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Friday, September 25, 2020

Explained: What counts as ‘Act of God’?

Amid disruptions caused by Covid-19, the Finance Minister has referred to an Act of God while businesses are looking at a legal provision, force majeure, to cut losses. How does it work, and when can it be invoked?

Written by Apurva Vishwanath | New Delhi | Updated: September 7, 2020 8:54:07 am
act of god, nirmala sitharaman act of god, india economy, india gdp, nirmala sitharaman force majeure clause, indian expressIn April, the Bombay High Court did not accept the force majeure argument that had cited the lockdown for failure to fulfil a contract. (Express Photo: Partha Paul)

The Covid-19 pandemic and the lockdown imposed across the globe to contain the spread of the virus has resulted in major disruptions in economic activity. Businesses are looking towards a legal provision — the force majeure or “Act of God” clause that has its origins in the Napoleonic Code — to cut losses.

This week, attributing the shortfall in GST collections to disruptions due to Covid-19, Finance Minister Nirmala Sitharaman said the economy is facing an Act-of-God-like situation.

On February 19, The Finance Ministry had issued an office memorandum inviting attention to the force majeure clause (FMC) in the 2017 Manual for Procurement of Goods issued by the Department of Expenditure clarifying that the pandemic “should be considered a case of natural calamity and FMC may be invoked, wherever considered appropriate”.

What is a force majeure clause?

The law of contracts is built around a fundamental norm that the parties must perform the contract. When a party fails to perform its part of the contract, the loss to the other party is made good. However, the law carves out exceptions when performance of the contract becomes impossible to the parties. A force majeure clause is one such exception that releases the party of its obligations to an extent when events beyond their control take place and leave them unable to perform their part of the contract.

FMC is a clause that is present in most commercial contracts and is a carefully drafted legal arrangement in the event of a crisis. When the clause is triggered, parties can decide to break from their obligations temporarily or permanently without necessarily breaching the contract. Companies in such situations use the clause as a safe exit route, sometimes in opportunistic ways, without having to incur the penalty of breaching the contract.

Generally, an “Act of God” is understood to include only natural unforeseen circumstances, whereas force majeure is wider in its ambit and includes both naturally occurring events and events that occur due to human intervention. However, both concepts elicit the same consequences in law.

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What situations legally qualify for use of force majeure?

While some contracts have clauses with standard circumstances, some contracts would have specific circumstances that are more focused. For example, a shipping contract would have a force majeure clause that could cover natural disaster like tsunami.

War, riots, natural disasters or acts of God, strikes, introduction of new government policy imposing an embargo, boycotts, outbreak of epidemics and such situations are generally listed. If an event is not described, then it is interpreted in a way that it falls in the same category of events that are described.

A force majeure clause is negotiated by parties, and events that could potentially hamper the performance of the contract are catalogued. It is not invoked just by expressing that an unforeseen event has occurred.

In case a contract does not have a force majeure clause, there are some protections in common law that can be invoked by parties. For example, the Indian Contract Act, 1872 provides that a contract becomes void if it becomes impossible due to an event after the contract was signed that the party could not prevent.

Read | Don’t blame God for man-made disaster: P Chidambaram tells Centre on economic slump

What happens when a force majeure clause is triggered?

If a party to a contract believes that the other party has invoked the force majeure clause in an unjustified situation, it can move court seeking performance of the contract.

Courts read the wording of the clause closely to allocate risks between the parties. Court rulings have established that force majeure cannot be invoked when performance of the contract has become difficult, but only when it has become impossible. It looks into whether the party arguing impossibility of performance has tried all other avenues to fulfil its liabilities before invoking force majeure.

For example, in a 2017 case, the Supreme Court cited a 1961 House of Lords decision that ruled that the closure of Suez Canal, although unforeseen, had not rendered a contract to ship goods from Africa impossible since a longer route around the Cape of Good Hope existed.

Vaguely indicating that the pandemic failed the contract would face a legal challenge. The court would look into specifics like whether a lockdown imposed to contain the pandemic locally prevented performance of the contract.

The court would also look into how unforeseen the cited circumstance really is when catalogued in the contract specifically. Global contracts signed after the initial outbreak in Wuhan could fail scrutiny if the contracts do not take into account viral pandemics.

In April this year, the Bombay High Court did not accept the force majeure argument in a case where the petitioner argued that Covid-19-related lockdowns had frustrated a contract for supply of steel. Although the decision factored in other arguments, the vague construction of the pandemic reason did not cut ice with the court.

Are there other global precedents dealing with pandemics and force majeure?

In China, where the Covid-19 outbreak originated, the Council for Promotion of International Trade is issuing force majeure certificates to businesses. China’s Supreme People’s Court had recognised the 2002 SARS outbreak as a force majeure event.

Singapore enacted the Covid-19 (Temporary Measures) Act in April to provide relief to businesses that could not perform their contractual obligations due to the pandemic.

The Paris Commercial Court in July ruled that the pandemic could be equated to a force majeure event.

In the UK, the Financial Conduct Authority has brought in a test case before the High Court to look into business insurance contracts and interpret the standard wordings in such contracts. The ruling, which is now reserved by the court, will be binding on insurers and will provide a framework to interpret similar contracts in court cases in Scotland and Northern Ireland.

Also in Explained | The issues in GST compensation

The International Chamber of Commerce has developed a Model Code on the force majeure clause reflecting current international practice. The Code states that the impediment triggering the operation of the force majeure clause must be beyond the party’s reasonable control; and that it could not reasonably have been foreseen at the time of the conclusion of the contract; and that the effects of the impediment could not reasonably have been avoided or overcome by the affected party.

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