Categories
Coronavirus

Analysing the Impact of COVID-19 on Contractual Obligations in the Supply Chain Mechanism

By Abhigyan Tripathi and Rishabh Chhabaria

Introduction

On December 31, 2019, China reported a number of pneumonia cases in Wuhan, Hubei Province, leading to the identification of the novel Coronavirus (Covid-19). Over the course of four months, the virus has transmitted to various parts of the world, including India and has claimed over two lakh lives.[1] The outbreak of the Coronavirus was declared to be a pandemic by the World Health Organization [“WHO”] after taking into account its startling spread as well as the alarming level of inaction.[2]

The said pandemic has led to a serious standstill in the supply chain mechanism in India, which would imply serious ramifications in the context of fulfilment of contractual obligations and subsequent legal action once there is a return to normalcy. Due to the imposition of a complete lockdown for flattening the Covid-19’s curve, the performance of several contracts would inevitably be halted, either temporarily or permanently.[3]

Hence the focus of this article would be on the various possible solutions to the legal action that suppliers (and other such parties on an equal footing) could avail in case of genuine incapacity since there is always a possibility that the doctrine of Force Majeure (in case of explicit clause provided for by the contract) or the remedy provided under section 56 of the Indian Contract Act, 1872 (in case the contract doesn’t provide for Force Majeure) may be used by parties to get out of deals which are not viable for them.

Current Legal Interpretation of Force Majeure

There exist certain exigencies which render the discharge of contracts impossible since they are beyond human control and anticipation. Such situations are termed as Force Majeure (French for superior force) [“FM”] and may include (but are not limited to) Acts of God such as earthquakes, floods, pandemics; employee strikes and lockouts; wars; change in government regulations or government-imposed lockdowns.[4]

As per the existing contract law in India there does not exist an explicit provision which pertains to FM events in the Contract Act and needs to be taken care of by inserting a related clause in the contract itself. The provisions that are relevant in this context are sections 32 and 56 contained in Chapters III and IV respectively:   

  • Section 32 deals with contingent contracts where performance of a contractual obligation is dependent on the happening or non-happening of an event. If such an event becomes impossible, the contract becomes void.
  • Section 56, which embodies the doctrine of frustration, states that a contract to do an impossible act or when such an act becomes impossible or unlawful after entering into the contract, is void. It is pertinent to note here that such an event must have been unforeseeable by the parties and has led to such a change in circumstances that it now stands in contravention with the purpose and object for which the contract was entered into.[5]

The intention of the above two provisions is to simply save any performing party from the consequences of any event over which there exists no control and is not provided for in the contract.[6]

As per the existing law and its subsequent interpretation by the courts, an FM clause existing in the contract entered into between parties can be invoked only when the claiming party shows that:[7]

  1. The event must be beyond control of the party concerned;
  2. All reasonable measures to discharge the contract were taken but the ability to perform the contract was hampered;
  3. The party not able to fulfil contractual obligations was not aware that such circumstances could arise.

The extent of protection under such a clause incorporated in the contract depends solely upon its wording and context of usage.[8]

Therefore, the first step, where the defence of force majeure is invoked, is to examine whether the clause is explicitly mentioned in the contract and can be enforced under the given circumstances. But where no such clause exists, then it must be checked whether the doctrine of frustration under Section 56 can be invoked.[9]

Corona – A Force Majeure with Devastating Consequences

The novel coronavirus has caught the whole world in a vice-like grip and has led to an adverse situation for the economy. The pandemic has led to the observance of a complete lockdown in the country which has had untoward consequences for the manufacturing sector and India’s contribution to the global supply chain.[10]

Merely focusing on non-fulfilment of contractual obligations without taking into account its subsequent economic implications, both national and global, is a misdemeanor that the authors would surely avoid. The corresponsive relationship between the two needs to be understood in a manner so as to take the adequate steps for ensuring smooth functioning of economic and legal mechanisms simultaneously after return to normalcy.

It is estimated that the pandemic will have a negative impact on the Indian economy between April and June, 2020 due to a decrease of almost 9% in the Gross Value Added (GVA) despite the announcement of a $22.5 billion relief package by the government.[11] Statistically speaking, a single day of lockdown entailing zero production of goods and services is around Rs. 50,000 crore of real GDP.[12]

On analysis of the situation it is found out that the stoppage in production of various goods due to non-procurement of raw materials leads to shortage in both the domestic pool of commodities as well as exports. It is simple to understand that the above phenomenon occurs due to non-performance of countless contractual obligations, on the part of primary producers, manufacturers, wholesalers, retailers, service providers, etc. owing to various reasons such as shortage of cash flow, stock, workforce and so on.

A general view for the majority of these cases that may be adopted is genuine inability to have predicted and preempted the above-mentioned circumstances which led to a complete change in the object and purpose of the contract formed. Performance of many of these contracts became impossible due to unprecedented reasons.[13]

It can therefore be concluded that the pandemic is an FM event owing to its unfavourable impact, and the fact that its escalation could not have been anticipated and controlled by various contracting parties not able to fulfill their contractual requirements, therefore satisfying the legal benchmark.[14]

The Way Ahead

The Ministry of Finance vide an office memorandum dated 19.02.2020 declared that spread of the covid-19 pandemic which has led to disruption in supply chain may be considered a natural calamity covered under the FM clause, if it is provided for in the contract.[15]

Such an event cripples the supply chain as it not only disables the parties to such a contract but also the related parties (such as subcontractors) from fulfilling their contractual obligations. In the wake of this pandemic, the Indian Government has also announced a relief package of $22.5 billion to aid the most vulnerable and affected. It includes provisions for struggling small-scale farmers, workers and daily wage labourers, who contribute greatly to the supply chain.[16]

To complement the above-mentioned policy measures taken by the government so far, the following steps may be taken to counter the challenges posed by the pandemic and ensure a smooth transition in the economic and legal spheres once there is return to normalcy:

  • So as to protect the interests of these parties, China has recently announced issuance of FM certificates to the companies that failed to discharge their international trade contracts.[17]

A similar approach can also be taken by the Indian Government in the form of FM certificates, incentives for performance of contractual obligations within set deadlines and appeasement of aggrieved parties through pricing regulations in three sectors of the economy.

  • The Chinese government has announced to pump funds into various infrastructure projects with the aim of creating new jobs, reduce taxes on small businesses and mandate banks to defer loan payments in the case of troubled households or companies for coping easily with the economic fallout.[18]

Taking the above as a blueprint, the government should make an effort of intervening by providing even greater amount of funds to the SMEs, primary producers and tertiary sector,[19] drawing up plans to ensure economic restructuring through policy measures (price regulation) and keeping a close eye on the three sectors (primary, secondary and tertiary) until the adverse effects of this pandemic are not nullified.

  • Moreover, the concerned parties should also try to reach a reasonable and pragmatic solution amid the adversities through mediation and other alternate dispute resolution mechanisms, in case of non-performance by one of the parties.

If however a legal conflict becomes inevitable the judiciary should adopt a lenient view rather than a restricted one that it has adopted so far, since there has been a fundamental change in the circumstances on account of the virus which could not have been reasonably foreseen and neutralized.[20]

Contractual obligations and economic conditions are closely interrelated. Thus, their mutualistic nature needs to be discussed in context of Force Majeure events to minimize their adverse impact on the economy.

The authors are currently in their second year, pursuing -their law degree from the Rajiv Gandhi National University of Law, Punjab.


[1] James Griffiths, Worldwide coronavirus death toll passes 200, CNN World (Mar. 24, 2020), https://edition.cnn.com/world/live-news/coronavirus-pandemic-04-26-20-intl/index.html.

[2] Who Timeline – Covid-19, World Health Organization, https://www.who.int/emergencies/diseases/novel-coronavirus-2019 (last visited Apr. 18, 2020).

[3] See Cyril Amarchand Mangaldas, Coronavirus, Force Majeure and Impact on Commercial Contracts, BloombergQuint (Mar. 23, 2020, 3:23 PM), https://www.bloombergquint.com/coronavirus-outbreak/covid-19-coronavirus-force-majeure-and-impact-on-commercial-contracts.

[4] Force Majeure, Black’s Law Dictionary (9th ed. 2009).

[5] Satyabrata Ghose v. Mugneeram Bangur & Co., AIR 1954 SC 44.

[6] Dhanrajamal Gobindram v. Shamji Kalidas & Co., AIR 1961 SC 1285.

[7] Gujarat Urja Vikas Nigam Ltd. v. Tarini Infrastructure Ltd., (2016) 8 SCC 743.

[8] Lebeaupin v. Crispin, [1920] 2 KB 714.

[9] Energy Watchdog v. Central Electricity Regulatory Commission, (2017) 14 SCC 80.

[10] Soutik Biswas, PM Narendra Modi says India will extend coronavirus lockdown until 3 May, BBC (Apr. 14, 2020), https://www.bbc.com/news/world-asia-india-52277096.

[11] Madhumita Jaganmohan, Estimated economic impact from COVID-19 on India’s GVA April-June 2020 by sector, statista (Apr. 17, 2020), https://www.statista.com/statistics/1107798/india-estimated-economic-impact-of-coronavirus-by-sector/.

[12] Madan Sabnavis, Coronavirus Outbreak: How a prolonged shutdown will affect India’s salaried class, jobs, farm production, manufacturing, Firstpost (Mar. 23, 2020, 9:39 PM), https://www.firstpost.com/health/coronavirus-outbreak-how-a-prolonged-shutdown-will-affect-indias-stressed-economy-cause-collateral-damage-to-jobs-farm-production-manufacturing-8179491.html.

[13] supra note 4.

[14] supra note 6.

[15] Ministry of Finance, Office Memorandum No. F18/4/2020-PPD (Feb 19, 2020), https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf.

[16] Katharina Buchholz, Who is the Indian Government Aid Package Benefiting, Statista (Apr. 01, 2020), https://www.statista.com/chart/21308/indian-government-coronavirus-aid-package/.

[17] Huileng Tan, China invokes ‘force majeure’ to protect businesses — but the companies may be in for a ‘rude awakening’, CNBC (Mar. 6, 2020), https://www.cnbc.com/2020/03/06/coronavirus-impact-china-invokes-force-majeure-to-protect-businesses.html.

[18] Laura He, China is trying to revive its economy without risking more lives. The world is watching, CNNBusiness (Mar. 24, 2020), https://edition.cnn.com/2020/03/24/economy/china-economy-coronavirus/index.html.

[19] supra note 15.

[20] supra note 8.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s