Dealing with the Notions of Hardship and Force Majeure in International Commercial Contracts: Tackling Unforeseen Events in a Changing World

Introduction

These days the impacts of Covid-19 have reverberated around worldwide, putting enormous strain on public health providers and enterprises of all sorts. While adopting a method to control and regulate Covid-19 is critical, individuals and organisations must also be aware of their contractual rights and obligations during this period. To better understand the impact of Covid-19 on international commercial contracts, as well as the remedies and exceptions available to company owners under such contracts, it is essential to undertake a study of the various concepts involved under the realm of these contracts, which is the aim of the article.

An insight into the principle of force majeure and the doctrine of frustration in light of the ongoing Covid-19 pandemic

A significant question here is whether the Covid-19 pandemic has rendered contractual duties impossible to fulfil, or whether the incapacity of a participant to fulfil contractual commitments is attributable to past choices or acts taken in consideration of the situation at present. To determine this, two concepts are of utmost importance. They are:

i. The Principle of Force Majeure; and

ii. The Doctrine of Frustration.

The Principle of Force Majeure: It is always feasible that severe and inevitable circumstances outside the control of the transacting parties will make business transactions unattainable. “Force majeure” occurrences are characterised by their extreme nature and unpredictability. The phrase “force majeure” comes from civil law in France and implies “superior force”. The concept of force majeure, on the other hand, does not exist under common law or English Law. War or acts of terrorism, lockouts, riots, energy supply shortages, as well as other catastrophes usually referred to as “acts of God”1 that no one can be held responsible for are examples of situations that fall under the umbrella of “force majeure” (i.e. natural disasters). Force majeure provisions can be negotiated to incorporate a checklist of particular circumstances that will activate the provision, or they can be designed generally and leave it up to the stakeholders to establish or accept that a “force majeure” event has occurred. While each contract’s phrasing for force majeure clauses is different, they usually include the following characteristics:

  1. text exempting one or both sides from completing the contract if a force majeure event happens;
  2. a list of force majeure events that are normally negotiated by the participants;
  3. impacted party requirements (i.e. notice and mitigation obligations); and
  4. prescribed remedies.

A force majeure clause, irrespective of its particular details, normally only applies to unanticipated situations and beyond reasonable human forethought and expertise. Company owners must be aware that for the Covid-19 pandemic to activate the application of a force majeure clause, the affected party must demonstrate that the pandemic was:

  1. unexpected; and
  2. rendered the fulfilment of its contractual obligations impracticable.

The impacted party must demonstrate that fulfilment of its duties has been hampered or postponed as a direct result of the pandemic in order to establish this causal relationship. It is indeed crucial to remember that when attempting to depend on or exercise a force majeure clause, the impacted party is usually required to minimise the impacts of the force majeure occurrence. Commercial reasonableness is the criteria for mitigation under a force majeure situation.

The goal of force majeure provisions in commercial contracts is to release participants from liability in the case of an unanticipated and inevitable event. Rather, it is up to the contracting parties to determine what constitutes force majeure and what the implications will be if a force majeure event occurs. In principle, force majeure provisions absolve parties to a contract of their contractual responsibilities in the case of an occurrence beyond the parties’ control.

Before utilising a force majeure provision, a party seeking remedy must meet specific requirements. First and foremost, the impacted party must adhere to any contractual procedural obligations. These obligations involve notifying the other party that the force majeure occurrence is interfering with the fulfilment of its contractual obligations. This notice must be sent within the time range specified. The necessity of giving notice is normally a condition precedent that must be met by the party requesting relief under this provision.

As a result, in order for a force majeure provision to apply (should a force majeure incident happen), the emergence of such events must be beyond the stakeholders’ power, and the stakeholders must demonstrate that they have made reasonable efforts to reduce the impact of the force majeure event. If an incident or circumstance falls within the scope of a force majeure event and meets the clause’s criteria for applicability, the stakeholders will be excused from executing their respective responsibilities under the contract for the duration of the force majeure event.

Additionally, according to the language of the provision, the parties may be obliged to provide a written notice informing the other party of the occurrence of such event and invocation of the force majeure clause. Some contracts additionally state that if a force majeure incident lasts for an extended period of time, the parties may be able to terminate the contract.

Lastly, the party claiming the force majeure provision must show that the force majeure incident prohibited, hampered, or postponed the performance of its contractual obligations. As a consequence of the force majeure incident, the party must demonstrate that it was legally or practically impossible to execute its commitments. The party must additionally show that it was unable to fulfil its responsibilities due to circumstances or events beyond its control and they did everything in its power to mitigate the effects of such a situation. There can be additional remedies granted to the affected party, but these additional remedies can be determined by the courts and tribunals or by negotiations with the defaulting party. Further, if a party receives a force majeure notice from the other party, then adequate measures have to be followed by the receiving party as elucidated below.

A force majeure notice and the way to handle it

The first step is to locate the appropriate contract. The notice will have been served in accordance with the contract’s force majeure clause. The second step is to interpret the clause. Force majeure provisions can take many different shapes. Its design will be determined by the contract and the nature of the business.

Here, some preconditions apply, such as whether there are any restrictions on the exercise of the provision, such as whether the supplier must serve the notice within a certain time-frame or in a specific format. If this has not been observed, the precondition may be classified as a condition precedent that must be met in order to activate the clause, or as an intermediate term whose non-fulfilment does not prevent the supplier from invoking the clause, based on the architecture of the clause. The receiving party must be cautious not to waive such requirements or act in such a way that estoppel is created.

Lastly, it should be determined whether the stated force majeure occurrence and the other party’s non-performance are related. Examine whether performance can be excused under another legal doctrine, such as the frustration of contract or impossibility of performance if there is not a force majeure provision. Insist on receiving the following:

a) proof of the factors purportedly delaying performance, and

b) regular updates on its attempts to resume performance and/or lessen the impact of the delay. Consider drafting a written contract revision to reflect a commercially sensible outcome if necessary.

Additionally, a party seeking relief under the force majeure clause has the obligation to establish the burden of proof to demonstrate that the force majeure incident has impacted such party’s performance of the contract.

Furthermore, the force majeure certificate plays an essential role under force majeure conditions. Although the “force majeure certificate” is the primary evidence that the company has been engaged in Covid-19 harmful impact, it is insufficient to release the company from its contractual responsibilities. It has also been established that contractual performance has become objectively implementable as a consequence of the pandemic or the authorities’ restrictions. In other words, the debtor must show that the pandemic is an “objective, unforeseen, inescapable, and insurmountable occurrence” that directly affects contractual performance in its specific circumstances.

The Doctrine of Frustration: When it comes to negotiating the parameters of a commercial transaction, stakeholders sometimes get caught up in the big image and overlook what could be considered as boilerplate clauses. As a consequence, a contract may be quiet on how to behave in the event of unforeseen and extreme circumstances. The present practice of the courts is not to read in a force majeure clause into a contract, whether the transacting parties intentionally opted not to add one or just neglected to do so. A party who is unable to perform contractual duties owing to a force majeure event must claim that the contract has been frustrated due to certain conditions. A party proposing that the theory of frustration of contract should apply, unlike invoking a force majeure provision, is not asserting that fulfilment of its contractual duties is impossible. Instead, this is a higher-level assertion that the impacted party’s motivation for engaging in the contract has vanished.

According to case law,2 an entity asserting frustration of contract must show that:

  1. the impacted party can no longer achieve its intent for the transaction;
  2. all parties to the contract were aware of the impacted party’s primary purpose for entering into the contract; and
  3. the frustration was caused by a qualifying supervening event.

When an employee’s place of employment is harmed and the reason for the employee’s hiring is no longer valid, the frustration of contract is widely utilised in employee-employer contracts. Another instance is when a property is sold for a certain use and a municipality passes a zoning by-law limiting that purpose after the contract is signed. Furthermore, the impacted party must consider whether the Covid-19 epidemic counts as an intervening event that has fundamentally altered the contract from what was originally agreed to. Despite the fact that this path is complicated, demanding and pricey, it may be the only viable alternative in the event of a crisis. While the aforementioned fundamentals may provide helpful reference to how force majeure clauses or the doctrine of frustration may apply to contractual obligations impacted by the Covid-19 pandemic, company owners should pay close attention to the specific info of their contracts and seek legal advice if such claims are made.

After taking a look at the force majeure principle and the doctrine of frustration, it is essential to understand the relevance of the notion of “hardship” in a contractual equilibrium, to completely understand the nitty-gritty associated with international commercial contracts.

Interpretation of the term “hardship” and its legal consequences

First and foremost, it should be noted that the Principles relating to International Commercial Contracts 2004, which includes provisions on hardship are issued by the International Institute for the Unification of Private Law (UNIDROIT). “Where the performance of a contract becomes more burdensome for one of the stakeholders, that party is nevertheless required to perform its obligations subject to the following restrictions on hardship,” according to Article 6.2.1 of the aforementioned principles.

The “following provisions” mentioned in Article 6.2.1 are provided in Article 6.2.2, which states that “hardship exists when the onset of incidents fundamentally modifies the equilibrium of the contract, either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and

a. the events occur or become known to the disadvantaged party after the conclusion of the contract;

b. the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;

c. the events are beyond the control of the disadvantaged party; and

d. the risk of the events was not assumed by the disadvantaged party.”

The consequences of hardship are outlined in Article 6.2.3, which states:

i. In the event of hardship, the affected party has the right to request renegotiations. The request must be made as soon as possible and must state the grounds for the request.

ii. A request for renegotiation does not give the disadvantaged party the right to refuse to perform.

iii. If the parties are unable to reach an agreement within a reasonable time, either party may take the matter to court.

iv. If the court finds hardship, it may

a) terminate the contract at a predetermined date and on predetermined terms, or

b) adapt the contract to restore its equilibrium.

Furthermore, hardship refers to situations in which the agreed-upon performance is still technically attainable. Nevertheless, some underlying facts have significantly changed, making proper fulfilment of contractual obligations possible in principle but not economically viable.

Hardship is founded on the premise that the contract’s underlying circumstances alter in a manner that the parties did not anticipate at the time of the contract’s conclusion, and while the contractual obligations are still fulfillable in principle, it does not make economic sense. For instance, suppose the seller of a specific object loses it in the ocean. In theory, he should try to recover it from the ocean’s depths, which is theoretically possible but not economically feasible.

In the event of adversity, contract performance is not impossible, but it is hampered. Hardship is described as any legal, technical, political, or financial incident that occurs after the contract’s completion that was unforeseeable at the time the contract was formed, regardless of the best efforts.  In principle, hardship does not render performance impossible, but it does permit contract renegotiation. A hardship provision can compel the parties to negotiate new contractual conditions if ongoing performance has become unreasonably onerous owing to an occurrence beyond a party’s reasonable control. It is the goal of a hardship clause to give the parties more freedom while also balancing the risk.

As far as the legal consequences of the hardship clause are concerned, it should be noted that the hardship provisions recognise that parties must fulfil their contractual obligations even if events make fulfilment more difficult than could have been reasonably anticipated at the point of the contract’s conclusion. The legal consequence of hardship is that the participant whose underlying circumstances have changed significantly can still perform the contract and fulfil its contractual responsibilities, but the performance has lost its economic value.

Further, hardship is founded on the core concept of civil law and international law, namely, pacta sunt servanda, which indicates “agreements must be fulfilled”. Private contract provisions are law between the parties, and non-performance of certain clauses represents a breach of the pact, according to this theory. Nonetheless, there is one caveat to this genuine pacta sunt servanda idea. The restriction is known legally as clausula rebus sic stantibus, which is a legal doctrine that allows contract terms to become unenforceable due to a substantial shift in conditions. It is effectively the “escape clause” that provides an exception to pacta sunt servanda’s general norm. Even so, it is evident from a review of the UNIDROIT principle that a contract’s clauses can be subjected to the “escape clause of hardship” only when:

  1. events occur or become known to a party after the contract’s conclusion;
  2. the events could not reasonably have been taken into account at the time of the contract’s conclusion;
  3. the events are beyond the party’s control; and
  4. the risk of the events was not assumed by it.

This philosophy can be applied to any contract, including domestic and international business agreements. Since the concepts of pacta sunt servanda and clausula rebus sic stantibus are essential principle of international as well as domestic laws, it is essential to study them in-depth.

Understanding the doctrine of clausula rebus sic stantibus

The doctrine of clausula rebus sic stantibus (Latin: “things standing thus”) states that a participant may withdraw from or cancel a treaty if there has been a significant change of circumstances.3 Also, the Latin phrase “clausula rebus sic stantibus” (things thus standing) refers to a scenario in which a contract cannot be retracted or terminated as long as the contract’s circumstances have not changed significantly.

Clausula rebus sic stantibus is a provision in international agreements (international treaties or accords) that allows a treaty to be rendered unenforceable owing to radically altered circumstances. One of the first standards of customary international law is this doctrine. Article 62 of the Vienna Convention on the Law of Treaties codifies a form of this idea. Individual treaties frequently include it as a clause4. This has frequently been employed as a theory in international law, particularly treaty law, and has been the topic of debate and disagreement.

Additionally, clausula rebus sic stantibus is a notion that permits the withdrawal or termination of an agreement or treaty when the parameters of the contract or treaty alter fundamentally. It serves to get around the principle of pacta sunt servanda, which asserts that all States must uphold agreements made in good faith between them. Pacta sunt servanda is also legally provided for in Article 26 of the Vienna Convention which provides that treaties in force are binding upon parties and are to be performed in good faith.5

Article 62 of the Vienna Convention on the Law of Treaties (1969) discusses the fundamental change of conditions in which clausula rebus sic stantibus can be asserted, but it is subject to the following conditions:

  1. There must be a fundamental change in the circumstances that existed at the time the treaty was signed to the current circumstances. The parties could not have predicted such a radical shift.
  2. Those circumstances must have been a necessary condition for the parties’ assent to enter the treaty and agree to be bound by it.
  3. The modification has the impact of significantly and drastically altering the scope of a party’s duties under the treaty.
  4. If no boundary is established by the treaty.
  5. This theory cannot be utilised to avoid treaty obligations if the fundamental change occurs as a result of a breach by the party invoking the change. This breach could be a violation of a treaty obligation or a violation of any international commitment owed to any party under that treaty.

Parties withdrawing from treaties have frequently invoked this doctrine in international relations. This notion can be used by a State in the following situations:

a) At the time of the treaty’s conclusion, the State believes the treaty’s provisions are favourable but later discovers that they are not. There could be an internal scenario in a country where the treaty is judged to be destructive or detrimental. In such cases, the State may consider withdrawing, terminating, suspending activities, or declaring the pact null and void.

b) State sovereignty and strategy may demand that the community does not always adhere to the conditions of the treaty, prompting the community to withdraw from the agreement. This option is available if a State believes a treaty is harmful to its security or the security of its subjects.6

As a result, it has been observed that States frequently apply this theory for internal purposes such as the defence of their objectives. Through the condition of “substantial change in circumstances”, this concept fulfils the goal of protecting State interests while also avoiding misuse.

Lastly, a party desiring relief under clausula rebus sic stantibus must demonstrate that exceptional and unpredicted occurrences have made performing its obligations overly onerous, to the point where they have substantially and completely modified the balance of the exchange under the contract (quid pro quo), all of which has resulted in an unreasonable imbalance in the reciprocal responsibilities.7 Further, an understanding of the principle of pacta sunt servanda is essential in order to appreciate the interplay involved in the simultaneous application of the rebus sic stantibus and pacta sunt servanda with respect to international commercial contracts.

The principle of pacta sunt servanda

In the history of international law, the dispute over stability and change – or the boundaries of pacta sunt servanda – has played a crucial role. The issue of when a State may deviate from treaty obligations due to new conditions appears to be a perennial issue. It is compounded by treaties’ natural ability to “freeze” legislation at the time of acceptance, thus fixing it at a specific point in time.

Contracts bind the parties, according to a fundamental contract law premise. Only with the approval of the other party can a party default, postpone, or change its contractual duties. To emphasise the importance of this crucial feature of contracts, the Romans developed the phrase pacta sunt servanda. This principle is so important in contract law that it has been attributed to Ferdinand I, Holy Roman Emperor from 1556 to 1564, and his modus operandi: “Let justice be done, though the world perishes.” The strict application of this fundamental contract law principle, on the other hand, may in some situations result in severely unfair outcomes, antithetical to good faith, which is also a significant factor in continental judicial systems.

Scholars and case law have typically defined any exemption to this fundamental principle very narrowly, but only as a way of avoiding any excessive and unfair effects that are regarded to be in contradiction with justice. The different civil law systems envisage particular procedures to deal with these extraordinary situations, such as

  1. the force majeure regime; and
  2. the rebus sic stantibus doctrine (or variants of the same).

In light of the above, parties to commercial contracts are at risk of defaulting on their obligations as a consequence of the Covid-19 epidemic, either directly as a result of government actions (e.g. lockdowns, curfews) or indirectly as a consequence of the demand shock produced by the pandemic. Distressed obligors argue that this is either:

  1. a force majeure occurrence that releases them from contractual obligations; or
  2. an unforeseen and unusual change of circumstances that warrants revising or rebalancing the contract’s provisions under the rebus doctrine (or similar legal constructs).

Moreover, the case of Balfour v. Balfour8 showed that not all agreements can be made as contracts. As a result, in order for any agreement to have legal effect, the parties must agree to carry out specific legal responsibilities. This rationale is reflected in the principle of pacta sunt servanda, which states that the parties have a legal obligation to keep their promises and that the agreement is obligatory on them to that extent.

The pacta sunt servanda idea has always had its limitations. Even though it is intellectually grasped, the legal impact is nullified if the base or subject-matter is eliminated. Even Roman Law stipulates that no contract is enforceable or enforceable in all situations.9 If a side failed to fulfil its contractual responsibilities, the contract could be terminated unilaterally (e.g. in the case of leases, mandates or contracts of sale). To apply the theory to its full impact, such an exception must be acknowledged.

It should be noted that the theory of clausula rebus sic stantibus has historically been used to undermine the principle of pacta sunt servanda.10As per this idea, a contract is only enforceable if the conditions at the time of the contract’s conclusion remain unchanged. Nevertheless, the essential beliefs of modern theory defining pacta sunt servanda have shifted. According to certain authors, modern contract law cannot be based on classical contract law viewpoints because those positions have necessarily become obsolete because of advances, as is also stated in the theory of radical change, which essentially makes the same argument. Others believe that because contract law’s scope is not limited to the sale of things, its principles must be adjusted to fit the length and width of its dimensions. In other terms, given the economic, social and basic issues, the rigidity of the pacta sunt servanda premise cannot be sustained. Irrespective of one’s perspective on the binding nature of contracts, the examination of legal grounds for contractual duty exemption has become increasingly relevant in recent years.

Concluding remarks

Looking into the various concepts underlying international commercial contracts, it is clear that along with a harmonious functioning of these concepts, various conflicts are also prevalent between them. Furthermore, a glimpse into the Indian law makes it clear that it has yet to fully examine such concepts, especially the notion of hardship, even though this concept has matured to some level under English Law, American Law, and certain European Law. Nevertheless, because India is a UNIDROIT participant, this concept will undoubtedly have persuasive value in Indian courts, and Indian courts may be asked to investigate whether this doctrine can be applied even where Indian law is the applicable law.

Further, it is impossible to deny that the theory has been heavily condemned for its role in jeopardising contractual consistency. Although it is important to remember that the doctrine of hardship is still evolving, and its parameters, like those of any other jurisprudential term, are never fully defined, but rather as broad as the categories of human behaviour. The theory was created to compensate for the flaws in the actual contract. An unexpected turn of event, such as a fully abnormal rise or decrease in prices, a rapid depreciation of the currency, an unanticipated hurdle to execution, or the like, frequently confronts the parties to an executory contract while carrying it out. Nevertheless, if the current legal system acknowledges the doctrine of hardship and provides reasonable consideration for the insertion of hardship clauses in contract terms, this problem can be successfully addressed. If the doctrine is applied correctly, it will undoubtedly benefit parties willing to engage in long-term commercial agreements, both domestic and international.

Lastly, further development concerning the notion of international commercial contracts is essential not only for the better application of domestic laws but also for clarifying the existing principles of international law, especially the doctrine of clausula rebus sic stantibus and the principle of pacta sunt servanda.


*Managing Associate, L&L Partners, New Delhi. Author can be reached at chatterjeeaor@swarnendu.co

**2nd year student LLB (Hons.), National Law University, Bhopal. Author can be reached at arushi1bhagotra@gmail.com

1“Force majeure”, Black’s Law Dictionary (8th Edn., West Publishing Co. 2015).

2Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310 .

3Blociszewski, ‘L’Annexion de la Bosnie et de l’Herzegovine’, (1910) 17 Rev. Gen. de Dr. Int. Pub. 441.

4Elihu Lauterpacht,International Law: Disputes, War and Neutrality (5th Edn., Cambridge 2004), 14-15.

5Carrasco Perera, Ángel: ‘Debtor’s Release by Covid-Hardship (Rebus Sic Stantibus) in Financial Debts? Spanish Trends’, (2020) 36 JIBLR.

6United Kingdom of Great Britain and Northern Ireland v. Iceland, (1973) ICJ Reports.

7Gómez Pomar, Fernando, Alti Sánchez-Agullera, Juan, Cláusula Rebus Sic Stantibus: Viabilidad y  Oportunidad de su Codificación en el Derecho Civil Español, InDret 1/2021 (2021).

8(1919) 2 KB 571 (CA).

9R. Zimmermann, The Law of Obligations: Roman Foundations of the Civilian Tradition, (1992) KLTP576.

10Treitel, The Law of Contract (12th Edn., Sweet & Maxwell Ltd. 2007) 924.

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