Material Adverse Change (“MAC”) and Force Majeure” or “Act of God” clauses

The businesses all across have come to standstill due to the pandemic outbreak and lockdown imposed thereafter by the GoI, it is further unclear till the outbreak is impeded, if any, restrictions further will be imposed in times to come under the provisions of Disaster Management Act. Thus, it is quite likely that the impact of the virus on commercial laws will be more profound and long term. It is thus time to revisit third party contracts qua the clauses related to the Force Majeure and Material Adverse Change in all Agreements and analyse the effects, consequences and the available remedies under law.

The present article therefore seeks to examine whether the outbreak of the coronavirus disease 2019, abbreviated as COVID-19 pandemic outbreak can be construed as a force majeure (FM) event or an “act of God” or Material Adverse Change (MAC), and can be taken as a defence by non-performing party on failure to perform or delay in performance as obligated under an agreement, from the liability arising out of. Both force majeure (FM) event or an “act of God” or Material Adverse Change (MAC) clauses (hereinafter collectively referred as the “FM Clause” have the same objective, however, MAC clauses is profoundly negotiated in financial Agreements to trigger an event of default. Accordingly, if there is a material deterioration in the business, financial conditions or operations of the borrower, the MAC clause can trigger a default or an event of default under the financing documents.

“Force Majeure” or “Act of God” – clause is present predominately in non-financial contracts. ‘Force Majeure’ clause provides grounds to exempts a party from performing his contractual obligations which have become impossible or impracticable due to an event or effect which the parties could not have foreseen or controlled. This clause is usually couched in general, inclusive terms to cover unforeseeable incidents such as natural calamities, war, riots, civil commotion, sudden change of government policies, “acts of God” (earthquake, floods, thunderstorms, cyclones, tsunami and or fire etc.) or impediments such as shortage of manpower or raw material, governmental action, change in law, shutdowns, etc. depending upon what is agreed to be defined and record the understanding between the parties. Interestingly, few Agreements may expressly list “epidemic” or a synonymous term as an FM or MAC event, others may have more events such as short supply of raw material or manpower negating the effects of the all possible unforeseen events.

In the past, the court have held that, the Agreement executed between the parties are sacrosanct and the courts have no power to absolve a party from the performance of his contractual obligations merely because its performance has become impossible or onerous on account of an unforeseen turn of events. i.e. no court can interfere or amend the contract. Having said this in exceptional situations, where the party is unable to perform or honour his part of the obligation/s, FM or MAC clause forms a boilerplate clause in the Agreement. In other words, where it is impossible or impracticable for the non performing party to perform its obligations under the Agreement due to an event or effect which the parties could not have foreseen or controlled, then parties are absolved from liability to perform the contractual obligations. Apropos, the occurrence of an event which is beyond the control of the parties render performance of their contractual obligations impossible. Thus, on occurrence of a force majeure event, the obligations under the Agreement may be suspended for the duration of the event, or render the entire contract frustrated. Albeit in the absence of FM clause in the Agreement, Section 32 and Section 56 of the Indian Contract Act, 1872 (the “Contract Act”) become relevant. Section 32 deals with “contingent contracts”, in which the performance of the contractual obligations is contingent on the happening or non-happening of an event i.e. return of normalcy after the present lockdown/outbreak. If the event becomes “impossible”, the contract becomes “void”.

Section 56 of the Indian Contract Act, 1872 (Act), enshrines the doctrine of frustration wherein it is stipulated that an agreement to do an impossible act is in itself void (and not be ab initio void). It is imperative to mention here that, the Contract will not be frustrated merely because its performance have become onerous on account of unforeseen events or merely due to hike in prices. Thus, impossibility or impracticability of the contract or incapacitation of the parties to perform the obligations under the contract, can only avoid or defer (as the case maybe) the contractual obligations of the parties either

(i) on grounds of force majeure (“FM”), or
(ii) on grounds of frustration of the contract. Further, the Court have also held that when the Agreement provides a force majeure clause whether express or implied, then based on the facts of the case, the Agreement will be analysed and Section 56 of the Act can have no application.

Conclusion

In conclusion Parties may argue that COVID-19 constitutes an FM or MAC event exempting them from their obligations under the contract during this period, it is important to remember that the party claiming an FM or MAC event would also need to establish that it prevented or hindered from discharging its obligations under the contract and or on account of an indefinite delays that may be caused in actual performance by the affected party. Albeit the contractual terms are sacrosanct and supreme, it may be argued that the contract stands frustrated due the party’s inability to perform and thereby discharging the other party of their obligations under the contract. Further, until return of normalcy of business, it is time to consider the following to safeguard the business interest in the changed scenario:

1. In contracts which do not have any Force Majeure or Material Adverse change clauses then it is time to amend the same.

2. To mitigate the damages on account of delay in contract wherein time is the essence and to safeguard against any future ambiguities, it is advisable to make representations to the authorities through the group of stakeholders or associations for seeking relief for the entire sector or industry.

Disclaimer: The views in this article is not a legal advice or legal opinion. The contents recorded in this document are for informational purposes only and should not be used for commercial purposes. All liability to any person for any loss or damage caused by errors or omissions, whether arising from negligence, accident or any other cause are disclaimed. This article should not be construed as hinting that COVID-19 pandemic will qualify as a ‘force majeure’ or material adverse change event. This is a broad summation of judicial principles on ‘force majuere’ and ‘ material adverse change’. The application of the same are subject to the facts and circumstances of each contracts.