Transfin.
HomeNewsGuidesReadsPodcastsTRANSFIN. EOD
  1. Reads
  2. Deep Dives

What is a Force Majeure Clause: How Can it Mitigate Rental Agreement, Bankruptcy and More During the COVID-19 Pandemic

Jul 4, 2020 7:26 AM 5 min read
Editorial

The coronavirus pandemic has brought forth boilerplate clauses once deeply hidden in legalese to life. One of them has now become a lightning bolt of sorts for conglomerates and organisations. 

 

What is Force Majeure Clause?

“Force majeure” meaning superior force, is a French term. Often used in contractual agreements and synonymous with the ungovernable, force majeure refers to an unforeseeable situation or circumstance that is beyond the control of parties to the contract and seeks to safeguard one or both the parties from the loss of its non-performance. 

A standard structure of a force majeure clause, if at all it exists in the contract, is supposed to be of two parts: 

  1. The explanatory clause and, 
  2. The post-invocation clause  

The explanatory clause orates the ambit of the instrument which can either be exhaustive or unexhaustive in nature. 

The post-invocation clause, on the other hand, lays out the rights, duties, liabilities, and obligations of the parties to the contract in case of occurrence of force majeure event. 

 

When Can a Force Majeure Clause Be Invoked?

A general trend in the case of modern contracts is to adopt force majeure clauses couched in language which gives it a sufficiently wide scope. 

However, in case of a situation where the parties have a force majeure clause without explicitly listing a “pandemic” in the list of events deemed as impossible to deal with, a closer analysis of the clause might prove beneficial to identify any general condition couched in the language, such as “events outside of the control of the party” et al. 

It is pertinent to note here that the use of the terms “act of god” or “viz major” may also be deemed as valid by the judicial system, provided the operations were hindered due to the pandemic.

The Ministry of Finance, Ministry of New & Renewable Energy, and other arms of the Government of India have declared 'COVID-19' as a 'natural calamity' within the definition of 'Force Majeure' under the relevant contracts covered under such Ministries/Government arms. 

Even though this is expected to provide much-required relief, the interpretation of this decision remains obscure to the areas outside the scope of these Ministries. 

A recent judgment by the Delhi High Court (Halliburton Offshore Services Inc v. Vedanta Ltd & ANR) explicitly suggested that although COVID-19 is a force majeure event, its involvement in the non-performance of the contract is specific to every case and requires scrutiny to justify whether it was actually the cause or not. In other words, there must be a “real reason”. 

 

What is a Force Majeure Clause

 

Doctrine of Frustration

Interestingly, the force majeure clause is not mandatory under the Indian judicial system. And in cases where the contract does not have a force majeure clause, the Doctrine of Frustration comes into play under Section 56 of the Indian Contract Act of 1872. 

This Doctrine envisages situations where the performance of a contract is either unlawful or impossible due to a situation which is beyond the control of the parties to the contract. 

The resolution in such a scenario, therefore, involves the “frustration” or cancellation of the contract, a major condition of which is the restitution of the party’s involved. However, proving the “frustration” of a contract is often a tricky task because courts along their history have had a very narrow approach to such instances. 

 

Previous Instances of Invocation of the Force Majeure Clause

During the due course of history, numerous situations have given rise to the invocation of the force majeure clause, the effects of which were clearly visible in the financial institutions. 

In 2018, Reliance Industries Limited (RIL) declared force majeure on its gasoline exports from the Jamnagar refinery stating that there were issues that need to be dealt with in the fluid catalytic cracker (FCC) unit in its export-oriented refinery. Though this halt lasted for a period of two weeks only, the effect was clearly visible in Asia’s gasoline market and the global prices, alike. Asia’s gasoline crack speed, which assesses the profit margin from refining a barrel of Brent crude into fuel, increased by almost 30%. 

Yet another example of its invocation surfaced last year when the Adani Group shielded itself from the penalties that the Government of Kerala imposed on it for not meeting the Vizhinjam International Deepwater Multipurpose Seaport’s deadline. There were two instances over which the force majeure clause was invoked. First was the Ockhi Cyclone that brought devastation to the southern Kerala coast in late 2017. The other was the December 2018 order of the National Green Tribunal which scarped the District Expert Appraisal Committees (DEACs) of its power to grant environmental clearances. 

One of the most relevant examples being the declaration of force majeure is by Adani Ports and Special Economic Zone Ltd (APSEZ), India’s biggest private port operating firm based in Mundra, Tuna, and Dhamra. About half a dozen ports nationally declared force majeure, implying that they have no responsibility in the losses faced by transporters whatsoever. 

However, implications of the invocation of the force majeure clause are many. It can heavily impact cross border trade, Engineering, Procurement, and Construction (EPC) and joint venture agreements. 

Under the RERA Act, real estate contracts too, have a provision for force majeure. If the clause is triggered, developers can demand an extension of registration or deadline of their projects without paying any compensation for the delay. The extension is however, restricted to a year. 

 

Examples of Invocation of Force Majeure Clause

 

For the Greater Good 

There have also been multiple instances, where the invocation of the force majeure clause has aided a sector or business otherwise struggling to stay afloat during the pandemic. 

Following the heavy losses faced by the food industry, Zomato and Swiggy are evoking the force majeure clause, thereby freeing partner restaurants from exclusivity contracts and enabling them to tie up with another food aggregators. 

Several large retail chains such as Big Bazaar and Reliance Retail, also declared force majeure to redeem their legal liability to pay license fees or rental dues. 

In fact, the ongoing pandemic should be taken as a precedent to further develop the force majeure clause, including making it a compulsory 

clause for contracts, and explicitly listing events and actions exclusive and inclusive to such a contract. 

Proper mitigation measures and a resumption date in case of the invocation of the force majeure clause with due consideration of the possible scenarios is also pertinent for the contract. 

A halt or longstop date for the termination of the contract and a proper insurance cover for the deal are equally vital. 

 

The Bottom Line 

Some believe that holders of contracts will move to the courts for resolution of their cases, thereby hindering and perhaps even stalling economic growth even after COVID-19

However, the more optimistic perspective that many agree with, is that of this economic crisis being a self-induced one, and that status quo will see the face of restitution very soon. 

Needless to say, humans have faced tougher times and have always jumped on the bandwagon of prosperity, be it the Spanish Flu of 1918 or the H1N1 pandemic in 2009.

 

Written By Hrithik Jaiswal 

FIN.

A Podcast a day can make you witty and wise. How about two former bankers bantering on all things Business and Finance? No jargon. Only substance. Subscribe to our Podcast Newsletter to receive them straight to your inbox.