Covid-19 is the common villain to almost all the businesses since the declaration of the epidemic by WHO. The magnitude of the effect of the virus on trade is yet to be determined. Businesses across the globe are suffering. Cross-border transactions have been significantly affected due to the restrictions on movement and closure of establishments. In the midst, the critical legal issues involved for international traders are to be examined to manage during the urgent situation, and businesses must take preparation for the coming days.
Most common legal issues arising out of this situation revolve around delay or termination of contract of international trade, and implication of such delay or termination on the otherwise settled principle of documentary credit through Letter of Credit. Hence, not surprisingly, all international traders are currently concerned about whether the contract should be subject to Force Majeure or Frustration and, depending on individual perspective, how payment under LC can be either recovered or stopped.
Therefore, the implications of two of the most frequently and widely discussed legal terms, “Force Majeure” and “Frustration” are to be examined in the prism of Bangladesh legal framework including the significance of underlying Letter of Credit terms. Additionally, we will explore the unwanted yet inevitable realm of dispute resolution proceedings, as of last resort, from the perspective of traditional litigation as well as alternative resolution.
“Force Majeure” and “Frustration” under Bangladesh law
With discontinuation of contracts, cancellation of work orders and disruption in supply chain, primary focus of international trade, besides restoring it to a pre-pandemic state, has revolved around Force Majeure and Frustration of contract.
It is now common knowledge in the business community that the implications of Force Majeure (“FM”) and Frustration are distinct from each other. While Force Majeure is a creature of contract, Frustration derives from statute. The conditions of Force Majeure and the procedure to invoke them are generally stipulated in the concerned contract itself in expressed terms.
In absence of an FM clause in the contract, it is generally not permitted to rely on Force Majeure. If it is available and relied upon, obligation will be deferred or suspended for the period of FM Event, with provision for, in most cases, mutual termination at a later stage if the FM Event persists.
The alternative is to invoke Frustration of contract, which is enshrined in section 56 of the Contract Act, 1872. The section provides that an agreement to do an act impossible in itself is void. Plain interpretation of the section would mean impossibility or unlawfulness of the performance of the contractual terms which the parties had not contemplated at the time when they entered into the contract, therefore releasing the parties from the respective obligation under the contract. Distinction must be drawn from the concept of breach or repudiation of contract as the relevant party is not refusing to perform but the act has become impossible to perform.
As indicated above, the factual and legal implications of the two principles are quite different. Successful invocation of Force Majeure clause will allow the parties involved to suspend performance for the force majeure period, if not terminated in case FM condition persists.
It does not generally relieve the parties from their respective performance. On the other hand successful invocation of Frustration would allow the parties to be relieved from their respective performance of the contract.
So, the business community must make an informed decision as to which route to be taken for addressing their legal needs during the pandemic and its immediate aftermath. But it is worth noting here that neither of the escape routes has been explored to the fullest extent in Bangladesh since there has not been any catastrophic situation like the one is passing all over the globe.
Making the choice
It is critical to determine at the early stage whether to invoke either Force Majeure or Frustration. Considering commercial practicality, the suggestion is common all around the globe, that parties are discouraged to outright terminate a contract by invoking either of them. We strongly second the suggestion that decades-long business relations should not be abruptly terminated until alternatives are explored.
Notwithstanding the recommendation to prefer for working out the challenges than jumping to the option of pulling the plug, if the decision is taken to invoke either of these legal doctrines, following critical components must be considered:
- Generally speaking, FM can only be relied upon if it is expressly referred in the contract (with arguable possibility of successful recognition of FM despite express reference due to pandemic)
- If available and/or can be relied upon, FM is likely to be strategically more prudent than frustration;
- Even if available under contract or can be relied in light of the nature of the pandemic, it may still need to satisfy other requirements to constitute Force Majeure, for example alternative means to perform contract during restrictive period
- FM cannot be used for deferring obligation for indefinite period and contractual clause is likely to have a maximum time period after which the contract is cancelled
- Generally, courts have a very restrictive view in allowing escaping from contractual obligation by invoking Frustration, unless the act is really impossible to perform, not just uncomfortable or time consuming
- The mere excuses that performance has become more expensive or any other self-induced circumstance making it difficult or impossible may not be allowed in invoking Frustration
Accordingly, it is submitted that if any dispute arises, the court will generally look into the contract, its language, the context, and actions of the parties. For instance, in determining Frustration, the threshold of contract being frustrated is generally a higher one, as the parties have to show that the contract has become impossible to be performed.
In this context impossibility is to be interpreted from a practical context not in its literal sense, meaning the subject matter of the contact has to be fundamentally changed which the parties had not contemplated at the time of executing the same.
So, in essence, if an exporter has laid-off his workers at the onset of the pandemic, he cannot claim his work order has become impossible to perform, ie, frustrated, because he has inadequate workforce to deliver the work. Similarly, an increase of price of raw materials after entering into the contract will not qualify as frustration.
On the other hand, in determining the merit of a claim for force majeure, options of the parties and scenarios like whether there were alternative means to continue performance, whether the matter was promptly notified, or whether any negligence was involved etc would play a critical role.
Generally speaking, if avoiding either is not an option, force majeure is a preferable option rather than claiming frustration. It is undeniable that the Covid-19 situation is a novel one and has affected almost everyone around the globe. It is advisable to mitigate losses by not to opt for performance that is beyond reach. However, the better approach would be to suspend or slow performance of the contract.
Outright termination of a contract may harm the long standing business relationship, and drag parties to unnecessary long legal battles. In most cross border supply contracts, the subject matter of the contract is not entirely lost, but it may have become difficult and/or expensive or temporarily impractical to perform the contract.
Even if hurdles related to force majeure are encountered, depending on the inclinations of the court in interpreting particular Force Majeure clauses, it may still be possible to invoke FM by interpreting Covid-19 as an “act of God” or “circumstances beyond control” or “government decision/administrative action” rendering performance of the contract impracticable for the period of the pandemic. However, it is pertinent to clarify that frustration of contract would be completely dependent upon particular facts and circumstances to be examined by the courts and tribunals.
Therefore, instead of wholesale termination of contract both inland and cross-border, the businesses should explore possible force majeure clauses to be applied/invoked, and in doing so, following may be considered in managing contract affected by Covid-19:
- It is advisable to contact the buyer and the carrier to ensure that it is possible to deliver the goods at the port of destination at a mutually agreeable later date; renegotiate the terms of contract and the time frame of performance
- Depending on the circumstances, a contract that has not incurred costs to any party yet — deferring performance would not be practical for either party — may be terminated by mutual consent to mitigate potential future losses
- Carefully check status and availability of L/C
- It is critical to ensure that documents comply with the L/C terms
Let us turn our focus to the effect and impact of Force Majeure on L/C terms, particularly in light of the unique challenge of the Covid-19 pandemic.
Effect on L/C terms underlying international sales contract
Managing sales contracts is critical during Covid-19 vis-à-vis the underlying L/C terms. The commonly used practice rules are UCP 600, URDG 785, URC. Among the rules, UCP 600 is the most frequently used with L/Cs.
Force Majeure has been defined in Article 36 of the UCP 600 as:
“A bank assumes no liability or responsibility for the consequences arising out of the interruption of its business by acts of God, riots, civil commotions, insurrections, wars, acts of terrorism, or by any strikes or lockouts or any other causes beyond its control.
“A bank will not, upon resumption of its business, honour or negotiate under a credit that expired during such interruption of its business.”
During Covid-19 lockdown, difficulties may arise reaching the nominating and issuing a bank with the documents. It is interesting to note that the outbreak of an epidemic has not been listed as a force majeure event in Article 36 of UCP 600, unless the pandemic can be successfully argued as part of the residue category defined under “any other causes beyond its control.” Notwithstanding the arguable inclusion under the said residual category, it may be contended that the undertaking and obligations of involved banks have not been changed unless it can be shown that the commercial transaction of the bank was closed. The potential consequence is that the bank may not pay at all. In most countries banks are in operation so it is unlikely that banks would refuse payment on account of force majeure relying on Article 36 UCP 600.
A number of situations may arise regarding presentation of documents since it is the responsibility of the beneficiary to ensure that the documents are presented to the nominated banks or issuing banks at the place specified in the L/C within the expiry date/presentation period, and if complying presentation is not made, payment may be denied.
First one is L/C being available with the nominated bank, but it may not be possible to forward the same to the issuing bank because the issuing bank is located in an inaccessible location due to the lockdown.
Secondly, it may so happen that the document cannot be delivered to the nominated bank due to lockdown; consequently it failed to reach the issuing bank. The obvious consequence in failing to ensure complying presentation to the issuing bank is that payment would be refused. The following are immediate action plans to ensure payment since complying presentation will obligate the bank to honour or negotiate:
- Contact issuing bank to extend maturity/presentation period
- Consider sending document via electronic means instead of courier until situation improves
- Reach the issuing bank to discuss if the document can be forwarded to another place or head office which is more accessible.
If a contract gets terminated or the bank refuses to honour L/C despite renegotiation efforts and mitigation measures, the unpaid seller will have to institute legal proceedings in the country where it would be easier to enforce judgment on the defaulting party.
While the rules on trade finance remain almost the same all over the globe, the law of contract may vary, depending on civil and common law jurisdiction. It is therefore advisable to contact a local lawyer for early advice in bringing a claim.
Nevertheless, if as of last resort, the crisis in L/C-based trade during the pandemic results into legal proceedings, the businesses must bear in mind the following critical issues.
Legal proceedings as the last resort
Interestingly, the Sale of Goods Act, 1930 is otherwise silent about Force Majeure or Frustration. However, the rights of unpaid sellers are protected under sections 55-58 of the Sale of Goods Act, 1930 and may essentially initiate a lawsuit for price of goods, including damages for non-acceptance or seek specific performance subject to the statutory provisions of Chapter II of the Specific Relief Act, 1877.
The rights of unpaid sellers are further protected under section 73 of the Contract Act under which damages can be claimed caused by breach of contract, provided it is not remote and/or indirect.
The full extent and scope of FM in Bangladesh jurisdiction in post Covid-19 litigations is yet to be tested. However, if Force Majeure/Frustration is invoked, the following have to be considered:
- The governing law stipulated in the contract
- The presence and incorporation of Force Majeure clause in the agreement
- The events agreed as Force Majeure include epidemic/pandemics
- The conditions to invoke Force Majeure
- Notice requirements
- Causation leading to Force Majeure (it is to be established that performance has hindered)
- The outcomes of triggering Force Majeure
- Mitigation measures taken
As an alternative to court proceedings, infamous for time delay, traders/businesses may consider referring the issue to arbitration. In fact, as the case is for most similar transactions, arbitration would be preferred as the dispute resolution mechanism instead of litigation.
While arbitration, or any form of ADR for that matter, has the prospect of being more commercially efficient for resolving dispute, for the context of Bangladesh, arbitration has yet to establish itself as a speedy or cost efficient alternative to litigation. If the legal seat is not in Bangladesh, under section 45 of the Arbitration Act, 2001, any foreign award will require filing of an execution suit, taking the whole matter back into the realm of litigation.
As such, we strongly recommend that the best way forward for businesses and traders during the pandemic crisis would be to avoid terminating the contract and to avoid any form of legal dispute.
Rather, it would be commercially more sensible to explore variations of contract delivery dates, reschedule payment periods, and to work with each other towards resolution by way of amending their contracts.
In essence, a contract is a meeting of minds between two parties, so any modification, variation, or amendment can be easily done focusing on the commercial viability, which would be more beneficial for the parties than tangling in legal dispute.
