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Covid-19 crises has led to constricted market liquidity affecting the credit access and has contributed to supply chain disruption.  As a result companies may face an array of contract issues and claims of non-performance from suppliers, contractors etc. It requires active tracking of affected contracts. Further, companies need to take warranties, representations, force majeure and other clauses more cautiously in drafting contracts.

A. Does the contract include force majeure clause? If yes, does Covid-19 qualify as a force majeure?

A force majeure clause allows parties to bear no liabilities for contractual non-performance if situations comprehended by the force majeure clause in the contract exists. Such situations are generally events beyond the parties’ control making it impossible for the contract performance. Muluki Civil Code (‘’CCA’’) does not define a ‘’force majeure’’, however, provisions of CCA which permits non-performance on grounds of the performance being illegal or impossible beyond the parties’ control carry sufficient spirit of the force majeure clause.

The clause defining a force majeure event can be exhaustive with narrow and specific language or open ended with phrases like ‘’…natural calamities and such situations/circumstances.’’, depending upon the parties’ construct. Thus, the question whether Covid-19 and its consequences amount to a force majeure situation depends on how force majeure event is defined, burden of proof allocated and interpreted. Moreover, the governing law of contract determines the interpretation of the overall force majeure clause. Broadly following checklist will assist companies in assessing the force majeure claim:

  1. Do ‘’pandemic’’, ‘’diseases’’, ‘’lockdown’’, ‘’permit restrictions‘’, ‘’quarantine’’ qualify as force majeure event in the contract?
  2. Has Covid-19 and its consequences made the performance of contract impossible?
  3. Is the impossibility of contract performance caused by the force majeure event?
  4. Has the claiming party made efforts to mitigate the event and perform its obligation under the contract?
  5. Has the claiming party fulfilled its obligation to notify or report of the force majeure event as required in the contract?

The consequences will be as per the contractual arrangement and may provide for deferred payments, extended performance, suspension, renegotiation, compensation or termination.

Taking examples, Engineering Procurement and Construction (EPC) contracts commonly include “release from the performance under law’’ clause within force majeure clause releasing parties of obligations in situation not limited to the parties’ force majeure definition if any event or circumstance outside control of parties arises which are acknowledged under the governing law of the contract which might include claims of ‘’frustration’’ and ‘’fundamental changes’’ as acknowledged by CCA.

Alternatively, the standard Power Purchase Agreement template with National Electricity Authority employs a wide definition of force majeure event, incorporating material changes not covered by the CCA including epidemic, plague, embargo, radiation and strikes.

Thus, where the force majeure clause is specific and clearly reflects the parties’ understanding as to what amounts a force majeure event, the force majeure clause may not allow parties to seek remedies out of the contract. However, in the absence of the force majeure clause or even when present lacks clarity, parties are afforded remedies under doctrine of frustration (detailed in no.b.) and fundamental changes (detailed in no. c), as provided in the CCA.

B. Has the party claiming frustration of contract due to Covid-19 met the threshold requirements?

Counterparty may claim non-performance of contractual terms reasoning impossibility of performance due to natural and legal reasons surrounding Covid-19 under the doctrine of frustration. CCA releases parties from performance of contracts on following grounds:

  1. Illegality of the contract (Sec. 501),
  2. Impossibility of performance (Sec. 502) and
  3. Fundamental change in circumstances (Sec 527, 531; detailed in no. c. below.).

The threshold of proving either of the above grounds is high because despite the Covid-19 difficulties, the party should have fulfilled its obligation ‘’to the extent possible’’ and is restricted to claim non-performance if some portion of the contractual obligations can be performed.

For a successful frustration claim, Supreme Court of Nepal in Pradip Raj Pandey v. Karmalakshmi Kansakar, (D.N. 9368, N.K.P. 2072) listed following grounds despite the presence of’party’s willingness to perform the contract’’:

  1. Impossibility of performance,
  2. Unlawful performance by change in law,
  3. Destruction of subject matter for performance, and
  4. Death or incapacity of party essential for contract performance.

However, companies should be mindful of distinguishing frustration claims against breach of contractual obligations or wrongful termination.

C. Can a party claim covid-19 outbreak as ‘’fundamental change’’ to qualify for nonperformance of the contract? What does not constitute as ‘’fundamental change’’?

CCA releases parties from obligation to perform the contract in presence of the following ‘’fundamental changes’’ which make the contractual performance ‘’impossible’’:

Circumstance beyond human control like wars, floods, landslides, earthquakes, fire, volcanoes etc. leading to the impossibility of contractual performance,

  1. Destruction of matter necessary for contract performance,
  2. Illegality of the Contract, and
  3. Death or disability of the person whose personal skillset was necessary for performance of contract.

Parties cannot claim a ‘’fundamental change’’ argument if Covid-19 or its consequences (quarantine measures, lockdowns, restrictive laws etc.) are not so drastic so as to make it impossible for contract performance. Difficulty, non-profitability, burdensome government fees, strikes and lock-outs, incapacity of third party or partial impossibility of performance do not qualify as ‘’fundamental change’’.

D. What are the alternative measures parties can undertake against non-performance of contracts?

Parties are obliged under CCA to communicate and facilitate each other for fulfillment of the contractual obligation. When not facilitated, the concerned party is not accountable for the non-performance. While claims for non-performance of contract before the courts seem tempting, thresholds of such claims are high and are not generally a first instance solution. Unless otherwise provided in the contract, the parties may discuss to suspend, waive, review or cause variation in the contractual provisions including payment terms. However, businesses should be mindful that such measures do not contradict the purpose of the contract itself.

E. What are the key takeaways?

The impact of Covid-19 on contractual obligations is not certain and largely depends on the nature and interpretation of the contract itself. Further, judicial interpretations, although not immediate, may address the Covid-19’s impact on contracts. In regards to the contracts under draft, consideration or amendments, companies should be mindful to incorporate a force majeure clause with clear reflection of parties’ intention in matters of definition, dispute settlement, and notification and mitigation measures. Further, early communications between the parties to strategize the future obligations are crucial. 

*Please note that the above information is for purposes of general usage and the readers are suggested a professional advice. Also, the information so provided are updated as per government decisions up to 31 May 2020 and does not reflect updates thereafter.