CLAT 2020 Legal Reasoning: COVID-19 induced 'Force Majeure' in Contracts

The COVID-19 pandemic has taken the entire world hostage in less than four months, and the global economy has been hit the hardest with governments across the globe implementing stringent policies including lockdown to control the coronavirus outbreak. The pandemic today presents unprecedented challenges and impediments to businesses in conducting their normal operations. The lockdown across the world has caused delays in the performance of contracts and transactions. Now, the question that arises is whether the current situation can enable parties to a contract to alter their obligations with non-compliance of terms neither being regarded as a "default committed by any party" nor a "breach of contract"? There are certain well-accepted practices for dealing with such extraordinary situations in commercial transactions by the inclusion of force majeure & material adverse effect (MAE) clauses. Determination of the types of circumstances so covered by the force majeure clause contained in a contract is essential. Provisions of force majeure often cover natural disasters like hurricanes, floods, and earthquakes as "acts of God." Other covered events may include war, terrorism, civil disorder, fire, disease medical epidemics or by reasons of applicable laws or regulations. Broadly, the Courts have interpreted the term "Force Majeure" as an event that can neither be anticipated nor controlled by either of the contracting parties. A force majeure clause applies in the context of ongoing contractual arrangements, whereas, an MAE or material adverse change (MAC) clause applies to the allocation of risk in transactions before their closure or completion. Pandemic and related consequences such as government action is a type of event covered by a force majeure clause, however, its impact on the affected party's ability to perform its contractual obligations may vary depending upon contractual terms. It is common for force majeure clauses to specify the impact that the event or circumstances in question must have, in order for the clause to be triggered. References may be made, for example, to the event or circumstances having "prevented", "hindered" or "delayed" performance. These terms require different levels of impact on performance before a party can claim recourse to these clauses. In other words, the force majeure and MAC clauses act as an exception to what would otherwise be treated as a breach of contract. Certain contracts may state that, if a force majeure clause is applied, the contract may automatically be terminated. On the other hand, some contracts may even state that the duty to fulfil the contractual obligation may be suspended for a certain period of time and if the force majeure event is not curbed or treated even after such time, then eventually the contract may be terminated. Though there cannot be a one-size-fits-all solution to this question, and it depends upon how the force majeure clause is worded in a specific contract; and in the absence of the same, applicable laws related to the same will be required to be taken into consideration.
[Excerpt from Business Today, by Ranjana Roy Gawai, April 17, 2020]

Typically, the MAE (Material Adverse Change) provision in an agreement contemplates events which if they occur, or are likely occur, would have a "materially adverse change or effect on the assets, business, property, liabilities, financial condition, results, operations of the target" or that "affects the ability of the transacting parties to consummate the transaction" or the "validity or enforceability of the transacting parties to its rights and remedies under the transaction documents". Which of the following sample clauses in a contract resembles an MAE clause?

MAE events typically include changes in the financial or controlling power of one of the contracting parties. This event is not completely beyond control of the party, but it significantly affects its ability to transact business with the other party.

Option (a) mentions ‘Act of God’ (completely unanticipated) and ‘damages reasonably beyond control of the party’. This is a Force Majeure clause.

Option (b) clearly states “failure as a result of cause beyond its control…” – hence it is also not a MAE clause.

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