Thursday, May 25, 2017

Geotagging: A New Way to Track Charged Assets

[Post by Rohit Sharma, who is an Executive at Vinod Kothari & Co. He can be reached at rohit@vinodkothari.com.]

Notification

The Ministry of Corporate Affairs (MCA) issued a notification dated 7 April 2017 introducing a new way to track down tangible assets on which charge has been created and registered with the Registrar of Companies (RoC).  This is to be accomplished by geotagging the charged tangible assets. It is pertinent to note that while this process of tagging assets is novel for the MCA, the Ministry of Rural Development been using the same since 2016 for tagging rural assets created under flagship rural employment program MGNREGA.

What is geotagging?

Geotagging is a process of tagging an asset by mentioning its specific geographical identification, including its latitude and longitude, on the portal where it is registered. The intent of such geotagging is to bring in transparency in the system by providing an ocular portrayal of assets on top of the map or satellite visual. In doing so, the assets are better monitored, and leakages can be plugged. Additionally, this helps in creating an online database for the government, which may in turn help the public obtain relevant information online.

Changes by MCA

The MCA has, by way of the aforesaid notification, made changes to several forms as follows:

Sl. No.
Charge Form
Prior to such notification
Post such notification

1.

CHG 1 – Application for registration of creation, modification of charge, including particulars of modification of charge by Asset Reconstruction Company in terms of SARFAESI, 2002

a. There was no column to fill in the detail regarding the authorisation of the charge holder assigning the charge as per the charge agreement.

b. There was no separate column for the pari passu charge holders.

c. Specific geographical indication of latitude and longitude was not required to be mentioned in the Form.


a. Details with respect to authority of the charge holder assigning the charge as per the charge agreement is required.

b. Details whether the charge ranks pari passu are required.

c. Particulars of the property being charged with respect to its location including the details of latitude and longitude of the asset

d. A declaration, as was required in CHG-9 has been added.

2.
CHG 9 – Application for registration of creation or modification of charge for debentures or rectification of particulars filed in respect of creation or modification of charge for debentures
a. Details of latitude and longitude of the property were not required.

b. The principal terms and conditions, extent and operation of charge were to be inserted without entering specific details of the terms and conditions.

c. No description of the document through which the title of the property has been obtained must be entered, as there was no such column.
a. The of the property charged now includes details of the latitude and longitude of the asset being charged as a mandatory field.

b. The purview of the principal terms and conditions, extent and operation of charge has been made elaborate. The holder will have to additionally add more details about the principal terms and conditions of the extent and operation of charge.

c. Description of the document by which the company acquired the title has been inserted.

3.
CHG 4- Particulars of satisfaction of charge thereof
a. ‘Declaration’ that was required from the authorised person signing the form related to the genuineness of the documents attached that is available with the charge holder.

a. The only change in this Form due to this notification is in the ‘Declaration’ part whereby new declarations have been added post this notification.

Analysis

Essentially, the genesis of the MCA notification can be attributed to the failure of the RoC to track down the assets registered with it as charge. This is also consistent with the government’s push towards a digital economy, as it moves in the direction of digitising the data of assets over which a charge has been registered.

One of the benefits of this notification is that the creditors, RoC and other statutory authority will be able to track down the charged assets virtually, which was not possible previously as there was no requirement to provide details regarding the specific geographical location of the asset. Monitoring of charged assets is important to the creditors and the government to bring in transparency and authenticity of the charged asset.

In all, while the intent on record with which such additional requirements have been set out in relation to charged assets seems to be bringing in more transparency and ease of monitoring the charged assets, it seems that the same will mostly lead to online data collection. Creditors will need to wait and watch to consider the extent to which the new process will aid them against falling prey to notorious debtors who may charge incorrect or non-existent assets.

- Rohit Sharma

Wednesday, May 24, 2017

Force Majeure Clauses and Impossibility Under the Indian Contract Act

[Post by Isha Jain, who is a 4th year student at the National Law School of India University, Bangalore.

Other posts related to this topic are available here and here.]

The Supreme Court’s recent decision in Energy Watchdog v. Central Electricity Regulatory Authority (“AdanĂ­”) has obscured rather than clarified the law on contractual impossibility in India. The case was concerned with the interpretation and application of force majeure clauses in certain power purchase agreements (PPA). In this post, I will examine: first, the legal position on force majeure clauses and impossibility in contracts under Indian law, and second, the correctness of the Supreme Court’s decision in Adani. Through this, I shall propose an alternative approach to the application of force majeure clauses.

Force Majeure Clauses Under Indian Law

A force majeure clause in a contract is an express provision of circumstances in which performance under the contract will be excused.[1] The purpose behind inserting such clauses is to save the performing party from the consequences of anything over which the party has no control.[2] However, an express force majeure clause is only one of several routes by which a party can escape its obligations under a contract on grounds of impossibility of performance.

The law on contractual impossibility under the Indian Contract Act, 1872 (“Contract Act”) can be best understood through a careful analysis of sections 9, 32 and 56 of the Act.

Section 32, read alone, provides for the discharge of obligations due to the impossibility of an express contingency. In other words, if the contract expressly provides that performance is contingent on the occurrence of an event, the impossibility of that event shall lead to the contract becoming void. Express force majeure clauses can be read as stipulating such contingencies. For instance, a force majeure clause that provides for the discharge of obligations in case of nationalisation of the assets that are the subject matter of the contract can be read as making the contract contingent on the assets not being nationalised.

Section 9 permits the courts to consider implied terms in contracts. Accordingly, section 9 read with section 32 provide the basis for discharge of obligations due to the impossibility of an implied contingency. This means that though the parties may not have expressly provided for it, there may be certain contingencies upon which performance of the contract rests. While the court may uncover such terms through construction of the contract,[3] it ought not to imply a term merely because such term would be a reasonable term to include.[4] Such implication may only derive from the intent of the parties, as indicated by the relationship of the parties, their prior dealings, and the purpose of the contract at issue.[5]

Section 56 provides, separately, that a contract to do an act becomes void when the act becomes impossible. Before delving into the interpretation of section 56, it is necessary to draw a clear distinction between the purport of section 32 and that of section 56. Under both sections 32 and 56, obligations under the contract stand discharged due to an impossibility. However, under section 32, the link between the impossibility and the discharge of obligations is to be found in express or implied contractual terms. In other words, section 32 accounts for the subjective intent of the parties to discharge obligations upon the occurrence of certain contingencies. On the other hand, section 56 is concerned with impossibilities which, on an objective determination by the court, go to the root of the contract.

The landmark decision interpreting section 56 is Satyabrata Ghose v. Mugneeram Bangur & Co.[6] The Supreme Court in this case acknowledged the aforementioned distinction between section 32 and section 56, stating: “Section 56 lays down a rule of positive law and does not leave the matter to be determined according to the intention of the parties.” The Court observed that section 56 allowed for discharge of obligations on grounds of impossibility if “an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement” (emphasis added).

The Decision in Adani

To reiterate, the Adani case was concerned with the interpretation and application of express force majeure clauses in certain PPAs. Under these PPAs, Adani Power had agreed to supply power to state utilities in Gujarat and Haryana. Subsequent to the conclusion of the contracts, a change of law in Indonesia, from where Adani sourced much of its coal, resulted in a significant increase in the export prices of coal from Indonesia. Because of this change, Adani sought relief on grounds of force majeure under the contract, and in the alternative, on grounds of FRUSTRATION under section 56 of the Contract Act. The relevant clauses of the PPA can be summarised as follows:

- Clause 12.3 provided a non-exhaustive list of events that would be considered “force majeure events” under the contract.

- Clause 12.4 specified “force majeure exclusions”, i.e., events which were not to be considered force majeure events under the contract.

- Clause 12.7 laid down the available relief in case of occurrence of a force majeure event.

In its decision, the Court first examined the development of the doctrine of frustration under common law. According to common law, a contract would be frustrated only if the fundamental basis of the contract was affected by the change in circumstances.[7] In this case, the Court found that the fundamental basis of the PPAs remained unaltered by the change in price of the Indonesian coal exports.

Next, the Court turned to examine whether Adani could take recourse to the express force majeure clauses in the PPAs. The clause provided for the discharge of obligations in case of an event that partly prevented or hindered the performance of obligations under the agreement. However, the Court observed that force majeure clauses are to be narrowly construed, and that a mere price rise rendering the contract more expensive to perform would not constitute a “hindrance”. More specifically, clause 12.4 of the PPA specified that “changes in cost of the ... fuel ... for the Project” or “the agreement becoming onerous to perform” would not constitute force majeure events under the contract. Thus, the contract itself was found to have provided for this contingency.

Finally, the Court declined to address Adani’s alternative argument under section 56, holding: “When a contract contains a force majeure clause which on construction by the Court is held attracted to the facts of the case, Section 56 can have no application.”

There are two issues with the manner in which the Court arrived at its decision. First, there was no reason for the Court to go into the common law doctrine of frustration,  and second, the Court was not precluded from going into the alternative argument under section 56. I shall address these issues in turn.

It is unclear why the Court went into the common law doctrine of frustration, immediately after acknowledging that the law on force majeure is contained in sections 32 and 56 of the Indian Contract Act. Yet, it chose to cull out a test of “impossibility going to the fundamental basis of the contract”, without expressly deriving this test from either statutory provision. Interestingly, all of the quotes from Indian cases that were cited by the Court were made in relation to section 56, and not in relation to an abstract common law doctrine of frustration. This stands out in contrast with the Court’s final conclusion that it would not consider Adani’s alternative claims under section 56.  

The Court declined to consider the alternative claim, stating that “As has been held in particular, in the Satyabrata Ghose case, when a contract contains a force majeure clause which on construction by the Court is held attracted to the facts of the case, Section 56 can have no application.” However, it appears that this is an unduly narrow reading of the cited case. Admittedly, the Court in Satyabhrata Ghose did observe: “When a contract contains a force majeure clause which on construction by the Court is held attracted to the facts of the case, Section 56 can have no application.” However, this should be read to mean that section 56 has no applicability in the construction of that force majeure clause. Section 56, and the ground of impossibility thereunder, should still remain available as an alternate basis for avoidance of obligations under the contract. There is nothing in the Contract Act or the PPAs to suggest that the contractual inclusion of a force majeure clause precludes parties from taking recourse to the statute under section 56.

A more forceful argument for the non-applicability of section 56 would be to say that the parties, through clause 12.4, expressly assumed the risks of rising prices. Where parties expressly assume the risk of impossibility, they cannot then avoid the performance of obligations on grounds of impossiblity.[8] If a contract provides that an obligation is unconditional or unaffected by any impossibility, it is not open for a party to bring a claim under section 56.[9] However, there is a difference between a contractual provision which says that a rise in prices shall not be considered a force majeure event under the contract, and a provision which says that the obligations of the supplier are unconditional or are to be unaffected by rise in prices. Clause 12.4 is in the mold of the former, and accordingly only restricts the scope of claims that can be brought under the force majeure clause of the contract. However, a claim under section 56 is distinct from a claim under the force majeure clause of the contract, and accordingly would not be restricted by the limitation imposed under clause 12.4.

Thus, the Court in Adani arguably misstated the law when it found that the mere existence of a force majeure clause would prevent the parties from bringing an alternative claim under section 56.

- Isha Jain



[1] Pollock and Mulla, Indian Contract and Specific Relief Acts (13th edn., 2006).


[2] Davis Contractors Ltd v Fareham Urban District Council, [1956] 2 All ER 145.

[3] Naihati Jute Mills Ltd. v. Hyaliram Jagannath, 1968 (1) SCR 821.

[4] Pradgas Mathuradas v. Jeewanlal, A.I.R. 1948 P.C. 217.

[5] C. Scott Pryor, Clear rules still produce fuzzy results: impossiblity in Indian Contract Law27 Arizona Journal of International and Comparative Law, 1, 10 (2010) .

[6] Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310.

[7] Taylor vs. Caldwell, (1861-73) All ER Rep 24.

[8] V.L. Narasu v. P.S.V. Iyer, AIR 1953 Mad 300.

[9] Piarey Lal vs Hori Lal, AIR 1977 SC 1226.

A Proposal for Dealing With Force Majeure Clauses Under Contract Law

[Post by Siddharth Bajpai, who is a 4th year student at the National Law School of India University, Bangalore.

Other posts related to this topic are available here and here.]

Introduction

In 2013, Adani Enterprises entered into a power purchase agreement (PPA) with Gujarat Electricity Regulatory Commission and Haryana State Regulatory Commission. Under the terms of the arrangement, Adani was bound to procure coal. The coal was imported from Indonesia. However, a change in the Indonesian law led to a substantial rise in the price of coal. In light of this, Adani sought to dissolve the contract on the grounds of frustration due to sudden escalation in prices.

At the outset, it must be highlighted that Adani incorporated a broadly worded force majeure clause (FMC) and chose the cost plus method for pricing of coal in the PPA. This implied that the coal charges would be fixed and not escalable. This was an aggressive and competitive factor which gave Adani an edge in the bidding process it won.[1] In this post, the author has two objectives: first, to analyse the correctness of the judgement regarding the frustration of the contract and second, to discuss the usage of FMC in commercial practice.

Judgement 

In the above matter, the Supreme Court of India (SC) held in its judgment that the contract was not frustrated, and it did so by relying on the interpretation of section 56 of the Indian Contract Act, 1872 (the Act). It relied on precedents and the terms of the contract to draw two conclusions regarding the FMC. First, the escalation in price of coal had only made the performance onerous and not impossible. Second, mere escalation of price could not be construed as a hindrance to prevent performance under the contract, and Adani could not be discharged from performance of the contract. 

Analysis

In India, section 32 of the Act is applicable if the terms of a contract expressly state that, upon happening of certain contingencies, it would stand discharged. Therefore, FMCs have to be interpreted in accordance with section 32 of the Act and the doctrine of proper construction will be applicable.[2] It entails the construction of the FMC with the events which preceded or followed it. Due regard must be given to the nature and general terms of the contract.[3] The rule of ejusdem generis also acts as an external aid in the interpretation in a manner so as to include only the happening and eventualities of a similar standard.[4] This is the legal position on the FMC in India.

In the present case, the Court extensively relied on cases in which the agreement in contention did not contemplate an FMC and an application of section 56 was sought. The Court came to the conclusion that economic downturns did not alter the fundamental basis of the contract. It must be highlighted that the application of this doctrine of fundamental basis is limited to the cases under section 56 where an external event that has not been contemplated by the parties radically changes the object of the agreement.[5]

The author is of the opinion that the judgement is sound in concluding that economic downturns cannot be considered as a factor for frustration of a contract. However, the SC has deviated from the crux of reasoning adopted by it. The author sets forth two main arguments regarding the analysis in this judgement. First, there was a pre-existing FMC and the application of section 56 was erroneous. Second, the interpretation of the hindrance was redundant because there was a specific exclusion in the agreement.

Regarding the first submission, section 32 of the Act should have been relied upon to enforce the agreement terms. The SC was bound to apply the doctrine of proper construction to the agreement. This doctrine has two main limbs: first, the court must evaluate the allocation of the risks in the agreement and second, the ejusdem generis rule must be employed to interpret the terms of the contract.[6] With regard to the first limb, the court must identify whether any party has expressly assumed the risk of the events which have occurred. In the present case, construction of risk allocation manifests in the fact that Adani expressly undertook the risk by choosing the cost plus method for pricing while being aware of the volatile prices in the coal market.[7] Although the SC has made an oblique reference to this fact in its judgement, it failed to discuss this issue in greater detail. As per the second limb, the rule of ejusdem generis should have been employed to determine if the economic downturns were within the ambit of the FMC. The two relevant considerations that the Court should have taken into account are: first, that the events mentioned in the FMC belong to the class of an act of God, war or unlawfulness; second, clause 12.4 of the PPA made a specific exclusion regarding the cost of fuel not being within the ambit of the FMC. With respect to the first consideration, the SC failed to rely on those precedents where facts were in pari materia with the present case. In such precedents, it had been held that the court would not interpret the FMC broadly to construe economic downturns within its ambit.[8]

The Court has skirted the issue of protecting the sanctity of the contract by relying on unrelated precedents and not construing the contract itself. This opens a Pandora’s Box where the court will be free to apply the principles of section 56 to the cases of contingent contracts, which should otherwise fall under section 32. The author submits that in a similar factual matrix, the terms of the agreement may provide for economic downturns as a force majeure event. In such cases, these precedents will not be directly applicable. Instead, the burden will fall on the courts to apply the doctrine of proper construction to ascertain the intention of the parties in that specific agreement.

Proposals 

Assuming that these clauses are not drafted in a broad, inclusive manner, the author would like to argue in favour of disbanding the practice of drafting such FMCs. Professor Berman’s “enumerative” principle laid down this practice.[9] As per this practice, parties list a number of discharging contingencies, intending that all the risks will be borne by the promisor. However, there are number of significant drawbacks to this approach. First, it is extremely onerous on the obligor. Assuming but not conceding that nothing is unforeseeable, it is unjust to hold the promisor liable for the risk of events that are not specifically mentioned.[10] Second, a logical corollary of this principle could suggest that the promisor can minimize his liability by specifically listing all the imaginable events. Third, due to the high drafting costs involved, it is a reality only in high value contracts. Hence, the author would like to suggest an alternative approach.

The fundamental purpose of the contract is to maximize its economic efficiency by fulfilling its purpose. The fact that the performance is to extend into the future introduces uncertainty, which in turn creates risks. Therefore, another incidental fundamental purpose is to allocate these risks between the parties to the exchange. At this juncture, the author submits that parties should not bargain with the future events because they cannot be anticipated. The courts in such cases should bear the duty of the allocation of risks after considering the implied or express terms of the contract. A two-step test should be applied. First, it should be determined whether the obligor is the superior risk bearer in the particular contract. This here is to be understood as the party which can bear the risk more efficiently.[11] Discharge from performance would be unjust and inefficient in cases where the obligor could have prevented the risk from materialising at a cost lower than the expected cost of the risky event. Cases may also arise where although the obligor was the superior risk bearer, he could not have prevented the risk from materialising.[12] In such cases, the court should proceed to the second step, i.e., evaluate which party could have insured itself at a lower cost. The author submits that insurance is a method of reducing the costs associated with the risk that performance of a contract may be costlier than anticipated. The author would also like to provide an illustration for this model.

Consider A, a printing machinery manufacturer, contracts with B, to install a customised and a totally unique model for printing. Since it is customised, its value to any other printer will be marginal. Just before its installation, a fire destroys B’s premises and puts B out of business. Since the machine has no value in the market, A accordingly sues B for the full price. B’s defence is that since the fire was not caused due to its negligence, it should be discharged from the performance. Applying the two-step test, it is clear that since the fire occurred in B’s premises, it had the superior ability to prevent the fire. However, considering the fact that it was not due to B’s negligence, B could not have prevented the incident. Therefore, the court should proceed to the second step in the test. Which of the parties could have obtained an insurance protection at a lower cost? Here, although B would be able to determine the probability that a fire would occur, A is in a better position to determine the actual loss. A is better aware than B of the stages of production of the machine and the salvage value at each stage. A could have easily known the contingencies and the magnitude of loss since the machine was highly unique. In such contracts, A could have charged a premium from customers like B. On the other hand, the cost of B’s insurance would be higher, i.e., not only against loss caused by the fire but also against its contractual liability to A. Thus, B should be discharged from performance.

Conclusion 

The Indian Contract Act is an exhaustive and lucid statute. The principles under every section are codified and the mode of their application has been provided in the illustrations. The Act solemnly protects the sanctity of contracts by also delimiting the jurisdiction of the court. However, in cases like Adani, the court has encroached upon this sanctity of contracts. Adani manifests that the courts often overlook the correct principled justification by finding an easy way out. Further, such precedents open the Pandora’s Box for further abuse of courts’ discretion. Added to this, considering the drawbacks of drafting the FMCs, the author has argued for their disbanding. Instead, a two-step test has been suggested for the courts to allocate the risk among the parties.

- Siddharth Bajpai






[1] Adani Power Limited v. UHBVN Ltd, Order in Petition No.155/MP/2012(I).

[2] Ganga Singh and Ors v. Santosh Kumar and Ors, AIR 1963 All 201.

[3] Mahadeo Prosad Shaw v. Calcutta Dyeing and Cleaning Co, AIR 1961 SC 70.

[4] Dhanrajamal Gobindram v. Shamji Kalidas and Co, (1961) 3 SCR 1020.

[5] Satyabrata Ghose v. Mugneeram Bangur & Co., 1954 SCR 310.

[6] Md. Serajuddin v. State of Orissa, 1969 SCC Online Ori 4. Davis Contractors Ltd v. Fareham Urban District Council, [1956] 2 All ER 145.

[7] Adani Power Limited v. UHBVN Ltd, Order in Petition No.155/MP/2012(I).

[8] British Machinery Supplies Company v. Union of India, 1993 Supp (2) SCC 76. Madras Society Ltd v. O. Ramalingam, (1976) 1 MLJ 136. Pioneer Shipping Ltd v. BTP Tioxide Ltd, [1981] 2 All ER 1030.

[9] See Michael G. Rapsomanikas, Frustration of Contract in Commercial Practice, 18 Duquesne Law Review 551, 562 (1979).

[10] Rapsomanikas, at 563.

[11] Richard A. Posner, Impossibility and Related Doctrines in Contract law: An Economic Analysis, 6(1) The Journal of Legal Studies 83, 99 (1977).

[12] Posner, at 105.