Managing Contracts

Implications of force majeure in light of contractual disruptions

The COVID-19 outbreak has resulted in unprecedented times. Construction contractors are experiencing disruptions due to shortages of raw materials, equipment and labour, idling plants and machineries, etc.

At a recent webinar organised by Indian Infrastructure, Rajesh Banga, arbitrator, Ministry of Housing and Urban Affairs; A.K. Gupta, executive director, operations, Afcons Infrastructure Limited; Puran Kumar, head, contract management, L&T Limited; Ajay Mishra, president, contract and claim management, DilipBuildcon Limited; Sanjoy Mukherjee, executive director, projects, Engineers India Limited; L.P. Padhy, chief general manager, National Highways Authority of India; and Atul Sharma, managing partner, Link Legal India law Services, discussed force majeure in light of contractual disruptions, consequences of force majeure, potential strategies and the need for long-term contract renegotiations…

In perspective – Legal aspects of the force majeure clause

The term force majeure is of French origin and translates to superior force. A party claiming force majeure must establish that:

  • The event adversely affects or prevents the performance of its contractual obligations
  • The event is of such permanence that further performance of the contract is not possible
  • Such non-performance is due to circumstances beyond its control
  • It is not possible to take any reasonable steps to prevent, mitigate or overcome the event.

Most contracts require that the affected party must notify the counterparty about such conditions within a specified time frame and must thereafter provide periodic updates. In the Indian context, contract frustration is the relevant principle. Unlike force majeure, which is a contractual provision, contract frustration is statutorily provided under Section 56 of the Indian Contract Act.

Two genres of force majeure

Force majeure clauses can be classified into two kinds – illustrative and exhaustive. Illustrative clauses may list out non-descriptive events that may qualify as force majeure events and set down broad parameters of force majeure events, while exhaustive clauses specifically list all events such as war, terrorism, epidemics, floods, natural calamities, actions of governments, strikes, lockouts, etc.

The present COVID-19 situation is an interesting event as it may be covered either as an “epidemic” or a “government order/action” due to the restrictions put in place by the central/ state governments enforcing the lockdown.

As per the model concession agreement (MCA) and the documents drafted by NITI Aayog, the force majeure clause can be classified into three categories – non-political, political and indirect political. Under a non-political clause, the parties (the concessioning authority and the concessionaire/contractor) decide on extension of the construction time since the construction activity was stopped during the lockdown. However, there is no cost compensation in the case of a non-political clause. In the case of a political clause, the concessioning authority bears all the costs associated with the force majeure event. Usually, the costs covered include the additional operations and maintenance costs that the contractor has to incur and the cost of additional interest on debt.

Consequences of force majeure

The consequences of force majeure may include excusing the affected party from performing its obligations in whole or in part, extension of time and, in some cases, payment of costs incurred for the duration of the event. Though most force majeure clauses provide for temporary suspension of contractual obligations, some even provide for termination of the contract when the force majeure event persists beyond a defined time frame.

Is force majeure the only option?

In most infrastructure projects, force majeure provisions may not provide compensable relief to contractors/concessionaires. Other provisions such as “change in law” may entitle the contractors/concessionaires to claim costs or revenue. The International Federation of Consulting Engineers’ Silver Book for engineering, procurement and construction (EPC) contracts allows the contractor to claim costs on account of force majeure conditions either as a consequence of the force majeure event or as a “change in law”. However, a pandemic is not covered as an event eligible for claiming costs.

The MCA for build-operate-transfer (BOT) projects recommended by NITI Aayog which is commonly used in road projects by the National Highways Authority of India and in some other infrastructure projects as well provides for compensation in case of “change in law”.

Force majeure and disputes

Force majeure and disputes are closely linked with each other. Resolution of disputes relating to force majeure would be contract specific and would depend on the remedy provided under the contract. Remedies to the present crisis may not necessarily be confined to force majeure clauses. There could be other forms of redressal under the contract. Most construction and infrastructure contracts provide for arbitration because it requires expert evaluation. Some construction contracts provide for pre-arbitration binding or non-binding determination such as dispute resolution boards.

How to manage the COVID crisis?

Most contracts include either epidemics or governmental action as a force majeure event. The current COVID situation attracts both as it is an epidemic and there were government directions ordering a lockdown as a result of which contractors/concessionaires were compelled to suspend operations.

Contractor and operator perspective – A political or a non-political event?

Force majeure has become one of the worst phrases since the outbreak of the COVID-19 pandemic, with all construction contracts currently facing the brunt of the virus. While the outbreak started as a non-political event, it took a political turn with the government invoking the Epidemic Diseases Act, 1897, and the Disaster Management Act, 2005, issuing orders for the lockdown, and restraining contractors from action that they could otherwise have taken.

COVID-19 has resulted in the concurrent occurrence of two situations – political force majeure and a “change in law”. While the lockdown was enforced, conditions under both the situations prevailed. However, post-lockdown, the “change in law” provision ceased to exist.

One aspect of force majeure events is that under this only time extensions are allowed. However, the damages to contractors include loss of wages (the government has asked contractors to continue to pay wages despite no work being carried out), deployment of machinery and escalation in costs because of passage of time. The contracts are silent with respect to the payment of wages. However, they specify that if the contractor is not able to carry out construction works for a period of one month, wages will be payable and the contractor will bear the loss for a month. If the lockdown period persists for over a month, the agencies (concessioning authority) will need to pay the costs incurred for the duration of the event to the contractors. With respect to the payment for machinery and other equipment, the concessioning authority is liable to pay only when there is a breach of contract by the authority itself. Since there is no breach of contract in the case of COVID-19, Section 73 of the Indian Contract Act does not apply. Finally, with respect to cost escalation, escalation clauses are already in place in most contracts.

To add to their woes, the months of March, April, May and June are prime months for construction companies to execute work. Due to the lockdown, labourers have returned to their villages and government rules are not permitting them to travel from one place to another. Technical project teams are also not travelling. Hence, even though construction activities were allowed to start after April 20, 2020, albeit on a limited scale, there have been supply chain management problems, labour availability issues, issues of local markets not having returned to normal, etc.

While force majeure is not exclusively covered under EPC, BOT and hybrid annuity contracts, epidemics are covered as a non-political event. The Ministry of Finance has stated that the COVID-19 situation will be considered as force majeure, though individual contracts will need to be looked at to check the provisions under which force majeure will be covered.

The way ahead

At a time when contractors are already under extreme stress due to stoppage of work and when banks are also shying away from helping them out in the near term, only proactive steps by the government can prove to be a panacea to their problems.

As per general consensus, while the government is calling COVID-19 a non-political event, contractors are referring to it as a political event due to the issuance of lockdown notifications by the government. That said, there is a dire need for a midway solution to ensure that the industry survives and moves forward. In this regard, a final decision needs to be taken at the earliest since a failure to take a concrete decision will result in arbitration in courts, resulting in a further waste of time and effort.

Though the nature of force majeure is yet to be determined, some compensation has to be paid to parties that have suffered losses due to an event beyond their control. Currently, the government is considering the nature of force majeure and is weighing all the options. While it is too early to say whether the final decision from the government will be to apply the provisions under “change in law” or force majeure, or a combination of the two, it is surely expected to be a rational one.

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