Business needs a ‘circuit breaker’ amidst Covid-19 crisis

Manu Seshadri | Updated on April 13, 2020

Smaller enterprises must be given the right to claim force majeure against meeting of contractual obligations for some time, to save them from collapse due to disruptions

What we need in these troubling times is a law that permits parties to defer their contractual obligations, due to the impact of Covid-19. A ‘circuit breaker’, as it were, to help small and medium-sized businesses navigate a unique period in history when they have been brought to a hard stop. The world is faced with a recession of record dimensions — almost 10 million people have sought unemployment benefits in the US; and an estimated 150 crore workers (who are also consumers) are going to lose their jobs in India. These are mind-boggling numbers, which even the most resilient government would be hard-pressed to deal with, and that too in just a matter of three weeks.

Should the government intervene and staunch the flow of blood or should it recognise that employment and economic buoyancy are a function of the market and let them balance themselves out with time? The answer is clear: the bottom has fallen out, and this is that rare moment when the government will have to step in and legislate to protect weaker sections of society and small businesses like lorry owners, cabs, autos, food and beverage businesses, and medium-sized companies from collapse.

These affected parties should be given the opportunity to claim force majeure and defer the performance of contractual obligations, without being circumscribed or compelled to declare that contracts are frustrated — with its attendant consequences.

Government interference

The government must contemplate such action in the backdrop of some salient principles: we are a country governed by the rule of law; and the government, or for that matter the courts, do not generally interfere with private contracts between parties or alter the performance of obligations.

Still, such intervention would not be without precedent. During the Great Depression, the state of Minnesota in the US passed a law that allowed its courts to extend the period of redemption from foreclosure sales for any time that was believed to be just and equitable. This was challenged by the mortgagor as unconstitutional — the US Constitution expressly bars the enactment of any law which impairs performance of contractual obligations. The case ultimately made its way to the US Supreme Court, which held that the state has a duty to safeguard the vital economic structure upon which the good of all depends, and upheld the Minnesota law — which in effect allowed mortgagees to defer performance of their obligations during the Depression. If the US, which believes in pure free-market capitalism, could enact such a law, then why not India?

Interestingly, while the Indian Constitution guarantees freedom of trade, it also says it is open to the state to impose such restrictions as may be necessary in public interest. The government could very well enact a law under the framework of the Constitution. This would retain freedom of contract, not alter the terms — only defer some of them for a limited period — and achieve the objective of injecting liquidity into the hands of contractual parties, to be the much-needed legal circuit breaker we need at this moment.

This would save supply chains, vendors, employees, consumers, and small businesses which make up that vital underlying circuitry of the economy from permanent damage. After all, without their help, we cannot expect the economy to rise again.

Defer obligations

The Singapore government has already introduced the COVID 19 (Temporary Measures) Act, 2020, which seeks to give temporary protection to contractual parties from being sued and prohibits certain actions from being taken against counterparties or their guarantors if the inability to perform such contracts is to a material extent caused by Covid-19. The law applies to leases, construction or supply contracts, performance bonds, contracts relating to goods and services, certain secured loan facilities etc, which are termed as scheduled contracts. It has been made retrospectively effective from February.

The law does not absolve parties but allows them to suspend their obligations for a fixed period. It also relaxes certain compliances under the company law pertaining to meetings and certain filings.

While we have increased the threshold for invoking insolvency proceedings from ₹1 lakh to ₹1 crore in India, we have not nearly gone far enough. We need a law that permits parties affected by Covid-19 to suspend their contractual obligations for a limited period. We would be well advised to borrow some of the vital design features of the Singapore law and enact a direction on similar lines to ensure that our circuits are preserved.

The writer is a Partner with MSA Partners, a Delhi-based legal firm

Published on April 13, 2020

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