Supreme Court decides upon interpreting force majeure clauses in a contract

The Supreme Court vide its judgment dated May 11, 2020, in the case of South East Asia Marine Engineering and Constructions Limited (SEAMEC Limited (“Appellant”) Vs. Oil India Limited (Civil Appeal No. 637 of 2012) (“Respondent”), adjudicated upon the issue of interpreting force majeure clauses in a contract. Brief Facts The Appellant was awarded the work order dated July 20, 1995 pursuant to a tender floated by the Respondent in 1994. The contract agreement was for the purpose of well drilling and other auxiliary operations in Assam, and the same was effectuated from June 5, 1996. Although the contract was initially only for a period of two years, the same was extended for two successive periods of one year each by mutual agreement, and finally the contract expired on October 4, 2000. During the subsistence of the contract, the prices of High-Speed Diesel (“HSD”), one of the essential materials for carrying out the drilling operations, increased. The Appellant raised a claim that an increase in the price of HSD, an essential component for carrying out the contract triggered the “change in law” clause under the contract i.e. clause 23 and the Respondent became liable to reimburse them for the same. After the Respondent rejected the claims of the Appellants several times, the Appellant eventually invoked the arbitration clause vide letter dated March 1, 1999. The dispute was thereafter, referred to an arbitral tribunal comprising three arbitrators. On December 19, 2003, the arbitral tribunal issued the award and the majority opinion allowed the claim of the Appellant and awarded a sum of Rs. 98,89,564.33 (Rupees Ninety-Eight Lakh Eighty-Nine Thousand Five Hundred Sixty-Four and Thirty-Three Paisa Only) with interest @ 10% per annum revised to Rs. 1,32,32,126.36 (Rupees One Crore Thirty-Two Lakhs Thirty-Two Thousand One Thirty-Six Paisa Only) in 2005. The arbitral tribunal held that while an increase in HSD price through a circular issued under the authority of State or Union is not a “law” in the literal sense, but has the “force of law” and thus, falls within the ambit of clause 23. On the other hand, the minority held that the executive orders do not come within the ambit of clause 23 of the contract. Aggrieved by the award, the Respondent challenged the same under Section 34 of the Arbitration and Conciliation Act, 1996 (“Arbitration Act, 1996”) before the Trial Court. On July 4, 2006, the Trial Court, upheld the award and held that the findings of the tribunal were not without basis or against the public policy of India or patently illegal and hence did not warrant judicial interference. The Respondent challenged the order of the Trial Court by filing an appeal under Section 37 of the Arbitration Act, 1996 before the Gauhati High Court. By the impugned judgment dated December 13, 2007, the Gauhati High Court, allowed the appeal and set aside the award passed by the arbitral tribunal. Aggrieved by the same, the Appellant filed the present appeal by the way of a special leave petition against the impugned judgment dated December 13, 2007. Issue The issue which arose before the Supreme Court was “Whether the interpretation provided to the contract in the award of the Tribunal was reasonable and fair, so that the same passes the muster under Section 34 of the Arbitration Act?” Held While deciding the aforesaid issue the Supreme Court held as follows- Under the Indian Contract Act, 1872 (“ICA”),the consequences of a force majeure event are provided for under Section 56 (agreement to do an impossible act) of the ICA, which states that on the occurrence of an event which renders the performance impossible, the contract becomes void thereafter. When the parties have not provided for what would take place when an event which renders the performance of the contract impossible, then Section 56 of the ICA, applies. When the act contracted for becomes impossible, then under Section 56 of the ICA, the parties are exempted from further performance and the contract becomes void. However, there is no doubt that the parties may instead choose the consequences that would flow on the happening of an uncertain future event, under Section 32 (contingent contracts) of the ICA. The ICA has already recognized the harsh consequences of such frustration to some extent and has provided for a limited mechanism to ameliorate the same under Section 65 (obligation of a person who has received advantage under void agreement) of the ICA. The Supreme Court held that Section 65 provides for the basis of restitution for ‘failure of basis’. On the basis of the facts and above interpretation of law, the Supreme Court held that the arbitral tribunal correctly held that a contract needs to be interpreted taking into consideration all the clauses of the contract, but it failed to apply the same standard while interpreting clause 23 of the ICA. While the Supreme Court did not completely subscribe to the reasoning of the Gauhati High Court holding that clause 23 was inserted in furtherance of the doctrine of frustration. It held that, under the Indian Contract Law, the effect of the doctrine of frustration is that it discharges all the parties from future obligations. It further held that in order to mitigate the harsh consequences of frustration and to uphold the sanctity of the contract, the parties with their commercial wisdom, chose to mitigate the risk under clause 23 of the contract. The Supreme Court also held that, the thumb rule of interpretation is that the document which forms a written contract should be read as a whole, and so far as possible, as mutually explanatory and consequently, set aside the appeal. This update has been contributed by Shahen Pradhan (Partner) and Prateek Katewa (Senior Associate).