Sep 21,2020 | 04 min read

Effect Of Force Majeure On Lease Agreement - I

By Rudra Law

“Rebus sic stantibus” and “Pacta sunt servanda” are two Latin aphorisms that are contemporary to the laws of Contract. While the former translates to “things thus standing”, legally, it implies that, where there has been a fundamental change of circumstances, a party may withdraw from or terminate the treaty in question. The later one, being a general principle, means “agreements must be kept”, implying that the agreements, even when conditions have changed, must be fulfilled. 

The UK House of Lords, In Paradine v. Jane , when faced with a dispute concerning a landlord who was denied rent on the grounds that the Royalist forces in the English Civil War had occupied the property and rendered the lessee landless- established a rule of absolute liability for contractual debts. The Court held while deciding in favour of the landlord that, ‘when the party by his own contract creates a duty or charge upon himself, he is bound to make it good, if he may, notwithstanding any accident by inevitable necessity, because he might have provided against it by his contract.’

In order to soften this rigid rule of construction, the Queens Bench, for the very first time in Taylor v Caldwell in 1863 – carved an exception, and established the doctrine of common law impossibility that eventually resulted in the birth of the Doctrine of Frustration. 

DEVELOPMENT OF FORCE MAJEURE & DOCTRINE OF FRUSTRATION 

UNDER THE PRIVY COUNCIL

The Doctrine of Frustration or Impossibility does not apply to a situation so as to excuse the performance where performance is not practically cut off, but only rendered more difficult or costly. Such cases may not fall within the purview of Section 56 and this is amply shown by the decision of Privy Council in Harnandrai Fulchand v Pragdas, wherein the Mills failed to perform their contract with the defendants as they were engaged in fulfilling certain contracts with the Government, and consequently the defendants could not supply the goods to the plaintiffs. The questions raised before the Privy Council were as to the meaning of the contract and whether its performance had been frustrated, and the Privy Council disposed of them in these words : "The Mills, from which the goods were to come, no doubt were contemplated as continuing to exist, though it does not follow that, in a bargain and sale such as this, the closing or even the destruction of the Mills would affect a contract between third parties, which is in terms absolute; but the Mills did continue to exist and did continue to manufacture the goods in question, only they were made for and delivered to somebody else". The same was later reiterated in the case of Ganga Saran v. Ram Charan Ram Gopal.

The same principle was also enshrined in the case of Tsakiroglou & Co. Ltd. V Noblee Thori GmbH wherein the appellants agreed to sell to the respondents Sudanese groundnuts for shipment to Hamburg during November/December 1956. The agreement included a CIF (cost, insurance and freight) term (requiring the seller to arrange the carriage of the goods by sea to Hamburg and to provide the buyer with the necessary documents to obtain the groundnuts from the carrier).  A force majeure clause was also incorporated in the contract. It provided that in cases of force majeure the deadline for the delivery of the goods should be extended by no more than two months, after which the contract should be cancelled.

At the beginning of November, the Suez Canal was closed to navigation due to the military operations by the British and French armed forces against Egypt, but the goods could have been shipped around the Cape of Good Hope. The alternative route via the Cape of Good hope was almost twice as long and respectively the freightage was more costly. The sellers failed to ship the goods. It was observed by the Privy Council that the shipping of the groundnuts via the Cape of Good Hope did not render the contract fundamentally different and therefore, did not present a frustration of the contract. Hence the appellants could not rely on the force majeure clause incorporated in the contract since it covered the ‘shipment’ of the goods, not the failure to ship them. Shipment meant loading the goods on the board of a ship prepared to carry them to the contractual destination.

Other cases as the Twentsche Overseas Trading Co. Ltd. vs. Uganda Sugar Factory Ltd. also elaborate on the principle that only because one of many possible ways of performing the contract had become illegal and impossible, the contract would not be frustrated. 

UK

“The court does not compel a person to do what is impossible". The truest enshrinement of the non-performance due to supervening events was with Lord Blackburn's recital of the 1863 judgment in Taylor V/s Caldwel. The Queen's Bench led by Lord Blackburn authorship:

"There seems no doubt that where there is a positive contract to do a thing, not in itself unlawful, the contractor must perform it or pay damages for not doing it, although in consequence of unforeseen accidents, the performance of his contract has become unexpectedly burthensome or even impossible".

However, Lord Blackburn dismissed Taylor's claim for damages for the music hall's destruction. Yet it is significant that Blackburn J. noted that the destruction of the music hall was the fault of neither party, and that this fact rendered the performance of the contract by either party impossible.

In the present times Force majeure clauses are fairly common in commercial contracts but there is no standalone concept of 'force majeure' under the laws of England & Wales.  Accordingly, such clauses are creatures of the contracts in which they appear, and their scope and effect will depend on the wording in question. Typical force majeure events are war, revolution, drastic government interventions and 'acts of God', among others.

Courts in the United Kingdom have specifically held that the expression ‘Act of God’ includes a pandemic/ epidemic. For instance, in Lakeman v. Pollard, a labourer at a mill left his job early during a cholera epidemic due to concerns of contracting the disease and, therefore, failed to complete his work contract. In an action by the mill owners seeking compensation for work done by the labourer, it was argued that the work contract had been breached. The Supreme Court of Maine held that the cholera outbreak was an ‘Act of God’ and the labourer was thus not in breach of his contract since duty to perform under the contract was discharged.

Under UK law, it has been held that the inability of a party to deliver an aircraft on time due to a pandemic causing a dearth of pilots fell within the catch-all residuary wording of a force majeure clause.

If there is no force majeure clause, or the impact of the COVID-19 pandemic is outside its scope, the parties may need to consider whether the contract is terminable by operation of law such as "frustration". The law around frustration applies where occurring events result in a situation that is fundamentally different to what was in the contemplation of the parties when the contract was made. 

Prior to the decision in Taylor vs. Caldwell, the law in England was extremely rigid. A contract had to be performed, notwithstanding the fact that it had become impossible of performance, owing to some unforeseen event, after it was made, which was not the fault of either of the parties to the contract. This rigidity of the common law in which the absolute sanctity of contract was upheld was loosened, in the sense that when the fundamental basis of the contract goes, it need not be further performed, as insisting upon such performance would be unjust.

It has also been held that applying the doctrine of frustration must always be within narrow limits. In an instructive English judgment namely, Tsakiroglou & Co. Ltd. v. Noblee Thorl GmbH, despite the closure of the Suez canal, and despite the fact that the customary route for shipping the goods was only through the Suez canal, it was held that the contract of sale of groundnuts in that case was not frustrated, even though it would have to be performed by an alternative mode of performance which was much more expensive, namely, that the ship would now have to go around the Cape of Good Hope, which is three times the distance from Hamburg to Port Sudan. The freight for such journey was also double. Despite this, the House of Lords held that even though the contract had become more onerous to perform, it was not fundamentally altered. Where performance is otherwise possible, it is clear that a mere rise in freight price would not allow one of the parties to say that the contract was discharged by impossibility of performance.

 

USA 

Twenty years after the in the English case of Taylor v. Caldwell (1863) the United States adopted the same rule of law in an aptly-named case called The Tornado. The Supreme Court determined the owner of a ship named the Tornado was not required to deliver freight on his vessel as contemplated by a contract, because his ship had accidentally caught fire before the ship commenced voyage and was rendered unseaworthy. It was observed that the Tornado could no longer deliver the goods, but the parties had failed to include a clause in their contract governing this situation hence the court expressly adopted that If a contract does not include a force majeure clause, the courts will apply the above common law principles first laid out in the English case of Taylor v. Caldwell. 

The point to be considered is whether the performance is objectively impossible or impractical? If neither the Force Majeure clause nor state law specify a standard, then courts often examine the impracticability of performance.

Although impracticability is a somewhat more lenient standard than impossibility, it still sets a high bar. For instance, it is widely observed that a substantial increase in the cost of performing contractual obligations, despite being caused by a Force Majeure event, does not render performance impractical, even if it results in a sizeable financial loss to the business. For example: 

  • A federal district court in Hawaii found that, while it made “good business sense” to cancel a conference five months after the September 11 attacks due to extremely low attendance (and resulting out-of-pocket expenses), performance was not impractical

  • The U.S. Court of Appeals for the District of Columbia  in the case of Transatlantic Fin. Corp v. United States held that Egypt’s closure of the Suez Canal following its nationalization did not render a cargo ship’s performance impractical, even though its alternate route added 3,000 miles and increased costs by 14 percent

Where a contract between parties includes a Force Majeure clause, if terms like “epidemic” or “public health restrictions” appear in the clause, then it is very likely that Corona-Virus, which the World Health Organization declared a pandemic, would be considered a force majeure event.

Even when a force majeure event indisputably occurs, courts examine whether the impediment to performance can be attributed to that event.   For instance, in the September 11 case cited above, the court alternatively found that the link between the attacks and low attendance rate for the conference was too attenuated.   Although the organizers presented evidence that the attacks severely impacted the tourism and travel industries, the court was of the view that the said evidence did not demonstrate that it was “objectively inadvisable” to travel or that there was a specific threat of a terrorist attack in the host city.

It is worth noting that states like California, Delaware, Nevada, and Utah, explicitly recognize impracticability.  Conversely, other states, such as New York, appear to excuse a party’s performance only if it is objectively impossible based on the unforeseen destruction of the means of performance. Moreover, in some states, the common law doctrine of impracticability requires that the event inhibiting performance be unforeseen.

Further, it is pertinent to note that where the Force Majeure clause does not specifically provide for pandemic/ epidemic, but a general category for ‘Act of God’, the Courts in USA do have a standard outlook. For example, at the time of outbreak of Spanish Flu (in 1918), in 1921, the Illinois Supreme Court in Phelps v. School District No. 109, Wayne County, held that an epidemic was not an Act of God that would allow the school district to avoid paying teachers who were ready, willing, and able to teach, but were prohibited from doing so by school closures.

 In contrast to this, Courts in USA have specifically held that the expression ‘Act of God’ includes a pandemic/ epidemic; in Coombs v. Nolan, the District Court for the Southern District of New York excused a delay in the discharge of cargo where the defendant could not obtain enough horses to unload a ship on time due to a then prevailing horse flu pandemic on the ground that the horse flu pandemic fell within the ambit of ‘Act of God’.

The North Dakota Supreme Court in Sandry v. Brooklyn School District No. 78 of Williams County held that a school district was excused from paying a driver for his services during the school closure, by determining that the pandemic was an Act of God and that non-payment be exempted.

In SNB Farms Inc v. Swift & Company where the District Court of the Northern District of Iowa (Eastern Division) held that Porcine Reproductive and Respiratory Syndrome affected hog production and triggered the Force Majeure Clause. However, the Court in this case held that due notice had not been given to the counter party of the force majeure event.

AUSTRALIA

As per Australian law, a force majeure clause is a contractual mechanism, rather than an underlying common law doctrine hence the effect of an event falling within the category of "force majeure" is dependent upon what the contract says will happen in those circumstances.  Force majeure events generally listed in a contract include acts of God, strikes, wars, embargos and supervening legislation. Over the years, "internet failure" and "acts of terrorism" have become common inclusions, while the Severe Acute Respiratory Syndrome (SARS) virus of 2003 caused many template definitions to be updated to include "epidemics" and, for the far-sighted, "pandemics". 

 In the absence of a force majeure clause, the Doctrine of Frustration comes into operation. A frustrating event operates to discharge the whole of the relevant contract, even where a contract contains severable obligations. No right to claim damages arises due to a contract being frustrated.

The Doctrine of Frustration, at common law, stands to be similar to that understood in India in the sense that there are numerous factors of varying weight to consider when determining frustration. The mere existence of hardship and impossibility to perform a contract does not necessarily establish frustration. Rather hardship may be construed to invoke a duty to renegotiate the terms of the contract.

 In the case of Codelfa Construction Pty Ltd v State Rail Authority of New South Wales, it was observed that for an event to be regarded as a “frustrating event”, generally it must have been unforeseeable at the time the contract was entered into. It was further observed that performance does not need to be literally impossible to frustrate a contract, it can be commercially impracticable. Even if it is literally impossible, the contract may not be frustrated if the promisor assumed the risk of the event in question.

While force majeure largely depends upon the terms of a contract between parties, the harshness of the common law in regard to frustration has been modified in some jurisdictions – New South Wales, Victoria and South Australia have enacted legislation that allows the court to adjust the position of the parties to prevent unfairness that could arise under common law where the traditional approach is "losses lie where they fall". The legislation provides that money paid under a frustrated contract can be recovered; and that partial performance is compensable. Those seeking to rely on the legislation need to consider whether it applies to their contract, as the legislation exclude certain contracts, such as contracts for the carriage of goods by sea.

COVID-19 and Possible Implications of Force Majeure Provisions in Contracts  | Beyond The Fine Print

 


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Rudra Law Firm

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