The Viewpoint: Frustration of Leases due to COVID – 19

A contract places a positive obligation on the parties to perform their respective obligations. Failure to do so often resulting in the non-performing party being saddled with claims of damages, interest etc. However, there are circumstances when a party to a contract may be prevented from performing its obligations without having to be penalised for the same.

INDIAN CONTRACT ACT, 1872 (Contract Act)

Section 32 of the Contract Act and Section 56 of the Contract Act deal with such circumstances where the performance of a contract can be dispensed with without being penalised for the non-performance.

Section 32 of the Contract Act deals with contract that have to be performed only upon the occurrence of a particular event viz., contingent contracts and Section 56 of the Contract Act deals with circumstances under which performance of a contract can be avoided. The distinction between the circumstances under Section 32 and Section 56 is that Section 32 provides for circumstance that are mutually acceptable to the parties and under Section 56 the circumstances are beyond the control of the parties.

Factors that render the performance of a contract impossible due to acts beyond their control are classified as events of “Force Majeure” or “Act of God”. Upon the occurrence of such Force Majeure events the parties may either exercise the option available to them under the Force Majeure clause as existing in their contract or in the alternative treat the contract as ‘frustrated’ thereby terminating it.

Force Majeure clauses are those that determine the obligations of parties during Force Majeure events. Typically, Force Majeure clauses operate to suspend or place on hold the obligations of the parties during the period of the Force Majeure. The purpose of Force Majeure clauses is primarily to prevent either party from being adversely affected as a result of an event that is beyond their control.

While a Force Majeure clause is a creation of contract between the parties, in the absence of a Force Majeure clause, the parties can exercise the option available under Section 56 of the Contract Act.

The concept of ‘frustration of a contract’ was first recognised by English Courts in the year 1863 [1]. Until this time the English common law was based on the rules of “absolute contract” that when a duty was cast upon a person who bound himself by contract absolutely to do a thing, he could not escape liability for damages for breach by proof that as events turned out performance was futile or even impossible [2].

The rule of “absolute contract” was later mitigated by the English court by an exception that if further fulfilment of the contract I brought to an abrupt stop by some irresistible and extraneous cause for which neither party is responsible, the contract shall terminate forthwith and the parties be discharged [3].

Section 32 of the Contract Act dealing with enforcement of contracts contingent on an event happening states that if the event contemplated becomes impossible, such contracts become void [4]. Section 56 of the Contract Act on the other hand identifies the below circumstances under which performance of a contract is excused or dispensed with on the ground of the contract being void:

1. An agreement to do an act impossible in itself is void.

2. A contract to do an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful.

3. Where one person has promised to do something which he knew, or, with reasonable diligence, might have known, and which the promisee did not know, to be impossible or unlawful, such promisor must make compensation to such promisee for any loss which such promisee sustains through the non-performance of the promise.

The word ‘impossible’ used in Section 32 and Section 56 of the Contract Act has not been used in the sense of physical or literal impossibility. Impossibility is not merely confined to something which is not humanly possible. The performance of an act may not be literally impossible but it may be impracticable from the point of view of the object and purpose which the parties had in view [5]. Where the supervening events take away the basis of the contract and be of such a character that it strikes at the root of the contract [6] whereby the performance is rendered, by intervention of law, invalid, or the subject matter assumed by the parties to continue to exist is destroyed or a state of things assumed to be the foundation of the contract fails, or does not happen, the contract stands discharged [7].

Impossibility and frustration are often used as interchangeable expressions. It is not hardship or inconvenience or material loss which brings about the principle of frustration into play. There must be a change in the significance of obligation that the thing undertaken would, if performed, be a different thing from that which was contracted for. A contract cannot be frustrated merely because the circumstances in which it was made are altered [8].

The law does not enable a party to a contract to ignore the express covenants thereof. There is no general liberty reserved to the courts to absolve a party from liability to perform his part of the contract, merely because on account of an uncontemplated turn of events, the performance of the contract may become onerous[9].

TRANSFER OF PROPERTY ACT, 1882 (TP Act)

Leases, though satisfying all the requirements of a contract, are instruments of conveyance and are governed by the Transfer of Property Act, 1882.

Lease is defined under the TP Act as:

“A lease of immoveable property is a transfer of a right to enjoy such property, made for a certain time, express or implied, or in perpetuity, in consideration of a price paid or promised, or of money, a share of crops, service or any other thing of value, to be rendered periodically or on specified occasions to the transferor by the transferee, who accepts the transfer on such terms. Lessor, lessee, premium and rent defined.—The transferor is called the lessor, the transferee is called the lessee, the price is called the premium, and the money, share, service or other thing to be so rendered is called the rent.”

Section 108(B)(e) of the TP Act recognises certain limited events which are akin to force majeure and their effect on leases as under:

“… if by fire, tempest or flood, or violence of an army or of a mob, or other irresistible force, any material part of the property be wholly destroyed or rendered substantially and permanently unfit for the purposes for which it was let, the lease shall, at the option of the lessee, be void: Provided that, if the injury be occasioned by the wrongful act or default of the lessee, he shall not be entitled to avail himself of the benefit of this provision”

In terms of Section 111(b) of the TP Act a party to a lease may determine the lease “on the happening of some event” vis., the event mentioned in Section 108(B)(e) inter alia others.

Neither Section 108(B)(e) nor Section 111 of the TPA provides for an automatic determination of a lease on the destruction of the premises due to an irresistible force. There can be no unilateral suspension of payment of rent. The lessee / tenant continues to be liable for the whole of the rent until there is an order from court or agreement from the landlord for reduction of the rent.

The High Court of Andhra Pradesh in the case of Gandavalla Muniswamy vs Marugn Muniramaiah clarified the position of Section 108(B)(e) as under:

“under section 108e, T.P. Act a lease is not automatically determined on the destruction by fire or irresistible fore of a substantial portion of the property leased. It is a matter of option with the lessee to get rid of the lease or not. He could treat it as void of he so desired. But the law does not compel him to do so. This aspect of the matter makes it all the more necessary that an unambiguous declaration of the lessees intention to treat the lease as void must be communicated to the lessor. The lessor would not otherwise be able to take appropriate steps on the footing that the lease has to come to an end and he is therefore after liberty to deal with the property as he chooses. What is even more important is that a mere declaration of intention to treat the lease as void is not sufficient. The lessee must also yield up possession of the property to the lessor as required by the provisions of Section 108(q) of the Transfer of Property Act. He cannot continue in possession and yet declare that he has treated the lease as void. That sould obviously be an inconsistent and impermissible position to adopt. So long as a lessee has not surrendered to his lessor the possession which he obtained from the latter at the time of the lease, he cannot rid himself of his obligations under the lease.”

The above position was reiterated by the High Court of Delhi in the case of Chamber of Colours and Chemicals Pvt. Ltd. v. Trilok Chand and the Supreme Court in the case of Shaha Ratansi Khimji & Sons vs Proposed Kumbhar Sons Hotel Pvt. Ltd. where the Supreme Court observed that:

“…where a premises has fallen down under the circumstances mentioned therein, the destruction of the shop itself does not amount to determination of tenancy Under Section 111 of the Act and there is no automatic determination of tenancy and it continues to exist.…..Under such circumstances it is the tenant who is to suffer as he is unable to enjoy the fruits of the tenancy but he is saddled with the liability to pay monthly rent to the landlord. It is for such a situation the tenant has been given an option Under Section 108(B)(e) of the Transfer of Property Act to render the lease of the premises as void and avoid the liability to pay monthly rent to the landlord.”

APPLICABILITY OF SECTION 56 OF THE CONTRACT ACT TO LEASES

The Hon’ble Supreme Court in the case of Dhruv Dev Chand vs Harmohinder Singh & Anr, while examining the applicability of Section 56 of the Contract Act to leases held that Section 56 is not applicable when the rights and obligations of the parties arise under transfer of property. The Hon’ble Supreme Court held as under:

“By Section 4 of the Transfer of Property Act the chapters and sections of the Transfer of Property Act which relate to contracts are to be taken as part of the Indian Contract Act, 1872. That section however does not enact and cannot be read as enacting that the provisions of the Contract Act are to be read into the Transfer of Property Act. There is a clear distinction between a completed conveyance and an executory contract, and events which discharge a contract do not invalidate a concluded transfer.

By its express terms s. 56 of the Contract Act does not apply to cases in which there is a completed transfer. The second paragraph of s. 56 which is the only paragraph material to cases of this nature has a limited application to covenants under a lease. A covenant under a lease to do an act which after the contract is made becomes impossible or by reason of some event which the promisor could not prevent unlawful, becomes void when the act becomes impossible or unlawful. But on that account the transfer of property resulting from the lease granted by the lessor to the lessee is not declared void.

If any material part of the property be wholly destroyed or rendered substantially and permanently unfit for the purpose for which it was let out, because of fire, tempest, flood, violence of an army or a mob, or other irresistible force, the lease may, at the option of the lessee, be avoided. This rule is incorporated in s. 108€ of the Transfer of Property Act and applies to leases of land, to which the Transfer of Property Act applies, and the principle thereof to agricultural leases and to leases in areas where, the Transfer of Property Act is not extended. Where the property leased is not destroyed or substantially and permanently unfit, the lessee cannot avoid the lease because he does not or is unable to use the land for purposes for which it is let to him.”

The above view was upheld in the subsequent case of Sushila Devi And Anr vs Hari Singh And Ors and T. Lakshmipathi & Ors vs P.Nithyananda Reddy & Ors wherein the Hon’ble Supreme Court reiterated that “The tenancy cannot be said to have been determined by attracting applicability of the doctrine of frustration consequent upon demolishing of the tenancy premises. Doctrine of frustration belongs to the realm of Law of Contracts; it does not apply to a transaction where not only a privity of contract but a privity of estate has also been created inasmuch as lease is the transfer of an interest (sic) immovable property within the meaning of Section 5 of the Transfer(sic Property Act (wherein the phrase ‘the transfer of property’ has been defined), read with Section 105, which defines a lease of immovable property as a transfer of a right to enjoy such property.”

CONCLUSION

The question of whether COVID–19 is an act of god/force majeure is yet to be ascertained. However, the manner in which COVID -19 has engulfed the world and the resulting economic collapse is definitely driving businesses around the world to relook at their contracts and more specifically their leases in light of the lock down.

The Order of the Ministry of Home Affairs, Government of India, bearing no. 40-3/2020 – DM – 1 (A), dated March 24, 2020, declaring a lock down resulting in disruption of business, is being considered by lessees / tenants as a Force Majeure event / Act of God, thereby seeking abatement of rent for the period of lock down, waiver of obligations under the lease, reduction of rent for a portion or remainder term of the lease and in some case termination of the lease on the grounds of frustration of contract arising out of Act of God or Irresistible Force.

In this context it will be relevant to note that even if a reasonable man test determines COVID – 19 as an event of Act of God/Force Majeure, however such a determination, in the absence a Force Majeure clause in the lease deed, will have very little bearing on leases and the liability of the lessee / tenant to pay rent much less declare the lease void for the following reasons:

1. Notwithstanding the applicability of section 56 of the Contract Act to leases, the lock down resulting from the COVID -19 Force Majeure may at best result in the performance of the lease being onerous on the lessee / tenant - it does not render the performance of the lease impossible hence the same cannot be treated to have frustrated the lease.

2. The COVID -19 resultant Force Majeure event, while akin to an Irresistible Force under the Section 108B(e) of TP Act, has not resulted in the destruction of the premise rendering it unfit for use by the lessee / tenants and hence cannot be of any avail.

Duvva Pavan Kumar is an advocate based out of Hyderabad practising before the High Court and NCLT. He is the founder of The Law Chambers.

Preetham Kunapareddy assisted in the preparation of the article.

[1] Taylor v Caldwell [1863] EWHC QB J1

[2] Paradine vs Jane (1647) Aleyn 26.

[3] Denny, Mott & Dickson Ltd. vs James B Fraser & CO Ltd [1944] A.C. 265

[4] Section 2 (j) defined Void contracts as “A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable.”

[5] Satyabrata Ghose v. Mugneeram Bangur & Co AIR 1954 SC 44

[6] Sushila Devi & Ors vs. Hari Singh & Ors AIR 1972 SC 1756

[7] Dhruv Dev Chand vs. Harmohinder Singh & Ors AIR 1968 SC 1024

[8] Naihati Jute Mills Ltd. v. Hyaliram Jagannath AIR 1968 SC 522

[9] Alopi Parshad & Sons Ltd. v. Union of India AIR 1960 SC 588; Energy Watchdog & Ors v. Central Electricity Regulatory Commission & Ors (2017) 14 SCC 80.