] Parties can harp upon the expression “prolonged break down of transport” but given the relaxations allowed by some state governments in India, it would be doubtful as to how far would this option be useful.[32]

Merely because the performance becomes onerous, it does not establish impossibility.[33] In case of alternative methods available, such clause cannot come to a party’s rescue, as it happened in Suez Canal case. [34]  Thus, wars[35], change in governmental policy on jute import,[36] protests[37] and escalation of prices[38] have not been held to be leading to impossibility. Similarly mere market upheavals like economic recession[39]  affecting the profitability of contract also does not constitute impossibility. [40]

Conclusion

The analysis above shows that arrival of a pandemic would not give an automatic leverage to parties to get an excuse from performing their contractual obligations. To strike a balance between two conflicting principles of pacta sund servanda (fulfilling the sanctimonious duty) [41]  and clausula rebus sic stantibus (excusal from performance on account of change in circumstances), [42] one needs to find who would be the superior risk bearer in order to allow discharge efficiently. Hence, even in the situation of pandemic, if the promisor can perform his part having better capacity to deal with risks, the force majeure should not be applied accordingly.

[1] International Monetary Fund, https://www.imf.org/en/News/Articles/2020/04/03/tr040320-transcript-kristalina-georgieva-participation-world-health-organization-press-briefing (last visited May 20, 2020).

[2] A force to be reckoned with-Chinese firms use obscure legal tactics to stem virus losses, The virus has led to firms trying to get out of contracts, The Economist (Apr. 20, 2020), https://www.economist.com/business/2020/02/20/chinese-firms-use-obscure-legal-tactics-to-stem-virus-losses.

[3] CCPIT Guides Enterprises to Leverage Force Majeure Certificates, which Help to Maintain Nearly 60% Contracts, China Council for the Promotion of International Trade (Apr. 20, 2020), http://en.ccpit.org/info/info_40288117668b3d9b017163990e5a082a.html.

[4] Lukasz A. Drozd & Marina M. Tavares, Responding to COVID-19: A Note 2-23 (Fed. Reserve Bank of Phila., Working Paper No. 20-14, 2020), https://doi.org/10.21799/frbp.wp.2020.14.

[5] Sayajit Chatterjee, Debt Overhang: Why Recovery from a Financial Crisis Can Be Slow, 2 Business Review 1 (2013), https://philadelphiafed.org/-/media/research-and-data/publications/business-review/2013/q2/brq213_debt-overhang-why-recovery-from-financial-crisis-can-be-slow.pdf; Gauti B. Eggertsson et. al., A Model of Secular Stagnation: Theory and Quantitative Evaluation, 11(1) Am. Econ. J.: Macroeconomics 1 (2019), https://doi.org/10.1257/mac.20170367.

[6] Ezra Klein, How the Covid-19 recession could become a depression, Vox (Mar. 23, 2020, 09:20 AM) https://www.vox.com/2020/3/23/21188900/coronavirus-stock-market-recession-depression- trump-jobs unemployment.

[7] Matthew Jennejohn et. al., COVID-19 as a Force Majeure in Corporate Transactions, in Law in the Time of COVID 141, 141 (Katharina Pistor ed., 2020).

[8] Jitesh Kadian & Rashi Paliwal, A New Emerging Pandemic COVID-19: Its Social, Legal and Economical impact, 31 (8) Purukala 1166, 1171 (2020).

[9] S. Mahendra Dev & Rajeswari Sengupta, COVID-19: Impact on the Indian Economy 1-6 (Indira Gandhi Inst. of Dev. Research, Mumbai, Working Paper No. 013, 2020), http://www.igidr.ac.in/pdf/publication/WP-2020-013.pdf.

[10] Jitesh Kadian & Rashi Paliwal, A New Emerging Pandemic COVID-19: Its Social, Legal and Economical impact, 31 (8) Purukala 1166, 1171 (2020).

[11] Abdullah Qazi, Force Majeure Clauses and the Limitation of Liability, Mondaq (Sept. 4, 2019, 08:00 AM), https://www.mondaq.com/construction-planning/842460/force-majeure-clauses-and-the-limitation-of-liability.

[12] James Gordley, Impossibility and Changed and Unforeseen Circumstances, 52 Am. J. Comp. L. 513, 518 (2004).

[13] See Ministere De La Justice, http://www.textes.jus-tice.gouv.fr/art_pix/THE-LAW-OF-CONTRACT-2-5-16.pdf (last visited May 20, 2020).

[14] Dhanrajamal Gobindram v. Shamji Kalidas And Co., AIR 1961 SC 1285 (India).

[15] Alan Berg, The detailed drafting of a force majeure clause, in Force Majeure And Frustration Of Contract 63, 71 (Ewan McKendrick ed., 1995).

[16] Int’l Inst. For Unification of Private Law [UNIDROIT], UNIDROIT Principles of International Commercial Contracts 2010, art. 7.1.7.

[17] Yohannes Hailu Tessema, Force Majeure and the Doctrine of Frustration under the UNIDOROIT Principle, CISG, PECL and the Ethiopian Law of Sales: Comparative Analysis, 58 J.L. Pol’y & Globalization 33 (2017).

[18] United Nations Convention on Contracts for the International Sale of Goods art. 79, Jan. 1, 1988, 1489 U.N.T.S. 3; Code civil [C. civ.] [Civil Code] art. 1792 (Fr.).

[19] Yohannes Hailu Tessema, Force Majeure and the Doctrine of Frustration under the UNIDOROIT Principle, CISG, PECL and the Ethiopian Law of Sales: Comparative Analysis, 58 J.L. Pol’y & Globalization 33 (2017).

[20] Id.

[21] Richard A. Posner & Andrew M. Rosenfield, Impossibility and Related Doctrines in Contract Law: An Economic Analysis, 6 J. Legal Stud. 83 (1977).

[22] Id.

[23] Siegel v. Eaton & Prince Co., 165 Il. 550, 46 N.E. 449 (1896).

[24] Tsakiroglou & Co. Ltd. v. Noblee Thorl GmbH [1962] AC 93 (HL) 94 (appeal taken from Eng.).

[25] Richard A. Posner & Andrew M. Rosenfield, Impossibility and Related Doctrines in Contract Law: An Economic Analysis, 6 J. Legal Stud. 83 (1977).

[26] Matthew Jennejohn et. al., COVID-19 as a Force Majeure in Corporate Transactions, in Law in the Time of COVID 141, 150 (Katharina Pistor ed., 2020).

[27] Id. at 149.

[28] Mary v. State of Kerala, (2014) 14 SCC 272 (India); Day v. United States, 245 U.S. 159, 161 (1917).

[29] Lebeaupin v. Crispin [1920] 2 KB 714.

[30] Christian Twigg-Flesner, A comparative Perspective on Commercial Contracts and the impact of COVID-19 – Change of Circumstances, Force Majeure, or what?, in Law in the Time of COVID 141, 161 (Katharina Pistor ed., 2020).

[31] International Chamber of Commerce, https://iccwbo.org/publication/icc-force-majeure-and-hardship-clauses/ (May 20, 2020).

[32] Christian Twigg-Flesner, A comparative Perspective on Commercial Contracts and the impact of COVID-19 – Change of Circumstances, Force Majeure, or what?, in Law in the Time of COVID 141, 155 (Katharina Pistor ed., 2020).

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

[34] Energy Watchdog v CERC (2017) 14 SCC 80 (India).

[35] Satyabrata Ghose v. Mugneeram Bangur & Co., AIR 1954 SC 44 (India); M/s Alopi Parshad & Sons Ltd. v. Union of India, 1960 (2) SCR 793 (India).

[36] Naihati Jute Mills Ltd. v. Khyaliram Jagannath, (1968) 1 SCR 821 (India).

[37] Mary v. State of Kerala, (2014) 14 SCC 272 (India).

[38] Coastal Andhra Power Ltd v. Andhra Pradesh Central Power Distribution Co Ltd, FAO (OS) No. 272/2012 (Del. HC).

[39] Stuart D Kaplan et. al., Trump v. Deutsche Bank: Does the Credit Crisis Constitute a Force Majeure Event?, Martindale (Mar. 23, 2009, 08:00 AM), https://www.martindale.com/business-law/article_Blank-Rome-LLP_648084.htm.

[40] Tandrin Aviation Holdings Ltd v. Aero Toy Store LLC, [2010] EWHC 40 (Comm)].

[41] Reinhard Zimmermann, The Law Of Obligations: Roman Foundations Of The Civilian Tradition 581 (Juta & Co., 1990).

[42] Robert Feenstra, Impossibilitas and clausula rebus sic stantibus, in Fata Iuris Romani: Études D’histoire Du Droit 364, 368 (Robert Feenstra ed., 1974)

Rishab Aggarwal is a student of law at Gujarat National Law University.