How and when the force majeure clause can protect financial contracts

The Economic Times | Sep 14, 2020 | Anju Gandhi

The Covid pandemic has been labelled an act of God but it is debatable whether this can safeguard the parties to the agreement from the consequences of breach of contract. When two parties sign a contract, they agree to perform their respective obligations as described in the agreement. If any party fails to do so, the other is entitled to compensation as mentioned in the contract. However, some contracts also have force majeure clauses that protect the signatories against the liability of compensation or other financial consequences in case they are not able to carry out their obligation due to circumstances beyond human control. 

The force majeure clause includes the phrase ‘act of God’ to mean situations that are uncontrolled by human intervention and could not have been prevented even with a reasonable degree of foresight. This includes lightning, tempests, tornadoes, floods, earthquakes or other natural disasters. In the absence of a force majeure clause in a contract, the parties may take the benefit of Section 56 of the Indian Contract Act, 1872. It allows a contract to be terminated if the obligations under the agreement are impossible to perform. 

However, the Covid-19 pandemic may not be an effective argument against breach of all contracts. In May this year, a company moved a court that the lease agreement for its office space should be terminated because the Covid lockdown had made the premises unfit for use. But the court ruled that in the absence of a force majeure clause, the temporary non-use of the premises due to lockdown cannot be a reason for suspension or exemption of rent. 

There is no clear definition of the term force majeure and such clauses may not be included in all contracts. The ambit of the force majeure clause can also vary. Some parties may want relief in case of war, natural calamity, man-made disasters, political upheavals, terrorist attack or even a technical problem in the computer systems. In April this year, the Supreme Court observed that Section 32 of the Indian Contract Act, 1872 applies when parties agree in advance on contingency which makes performance impossible and upheld the principles of force majeure. 

Many such cases have been decided in Indian courts. A contractor was forced to pay for rebuilding a bridge that was destroyed in a flood. At the same time, the force majeure clause has helped signatories from the liability. In another case, a leading power company was not allowed to take the benefit of force majeure to terminate the contract as its contention of unprecedented rise in coal prices was held not to be a valid ground. A contract to provide a musical hall for entertainment was terminated because the hall accidentally burnt down and a contract to build a factory was ended because of a fire in the building. 

The termination of a contract due to a force majeure event depends on several factors. In 2015, Morocco was fined $1 million for putting off the African Nations Cup football tournament. The Moroccan government invoked the force majeure clause to limit its legal liabilities, citing the ebola outbreak in West Africa as the reason. The Court of Arbitration ruled that hosting the event had become difficult but not impossible. Morocco had to pay the fine. 

A well-designed contract should have a force majeure clause that clearly absolves the parties from their obligations in case of circumstances beyond their reasonable control. To safeguard your interests, make sure it is included in the agreements you sign.