Covid-19 and Force Majeure: Part II

In the previous post, I had discussed the force majeure clause in Standard Retail Pvt. Ltd. v. G.S. Global Corp & Ors. and argued that Section 56 is non-derogable to the extent that it leads to frustration of contract on the ground of a supervening illegality; and a force majeure clause compelling performance despite the supervening illegality is void. In this post, I discuss the strength of this argument in light of the existing precedent on this issue.

Two decisions of the Supreme Court – Satyabrata Ghose v. Mugneeram Bangur & Co. and Energy Watchdog v. CERC – have been cited for the proposition that a force majeure clause in a contract entirely excludes the applicability of Section 56. This is incorrect. In Satyabrata Ghose, the Court held that if the parties expressly undertake to perform the contract irrespective of a force majeure event, Section 32 would apply and the contract is not frustrated upon the occurrence of such an event. However, the Court did not express an opinion as to whether this would extend to a supervening illegality as well. In fact, the excerpt from the House of Lords’ decision in Matthey v. Curling relied upon by the Court for this proposition referred only to a supervening impossibility, and not a supervening illegality. In Energy Watchdog, the Court relied upon Satyabrata Ghose to hold that when a contract contains a force majeure clause, Section 56 has no application. However, as in Satyabrata Ghose, the Court in Energy Watchdog did not expressly comment on whether a force majeure clause would be valid even when it requires performance despite the occurrence of a supervening illegality.

This issue arose for the Delhi High Court’s consideration in a recent decision in NTPC Limited v. Voith Hydro Joint Venture. In this case, the Court held that parties had the right to agree that even if the performance of the contract was rendered impossible on account of a force majeure event, one party would compensate the other for non-performance. The Court then went on to hold that a binding decision of a statutory authority (which constitutes ‘law’ and therefore amounts to a supervening illegality) which led to the abandonment of a hydro power project would not automatically frustrate the contract; NTPC was required to invoke the force majeure clause in according with its terms in order to be excused for non-performance. Thus, the Court upheld Voith’s claim for damages for breach of contract by NTPC despite finding that performance had become illegal in light of the decision of the statutory authority. It is submitted that this aspect of the Court’s ruling is incorrect. On the one hand, the Court held that the non-performance was due to a supervening illegality, and not on account of any fault on the part of NTPC. On the other hand, the Court granted damages to Voith for breach of contract by NTPC. This ruling is plainly self-contradictory and cannot be good law. Once the Court held that the project had to be abandoned as a result of a supervening illegality, it would automatically frustrate the contract under Section 56. Once the contract is frustrated, the necessary consequence under Section 65 of the Contract Act must follow.

English law endorses the position that parties cannot agree upon performance of a contract notwithstanding a supervening illegality (See Chitty on Contracts, 30^th Edn., Para 23-058). The seminal judgment on this issue was rendered by the House of Lords in Ertel Bieber & Co v. Rio Tinto Co Ltd, [1918] A.C. 260. There, Rio Tinto Co. Ltd. (an English entity) and Ertel Bieber & Co. (a German entity) entered into a contract for supply of cupreous ore by Rio Tinto to Ertel Bieber. Before the contract could be performed, World War I broke out and according to English law, the existence of a state of war between England and Germany would abrogate (and not merely suspend) the contract. However, the contract contained a force majeure clause which provided for the suspension of the obligation to supply the goods during the existence of a state of war. In this background, the issue before the House of Lords was whether the force majeure clause could exclude the application of English law on abrogation of contract upon the existence of a state of war. The House of Lords held that the continued existence of a contractual relationship with alien enemies was prohibited by law and this prohibition dissolved, and not merely suspended, the contractual relationship. In such circumstances, a private contract could not provide for mere suspension of the contract. If the contract is illegal and void on account of a supervening illegality, a force majeure clause cannot save its legality.

That said, the Supreme Court in Satyabrata Ghose has cautioned against relying on English judgments on the doctrine of frustration de hors the statutory provision. However, the dictum in Ertel Bieber is aligned with the provisions of the Contract Act. Neither Section 32 nor Section 56 provides any guidance on whether parties can contract out of Section 56. Therefore, the issue has to be determined keeping in mind the overall scheme of the Contract Act. While the Act recognises freedom of parties to agree upon the terms of their contractual relationship, this is subject to norms of public policy. This is best evidenced in Section 23 of the Act, which, broadly stated, proscribes parties from contracting to do acts which are illegal. The supervening-illegality ground for frustration in Section 56 is another application of the principle contained in Section 23. The difference between the two provisions is in their temporal application – under Section 23, the illegality which renders the agreement unenforceable prevailed at the time of execution of the agreement, whereas under Section 56, the performance of the contract becomes unlawful after it has been executed. Therefore, the overriding nature of public policy over freedom of contract is recognised under English law as well as under Indian law. For this reason, the law laid down in Ertel Bieber must be applied in the Indian context as well. As the House of Lords held in Ertel Bieber, if a contract becomes illegal and void, a force majeure clause in the contract cannot eliminate its illegality. Therefore, the doctrine of frustration on the ground of supervening illegality must apply irrespective of the presence (or scope) of a force majeure clause in the contract and to that extent, Section 56 must be construed to be non-derogable.

This limited non-derogable nature of Section 56 assumes particular importance in the current scenario, where there is a legal prohibition on most commercial activity. This legal prohibition, which can ultimately be traced to the Disaster Management Act, 2005 or The Epidemic Diseases Act, 1897, constitutes a supervening illegality. The supervening illegality was absent in Standard Retail as distribution of steel has been designated as an essential service and there exists no restriction on its movement. Now, let us assume that the contract is for supply of a non-essential item and it contains a force majeure clause as in Standard Retail, entitling only the seller to terminate the contract or delay performance upon the occurrence of an event beyond the parties’ control. In such circumstances, if the notifications issued under the Disaster Management Act, 2005 or The Epidemic Diseases Act, 1897 altogether prevent the buyer from performing its obligations under the contract, the buyer is entitled to rely on Section 56 and contend that the contract is frustrated. The force majeure clause is void to the extent that it impliedly compels the buyer to perform the contract despite the occurrence of a supervening illegality. The situation would be no different if the compulsion to perform the contract was express in nature.