Time to renegotiate the renegotiation clauses in contract law?
Change is inevitable. The field of contract law is not far removed from the application of this principle. Contracts are set to govern the legal relationship between the parties within the existing regulatory framework. Parties enter into a bargain on the basis of the then existing law and the applicable regulation. For instance, with the advent of regulators like the Competition Commission of India which regulates the behavioral aspects of a party's dealings, one necessarily structures a contract to be compliant with these regulatory requirements. Commercial forecasts, long term expectations and business plans of parties to a contract are accordingly structured and understandings arrived at with a counter party. This understanding forms the very basis and the backbone of a contractual relationship.
However, it is not always possible to foresee, contemplate or predict changes which may take place in the regulatory and legal landscape after entering into an agreement which may have a material bearing on the original contract. These changes in the applicable law may at times alter the equilibrium of a contract in such a significant manner that it may become inequitable to insist that the affected party perform its part of the contract in the changed circumstance. These changes may strike at the root of a contract and alter the very basis or the substratum of the contract.
Accordingly, in order to offset the effects of an unforeseen change, parties often provide for a pre agreed contractual mechanism which takes effect in case of such unforeseen changes after the date of the agreement. This is particularly true for long infrastructure contracts relating to roads, power and other sectors which are capital intensive and performance spans over a period of 20 to 30 years. In such cases, parties generally provide for "renegotiation" or "hardship" clauses within the body of the original contract, which may be invoked in case of any supervening circumstance that renders performance commercially unviable. These clauses enable a party to renegotiate terms of a contract and restore the balance of the contract.
In the absence of parties agreeing upon such a mechanism or giving effect to an agreed mechanism of this nature, a contract runs the risk of being frustrated. Indian Courts have recognized the doctrine of frustration of contracts which has been embodied within the provisions of the Indian Contract Act, 1872. Courts have interpreted frustration or impossibility to perform in the practical and commercial sense and not strictly in a literal sense. Parties may avoid performing a contract which is rendered impracticable by availing this remedy under contract law. However, avoiding contracts as being frustrated may not always be a desirable option in a developing economy where investors look for stability and predictability in doing business. With a proactive Government striving hard to provide a business friendly environment for investors, a change in the traditional outlook may indeed be warranted. This is where renegotiation clauses in a contract derive their significance.
These clauses provide for an agreed mechanism of renegotiation so as to enable the parties to restore the balance of a contract which has been disturbed as a result of the unforeseen change in law post the agreement. Jurisprudence surrounding the enforceability of renegotiation clauses is still in a nascent stage. It may be worthwhile exploring international law on this aspect. For instance, the UNIDROIT Principles adopted by the United Nations provide that in case parties fail to agree upon suitable changes to a contract in case of a subsequent event rendering performance inequitable, the matter may be settled by arbitration. The arbitrators are empowered in such cases to inter alia direct suitable modifications to a contract in order to adapt the contract to the changed circumstance and restore the equilibrium of a contract.
Investors who make substantial investments do necessarily seek to run a viable business, protect their investments and make a reasonable profit. Towards that end, they provide for appropriate contractually agreed remedies in case of an unforeseen supervening event. Recognition and enforcement of these measures may indeed bring in the much needed stability, consistency, clarity and certainty which are the fundamental requirements of carrying on a profitable business in a developing economy.
Originally Published Business World Online, December 24, 2014
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