Monday, June 26, 2017

Frustration in Indian Law

On this blog, we had previously looked at the judgment of the Supreme Court of India in Energy Watchdog v. CERC and connected appeals. An earlier post had examined the decision, and had concluded that the Court “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….” The decision of the Supreme Court presents an interesting opportunity to examine the nature of several legal concepts. In this post, I concentrate on the doctrine of frustration. It seems to this author that the best explanation for the judgment of the Supreme Court is that (as a matter of Indian law) the doctrine of frustration is not at all a free-standing doctrine at all, but is only a question of construction of contracts.

The facts which fell for consideration before the Supreme Court were summed up earlier. The basic issue was whether “force majeure” and “change in law” provisions in PPAs between Adani Power (and other generating companies) and the Gujarat Urja Vikas Nigam were triggered on account of a 2010 Indonesian regulation stipulating benchmark coal prices. Put simply, the contractual question on frustration would be whether the 2010 Indonesian regulations were an event frustrating the PPAs. The underlying contracts for supply of coal were presumably entered into for a long term, with the result that the prices for supply of the coal were agreed at a lower rate. This lower rate would have been in the contemplation of parties at the time of fixing the pricing for the PPAs. Indeed, the coal supply agreements were to be annexed to the PPAs. Did the 2010 Indonesian regulations amount to a frustration of the PPAs?

The Supreme Court noted its earlier precedent around section 56 of the Contract Act – these include Satyabrata Ghose v. Mugneeram Bangur (‘If an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement, it can be said that the promisor finds it impossible to do the act which he had promised to do…’), and Alopi Parshad v. Union of India (‘[it is only if it is demonstrated that the parties] never agreed to be bound in a fundamentally different situation which had unexpectedly emerged, that the contract ceases to bind… the performance of a contract is never discharged merely because it may become onerous to one of the parties…’)

The Court also referred to English law, including the Suez canal cases (Tsakiroglou v. Noblee [1962] AC 93), where it was held that the closure of the Suez Canal did not amount to frustration (even though the goods would now have to be shipped around the Cape of Good Hope). Tsakiroglou was a case where  a different method of performance (i.e. going around the Cape of Good Hope, rather than through the Suez canal) was not, on facts, sufficiently fundamental. Indeed, Treitel (13th edition) notes, “the seller in the Tsakiroglou case would have made [a profit] if his plea of frustration had been upheld, for the market price of the goods had risen more than the extra cost of carriage via the Cape of Good Hope, and this fact may have had some influence on the decision that the contract remained in force…” There was thus sufficient reason in Tsakiroglou to demonstrate that the method of performance was not intrinsically fundamental, and hence the contract was not frustrated due to events requiring a different method of performance.

Citing the above cases, and English law, the Court concluded that the PPAs could not be considered as being frustrated. It held:
the fundamental basis of the PPAs remains unaltered. Nowhere do the PPAs state that coal is to be procured only from Indonesia at a particular price. In fact, it is clear on a reading of the PPA as a whole that the price payable for the supply of coal is entirely for the person who sets up the power plant to bear. The fact that the fuel supply agreement has to be appended to the PPA is only to indicate that the raw material for the working of the plant is there and is in order. It is clear that an unexpected rise in the price of coal will not absolve the generating companies from performing their part of the contract for the very good reason that when they submitted their bids, this was a risk they knowingly took… the fact that a non-escalable tariff has been paid for, for example, in the Adani case, is a factor which may be taken into account only to show that the risk of supplying electricity at the tariff indicated was upon the generating company.

This is an important passage, because it shows that the enquiry on frustration is – like many other contractual questions –a question of whether the relevant risk was contemplated and allocated. The Court has not really given detailed reasons in this passage for why it concluded that the risk of increased coal prices were on the generating companies. The only reason in the passage above is that the tariff was a non-escalable one. But that is hardly conclusive, especially in a situation where the pricing was based – to the knowledge of both parties – on an underlying supply contract.

Another earlier post noted, “The Court has skirted the issue of protecting the sanctity of the contract by relying on unrelated precedents and not construing the contract itself…” With respect, that is perhaps not taking into account the full reasoning of the Court. The Court’s strongest reason appears later in the judgment, when the Court notes that the question of frustration must be decided in the backdrop of the express contractual provisions in place. There was a detailed force majeure clause in the PPA which in terms excluded “changes in cost… of fuel”. Ultimately, the question of whether a contract is frustrated or not is purely as a question of constructing the contract (rather than as one of applying an external legal rule).

This is also borne out by the further holding of the Court also that “general recourse to section 56 is not available 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…” This is, with respect, no misstatement of the law if one accepts the theory that the doctrine of frustration is essentially simply a rule of construction of the contract. If frustration is essentially a question of construction, then a general reliance on the principle will be unavailable when there is indeed an express provision to be construed – it would be quite inconceivable for an implied term to override an express term.

The Court’s reasoning thus seems to situate the doctrine of frustration clearly within the domain of contractual construction. It shows that the enquiry is entirely one of construction of the relevant contract – with express provisions, the task may be simpler; but even otherwise, the Indian doctrine of frustration is best understood as giving effect to parties’ intentions on what counts as a “fundamental” change, without imposing any external legal rule on what does and does not count as a frustrating event.

This reading of the law is however at some tension with Satyabrata: for there, the Court expressly said that the doctrine of frustration is not one based on constructing a contract or finding an implied term, but is really a “rule of positive law”. The Court there rejected the construction theory only on the basis that “there is no question of finding out an implied term agreed  to by the parties embodying a provision for discharge, because the parties did not think about the matter at all…” With respect, this (a) was not a finding essential to the ultimate decision in Satyabrata; and (b) misunderstands the principle of objective construction and the true nature of implication of terms.

In other words, Energy Watchdog is an important recognition of the proposition that the “doctrine” of frustration can best be understood – notwithstanding Satyabrata – as a question of construction of contracts. What tilted the balance in Energy Watchdog was the Court’s approach to the question as one of ascertaining parties’ intents in allocating risks, and of the interpretation of the PPA at issue. The decision must not be therefore read as one laying down a rule of law that economic impracticability can never be a frustrating event.

[Note 1: This post does not independently offer any justification for why the ‘construction’ theory is the best explanation of the doctrine. I only note that if the theory is rejected, then there does not seem to be any basis on which the Courts can ascertain what exactly is a “fundamental” change. For instance, in the absence of a detailed force majeure clause, it is as likely that the change in the cost of fuel would indeed be ‘fundamental’ to long term agreements in the energy sector. The construction theory enables Courts to apply settled principles of interpretation and implication in the task and thereby introduces objectivity into the process.] 

[Note 2: The relevant clause in the exclusions on force majeure said: “Force Majeure shall not include …  (ii) the following conditions, except to the extent that they are consequences of an event of Force Majeure…  changes in cost of the plant, machinery, equipment, materials, spare parts, fuel or consumables…” In other words, changes in fuel price was not itself a force majeure event (and therefore not a frustrating event). But the clause comes with an important rider: changes in cost of fuel will indeed be a force majeure event if that change in the cost is itself a consequence of another force majeure event. We will look at questions of interpretation of these clauses in a subsequent post. For now, it is important to note that the decision of the Court must not be seen as absolutely ruling out pleas of frustration on account of economic hardship or impracticability.]

1 comment:

Rahul Sibal said...

Read an article authored by you after a long hiatus. Like always a good read.