Abstract

Over the last one year the world has been facing and fighting the COVID – 19 Pandemic. As a result of the contagious nature of the disease, countries have resorted to imposing lockdowns with strict measures which in turn has negatively affected the production, transportation and general supply chain of goods and services, across the globe. The energy sector stands to be one amongst the several industries to have been severely impacted, largely due to its nature of being classified as an essential service and/or the cross – border, multiparty contracts that are more often than not inevitable in energy deals. Consequently, there arises a gridlock situation where a party to the contract (usually the supplier) is unable to perform due to reasons beyond its control, and the buyer is left stranded, also due to reasons beyond its control. This article aims to understand the application of the doctrines of force majeure and hardship in such situations through a combined method of case study and comparative analysis.

What are the doctrines of Force Majeure and Hardship?

The general rule of law with respect to agreements is that they must be kept, i.e., Pacta Sunt Servanda. However, under certain circumstances (usually not within the control of the parties), one or more parties to the contract may not be in a position to perform their obligations in the contract. These situations are captured under doctrines developed by the Romans – rebus sic stantibus (things thus standing) and impossibilium nulla est obligation (there is no obligation to perform impossible things). In a nutshell, parties are exempted if an unforeseeable situation not within their control prohibits them from complying with their obligations. The doctrine as it stands today was identified and applied by Justice Blackburn when he held that parties to a contract should be excused when performance becomes impossible without the default of the parties. [1] Since then, impossibility, force majeure and/or hardship have become grounds for exemption in almost every legal system. Article 1148 of the Code Civil in France, S. 2-615 of the Uniform Civil Code in the United States of America, Article 156 of the Vietnam Civil Code are some examples of laws that recognize force majeure. Additionally, international law such as Article 79 of the Convention on the Sale if International Goods (CISG), Article 6:111 of the Principles of European Contract Law also recognize frustration of contract due to force majeure. Countries such as Germany, Austria and Greece [2] have also codified hardship and recognize the right to adapt the contract on such grounds. [3] Article 6.2.2 of the UNIDROIT Principles of International Commercial Contracts defines hardship and allows for renegotiation, adaptation and/or termination as consequences for hardship.

A question that follows from the above paragraph is if there exists a difference between force majeure and hardship. There is a tendency to sometimes interchangeably use force majeure and hardship. However, a deeper understanding of the both will reveal that such is not the case. A force majeure event usually involves (a) an event caused due to external circumstances (b) unforeseen by the parties and therefore not preventable, and (c) this event more often than not, renders performance impossible either forever or for a period of time. However, the same cannot be said for hardship. Hardship is when the occurrence of an event changes the equilibrium between the rights and obligations of the parties to an extent where performance of the contract becomes unviable. Essentially, in a situation of force majeure, performance of obligations is altogether impossible whereas in a situation of hardship, performance may be possible but commercially onerous for one party, thereby creating an imbalance between the parties. The difference between force majeure and hardship also exists with respect to the remedies available. In the former, termination is sought as a relief since there is complete frustration of contract, i.e. parties are no more in a position to perform their obligations and abide by the contract. However, in a situation of hardship, termination of the contract is a last resort and parties instead opt for renegotiation or modification of the contract. [4]

Construction of FM and Hardship clauses in energy contracts – India

Hardship and force majeure clauses are essential to energy contracts especially owing to the fact that these contracts are mostly long-term, cross-border agreements. Therefore, there is a probability of several events such as government sanctions, disasters and price volatility that may occur during the time period of such contracts, affecting the performance and obligations of parties. In situations where the hardship clause is triggered, especially in energy contracts, parties prefer renegotiation or modification as opposed to termination. [5] A major reason for this preference is due to the fact that the energy and natural resources industry is comparatively narrow, and parties do not want to terminate contracts at the risk of being viewed as incompatible for business, or losing business. [6]

Under Indian law, the Indian Contracts Act (1872 (Contracts Act), particularly Sections 32 and 56, govern the concepts of force majeure and frustration of contracts. While the concept of hardship is not codified under Indian law, the Supreme Court has held that the meaning of the word “impossible” under Section 56 is not restricted to physical or literal impossibility. It also includes within its ambit, any event that upsets the foundation of the contract or that which renders the performance of an act impracticable to the promisor. [7] The approach of the court in distinguishing between impossibility and impracticability portrays the intention of the judiciary to differentiate between force majeure and hardship, and to include hardship within Section 56 of the Contracts Act.

However, the Supreme Court’s decision in Energy Watchdog v. CERC is not in sync with the previous judgements of the Supreme Court on this matter. Unfortunately, it also seems to be a setback for energy contracts vis-a-vis hardship. The dispute in this case concerned long term Power Purchase Agreements (PPA) between Adani Power Limited (APL) and certain utilities in Gujarat and Haryana. Under the PPA, APL was to supply power to state utilities in Gujarat and Haryana and for doing so, APL was sourcing a majority of the coal required, from Indonesia. However, after the execution of the PPA, the export prices of the coal drastically increased due to sanctions imposed by the Indonesian government. This resulted in the purchase price of coal significantly increasing, leading to the PPA becoming unviable for APL. Consequently, APL sought relief under the force majeure clause in the PPA and additionally argued that the PPA had been frustrated under Section 56 of the Contracts Act. While rendering the judgement, the court examined the history of frustration of contracts and observed that as per common law, frustration of contract can take place only if the fundamental basis of the contract were to be affected. It further observed that Section 32 of the Contracts Act involves intention of the parties and would therefore apply in situations where the contract expressly or impliedly deals with force majeure. Section 56 of the Contracts Act on the other hand, is objective in nature and would apply when force majeure clauses are not present in contracts. Finally, the court held that change in price of the coal did not meet the threshold of frustration since APL had an option of procuring coal from elsewhere and the price rise was a risk they took while entering into a PPA with a non-escalable tariff. Therefore, the increase in coal price resulted in onerousness but did not render the contract impossible to perform. Further, the Supreme Court completely discarded APL’s argument with respect to Section 56 of the Contracts Act on the grounds that the PPA has a force majeure clause.

This judgement of the Supreme Court is highly criticized and rightly so. At the outset, the Supreme Court’s decision to refer to the doctrine of frustration under the principles of common law without applying the same doctrine espoused in the Contracts Act and relevant decisions, is inexplicable. Further, the Supreme Court failed to consider an important aspect – the force majeure clause in the PPA did not entirely exclude price changes and had several references to government embargoes and decisions. This clause warranted the Supreme Court’s attention as the rise in coal prices was due to the Indonesian government’s interference. The Court also overlooked the fact that an energy law contract merits treatment that is different from other contracts owing to their nature of being long term, transnational agreements involving goods that are price sensitive. Finally, the Supreme Court in passing this decision, failed to uphold the commercial sense of contracts that was well captured in the case of Satyabrata Ghose v. Mugneeram Bangur [8].

COVID, FM/Hardship and Energy Contracts

The COVID-19 pandemic has unfortunately disrupted operations all across the globe and has left parties and courts flummoxed on how to treat nonperformance of obligations. However, this is not the first time that courts have dealt with epidemics and frustration of contracts. A decision by the North Dakota Supreme Court, as old as 1921 recognized the Spanish flu to be an “Act of God” and exempted a school from paying dues to a bus driver for his services during the flu outbreak. [9] A more recent example is from 2005 when the China International Economic and Trade Arbitration Commission passed an arbitral award refusing to grant an exemption to parties who had signed the contract two months after the breakout of the SARS epidemic. The award held that there was no hardship of force majeure under Article 79 of the CISG since the parties could not meet the threshold of foreseeability, amongst the other prerequisites under Article 79 of the CISG. [10]

With respect to COVID-19 in India, the Ministry of Finance issued a clarification through an office memorandum stating that COVID-19 should be considered as a natural calamity and force majeure may be invoked wherever necessary, following due process as per the office memorandum. It further states that “a force majeure clause does not excuse a party’s non-performance entirely, but only suspends it for the duration of the force majeure. The firm has to give notice of force majeure as soon as it occurs and it cannot be claimed ex-post facto…If the performance in whole or in part or any obligation under the contract is prevented or delayed by any reason of force majeure for a period exceeding ninety days, either party may at its option terminate the contract without any financial repercussion on either side”. [11] While this is a welcome move, it is to be noted that this office memorandum is limited in its recommendations and is only a guiding document as opposed to a binding one. 

Specifically concerning the energy sector, the Ministry of New and Renewable Energy (MNRE) has taken the view through its office memorandum that renewable energy generating stations must not stop operations. In furtherance of the same, DISCOMS are directed to continue making payments to generating stations. However, the MNRE has not taken into consideration the several issues faced by the power sector due to the government announced lockdowns. For example, shortage of manpower, supply chain disruptions, fall in revenue realisations by DISCOMS and cash liquidity issues are some of the basic problems plaguing the energy sector. There has also been a sharp decline in the prices of gas and oil, specifically in Asian markets. [12] As per a report by the International Energy Agency, countries that have gone under a lockdown are facing an average of 25% decline in energy demand. [13] The office memorandum is also in conflict with the force majeure clause in the Power Sale Agreements governing the sale and purchase of power between DISCOMS and the Government. This raises the question on how courts will decide disputes arising relating to COVID-19 and force majeure, arising out of these Power Sale Agreements. However, it is certain that if courts are to rely on the  judgement in Energy Watchdog v CERC, the players in the energy sector can expect more harm than help with respect to this question.

At this point, it is clear that it is pertinent for India to review and revamp its position on hardship and force majeure, in a holistic manner that is concurrent with its growing international presence. It would help if Indian courts can adapt the doctrine of hardship along with modification of contracts as a relief, especially in light of the fact that India is a member to the UNIDROIT.

About the Author

Meenakshi KK. is a former associate at Trilegal Bangalore and is an alumnus of National Law Institute University (NLIU).

Editorial Team

Managing Editor: Naman Anand

Editors-in-Chief: Akanksha Goel and Aakaansha Arya

Senior Editor: Kanak Mishra

Associate Editor: Mitali Kshatriya

Junior Editor: Dipali Singh

Preferred Method of Citation 

Meenakshi KK., “Force Majeure & Hardship Clauses in Energy Contracts in Light of the Pandemic” (IJPIEL, 18 June 2021)

<https://ijpiel.com/index.php/2021/06/18/force-majeure-hardship-clauses-in-energy-contracts-in-light-of-the-pandemic/>

Endnotes

[1] Taylor v. Caldwell [1863] EWHC J1 (Eng.).

[2] Bürgerliches Gesetzbuch [BGB] [Civil Code] §§ 313, 936, 1052, 1170a (Austria); Astikos Kodikas [A.K.] [Civil Code] Article 388 (Greece).

[3] Ingeborg Schwenzer, Force Majeure and Hardship in International Sales Contracts, 39 VUWLR (2008).

[4] Catherine Kessedjian, Competing Approaches to Force Majeure and Hardship, 25 Int’l Rev L. & Econ. (2005).

[5] A. Kolo & T.W. Walde, Renegotiation and Contract Adaptation in International Investment Projects, 1 JWIT 5 (2000).

[6] 3 W.L. Craig, W.W. Park, & J. Paulsson, International Chamber of Commerce Arbitration, 142 (1990).

[7] Sushila Devi v. Hari Singh, (1971) 2 SCC 288 (India), referring to Satyabrata Ghose v. Mugneeram Bangur and Co., AIR 1954 SC 44 (India).

[8] Id.

[9] Phelps v. Sch. Dist. No. 109, Wayne Cty., 134 N.E. 312, 312 (Ill. 1922).

[10] L-Lysine case (2005) (China International Economic & Trade Arbitration Commission CIETAC (PRC) Arbitration Award), <http://www.cisgw3.law.pace.edu/cases/050305c1.html#cx> Accessed 4 June 2021.

[11] No.F. 18/4/2020-PPD Office Memorandum Force Majeure Clause, issued by Department of Expenditure, Procurement Policy Division, Ministry of Finance, Department of Expenditure (Feb. 19, 2020), https://doe.gov.in/sites/default/files/Force%20Majeure%20Clause%20-FMC.pdf.

[12] Global Energy Review 2020, International Energy Agency (Apr. 2021), https://www.iea.org/reports/global-energy-review-2020.

[13] Id.