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“Gasmaggedon” Sweeps Over Global Gas Market
Manufacturers entangled in logistical nightmare as virus-hit China limps back to work
Coronavirus casts a shadow on solar projects
The above headlines are a stark reminder that the humanitarian challenges brought about by the outbreak of Severe Acute Respiratory Syndrome Coronavirus 2 (SARS-CoV-2) that is causing the Coronavirus disease (COVID-19) are closely followed by logistical challenges and economic impact.
On 11 March, 2020, the World Health Organisation (WHO) classified the outbreak as a “pandemic”, which is considered more severe than an “epidemic” because of its geographical spread. There is scarcely an area of economic activity that is untouched by the outbreak.
The crisis has shone a spotlight on over-dependence of supply chains from China. Once the worst is behind us, the decoupling from China that had already commenced against the backdrop of rising labour costs and trade tensions may accelerate.
In India, certain industries have been especially affected by the outbreak.
In the pharmaceutical industry, China’s dominance of the active pharmaceutical ingredient (API) is now being re-examined. It is estimated that Indian pharmaceutical companies rely on China for approximately 70% of their API requirement.
There is an apprehension that if the epidemic continues, manufacturing facilities of pharmaceutical companies in India, which is the world’s largest manufacturer of generic drugs, will be affected. India has announced restrictions on the export of twenty-six ingredients and the medicines made from them. There is already evidence that prices of certain drugs in India have started to increase.
Already reeling from demand shock, the automotive industry in India is preparing for transition to higher emission standards from 1 April 2020. Over-dependence on suppliers in China for automobile parts and components is presenting the industry with another headache. Most of the major manufacturers are apprehensive that production cuts will be inevitable as activity in the supply chain in China and South Korea have been curtailed. Securing alternative sources of supply from Europe, Japan and Thailand in a short span of time is not practical.
One of the worst affected sectors in India may be renewable energy projects. China is a leader in the global solar supply chain; nine of the top ten cell makers in the world are Chinese. It is estimated that Indian solar power producers meet approximately 80% of their requirements for solar cells and modules from China. To take advantage of the generally falling prices of PV technology and the relatively short construction period for solar PV projects, power producers pursue aggressive scheduling of supply and services contracts with their contractors.
This is risky because unexpected delays in procurement and construction can lead to critical delays in the commissioning of projects and expose the producers to liability under power purchase agreements (PPAs).
Solar power producers in India, already struggling with wafer-thin margins on the back of record-low tariffs and a volatile depreciating Indian Rupee, are being battered by a perfect storm: regulatory risk, the ballooning of regulatory assets and payment risk. There are even murmurs of discontent about producers experiencing higher-than-expected degradation in their solar plants owing to significant variability in the quality of solar cells.
The author is fielding enquiries from solar power producers in India concerned about notifications they have received from their suppliers in China about delays in manufacturing, inspection, certifications from accredited labs and transportation. The imposition of quarantine, production bans and city-wide lockdowns may have a significant impact on ongoing projects and impair contractors’ abilities to participate in new projects.
Prolonged disruption due to SARS-CoV-2 can impact projects due for commissioning later in 2020. If the producers’ delay is significant (beyond 6 months), the consequences become more severe: contracted capacity of projects may get reduced or an event of termination may be said to have occurred with secondary obligations to pay additional damages ensuing.
At the time of this article, it is not clear whether there exists in law valid grounds for affected parties to receive relief from liability for delayed or failed performance of contracts in the aftermath of the outbreak of SARS-CoV-2.
The doctrine of force majeure is a creature of contractual innovation. Its precise scope is agreed between the parties in the terms of the underlying contract. Force majeure is not a term of art and the contract will have to define with care the parameters of the relief that will be afforded to the parties.
Force majeure provisions import the principle that upon the occurrence of an event or circumstance that is not reasonably within the control of and would not have been avoided or overcome by a party, which prevents or delays that party from performing some or all of its contractual obligations, that party will be relieved from liability which might otherwise arise as a result of that party’s failure to perform those affected obligations.
Force majeure provisions do not suspend the requirement for performance and typically require the affected party to continue to perform its obligations to the extent not prevented by the event of force majeure. In some contracts, after a period of prolonged event of force majeure, parties may be permitted to terminate the contract with moneys being payable depending on the nature of the force majeure event.
The practical utility of force majeure contrasts with the rigid common law doctrine of frustration, although they are similar in the sense that they both deal with occurrences beyond the control of parties to an agreement.
Under the doctrine of frustration, where subsequent to the execution of a contract, the emergence of supervening circumstances beyond the control of the parties renders further performance of the contract impossible or radically different from what had been contemplated in the contract, the contract will be terminated and the parties will be discharged from the requirement of further performance.
The doctrine evolved as a means of mitigating the perceived harshness of the law’s requirement for strict compliance with a promisor’s promises. Under Indian law, the doctrine of frustration is well-developed by judicial precedents interpreting Section 56 of the Indian Contract Act, 1872.
The following are the key considerations for affording a party force majeure relief:
Burden of proof
The affected party carries the burden of proving the validity of its claim for force majeure relief. It has to adduce evidence that an event of force majeure occurred, which was beyond its reasonable control and which prevented or delayed its performance of the affected obligations.
Scope and interpretation
As noted above, because there is no accepted definition, force majeure provisions typically identify a series of events or circumstances that can legitimately be claimed by a party as an event of force majeure. This is critical because the event or circumstance must fall within the definition of force majeure if the affected party is to have any prospect of securing relief.
This will turn on the specific wording of the provision subject to the rules of contractual interpretation. In disputes arising out of sophisticated and complex contracts, tribunals will carry out a textual, natural and ordinary interpretation of the force majeure provision in order to ascertain its objective meaning.
A force majeure provision may set out an exhaustive list of events or circumstances that constitute events of force majeure. Commonly listed items are occurrences such as adverse weather conditions, explosions, fire, acts of God and other natural catastrophes. It is not clear whether in the selection of the above descriptions of events or circumstances, the outbreak of SARS-CoV-2, which is a biological entity that can cause an infectious disease, would fall within the contemplated use of the provision.
The concept of force majeure is wide enough to accommodate man-made interventions such as wars, blockades, strikes and legislative and executive interference and can even be extended on account of changes in law, economic hardship, and accidental damage to specified facility.
Alternatively, a force majeure provision may set out an inclusive list that recites several events or circumstances for the purposes of illustration only, with a catch-all provision that force majeure relief will also be extended on account of any other event unless that other event is specifically named in a list of excluded items.
In any event, the interpretive rule of ejusdem generis – that when a list of specific items belonging to the same class is followed by general words, the general words are to be treated as confined to other items of the same class – will be used to determine contractual intention.
A force majeure provision may exclude outright certain events such as changes in either party’s market factors, a party’s inability to finance its obligations under the agreement or the unavailability of funds to pay amounts when due, breakdown or failure of plant or equipment caused by normal wear and tear or by a failure to properly maintain such plant or equipment from constituting events of force majeure.
Occasionally, events that are carved out of force majeure can be brought back within its fold if those events were themselves the consequence of an event of force majeure. For example, in some PPAs in the solar power sector in India, the unavailability or late delivery of equipment, although not an event of force majeure by itself, may constitute an event of force majeure if it was the consequence of an event of force majeure.
Another key threshold consideration is causation. Depending on the precise wording of the force majeure provision, it is for the affected party to demonstrate that an event of force majeure (and not some other factor) delayed performance of the contract (i.e. a lower standard) or caused the failure in performance of the contract (i.e. a higher standard) notwithstanding the commercially reasonable efforts of the affected party to overcome or mitigate the effect of the event of force majeure.
The affected party is required to notify its counterparty of the occurrence of an alleged event of force majeure within a specified timeframe and failure to do so can be fatal to its eligibility to force majeure relief. The notice requirement is ongoing and the affected party must continue to update the notices periodically during the subsistence of the event of force majeure specifying the actions being taken to remedy the event.
The extent of force majeure relief will be affected by the following considerations:
Duty to mitigate
In the unlikely event that an express duty to mitigate is absent, a duty to do so may be implied albeit on commercially reasonable terms, which can be ousted only by clear and unequivocal language. Provisions may specify the extent to which a party declaring force majeure must mitigate not only the event of force majeure but also its effect.
In some PPAs used in the solar power industry in India, there are express provisions that require power producers to make reasonable efforts to mitigate the effect of an event of force majeure.
Might it be reasonable to expect a solar power producer to attempt to source modules and other equipment from alternative vendors? Did the producer make effort to obtain quotations from alternative vendors and freight forwarders and be able to demonstrate that it did so? Did the terms of those quotations meet the standard of commercial reasonableness given that prices from alternative vendors in Taiwan and Malaysia are estimated to be about 15 to 20% higher than the prices that are typically quoted from vendors in China?
In light of the global footprint of SARS-CoV-2, was there available capacity with any other manufacturer in any event? Were there pre-existing or concurrent delays attributable to the power producer that were aggravated by the delay caused by the event of force majeure? Given that businesses endured the outbreak of another virus in 2002 (SARS-CoV), was the outbreak of SARS-CoV-2, in fact, not unforeseeable?
These are all key issues that a tribunal will have to address if a power producer’s counterparty contests its claim for force majeure relief.
Force majeure certificates issued by governmental agencies may aid an affected party’s efforts in securing force majeure relief, but they may not prove determinative.
In a long-term LNG sales and purchase agreement, it was an express term that an “epidemic” would constitute an event of force majeure. The WHO’s categorisation of the outbreak as a “pandemic” may be of significant persuasive value in cases where the force majeure provision contains appropriate language.
In response to industry concerns, on 19 February 2020, the Department of Expenditure, Ministry of Finance, Government of India issued a cryptic Office Memorandum stating that the outbreak that has caused disruptions in the supply chain should be considered as a “natural calamity” and force majeure provisions may be invoked “wherever considered appropriate”.
This memorandum may persuade pliant counterparties, but it is debatable whether such certificates have force of law. Ultimately, the question of whether relief will be afforded can be settled only by construing the terms of the contract and assessing each case on its merits. Even if force majeure relief is granted, producers may need financial support to deal with working capital costs and interest payments due to delays in commissioning.
The Way Forward
The author is aware of businesses in India that have overstated their eligibility for force majeure relief. As a negotiated term of contract, the language of the provision and the facts and circumstances of the affected party will determine the prospects of a successful claim.
Alternatively, parties may wish to circumvent the effect of a restrictive force majeure provision by claiming relief under the doctrine of frustration. Owing to the more limited application of this doctrine, however, this may well be more difficult to establish. It may be that counterparties, mindful of nurturing long-term relationships, will choose to be pragmatic and accommodate claims for relief to a limited extent.
Parties wishing to assert a claim for force majeure relief need to prepare well. That involves compiling a dossier on the event or circumstance constituting an event of force majeure, retaining all relevant documents and complying with notice provisions. Those intending to resist claims for relief should scrutinise whether notice provisions have been complied with and put affected parties on notice about establishing the chain of causation.
Rajdeep Choudhury is Partner at HSA Advocates.