ENERGY WATCHDOG CASE: A CRITICAL EVALUATION OF FORCE MAJEURE CLAUSE

Facts

On 1st February 2006, Gujarat Urja Vikas Nigam Limited (GUVNL) issued a public notice inviting tenders for supply of power.  The participating bidders were to quote their prices under three competitive bidding processes- escalable tariff, non-escalable tariff or partly escalable and partly non-escalable tariff (In escalable tariff, the company is allowed to increase the price in the future, subject to market conditions, while in non escalable tariff, the price remains constant throughout the period of the contract).  The best levelised tariff as per certain pre-determined conditions was followed to arrive at the lowest tender. Subsequently, Haryana Utilities initiated a separate bidding process on 25th May 2006 for purchase of power. The bidding process was similar to that of the GUVNL public notice.

On 11th July 2007 and 17th July 2008, Adani Enterprises Consortium was selected as the successful bidder in both Gujarat and Haryana respectively.  Separate Power Purchase Agreements (PPAs) were issued to Adani Enterprises by both the states. In 2010 and 2011 there was a change in Indonesian Law, due to which the price of coal aligned to international price levels instead of the price which was prevalent for the last 40 years. Since Adani Enterprises acquired coal from Indonesia, this change in price made it uneconomical for them to supply power at the rate decided during the bidding process.

On 5th July 2012, the appellants filed a petition before the Central Electricity Regulatory Commission under Section 79 of the Electricity Act seeking relief from performance of the PPA due to the change in Indonesian Regulation on account of frustration or to evolve a mechanism to restore the petitioners to the same economic condition in which they were, prior to the change in law.  The Central Commission passed an order on 2nd April 2013, where the claims of force majeure by Adani Powers was held to be inadmissible. However, in larger public interest, the Central Commission proceeded to grant compensatory tariff on 21st February 2014. Appeals and cross-appeals were filed against this order, and finally on 31st March 2015, Adani Power filed an appeal before the Supreme Court.

Issues

The issue before the Apex court was:

  1. Whether the respondents were entitled to raise and claim benefits for force majeure?

Rule

The force majeure clause in a contract relieves one or both parties of the contract from the liability to perform the contractual obligations in the occurrence of an intervening event which makes it impossible to fulfil the necessities of the contract. Force majeure events are governed by Section 32 of the Indian Contract Act, 1872, provided the contract has an express or implied provision for Force Majeure. Section 32 of the Indian Contract Act states:

Enforcement of contracts contingent on an event happening.—Contingent contracts to do or not to do anything if an uncertain future event happens cannot be enforced by law unless and until that event has happened.

If the event becomes impossible, such contracts become void. “

A force majeure clause typically mentions a few events or circumstances like natural disasters, civil strife, terrorism or labour unrest which will deem it impossible to perform the contract. It is necessary for the intervening event to be mentioned in the clause to be able to invoke it.

The essentials for invoking force majeure in a contract are as follows:

  1. The intervening event must have been unforeseeable by both the parties in the contract.
  2. The intervening event makes the execution of the contract wholly impossible.
  3. The intervening event should not arise due to the fault of either parties in the contract.
  4. The contract should have a force majeure clause.

In the absence of a force majeure clause in a contract, parties can take relief under Section 56 of the Indian Contract Act, 1872. It states:

“Agreement to do impossible act.— An agreement to do an act impossible in itself is void.

Contract to do an act afterwards becoming impossible or unlawful — 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.”

Section 56 of the Indian Contract Act, 1872 governs the doctrine of frustration. Section 56 can be invoked by parties when the performance of a contract becomes impossible after it is made, on account of any supervening event or change in circumstances which were unforeseeable and  beyond the control of the parties to the contract. If the event was reasonably foreseeable or took place due to the conduct of either parties, non-performance of the contract will amount to breach of contract.

Analysis

  • On invocation of force majeure clause:

In the present case, Adani Enterprises Consortium had knowingly quoted a non-escalable bid and hence it is assumed that they were aware of the risk they had undertaken in doing so.  The force majeure clause can only be invoked if the intervening event renders it impossible to perform the contract. Nowhere in the Power Purchase Agreements between Adani Enterprises and the states of Gujarat and Haryana was it mentioned that coal has to be brought exclusively from Indonesia or at a certain price. It was clear from the PPA that the entire cost of the coal has to be borne by the person who sets up the power plant, Adani Enterprises in this case. The sudden change in Indonesian Laws, which aligned the price of coal to international price levels, increased the cost of operations for the appellants. However, this event did not alter the fundamental basis of the PPA, i.e., to supply coal to the state. There were other modes of fulfilling the terms of the contract.

Clause 12.4 of the Power Purchase Agreement, which deals with force majeure exclusions reads as follows:

“Force Majeure Exclusions Force Majeure shall not include:

  • any event or circumstance which is within the reasonable control of the parties and
  • the following conditions, except to the extent that they are consequences of an event of Force Majeure:
  • Unavailability, late delivery, or changes in cost of the plant, machinery, equipment, materials, spare parts, fuel or consumables for the Project;”

The Clause makes it clear that rise in cost of fuel will not be treated as a force majeure event under the contract.

  • On applicability of Section 56 of Indian Contract Act, 1872:

In the case of Satyabrata Ghose v. Mugneeram Bangur & Co.,[1] the court held that the term ‘impossibility’ in the section is to be used in a practical sense and not literal sense. Due to the occurrence of an intervening event, the performance of a contract may become impracticable or useless from the point of view of the parties to the contract. It may also disturb the foundation based on which the parties entered into the contract.

Even if a party in a contract is faced with an event like abnormal rise in prices of raw materials which makes it unprofitable to carry out the contract, the performance of contract is not discharged simply because it becomes onerous to one of the parties (as held in Naihati Jute Mills v. Khyaliram Jagannath).[2] Furthermore, where there exists alternate modes of performance of an act, Section 56 of the Indian Contract Act, 1872 cannot be invoked.

Hence, in the present case, the appellants cannot seek relief under Section 56 of the Indian Contract Act merely due to a rise in the price of coal.

Conclusion

The Supreme Court held that the doctrine of frustration remains inapplicable in the present case. The verdict of the Apex Court received criticism from the power industry for the rigid application of law. Investment in the power sector was seen as public investment for the consumption of a public good and therefore, failure to protect Adani Enterprises Consortium was negative to public policy execution.

This case presents a conflict between sustainability of business and sanctity of contract. On one hand, it became unfeasible for Adani Enterprises to supply power to the states. Not only were they not relieved from the performance of the contract, they were also not given any compensatory tariff or allowed to change to an escalable bid. On the other hand were the laws laid down in the Indian Contract Act, 1872 and the court’s strict application of the same. What the court failed to take into account is the economic health of the country. A decision like this affects not only the parties to the contract but also the numerous financial institutions which provide loans to these powerhouses and also the upcoming investments in the country.  

While the Supreme Court of India has been praised time and again for its verdicts on conflicting and difficult matters, in my opinion, the court should have viewed this case from a more practical perspective which would be in the best interest of the financial health of the country.

Author(s) Name: Sreeja Chatterjee (Symbiosis Law School, Pune)

References:

[1] (1954) AIR 1954, SC 44.

[2] (1960) AIR 1960 SC 522.

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