Importance of ‘Hardship’ Clauses in Contract
The impact of the economic slowdown, witnessed all over the world, on the commercial contract, both international and domestic, had been enormous. There have been instances, where one of the parties to the contract had failed to perform its obligations under the contract because of the sheer enormity of the consequences of economic slowdown. In most of these cases, it was felt, and rightly so, by one of the parties that to continue with the obligations under the contract amidst the current economic scenarios would have been fatal for them. However, one ought to be sympathetic for them considering the laws prevailing in our country are inadequate for protecting the interests of the contracting parties in the event of such hardships. There is a greater need to peruse the existing laws in our country and to amend them suitably to retain the fundamental principles of law. Mr. Edwin C. Mckeag, has rightly written that “upon general principles it is a fair conclusion that no one should be held liable for what he did not intend. In criminal law, the intent is the essence of the Act. In private law also, the intent is just as important”. Therefore, hardships faced by any of the parties to the contract have the ability in itself to alter the intention for which the contract arose and ought to be considered by the courts of law, while deciding cases of non performance of contracts. ‘Doctrine of Hardship’ is certainly one of the guidelines, which can be adopted by the draftsmen, legislators as well as the judiciary to reduce the burden of non-performance of contracts.
History of the Doctrine of Frustration and Impossibility
Before analysing the ‘Doctrine of Hardship’, it is imperative indeed to consider the history of the ‘Doctrine of Frustration’ and also relevant laws in India to understand the concept properly. The history of the modern law of impossibility and frustration is generally traced to the celebrated English case of Taylor v. Caldwell. In that case, the contract provided that plaintiff, a concert musician, would have the use of the defendant’s music hall to give concerts on certain dates. Unfortunately, the music hall was destroyed by fire before the dates of performance of the contract. The musicians sued the music hall owner and the court ruled that the defendant, i.e. the owner of the music hall was excused from nonperformance of the contract. While delivering the judgment, Justice Blackburn observed that “The principle seems to us to be that, in contracts in which the performance depends on the continued existence of a given person or thing, a condition is implied that the impossibility of performance arising from the perishing of the person or thing shall excuse the performance. In none of these cases is the promise in words other than positive, nor is there any express stipulation that the destruction of the person or thing shall excuse the performance; but that excuse is by law implied, because from the nature of the contract it is apparent that the parties contracted on the basis of the continued existence of the particular person or chattel. In the present case, looking at the whole contract, we find that the parties contracted on the basis of the continued existence of the Music Hall at the time when the concerts were to be given; that being essential to their performance.” The court further went on to hold that the destruction of the music hall was not within the contemplation of the parties and there is an implied condition that the music hall would continue to exist.
The law laid down in Taylor v. Caldwell received criticisms from many quarters. The soundness of the law laid down was questioned on the ground that the risk of impossibility ought to be allocated to the superior risk bearer because that party is often better able to prevent the happening of the risk, often by physical means, as by guarding property that is subject to loss by fire and almost always by legal planning, by insuring or by hedging. Those who opposed the law of Taylor v. Caldwell argued that clearly the owner is the superior risk bearer, not the musicians. The owner had a better opportunity to prevent or control the fire. Thus the defendant, as the superior risk bearer, should and ought to have borne the losses. Others chose to oppose the judgment suggesting that even if the defendant should have been excused because of the destruction of the music hall, the financial position of the parties ought to have been adjusted on an extra-contractual basis. The musicians had expended money for advertising the concerts and for preparation for performance. Under a broad view of quasi-contractual recovery, they should have been awarded a judgment for these sums to restore the status quo ante. Instead, the entire risk of the fire, as it affected this contract, was allocated to them.
However, despite the criticisms, it cannot be disputed that the decision of Taylor v. Caldwell opened a new era in the judicial history of discharge of the contract. A second major development in the common law treatment of hardship occurred when the doctrine of frustration of ‘purpose’ was recognized in England in a case arising from the cancelled coronation of King Edward VII. The coronation was advertised as the show of the century. Processions, regattas, and spectacular fireworks and elegant galas were planned. One Mr. Henry agreed to pay £75 but for the coronation processions that were planned. Mr. Henry made part payment of one-third of the price. However, the King became very ill resulting in postponement of the coronation. Mr. Henry refused to pay the balance and Mr. Krell sued for payment. The court held that the contract was terminated by the unexpected cancellation of the coronation.This case was different from the case of Taylor vs. Caldwell for the simple reasons that in this case, the performance of the contract did not become impossible, but it became useless. However relying upon the judgment of Taylor vs. Caldwell, Justice Romer, one of the three judges held that,
“With some doubt I have also come to the conclusion that this case is governed by the principle on which Taylor vs. Caldwell was decided, and accordingly that the appeal must be dismissed. The doubt I have felt was whether the parties to the contract now before us could be said, under the circumstances, not to have had at all in their contemplation the risk that for some reason or other the coronation processions might not take place on the days fixed, or, if the processions took place, might not pass so as to be capable of being viewed from the rooms mentioned in the contract; and whether, under this contract, that risk was not undertaken by the defendant.” The suit was accordingly dismissed.
In India, Section 56 of the Indian Contract Act, 1872 provides that agreement to do an act impossible in itself is void. The doctrine of frustration, according to Indian Law, is really an aspect or part of the law of discharge of contract by reason of supervening impossibility or illegality of the act agreed to be done. Where the entire performance of a contract becomes substantially impossible without any fault on either side, the contract is prima facie dissolved by the doctrine of frustration. However, it is to be noticed that, Section 56 is exhaustive in itself and it is not permissible for the courts to go beyond its provisions. Courts in India have developed the theory of construction while interpreting Section 56. According to Indian Law, when an event of change of circumstances occurs, which is so fundamental as to be regarded by law as striking at the root of the contract, the court will generally examine the contract, the circumstances under which it was made, the belief, knowledge and intention of the parties, being evidence of whether the changed circumstances destroyed altogether the basis of adventure and its underlying object. In substance, Indian Courts have always been very cautious while pronouncing judgments under Section 56 and relied more on the ‘Construction of contract’ test. Credit has to be given to the judiciary for its role in relying upon the construction theory, which in fact is a sound theory and minimizes the difficulty in interpreting the terms of contracts. However, in light of the present economic scenario, it is doubtful whether merely relying upon the construction theory would serve the purpose. For this reason, there is a view that the time has indeed come for draftsmen to include hardship clauses in the contract to enable the judges to take the assistance of those clauses while interpreting the contracts.
‘Doctrine of Hardship’
Provisions relating to Hardship can be found in UNIDROIT Principles of International Commercial Contracts 2004. Article 6.2.1 of the said principles provides that,
“Where the performance of a contract becomes more onerous for one of the parties, that party is nevertheless bound to perform its obligations subject to the following provisions on hardship.”
The “following provisions” referred to in Article 6.2.1 are provided in Article 6.2.2 which provides that,
“There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party’s performance has increased or because the value of the performance a party receives has diminished, and
(a) the events occur or become known to the disadvantaged party after the conclusion of the contract;
(b) the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract;
(c) the events are beyond the control of the disadvantaged party; and
(d) the risk of the events was not assumed by the disadvantaged party.”
The effects of hardship are given in Article 6.2.3 which provides that,
(1) In case of hardship the disadvantaged party is entitled to request renegotiations. The request shall be made without undue delay and shall indicate the grounds on which it is based.
(2) The request for renegotiation does not in itself entitle the disadvantaged party to withhold performance.
(3) Upon failure to reach agreement within a reasonable time either party may resort to the court.
(4) If the court finds hardship it may, if reasonable,
(a) terminate the contract at a date and on terms to be fixed, or
(b) adapt the contract with a view to restoring its equilibrium.”
As seen above, The ‘Doctrine of Hardship’ signifies and refers to certain fundamental circumstances forming the basis of contract, which have altered in a major way resulting in upsetting the fundamental equilibrium of the contract. It also signifies circumstances where one of the parties being disadvantaged to such an extent that if that party is required to continue to perform that contract it would be unduly burdensome and harsh.
H. Kronke, Secretary-General of UNIDROIT, pointed out that the doctrine of hardship as formulated in the UNIDROIT Principles could be regarded as balanced, averaged provisions of the best rules which a hypothetical modern legislator would have developed for transnational application. The concept of hardship, intended primarily for application to long-term contracts, recognised that a fundamental alteration of the contractual equilibrium entitled the disadvantaged party to demand good faith re-negotiation of the contract and to have it adapted or terminated by the courts if the attempt to re-negotiate were to fail.
This doctrine can be invoked for any contracts, both domestic contracts and also for international commercial contracts. But Indian Law has yet to explore this doctrine to great extent though it has evolved to a certain extent under the English law as well as the American laws as well as certain European law. However, though the India, being a member to the UNIDROIT, this doctrine will surely have persuasive value with the Indian courts and the Indian courts can be called upon to explore whether this doctrine can be adapted even when the Indian law is the applicable law. The doctrine of hardship is still an unexplored concept in India, but given the exceptional circumstances facing the world today, successfully arguing this doctrine will hold tremendous value for companies who are genuinely burdened by their contracts. And going forward legal experts now recommend that companies should try and negotiate a hardship clause into their contract to help avoid any future litigation.
Hardship entitles the disadvantaged party to request the other party to enter into renegotiation of the original terms of the contract with a view to adapting them to the changed circumstances. It must make a request for renegotiations without undue delay, indicating the grounds on which the request is sought. Such request does not entitle the disadvantaged party to withhold performance. The request for renegotiations, as well as the conduct of both the parties during the renegotiation process, is subject to the principle of good faith and the duty of co-operation. If the parties fail to reach agreement on the adaptation of the contract to changed circumstances within a reasonable time, either party may resort to the court. The court may, when this is reasonable either a) order the termination of the contract at a date and on terms to be fixed by the court, or may b) adapt the contract with a view to restore its equilibrium.
This principle of Hardship is based on the basic principle of civil law and International Law, i.e. Pacta Sunt Servanda which means that “Agreements must be kept”. According to this principle, clauses of private contracts are law between the parties and the non-performance of those clauses constitutes a breach of the pact. However, this bona fide principle of Pacta Sunt Servanda is subject to one restriction. The restriction is legally called clausula rebus sic santibus, a legal doctrine allowing for clauses of a contract to become inapplicable because of a fundamental change of circumstances. It is essentially an "escape clause" that makes an exception to the general rule of Pacta Sunt Servanda. However, from the perusal of the UNIDROIT principle, it is clear that clauses of a contract can be put to the “escape clause of Hardship” by a party to the contract only when,
(i) The events occur or become known to a party after the conclusion of the contract;
(ii) The events could not reasonably have been taken into account at the time of the conclusion of the contract;
(iii) The events are beyond the party's control; and
(iv) The risk of the events were not assumed by it.
It would be wrong to assume that the international commercial fraternity has only recently given due consideration to this concept of Hardship. A somewhat similar provision could be found in Vienna Convention on the Law of Treaties, 1969. Article 62 of the said convention provides for fundamental change in circumstances. It stated that
“1.A fundamental change of circumstances which has occurred with regard to those existing at the time of the conclusion of a treaty, and which was not foreseen by the parties, may not be invoked as a ground for terminating or withdrawing from the treaty unless:
(a) the existence of those circumstances constituted an essential basis of the consent of the parties to be bound by the treaty; and
(b) the effect of the change is radically to transform the extent of obligations still to be performed under the treaty.
2.A fundamental change of circumstances may not be invoked as a ground for terminating or withdrawing from a treaty:
(a) if the treaty establishes a boundary; or
(b) if the fundamental change is the result of a breach by the party invoking it either of an obligation under the treaty or of any other international obligation owed to any other party to the treaty.
3. If, under the foregoing paragraphs, a party may invoke a fundamental change of circumstances as a ground for terminating or withdrawing from a treaty it may also invoke the change as a ground for suspending the operation of the treaty.”
United Nations Convention on Contracts for the International Sale of Goods, 1980 also contained a similar provision for changed circumstances pursuant to the formation of contract. Article 79 of the said convention provided that,
(2) If the party's failure is due to the failure by a third person whom he has engaged to perform the whole or a part of the contract, that party is exempt from liability only if:
(a) he is exempt under the preceding paragraph; and
(b) the person whom he has so engaged would be so exempt if the provisions of that paragraph were applied to him.
(3) The exemption provided by this article has effect for the period during which the impediment exists.
(4) The party who fails to perform must give notice to the other party of the impediment and its effect on his ability to perform. If the notice is not received by the other party within a reasonable time after the party who fails to perform knew or ought to have known of the impediment, he is liable for damages resulting from such non-receipt.
(5) Nothing in this article prevents either party from exercising any right other than to claim damages under this Convention.”
Therefore, undisputedly the need for a provision in the event of changed circumstances has always been recognized by the international communities, but its importance and significance have come to the forefront only recently due to the slowdown, the world economy is going through.
Hardship Doctrine in other countries
Traditionally, both the systems of common law and civil law have supported the doctrine of pacta sunt servanda, i.e. agreements must be kept though the heavens fall. The major exceptions, which the civil and common law provide to the doctrine of Pacta Sunt Servanda are the doctrines of impossibility of performance, "force majeure", and frustration of the venture. Either performance is made impossible by force majeure and the contract disappears or the performance is impossible and the contract has to be performed, at whatever cost. Hardship provides an additional ground for the discharge of a contract or for its adaptation to changed circumstances. The traditional rule that hardship, short of impossibility, is no excuse for non-performance of a contract, and the modern rule providing relief on grounds of hardship are not the only solutions employed by legal systems. The United States flirts with a vaguely defined doctrine of impracticability.
England firmly claims to stand on the traditional rule that contract will only be frustrated if the substance of it has become impossible or illegal, or the commercial purpose has been completely destroyed. Yet consider the case of Staffordshire Area Health Authority v. South Staffordshire Waterworks Co. A waterworks company had agreed to provide a hospital "at all times hereafter" with its requirements of water at fixed prices. Decades later, the other rate payers were paying a rate that was 19 times greater than the agreed prices promised to the hospital. The supplier gave 6 months notice of termination of the contract. The question had arisen whether the phenomenal rise in price of water would frustrate an old contract for supply of water providing for very low rates of water. The court construed the contract and implied a term that the contract was terminable at a reasonable notice. One of the three judges seemed to state that even if the contract had been perpetual in duration, the contract should be discharged on grounds of changed circumstances, although this line of reasoning had been disapproved by the House of Lords. The other two judges took the path of interpreting the contract as one for indefinite duration, and therefore terminable on reasonable notice. This approach, however, cannot be taken in England when the contract has a definite period of duration that cannot be interpreted away. Belgium also adheres to the traditional doctrine; force majeure is recognized as an excuse, but unforeseen hardship is neither an excuse nor grounds for revision of the contract. Yet other doctrines have occasionally been employed to redress hardship, and force majeure has been found where performance was possible but extremely costly and strained interpretation has also been employed to redress hardship. The Convention on the International Sale of Goods is silent on the question of hardship though it contains a somewhat similar provision. Therefore, the UNIDROIT Principles can be used to supplement the Convention.
After World War I, the German economy was devastated by inflation of an almost incredible scale; the mark ultimately sunk to one-trillionth of its former value. Although the German Civil Code explicitly granted relief for hardship only in cases of impossibility, the courts ultimately held that they could give relief for hardship as an emanation of the principle of good faith also found in the Code. Professor Paul Oertmann developed the theory of the Wegfall der Geschäftsgrundlage -- disappearance of the foundations of the contract. Germany's High Court seized upon this theory and ruled that legal tender no longer had to be accepted in payment of debts, as no debtor could in good faith make such a tender. As the case law has evolved, the party who is unduly burdened because of changed circumstances may obtain a discharge of the contract, or the court can adapt the contract to changed circumstances if both parties want the contract to continue. The changed circumstances must be exceptional and the court must balance the interests of both parties. Other countries have reached the same result by legislation, Italy in 1942; Greece in 1946, more recently the Netherlands.
Usages of ‘Doctrine of Hardship’ in Domestic and International Trade
Although many legal systems do not generally give relief to a party who is burdened with excessive hardship, these same systems generally recognize party autonomy to provide for the adaptation/alteration of contracts to changed circumstances. Consequently, it is fairly common in contracts dealing with international trade, particularly those that have long durations, to make provisions for revision of the contract in case of changed circumstances.
International trade agreements of long duration typically contain a renegotiation or other adaptation clause that provides flexibility to the relationship. The absence of such a clause may reflect that such a clause has been rejected by one or both parties.
The provisions on "hardship" contained in the chapter on Performance in UNIDROIT principles should be compared with the provision on "Force Majeure", contained in the chapter on Non-Performance. The rule of force majeure is draconian and unforgiving. Nothing short of total impossibility will excuse non-performance or partial non-performance. Impracticability will not suffice as an excuse. Rather, impracticability as well as hardship far short of impracticability must be tested under the Hardship articles. Hardship alone never forgives non-performance. It instead compels renegotiation and authorizes courts to revise the contract to take the hardship into account.
The definition of hardship, which appears in Article 6.2.2, is complex, because it not only defines the nature of the burden, but also other factors that must coexist with the burden to make it legally relevant. As a predicate to legally relevant hardship, there must have been "the occurrence of events fundamentally altering the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished. As a factual matter, hardship exists if the equilibrium of the contract is fundamentally altered by events that occur or become known after the execution of the contract. As with the case of impossibility, hardship as a fact does not automatically trigger the legal concept of hardship. In addition, it must be shown that the events could not reasonably have been taken into account, are not within the party's control and the risk was not assumed.
Foresee ability is a central concern in hardship cases. The general notion is that if an event is foreseeable, the parties should deal with it in the contract; otherwise, the party disadvantaged by the event should bear its burden. Yet, as stated above, almost everything that ever happens is in some sense foreseeable. Again, the question is whether the event was so outside the bounds of probability that reasonable parties would not provide for it.
If performance has become excessively onerous, the party so burdened is entitled to request negotiations to adapt the contract to the changed circumstances. The request should be made without undue delay, but a delayed request is not automatically excluded. Therefore, it is important that the request states the grounds for the request, unless those grounds are obvious. If the hardship claim is justified, the other party is obligated to negotiate in good faith to adapt the contract to alleviate the burden. However it must be remembered that the request for renegotiation does not in itself entitle the disadvantaged party to withhold performance. If the court finds that legally redressable hardship exists, it can terminate the contract, or revise it to restore the equilibrium of the contract. The termination may be on such terms as the court deems just. It should be noted that in many cases, the interest of the party not burdened by hardship ought to be redressed.
Drafting of Hardship Clauses
Having considered the doctrine, it is important to discuss the practical aspects of Hardship Doctrine, viz. requisites of valid hardship clauses in the contract. The drafting of hardship clauses follows and ought to follow the same general principles as those for force majeure clauses. The identification of events triggering hardship frequently includes a general description illustrated by a list of specific events or may be accompanied by a list of excluded events which the parties do not intend to treat as hardship. In formulating the impact that the change of circumstances has on their contractual performance, parties may resort to objective terminology (e.g. "contractual equilibrium"), subjective terminology (criteria of fairness, good faith, equity, etc.), and specific terminology (imposing thresholds), or adopt a mixed approach. The main difference between a hardship clause and a force majeure clause lies in the effects of changed circumstances on the contract. In addition to providing the possibility to renegotiate, terminate or suspend the contract, the hardship clause could also be adapted by various mechanisms of third party intervention. Apart from merely conventional differences, the relaxation of standards of force majeure attenuates the difference between triggering events and makes it possible to refer to the fading distinction between force majeure and hardship.
It cannot be denied that the doctrine has been widely criticized for its role to put contractual stability at risk. But let’s not forget that the doctrine of hardship is a developing concept and like any other jurisprudential concept, its categories are never closed but are as wide as the categories of human conduct. The doctrine is invented in order to supplement the defects of the actual contract. The parties to an executory contract are often faced, in the course of carrying it out, with a turn of event which they did not at all anticipate - a wholly abnormal rise or fall in prices, a sudden depreciation of currency, an unexpected obstacle to execution, or the like. However, this difficulty can be successfully dealt with if the present legal system recognizes the doctrine of hardship and reasonable consideration in given for inclusion of hardship clauses while drafting the terms of the contract. If the doctrine is used judiciously, no doubt it shall be beneficial for parties who are willing to participate in long term commercial transactions, both domestic and international.
# Mistake in Contract, A comparative study in Jurisprudence by Edwin C. Mckeag, Sometime University fellow in Columbia University, The Lawbook Exchange Ltd, Clark, Jersey 2
# Taylor vs. Caldwell, delivered by Justice Blackburn of Queen’s Bench, 3 B. & S. 826, 122 Eng. Rep. 309 (1863).
#  2 KB 740
# Boothalinga Agencies vs. VTC Poriaswami Nadar AIR 1969 SC 110.
# PS Atiyah, An introduction to the title Law of Contract, fifth edn, p. 231.
# Naihati Jute Mills Ltd. Vs. Khyaliram Jagannath AIR 1968 SC 522
# Berjis Desai, Managing Partner, Jyoti Sagar, Published at Fri, Mar 27, 2009 at 10:08 Source : CNBC-TV18
# Mulla Indian Contract and Specific Relief Acts, Thirteenth Edition, Edited by RG Padia, LexisNexis Butterworths India
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# Force Majeure and Hardship under the UNIDROIT Principles of International Commercial Contracts, Joseph M. Perillo
# Conference Report on "Force Majeure and Hardship" - Paris (France), 8 March 2001
organised by the International Chamber of Commerce (ICC) by Alexei G. Doudko, Associate, Linklaters & Alliance, Moscow (Russian Federation); Rapporteur, International Commercial Arbitration Court at the Russian Federation Chamber of Commerce and Industry.
The author can be reached at: email@example.com