With the Covid-19 Pandemic spread across the world, the global decline of oil prices to negative has impacted the oil and gas industry catastrophically. This situation would also give rise to a minefield of litigation over the inclusion of the Pandemic under the Force majeure clause in Production-Sharing contractual arrangements.
INTRODUCTION:
Dramatic fluctuations in the global economy have often resulted in increased litigation risks. With the historic plunge in the demand for oil, prices in the United States dropped to negative on the 20th of April,2020. In such times, it is reasonable to worry about the ability to execute contractual obligations by Companies involved in the production, imports and exports of Crude oil. One such contractual clause that could possibly delay or free corporate entities from their contractual obligations is that of ‘Force Majeure’. This clause comprises of extraordinary events which are usually beyond human control such as War, Act of God (natural calamities), riots, etc. A fall in the prices of oil would not in itself result in a force majeure event, or provide for the basis of negotiating and terminating a commercial contract. The legal disputes would arise when the companies alter their contracts in order to fit the economic realities.
IMPACTS ON THE PRODUCTION-SHARING CONTRACTUAL SET-UP
It is very essential to have a stable contractual arrangement for a commodity like crude oil which has high user-based price volatility. Multiple Hydrocarbon Producing Countries have dominantly used ‘PSC’s (Production Sharing Contracts) as the contractual set-up for securing investments from Foreign Governments by allotting them a part of the production outcomes.
Under the Indian model of Production Sharing Contracts, Force Majeure clause is defined as unanticipated or unforeseeable circumstances which are not brought about at the instance of, the Party claiming to be affected by such event, or which, if anticipated or foreseeable, could not be avoided, and which has caused the non-performance or delay in performance. Besides the aforementioned requirements, the party seeking for the claim shall have the burden of proving valid grounds for its subsequent application along with the exercise of reasonable diligence on its part to support the alleged claim.
Unlike the Doctrine of Frustration of Contract which involves stringent proof for impossibility of performance of a contract, the Force Majeure clause is comparatively easier to invoke when a contract provides for it. In the aforementioned definition of the clause under the Indian Model, there is no express mention of an epidemic or pandemic outbreak which creates ample ambiguity for the inclusion of this scenario under the clause of natural calamity/ phenomena which has been provided for. In case such a contract does provide for an epidemic under its contractual definition of Force Majeure, then it is reasonable to presume the likeliness of its enforcement.
While the order by the Ministry of Finance dated 19th February 2020 has rightly clarified that this clause could be invoked in the disruption of supply chains resulting from the /COVID-19 lockdowns, the words ‘wherever appropriate’ leave room for ambiguity.
India, in the E&P Sector, has signed Various Production Sharing Contracts with Private players like Geo Global Resources(GGR), Essar Oil, Geo-Enpro Petroleum, etc, With the worldwide fall in prices due to the pandemic, the pre-existing agreements between governments and companies will possibly be adjusted in the near future with a vigour to cut on costs and focus on the efficiency of the existing contracts. Some parties to such contracts may choose to voluntarily breach a contract than to comply with obligations in such times in case it proved to be more efficient based on pure economic analysis. Such contractual breaches would soon be giving rise to increased litigation thereby putting commercial relationships at risk for the sake of economic viability during hard times.
Some Oil firms under PSC arrangements have voiced their opinions against the pandemics’ classification as Force Majeure stressing on the fact that it cannot be considered an Act of God or unnatural circumstance. An additional burden that further falls on the shoulders of parties that would claim the provision is that of proving how consumers could have anticipated the commercial impact of the pandemic in advance. Consumers in the crude oil market have already started option for Force Majeure notices to oil and gas marketers like GAIL and Indian Oil Corporation(IOC) who have further issued similar notices to their suppliers and upon crude purchases from Iraq, UAE, Dubai and Kuwait as the demands have gone down.
Such declarations of Force Majeure by Production-sharing contractors act as a strategic benefit for them by buying some more time to fulfil the outstanding contractual obligations. While on the other hand, the government/ host states may challenge such declarations and further terminate these contracts.
In cases of breach or termination of contracts, the attraction of the Force Majeure clause to escape obligations for a specified time would then ultimately depend on the construction of words used in the contract. It is well established under the English Law that mere change in market conditions effecting the profitability of an agreement would not result in an event being classified as a force majeure event, thus companies will not be able to seek any remedy based solely on fluctuation of economic conditions in the current circumstances.
Every Judicial decision made with respect to a country’s Petroleum Industry which indeed holds immense strategic importance should be looked at from the long-term perspective. Typically, as seen in past judgements across various jurisdictions, the invocation of a Force Majeure clause would prove to be advantageous for parties only when it has obligations that it can no longer fulfil and when such invocation would not lead to loss of profits and operational interruptions due to breach. Such clauses, when not invoked carefully would also affect the chain of contracts that are contingently based on performance of other parties thereby creating a ripple effect.
With specific regards to the Covid-19 pandemic, formal declarations by Host states regarding the inclusion of the public health emergency as Force Majeure and the definition of events beyond human control as specified under contractual clauses would be important points for scrutiny in courts. The degree of flexibility of excusing one’s contractual obligations under such a clause would also depend on its construction and interpretation.
About author –
Priyanka Dhage is a second-year B.A LLB. student at NALSAR University of Law, Hyderabad. She is an Alternative Dispute Resolution Enthusiast and has a special interest in commercial laws.
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