COVID-19 Outbreak – Is your bargain frustrated?

Introduction and evolution of the concept of frustration under Common Law

The “absolute contracts” rule[1] and one of its exceptions i.e. the contractual risk allocation clauses have already been analysed in detail and can be accessed here. Independent of the above, common law evolved many theories to carve out exceptions to the “absolute contracts” rule including:

(a) ‘Implied term’ theory i.e. if the contract was based on continued existence of a certain thing or circumstance, it would be implied that on destruction/change of the said thing or circumstance, the parties would stand excused from performance. [2]

(b) ‘Disappearance of foundation of contract’ theory i.e. if the very basis or foundation of the contract disappeared due to subsequent alteration of circumstances which were never contemplated by the parties at the time of entering into the bargain, the parties would stand discharged.[3]

(c) ‘Just and equitable result’ theory i.e. if the court found that it was unjust and unreasonable to enforce the terms of the contract in light of the altered circumstances that were not contemplated by the parties.[4]

(d) ‘Radical change of obligation’ theory, i.e. the parties would stand discharged if due to the supervening events, there was a radical change in the obligations of the parties from what they had originally contracted for. [5]

Frustration/ impossibility to perform under Indian law

Unlike common law, the Indian law of frustration has been statutorily incorporated in Section 56 of the Indian Contract Act, 1872 (“the Act”). It is for this reason that the Supreme Court held that English law and American law on frustration are merely of persuasive value and that it is sufficient if the essentials of Section 56 of the Act stand satisfied[6]. Section 56 of the Act is positive and exhaustive in nature and only applies to circumstances or events de hors the contract. Therefore, if there is any event that has been contemplated under the contract impliedly or expressly, for example, force majeure clauses, it would be governed by Section 32 and not Section 56 of the Act.[7]

Further, the test of frustration under Section 56 of the Act is an objective test, not dependent on the intention of the parties and leads to automatic discharge of contract.[8] The intention may be relevant as a matter of evidence to decide what the fundamental basis of the contract is, but unlike under English law, frustration is not a matter of contractual construction based entirely on the intention of the parties.

Section 56 of the Act is applicable when it becomes impossible to perform due to some supervening circumstances or events. ‘Impossibility’ referred therein includes practical impossibility which goes to the root of contract or affects the object or purpose of the contract, i.e. a radical change in the obligations that were never contemplated by the parties at the time of entering into the bargain.[9] For example, if the parties had entered into a contract for hiring a marriage hall on a particular date and the Government subsequently orders a shutdown on that date owing to COVID-19, the performance of the said contract becomes impossible to perform due to the unexpected shutdown ordered by the Government.

It is pertinent to point out that the term practical impossibility is a subjective term and depends on the facts and circumstances of each case. It may also depend on whether the time is the essence of contract i.e. whether non-performance of the contract within a particular time would frustrate the object of the contract. [10] An example of this can be a contract to supply masks during the COVID-19 outbreak on a specified date. If the masks are not provided before or during the COVID-19 break, the contract would stand frustrated as the object of the availment of masks was to protect oneself from COVID-19 and therefore, supply of masks within the stipulated time was of essence. It is unlikely that in a contract where time is not of the essence (like in a construction contract[11]), frustration would result from a stoppage of work due to COVID-19.

Therefore, if the parties had entered into a long term contract for construction and maintenance of roads for 2 years, the contract would not stand frustrated due to the stalling of activities for a period of 3 months in light of the government ordered shutdown on account of COVID-19. However, the consequence may be different where the contract is only for a period of 6 months. In such a scenario, shutdown for a period of 3 months may frustrate the contract thereby excusing further performance as the parties would not be in a position to substantially fulfil their obligations under the contract within the stipulated time.[12] The consequence may also be different where the frustration is owing to the principle set out in the case of Tarapore and Co. v. Cochin Shipyard Ltd.[13]in the following words:

“……..When an agreement is predicated upon an agreed fact situation, if the latter ceases to exist the agreement to that extent becomes irrelevant of otiose.”.

Therefore, a construction contract may become frustrated if it can be shown that the pricing in the contract was based on steel being available at Rs. 1000/- per unit but the price at the time of execution was Rs. 1,00,000/- per unit. However, this principle will apply only in exceptional circumstances.

It is also imperative to point out that where performance of the contract does not become fully impossible i.e. a part of the contract is still capable of being performed, the entire contract does not stand frustrated and discharged. The parties are under an obligation to perform the part of contract that is capable of being performed provided the frustrated obligations are severable and do not form the foundation of the contract.[14]

Exceptions to the Rule

The rule of frustration under Indian law is subject to the exceptions set out below:

I. Event contemplated by parties – If the parties contemplate the possibility of happening of a supervening impossibility or event in the contract expressly or impliedly, the contract does not stand frustrated on the happening of the said event.[15] An example is the presence of broadly worded force majeure clauses in contract. The contract does not stand frustrated in such cases but is merely governed by the force majeure clause.

II. Possibility of substantial performance – Mere occurrence of a supervening impossibility or event does not frustrate the contract if it is possible for the parties to substantially fulfil their obligations even after the said occurrence.[16]

III. Self-induced frustration – When the supervening event takes place due to the fault of the party pleading frustration the contract does not stand frustrated.[17] Illustratively, if the Indian Government decides to regulate the supply of oxygen cylinders through issuance of licenses during the period of shutdown, a seller who had already contracted to supply oxygen cylinders to a hospital cannot plead frustration if it fails to apply for a license and is therefore unable to supply the goods despite having sufficient knowledge about the need to obtain the license. However, the burden of proof in cases of self-induced frustration lies on the party making such an allegation[18].

IV. Onerous performance – The contract does not stand frustrated merely because one of the parties faces hardship or finds it onerous to perform the contract due to the supervening event.[19] For example, if a power supplier is not able to import fuels from certain countries in light of the COVID-19 outbreak, the contract for supply of power would not stand frustrated if there are alternate sources to avail the fuel and supply electricity even if it is onerous and results in escalation of costs. However, in certain scenarios availability of alternative sources would not prevent frustration of contract where certain specific requirements are stipulated which form the basis or foundation of the contract.

Consequential remedies

Upon a contract becoming impossible to perform, the parties may be entitled to compensation/restitution in certain scenarios:

a. Damages for non-performance of frustrated contract: A party is entitled to damages for non-performance of the part of the contract that stands frustrated provided the supervening event has occurred due to the other party’s fault. This is based on a conjoint reading of paras 2 and 3 of Section 56 of the Act.[20] Therefore, in the example of contract for supply of oxygen cylinder stated above, the hospital would be entitled to claim damages under Section 73 of the Act for non-performance of the contract.

b. Damages for breaches prior to the frustration of contract: All the claims arising out of the contract prior to the occurrence of supervening event are capable of being enforced. Therefore, a party cannot take the defense of frustration of the contract to negate its previous breaches.[21] A detailed analysis on assessment of damages in such scenarios can be accessed here.

c. Restitution of unjust enrichment: Restitution is a remedy to prevent the unjust enrichment of the defendant as against the damages which is a remedy to compensate the loss of the plaintiff. The following restitutionary remedies are available:

• Remedy under Section 65 of the Act - If a contract becomes impossible to perform under Section 56 of the Act, the party who has received any advantage prior to the occurrence of the impossibility has to restore it or compensate for it in accordance with Section 65 of the Act.[22]

• Remedy for quantum meruit - Quantum meruit as recognised under Section 70 of the Act is the duty to compensate for a good/ service non-gratuitously supplied/ provided. This remedy is available when an act is performed in the absence of a contract.[23] Therefore, where a contract stands frustrated and becomes void, a party would be entitled to compensation under Section 70 of the Act for any subsequent performance (of a bargain different from what was originally contemplated) after frustration. Hence, in the example given on the dramatic rise in price of steel, the increased price can be claimed on actuals if, subsequent to frustration of the pricing element of the contract, works were carried out using steel.

• Other remedies - Besides what is statutorily provided in the Act, the discharge and consequent absence of the contract opens up the entire gamut of restitution remedies under common law.[24] One such remedy is the common law equitable remedy of tracing[25] that has been recognised by Indian Courts[26] as well. Illustratively, if there is a contract for supply of goods for which an advance is paid and the contract is thereafter frustrated, the party who has paid the advance can either claim the money back (under Section 65) or where that advance has been used to purchase some shares in company, an equitable remedy of tracing to the shares is also available.

Anirudh Krishnan is a Partner at AK Law Chambers and Adith Narayan is Of Counsel and Akash Loya is an Associate.

[1] Paradine v. Jane,(1647 )Aleyn26.

[2] Taylor v. Caldwell,122E.R.309.

[3] W.J. Tatem Ltd. Gamboa, (1939)1K.B.132,137,138.

[4] British Movietowns LD v. London and District Cinemas LD,(1951)1K.B.190,200to202. (Just and equitable result theory – It is pertinent to note that this decision was overruled by the House of Lords in appeal)

[5] Davis Contractors Ltd. v. Fareham Urban District Council,(1956)A.C.696,728,729.

[6] Satyabrata Ghose v. Mugneeram Bangur and Co., A.I.R.1954S.C.44,¶18; Dhruv Dev Chand v. Harmohinder Singh, A.I.R.1968S.C.1024,¶8.

[7]Satyabrata Ghose, at¶18; Energy Watchdog v. Central Electricity Regulatory Commission,(2017)14S.C.C.80,¶32.

[8] Satyabrata Ghose, at¶23.

[9]Satyabrata Ghose, at¶17and18; Sushila Devi v. Hari Singh,(1971)2S.C.C.288,¶11; Govindbhai Gordhanbhai Patel v. Gulam Allibhai, (1977)3S.C.C.179,¶¶10to12, Energy Watchdog, at¶40.

[10] Satyabrata Ghose, at¶26; Pioneer Shipping v. BTP Tioxide, (1982)A.C.724,752; Codelfa Constructions v. State Rail Authority of New South Wales, (1982)41A.L.R.367,381,382,383.

[11]Hind Construction v. State of Maharastra, A.I.R.1979S.C.720, ¶¶7,8,9.

[12] See Li Ching Wing v. Xuan Yi Xiong, (2004)1H.K.L.R.D.754,¶¶10,11.

[13] A.I.R.1984S.C.1072, ¶56.

[14] Augusthy Jose v. State of Kerala, (1995)1K.L.J.736,¶2; Leiston Gas Co. v. Leiston-cum-Sizewell Urban District Council,(1916)2K.B.428,435; Denny, Mott and Dickson Ltd v. James B. Fraser and Co.,(1944)2A.C.265, 270.

[15] Satyabrata Ghose, at ¶19; Delhi Development Authority v. Kenneth Builders, (2016)13S.C.C.561,¶33.

[16]Ganga Singh v. Santosh Kumar, A.I.R.1963All.201,¶¶11,12; See also F.A. Tamplin Steamship Company Ltd v. Anglo-Mexican Petroleum Products Ltd, (1916)2A.C.397,404to406; Leiston Gas Co., at p. 433

[17] Ganga Saran v. Ram Charan Ram Gopal, A.I.R.1952S.C. 9,¶14; Boothalinga Agencies v. V.T.C. Poriaswami Nadar, A.I.R.1969S.C.110,¶14.

[18] M.D., Army Welfare Housing Organisation v. Summangal Services Ltd, (2004)4S.C.C.619,¶¶120 to 124.

[19] Alopi Prasad and Sons v. Union of India, A.I.R.1960S.C.588,¶22; Naihati Jute Mills Ltd v. Khyaliram Jagannath, A.I.R.1968S.C.522,¶17; Travancore Devasom Board v. Thanath International, (2004)13S.C.C.44, ¶¶11 to 13; Tsakiroglou & Co. Ltd. v. Noblee & Thorl GmbH, [1962]A.C.93,119.

[20] Firm of Hussainboy Karimji, at¶¶14,23; Gujarat Housing Board, at¶9; Babulal Agarwal v. Vijaya Stores, A.I.R.1955Ori.49,¶11.

[21] Damodar Valley Corporation, ¶9; Courts of Wards Dada Siba Estate, ¶6.

[22] Bombay Dyeing & Manufacturing Co. v. State of Bombay, A.I.R. 1958 S.C. 328, ¶24.

[23] Mulamchand v. State of Madhya Pradesh, A.I.R.1968S.C.1218,¶5; Mahanagar Telephone Nigam Ltd. v. Tata Communications, A.I.R.2019S.C.1233,¶¶ 2, 6, 7, 8, 9; Trimis v. Mina, (2000)2T.C.L.R.346,¶¶54to56; Macdonald Dickens and Macklin v. Costello,(2011)EWCACiv.930,¶23.

[24] Parkinson (Sir Lindsay) and Co. Ltd. v. Commissioners of His Majesty’s Works and Public Buildings, (1949)2K.B.632,659,660; Robert Taylor v. Motability Finance Ltd., (2004)EWHC2619,¶23;

[25] Lipkin Gorman v. Karpnale Ltd., (1991)2A.C.548,563; Boscawen v. Bajwa, (1996)1W.L.R.328,335-338.

[26] Data Access India Ltd. v. Canara Bank,Company Petition 292/2004(Order dated 21^st January 2011, Del. HC), ¶27; Chitra Desai v. S. Arjunlal Sunderdas, (2018)4L.W.838,¶¶ 120, 122, 126 to 128, 157.