Effect of COVID-19 on performance of contracts where time is of the essence and passing of risk in sale of goods contracts

Introduction

Generally, in contracts for sale of goods time is of the essence or at least performance is expected within a reasonable period of time. Many may find themselves unable to meet contractual deadlines due to the effect of COVID-19. Furthermore, in the context of sale of goods, whether risk has been passed from buyer to seller will decide who will endure the consequences of this pandemic.

As a first step, companies would have to review their contracts to determine the effect of the force majeure[1] (“FM”) or change in law provision, if any, that might justify delayed performance of contractual obligations owing to the outbreak of COVID-19. This article attempts to give a birds eye view to issues relating to (1) when time will be considered essence of the contract (2) FM clauses in sale of goods contracts (3) impossibility leading to frustration of the contract and (4) passing of risk in sale of goods contracts.

Time of Performance

In a contract where no time limit is fixed for performance the contract is to be performed within a “reasonable time” period.[2] However, where parties have made time of the essence, by including an express stipulation to this effect, failure of a party to observe a timeline would entitle the other party to terminate the contract.[3] On the other hand, if time is not the essence of the contract, performance may be allowed at a time other than that agreed upon.

It is to be noted that mere fixation of a period within which the contract is to be performed does not make time the essence of the contract.[4] An express stipulation that time is of the essence, consequences of non-completion, commercial nature of transaction and conduct of parties would determine the intention of the parties.[5] The stipulation that time is of the essence has to be read along with other provisions of the contract as such other provisions may exclude the inference that time is of the essence.[6] Generally, the courts have held time to not be the essence of the contract where the contract provides for penalty and extension of time[7] or when performance is accepted after the expiry of the original time period[8].

Effect of COVID-19 on time of performance

Due to COVID-19, performance of some contractual obligations may become impossible for the time being. In contracts where time is of the essence, the FM event may even lead to frustration of the contract because of the supervening impossibility to perform obligations under the contract.[9] The law in relation to frustration of contracts can be traced back to the landmark decision in Satyabrata Ghose Vs. Mugneeram Bangur and Co. and anr.[10] Depending upon the contract, the party alleging frustration may be required to prove that it is attributable to COVID-19 and not to itself as the doctrine of frustration cannot be applied where it is a result of an act or election of a party[11].

There will be contracts where COVID-19 may render performance impossible only during the lockdown period in which the FM event is in operation, thereby providing a window for resuming normal contractual obligations after the lockdown ends. Due to the invocation of the FM clause, even where time is the essence of performance, the performance of contract may stand suspended until the FM event has ceased to exist.[12] Therefore, it is imperative to examine the contract and peculiar facts relating to performance to assess the impact of COVID-19.

FM clauses in Sale of Goods Contracts

Generally, in contracts for sale of goods, time is of the essence. In present day contracts, FM clauses are bound to be included to ensure allocation of risk in case of supervening and unforeseeable events that may lead to suspension/ dispensing of obligations under the contract. While the general common law doctrine of frustration can be applied by Indian Courts in accordance with Section 56 of the Indian Contract Act, 1872[13], FM clauses allow predetermination of what may be deemed an unforeseeable event and how it would affect obligations under a contract.

Parties may, through FM clauses specify an extension of time to enable them to fulfil obligations as opposed to termination of contract. It is pertinent to note that such clauses could either be construed to mean that time was never the essence of the contract or, that a FM event could be an exception carved out in the contract that would not attract the consequence of termination upon material breach.

Impossibility leading to Frustration of contract

In case the FM clause does not contemplate an event such as the COVID-19 outbreak or in the absence of an FM clause, such an event may lead to frustration of a contract on account of impossibility to perform. An essential aspect of determining whether the contract has been frustrated is determining whether it has become impossible to fulfil the contract or merely impracticable or onerous. As stated in the case of Alopi Parshad & Sons Ltd. v. Union of India[14], a party is not absolved from performance merely because it faces an obstacle which it did not anticipate or merely because performance has become onerous[15]. The Doctrine of Frustration comes into play when a contract becomes impossible to perform, after it is made. However, in the present circumstances of lockdown, it would not only become physically impossible to execute certain contracts, but in some cases, the purpose and object of the contract would become frustrated[16]. It is pertinent to note that, be it under FM clauses or under the Doctrine of Frustration, parties would still have to illustrate that the contract was impossible to perform. However, the threshold to prove the occurrence of an unforeseen event would be much higher than in case of a FM clause where such an event is already foreseen and specified to be a circumstance under which performance can be excused.

An additional consequence of lack of a FM clause or ineffective application of one to the present circumstances is that where parties terminate the contract as frustrated, without proper allocation of risk. Thus, it becomes relevant to examine the provisions under law that could effectively assign risk to the parties.

Passing of Risk in Sale of Goods contracts

In the context of sale of goods, the concept of ‘risk’ and its movement from a buyer to a seller plays an important role in deciding who is to bear the consequences of this pandemic. Section 26 of the Sale of Goods Act,1930 (“Act”) provides that the risk generally passes with the property.[17] This brings us to the question, ‘when is property said to have been transferred to a buyer?’. The answer to this question lies in Sections 18 to 25 of the Act.

As per Section 18 of the Act, in case of a contract for sale of unascertained goods, no property in the goods is transferred to a buyer until the goods are ascertained[18]. Ascertainment, through Section 23 can be understood to occur on appropriation as laid down in the said provision.[19] Further, under Section 23(2), the property in the goods stands transferred to a buyer upon delivery without reservation of right of disposal[20], to the buyer, or to a carrier or other bailee as per the terms of the contract.

Section 19 of the Act plays the most vital role in the current scenario by making the very need to delve into Sections 20 – 24 subject to the terms of the contract and the intention and conduct of the parties[21]. Transfer of property in goods in case of sale of specific or ascertained goods occurs at such time the parties to the contract intend it to occur[22]. This intention is to be gathered from terms of the contract, intention and conduct of the parties.[23],[24]

In an unconditional contract for the sale of specific goods in a deliverable state, the property passes to the buyer when the contract is made, and it is immaterial whether payment or delivery or both are postponed.[25] In a contract for the sale of specific goods where the seller is bound to do something to the goods to put them in a deliverable state, the property passes when such thing is done by the seller and the buyer has notice of the same.[26] In a contract for the sale of specific goods in a deliverable state, where the seller is to weigh, measure, test or do some other act or thing for the purpose of ascertaining the price, the property passes when such thing is done by the seller and the buyer has notice of the same.[27] When goods are delivered to the buyer on approval or “on sale or return” or other similar terms, the property therein passes to the buyer when he provides his approval expressly or impliedly or by lapse of time, either express or reasonable if the buyer does not return the goods.[28]

While the rules to determine the passage of ownership and therefore risk are as above, it is important to bear in mind that it is open to the parties to bifurcate risk and ownership by agreement in light of the “unless otherwise agreed” clause and the provisos contained in Section 26[29].

Conclusion

In the current scenario, in order to determine where the risk lies, primary importance is to be given to the contract, especially the FM clause, the intention of the parties and thereafter to the rules explained hereinabove in order to determine where the risk falls. Apart from the above, one must vigilantly keep an eye out for notifications issued by the government that may provide relief to some businesses allowing them to resume their pending deliveries. However, businesses may continue to face other challenges like labour and material shortage which will negatively impact their ability to fulfil contractual obligations. Hence, businesses should stay updated and continue to constantly re-evaluate their ability to operate.

The authors are Adarsh Subramanian, Senior Associate, Shivani Singh and Varsha Manoj, Associates at AK Law Chambers.

[1] SPIC SMO v. TNEB, (2013) 1 CTC 500

[2] Section 46, Indian Contract Act, 1872.

[3] Section 55, Indian Contract Act, 1872.

[4] Gomathinayagam Pillai v. Palaniswami Nadar, AIR1967SC868.

[5] Citadel Fine Pharmaceuticals vs M/S Ramaniyam Real Estates Pvt. Ltd. and Ors., (2011)9SCC147.

[6] M/s. Hind Construction Contractors v. State of Maharashtra, (1979)2SCC70.

[7] Hind Construction supra.

[8] Union of India v. Gujrat Co-operative Grain Growers Federation Ltd. MANU/DE/4669/2009.

[9] Section 56, Indian Contract Act, 1872.

[10] AIR1954SC44.

[11] Ganga Saran v. Firm Ram Saran Ram Gopal, AIR1952SC9, Boothalinga Agencies v. VTC Poriaswamy Nadar, AIR1969SC110

[12] Smita Conductors v. Euro Alloys Ltd., 2001AIRSCW3517.

[13] Raja Dhruv Dev Chand v. Raja Harmohinder Singh, AIR1968SC1024, Boothalinga Agencies supra.

[14] 1960(2)SCR793.

[15] Naihati Jute Mills Ltd. v. Khyaliram Jagannath, AIR1969SC522, Continental Construction Company v. State of MP, (1988) 3 SCC 82, Energy Watchdog v. CERC. (2017)14SCC80

[16] Satyabrata Ghose v. Mugneeram Bangur and Co., AIR1954SC44

[17] Phulchand Exports Limited v. O.O.O. Patriot, (2011)10SCC300

[18] PSNS Ambalavana Chettiar v. Express Newspapers Ltd., AIR1968SC741, State of Karnataka v. West Coast Paper Mills Ltd., ILR1985Kar3857

[19] Salar Jung Sugar Mills Ltd. v. State of Mysore and others, (1972)1SCC23, Juggilal Kamlapat v. Pratapmal Rameshwar, (1978)1SCC69, Bhajan Singh Hardit Singh and Co. v. Karsen Agency (India), ILR(1985)2Del779

[20] Section 25, Sale of Goods Act,1930.

[21] Section 19(3), Sale of Goods Act,1930, Arihant Udyog v. State of Rajasthan and others, (2017)8SCC220

[22] Section 19(1), Sale of Goods Act,1930.

[23] Section 19(2), Sale of Goods Act,1930.

[24] Agricultural Market Committee v. Shalimar Chemical Works Ltd., (1997)5SCC516

[25] Section 20, Sale of Goods Act,1930, Shalimar Chemical Works supra.

[26] Section 21, Sale of Goods Act,1930.

[27] Section 22, Sale of Goods Act,1930.

[28] Section 24, Sale of Goods Act,1930.

[29] State of Orissa v. Titaghur Paper Mills Co. Ltd. AIR1985SC1293, Phulchand Exports Limited v. O.O.O. Patriot, (2011)10SCC300