COVID-19 and interestingly, the unavoidable lock down direction that followed, have waylaid the performance of various types of contracts, resulting in delaying of obligations in many cases and voiding of agreements in some. From the suspension of rent payments to halting of construction and infrastructure projects, commercial contracts have been put on pause and the rarely applied force majeure clause has taken centre-stage. One of India Inc’s most common reactions have been an urgent call to their legal consultants to review the force majeure clauses in their respective commercial contracts.
While the concept of force majeure finds its place primarily in civil law and commercial contracts, it has been broadly recognised in Indian common law under Sections 32 and 56 of the Indian Contract Act, 1872 (“Contract Act”)1 . According to the Supreme Court of India, an unforeseen and unavoidable impediment to performance which is beyond the control of the parties would attract the applicability of a force majeure clause2 .
In the absence of a force majeure clause and contracts other than for the lease or tenancy arrangements, parties may seek recourse under Section 56 of the Contract Act, which contains the doctrine of frustration. However, enough has been said by experts on the doctrine of frustration and its precise applicability, to the effect that it renders void those contracts which are impossible to perform, and also that it cannot be applied to concluded contracts, but only to executory contracts3 .
Indian courts in the past have settled the position relating to force majeure4 and given a wide connotation to the term “force majeure”. Though COVID-19 would activate most force majeure clauses, they do not apply where alternative modes of performance are available. As a result, Courts would have to ascertain on a case-to-case basis whether the force majeure event actually prevented the performance of the contract, rather than simply making it more difficult.
Various governmental agencies have been quick to react and address the overarching question of whether COVID-19 is in fact a force majeure event. While addressing supply chain contracts, the Ministry of Finance, Government of India has clarified that the spread of COVID-19 should be considered as a natural calamity and that force majeure may be invoked 5. Consequently, the Ministry for New & Renewable Energy has clarified that delays due to disruptions caused by COVID-19 shall be treated as force majeure, and that suitable extensions may be granted6 .
Similarly, Securities Exchange Board of India (“SEBI”) has extended the due date for regulatory filings for Alternative Investment Funds (AIFs) and Venture Capital Funds (VCFs), for the periods ending on March 31, 2020 and on April 30, 2020, by two months7 . In the case of Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs), SEBI has extended the due date for regulatory filings and compliances for the period ending March 31, 2020 by one month 8. Though this will surely give some relief, if the underlying assets suffer losses, this may amount to nothing more than a bucket in a sinking boat.
1 Energy Watchdog vs CERC [(2017) 14 SCC 80]
2Industrial Finance Corporation of India vs. Cannanore Spinning & Weaving Mills Ltd. [(2002) 5 SCC 54]
3Raja Dhruv Dev Chand vs Raja Harmohinder Singh & Anr [(1968) AIR 1024]
4Satyabrata Ghose vs Mugneeram Bangur & Co [AIR 1954 SC 44]
5No. F.18/4/2020-PPD dated February 19, 2020
6No. 283/18/2020-GRID-SOLAR dated March 20, 2020
7SEBI/HO/IMD/DF1/CIR/P/2020/58 dated March 30, 2020
8SEBI/HO/DDHS/CIR/P2020/42 dated March 23, 2020
Impact on Real Estate:
Due to the pandemic, the slow recovery of India’s already stressed real estate industry (perhaps set in motion by low interest rates and tax exemptions) has been set back majorly, with the suspension of rent payments and halting of construction activities resulting in more liquidity concerns for the future and the need for robust business continuity planning. Another consequence has been the loss of incentive for investors, including AIFs and REIT geared towards financing real estate activities. With no end in sight, and a rocky road to pre-pandemic (and perhaps pre-2015) levels, investors must consider the possibility of looking towards long-term aspirations rather than short-term profit.
These concerns are further compounded by the inability of property buyers to meet their financial obligations to developers for future payments, with the industry already facing up to 65% payment defaults according to the Indian Chamber of Commerce9 . With the expected drop in purchasing power and potential for default of home loans in the coming months, the lingering uncertainty of monetary demands by real estate project developers going unanswered will have its own consequences for the industry.
Furthermore, due to the heavy reliance on Chinese manufacturing for the raw supplies needed in real estate and infrastructure activities, the necessary lockdown of borders has had the detrimental effect of making construction unreasonably difficult, if not impossible. Without a major push towards incentivising the manufacturing of these supplies domestically, and relief for the inevitable losses which will be incurred in this period, we may see another period of deterioration for the real estate industry as well as other construction oriented and supply reliant sectors.
The Real Estate (Regulation and Development) Act, 2016 (“RERA”) is unique in its reference to the term “force majeure” in the explanation of Section 6 of RERA, which includes a case of war, flood, drought, fire, cyclone, earthquake or any other calamity caused by nature affecting the regular development of the real estate project. Section 6 itself comes as a relief to the industry as it allows promoters of RERA-governed real estate projects to apply for an extension of up to one (1) year to the registration granted to their real estate project, including by reason of force majeure. It may be interesting to see if any realty developers or businesses attempt to use the lockdown as the cause to avail an extension under the said provision, despite having pre-existing conditions such as financial crisis and lack of timely approvals in any project.
As a measure to prevent the undue lapsing of any regulatory requirements under RERA, various States have revised the project registration validity and extended the timeline for statutory compliances expiring on or after March 15, 2020 by three months. Statutory compliances due under RERA in March, April and May of 2020 have been extended to June 30, 202010. The Ministry of Home Affairs has issued an order that landlords shall not demand rent payments from workers staying in rented accommodation for a period of one month , whereas the Government of Maharashtra has directed landlords not to evict tenants and to defer rent collection for a period of at least three months . Though tenants will have to pay these amounts after the directions and restrictions are lifted, this comes as a sigh of relief during the suspension of almost all commercial activities. However, no relief seems to have been given to the purchasers on whom demands have already been raised by the realty developers for the balance consideration / interest for delay, just before or during the lockdown.
9 https://www.indianchamber.org/wp-content/uploads/2020/04/Real_Estate_Press_Note.pdf
10 F.No.3/RERA/Tech.Orders/2020/278 and MahaRERA/Secy/25/2020
11 circular no. 40-3/2020-DM-I(A) dated March 29, 2020
12circular no. 40-3/2020-DM-I(A) dated March 29, 2020 br/>
13https://economictimes.indiatimes.com/industry/services/property-/-cstruction/covid-19-impact-construction-projects-hit-as-workers-keep-away/printarticle/74738820.cms<
Impact on Infrastructure:
Similar to real estate, infrastructure projects have been hit hard by the pandemic. Construction alone provides employment to about 8.5 million . Due to the lockdown, construction activities have halted almost entirely, resulting in an increase in unemployment rates. The reported mass migration of labourers resulting from the loss of jobs in various sectors may cause reduced availability of labour for at least a short period after restrictions are lifted. That said, the availability of labour may become an afterthought if the problem of lack of available capital is not addressed as soon as projects can be resumed. This can be done by providing incentives to lending institutions for financing certain categories of infrastructure. Without incentives or other measures, lenders may be reticent in lending to stressed sectors, and may impose unattractive terms and high interest rates.
Considering the importance of infrastructure projects in moving society forward, and in order to cope up with the tremendous backlog and pandemic-induced delays, the Ministry of Home Affairs has notified some construction works to be resumed from April 20, 2020, except in the containment zones demarcated by the State/Union Territories/District Administrations14.
One card that the Union and State Governments must consider playing is the Building and Other Construction Workers’ Welfare Fund, required to be constituted under the Building and Other Construction Workers Act, 1996 and the Building and Other Construction Workers Welfare Cess Act, 1996. This fund, to be credited with contributions from employees/workers as well as a cess of amounts equal to 1-2% of the cost of the project, to be levied on projects exceeding a certain value. As per some news sources, the aggregate amount available with the funds created by the various State boards is around Rs. 52,000 crores, with beneficiaries / worker registered under the statutes numbering around 3.5 crores. Direct transfer schemes directing payment of funds to these beneficiaries would provide much needed relief to one of India’s most important groups. It is perhaps with this consideration that a Labour minister of the Union Government wrote to Chief Ministers and Lt. Governors, advising them to “transfer funds in the account of construction workers through DBT (direct benefit of transfer) mode from the Cess fund collected by the Labour Welfare Boards under the Building and other construction workers (regulation of employment and condition of Services) Act” 15. Considering the decision by some States to suspend specific labour statutes, it will be interesting whether this large publicly held fund, audited by the CAG as recently as 2017, can be used for its stated object and purpose.
COVID-19 and its impacts may be a wake-up call to make more robust contingencies and guidelines for infrastructure planning in case of future crises. Though the applicability of the force majeure clause in most commercial contracts is likely, and most deadlines will be proportionately pushed forward, the ongoing delay may have a knock-on effect on time-bound construction work lying stalled. It will be interesting to see what imperative measures are taken to minimise the overall delay and additional cost in making the much-awaited Metro functional.
Impact on Banking and Finance:
The inability of these sectors to perform and repay their lenders may cause a cascading effect on financial institutions, which were already weathering a wave of disproportionate non-performing assets (NPAs), liquidity constraints, and other major setbacks prior to the pandemic. Back to back defaults and non- compliance by large market players including Yes Bank, PMCB and PNB have raised concerns for depositors and creditors, who have become even more risk averse. Private sector banks and NBFCs lending to MSMEs and companies with limited cash buffers may see major repayment defaults due to lack of liquidity, thereby damaging the balance sheets and asset quality of their lenders.
Having contemplated various scenarios, the Reserve Bank of India (“RBI”) has taken initiatives such as cutting repo rates16 and directing lenders to take various steps towards building resilient continuity plans and preparing for a longer period of COVID-19 related restrictions17 . Considering the likelihood of repayment defaults during the lockdown, borrowers have been granted relief by RBI through its COVID-19 Regulatory Package18 , which permits banks to grant a moratorium of three months on repayment instalments falling due between March 1, 2020 and May 31, 2020 (“Deferment Period”). Additionally, lenders may recalculate the drawing power in working capital facilities by reducing margins or reassessing the cycle. However, interest will accrue at existing rates and may become payable immediately upon the expiry of the Deferment Period. This also means that the overall loan term is extended proportionate to the Deferment Period without any relief for payment of additional interest for the extended period, which was not originally contemplated while availing the loan facility.
This could potentially lead to a multitude of courtroom battles, once COVID-19 exits the daily news cycle and enters the archives of history. One such battle has already begun, in the case of Gajendra Sharma vs Union of India and others 19, with the writ petitioner challenging accruing of interest during the Deferment Period. At the same time, there are rumors indicating that the Deferment Period may be extended by a further period of three months by the RBI20 .
Most importantly for lenders, any deferments to repayment instalments granted under the COVID-19 Regulatory Package would not result in asset classification downgrade, and lending institutions who choose to participate would be able to maintain their asset quality, at least on paper. Further, as a part of its COVID-19 Regulatory Package, RBI gave instructions to financial institutions for the exclusion of the Deferment Period from the timeline for the review period and implementation of the resolution plan to be formed in respect of entities in default .
15 https://www.livemint.com/news/india/covid-19-centre-asks-states-to-dip-into-rs52-000-crore-construction-cess-fund-11585054540334.html
16 FMOD.MAOG.No.140/01.01.001/2019-20 dated March 27, 2020 and circular FMOD.MAOG.No.141/01.01.001/2019-20 dated April, 17, 2020
17 circular no. DoS.CO.PPG.BC.01/11.01.005/2019-20 dated March 16, 2020
18 Supreme Court of India - Diary No. 11127/2020
19https://www.bloombergquint.com/coronavirus-outbreak/rbi-may-extend-moratorium-on-loans-by-another-3-months<
20 circular DOR.No.BP.BC.62/21.04.048/2019-20 dated April 17, 2020
Conclusion
With the vast disruption and fundamental inability to work caused by COVID-19 and the lockdown, the real estate sector, infrastructure and financial institutions have taken a massive hit. Even after the pandemic is behind us and restrictions are lifted, the real estate and infrastructure industries may face challenges including payment defaults by purchasers, shortage or surge of raw supplies, disruptions in the supply chain, lack of adequate manpower, etc. Financial institutions seeking repayment from the impacted industries may find more doors closed than before, as companies struggle to find their feet and retain continuity of operations. It will be the role of the authorities and industry associations to create impactful solutions and harmonise the interests of various stakeholders into ensuring the survival and growth of these sectors.
It has also been noted by some that there is a possibility that Courts may take contradictory stands on the impact of the pandemic on certain contractual obligations. While the judiciary will eventually find one view to prevail over all others, the impact of COVID-19 on contractual obligations has been addressed by some nations through temporary legislations providing relief to performance of those contracts which have been affected by COVID-19. For example, the Singapore COVID-19 (Temporary Measures) Act, 2020 provides relief in the case of inability to perform obligations in certain categories of contracts on or after February 1, 2020, where the inability is caused by the pandemic.
Such measures provide support to the legal community, and reduce the burden on legal infrastructure during and after the pandemic, by making the applicability of certain impacted obligations amply clear. At the same time, it is also expected from all of us that we act responsibly at all times, and avoid unnecessary and vexatious litigation. We remain positive that the authorities, businesses and people at large will give due consideration to the numerous factors at play, and act collectively towards a steady recovery of the economy despite the trying times ahead.