31 Mar 2020
Force Majeure and Impact of Covid-19 on Contractual Obligations

1. Introduction

Given the economic dislocation caused by the rapid spread of Covid-19 around the world, many parties facing difficulties in performing contracts will obviously be thinking about their legal situation. Can they be held liable for damages for breach of contract or losses suffered by third parties due to circumstances beyond their control or does the law provide a relief mechanism in such dire circumstances as those currently prevailing? Well, Indonesian law does actually provide a relief mechanism known as force majeure (FM), but it is a mechanism that is quite difficult to avail of.

2. Overview of Force Majeure in Indonesia

Indonesian law does not define FM in detail. However, clear indicators as to the general scope of FM are provided by Articles 1244 and 1245 of the Indonesian Civil Code (ICC), which articles may be freely translated as follows:

Article 1244 ICC: An Obligor[1] shall be required to provide compensation for costs, losses and interest if Obligor cannot prove that the non-performance or the late performance of Obligor’s obligation is the result of an unforeseen event for which Obligor was not responsible, provided Obligor was not acting in bad faith.

Article 1245 ICC: No compensation for costs, losses and interest shall be payable if Obligor, because of an act of God or an accident, was prevented from delivering or performing an obligation that Obligor was obliged to deliver or perform, or Obligor was compelled to do something that it was prohibited from doing.[2]

In the light of the above provisions, for FM to be recognized under Indonesian law, the Obligor will need to prove the following:

(a) the occurrence of an unforeseen event;

(b) the unforeseen event was not within its control; and

(c) it acted in good faith.

In accordance with the principle of freedom of contract, the parties to a contract are free to agree on what precisely constitutes FM for the purposes of their contract, and whether it can be invoked in case of non-performance and/ or the late performance of the contract. Thus, generally speaking, whether or not a particular event will be recognized as an event of FM will depend on the agreement of the parties, as reflected in an FM clause in the contract.

3. Force Majeure and Disasters under Indonesian Law

In general, many commercial contracts governed by Indonesian law will contain an FM clause. Further, the FM clause will often specifically refer to 3 types of disaster (among other FM events) in line with the disaster classifications set out in Law No. 24/2007 on Disaster Response.[3] These 3 classifications are as follows:

1. Natural disaster (bencana alam)

2. Non-natural disaster (bencana non-alam)

3. Social disaster (bencana social)

As regards a “non-natural disaster,” this is defined by Law No. 24/2007 as a disaster that is caused by, among other things, epidemic and plague (the categorization of “epidemic” and “plague” as non-natural disasters may be explained by the fact that the term “natural disaster” in Indonesia generally refers to disasters that are caused by extreme weather events or movements or eruptions of the Earth).

Crucially from the perspective of a party considering servicing a notice of FM, Covid-19 was declared a “national non-natural disaster” by Indonesia’s President, Joko Widodo, on Saturday, 14 March 2020. Consequently, this should afford a sound legal basis for declaring an event of FM, given that, as mentioned above, almost all FM clauses in contracts governed by Indonesian law will often specifically cover non-natural disasters.

Nevertheless, before rushing to send out a notice of FM, it should be remembered that Indonesian law requires each event of FM to be considered on the facts, having regard to the 3 requirements described in points (a)-(c) in Section 2 above, namely, actual occurrence of an event that was beyond the control of Obligor in a situation where Obligor acted in good faith. Thus, even though a national non-natural disaster has been declared by the President, this in no way confers carte blanche on those who, in bad faith, would attempt to avail of the disaster to shirk their contractual obligations.

4. Force Majeure and Economic Disruption under Indonesian Law

Given that significant economic upheaval seems unavoidable as a consequence of the Covid-19 pandemic, we will now consider Indonesian law’s approach to FM in relation to losses caused by economic disruption.

Traditionally, FM was interpreted very narrowly by the Indonesian courts, with the defense only being allowed where performance was rendered completely impossible by the FM event. If performance was possible, then the FM argument would normally be dismissed, even if this placed an excessively onerous or unjust burden on the party pleading FM. However, this strict interpretation changed somewhat in the wake of the economic dislocation caused by the Asian Financial Crisis in 1997/98.

This change is most clearly reflected in the Supreme Court’s 2005 decision in PT Pertamina (Persero) v PT Wahana Seno Utama, where the country’s highest court held that the economic disruption caused by the financial crisis constituted an event of FM.

While the Pertamina decision is well-known and frequently cited, there have been many other decisions where the Supreme Court has applied the opposite approach, ruling that economic disruption does not constitute a ground for FM. In this regard, it needs to be remembered that Indonesian law does not adhere to a strict system of precedent and that judicial decisions at all levels primarily turn on the facts. Thus, the particular facts of each case will be of the utmost importance in shaping the stance of the adjudicating judges.

Consequently, it should not be assumed that even the massive difficulties that are likely to be caused by Covid-19 will be treated as coming within the scope of FM by the courts, particularly where this is not specifically provided for in an FM clause.

5. Modification or Amendment of Contract by Indonesian Court in Case of Economic Disruption

As a civil law jurisdiction, Indonesian law recognizes the importance of good faith in contractual relations, as specifically provided for by Article 1338(3) ICC, which requires all contracts to be performed in good faith.

In the past, the principle of good faith has been used by the Supreme Court to mitigate the consequences of unforeseen events by amending or inserting contractual terms. For example, in a 1955 case, the Supreme Court considered the impact of currency devaluation on the amount a borrower was required to repay under a mortgage agreement that was entered into prior to the Second World War. According to the terms of the contract, the borrower was required to repay Rp 50. However, the value of the Indonesian currency had collapsed in the intervening period. In its decision, the Supreme Court held that the principle of good faith meant that risk of currency devaluation must be borne by both parties and thus increased the amount that should be repaid by the borrower based on the prevailing price of gold as a benchmark. More recently, in Haryo v Bank Pasar Dwimanda in 1996[4], the Supreme Court adjusted contractual provisions based on Article 1338(3) ICC by reducing the annual rate of interest under the contract from 39.6 percent to 15 percent.

Overall, the chances of success of any attempt to avail of Article 1338(3) to amend a contract in present circumstances are likely to be low. However, as we mentioned in Section 4 above, Indonesia’s lack of a developed system of precedent means that everything will ultimately turn on the specific facts of the case.

What Should I Do Now?

If you have a contract that is experiencing stress as a result of the Covid-19 pandemic and you are consequently considering declaring an event of FM, you should first carefully consider the following:

  • What law governs my contract (Indonesian or foreign)? If your contract is governed by Indonesian law, the following points apply.

  • Does the contract contain an FM clause that includes the usual formula on disasters (natural, non-natural and social disasters)? If so, then theoretically Covid-19 should be covered.

  • Under the contract, must performance be essentially impossible before the FM clause can be availed of or can it also be deployed in circumstances where performance is delayed or hampered?

  • The good faith requirement (as described in Sn 5 above) means that you must keep your counterparty fully informed of the difficulties you face in performing your contract and the impacts these difficulties are likely to have on performance. In this regard, you need to carefully consider and weigh up the precise extent of the information that you should provide to your counterparty.

  • You will need to diligently comply with all notice requirements so as to avoid any possibility of your counterparty claiming that you failed to keep them properly informed of the situation. Things that need to be considered in this regard include precisely when notice should be given? For example, should it be given upon the occurrence of an actual impact or when an impact becomes likely?

  • Mitigation – it is essential under Indonesian law that you do everything in your power to mitigate any reasonably foreseeable losses that will impact on your counterparty or a third party. Besides general mitigation, you should review the contract to see if there are any specific mitigation measures or actions that you are required to take.

Should you have any queries or require legal advice on how you can best protect your interests during this time of uncertainty, please contact the persons below, call us on +6221-2505125 or email us at info@abnrlaw.com.

Mr. Emir Nurmansyah (enurmansyah@abnrlaw.com)

Mr. Nafis Adwani (nadwani@abnrlaw.com)

Mr. Agus Ahadi Deradjat (aderadjat@abnrlaw.com)

[1] A party bound to another by a contract.

[2] Further, Article 47 of the Construction Services Law of 2017 (Undang-undang No. 2/2017 Tentang Jasa Konstruksi) provides that a construction contract should contain an FM clause covering “events that are outside the expectation and control of the parties that inflict losses on [one or more of the parties].”

[3] Undang-Undang Nomor 24/2007 Tentang Penanggulan Bencana

[4] Case No. 983.K/PDT/1991

This ABNR News and the contents hereof are intended solely to provide a general overview, for informational purposes, of selected recent developments in Indonesian law. They do not constitute legal advice and should not be relied upon as such. Accordingly, ABNR accepts no liability of any kind in respect of any statement, opinion, view, error, or omission that may be contained in thislegalupdate. In all circumstances, you are strongly advised to consult a licensed Indonesian legal practitioner before taking any action that could adversely affect your rights and obligations under Indonesian law.

More Legal Update

NEWS DETAIL

Back

31 Mar 2020
Force Majeure and Impact of Covid-19 on Contractual Obligations

1. Introduction

Given the economic dislocation caused by the rapid spread of Covid-19 around the world, many parties facing difficulties in performing contracts will obviously be thinking about their legal situation. Can they be held liable for damages for breach of contract or losses suffered by third parties due to circumstances beyond their control or does the law provide a relief mechanism in such dire circumstances as those currently prevailing? Well, Indonesian law does actually provide a relief mechanism known as force majeure (FM), but it is a mechanism that is quite difficult to avail of.

2. Overview of Force Majeure in Indonesia

Indonesian law does not define FM in detail. However, clear indicators as to the general scope of FM are provided by Articles 1244 and 1245 of the Indonesian Civil Code (ICC), which articles may be freely translated as follows:

Article 1244 ICC: An Obligor[1] shall be required to provide compensation for costs, losses and interest if Obligor cannot prove that the non-performance or the late performance of Obligor’s obligation is the result of an unforeseen event for which Obligor was not responsible, provided Obligor was not acting in bad faith.

Article 1245 ICC: No compensation for costs, losses and interest shall be payable if Obligor, because of an act of God or an accident, was prevented from delivering or performing an obligation that Obligor was obliged to deliver or perform, or Obligor was compelled to do something that it was prohibited from doing.[2]

In the light of the above provisions, for FM to be recognized under Indonesian law, the Obligor will need to prove the following:

(a) the occurrence of an unforeseen event;

(b) the unforeseen event was not within its control; and

(c) it acted in good faith.

In accordance with the principle of freedom of contract, the parties to a contract are free to agree on what precisely constitutes FM for the purposes of their contract, and whether it can be invoked in case of non-performance and/ or the late performance of the contract. Thus, generally speaking, whether or not a particular event will be recognized as an event of FM will depend on the agreement of the parties, as reflected in an FM clause in the contract.

3. Force Majeure and Disasters under Indonesian Law

In general, many commercial contracts governed by Indonesian law will contain an FM clause. Further, the FM clause will often specifically refer to 3 types of disaster (among other FM events) in line with the disaster classifications set out in Law No. 24/2007 on Disaster Response.[3] These 3 classifications are as follows:

1. Natural disaster (bencana alam)

2. Non-natural disaster (bencana non-alam)

3. Social disaster (bencana social)

As regards a “non-natural disaster,” this is defined by Law No. 24/2007 as a disaster that is caused by, among other things, epidemic and plague (the categorization of “epidemic” and “plague” as non-natural disasters may be explained by the fact that the term “natural disaster” in Indonesia generally refers to disasters that are caused by extreme weather events or movements or eruptions of the Earth).

Crucially from the perspective of a party considering servicing a notice of FM, Covid-19 was declared a “national non-natural disaster” by Indonesia’s President, Joko Widodo, on Saturday, 14 March 2020. Consequently, this should afford a sound legal basis for declaring an event of FM, given that, as mentioned above, almost all FM clauses in contracts governed by Indonesian law will often specifically cover non-natural disasters.

Nevertheless, before rushing to send out a notice of FM, it should be remembered that Indonesian law requires each event of FM to be considered on the facts, having regard to the 3 requirements described in points (a)-(c) in Section 2 above, namely, actual occurrence of an event that was beyond the control of Obligor in a situation where Obligor acted in good faith. Thus, even though a national non-natural disaster has been declared by the President, this in no way confers carte blanche on those who, in bad faith, would attempt to avail of the disaster to shirk their contractual obligations.

4. Force Majeure and Economic Disruption under Indonesian Law

Given that significant economic upheaval seems unavoidable as a consequence of the Covid-19 pandemic, we will now consider Indonesian law’s approach to FM in relation to losses caused by economic disruption.

Traditionally, FM was interpreted very narrowly by the Indonesian courts, with the defense only being allowed where performance was rendered completely impossible by the FM event. If performance was possible, then the FM argument would normally be dismissed, even if this placed an excessively onerous or unjust burden on the party pleading FM. However, this strict interpretation changed somewhat in the wake of the economic dislocation caused by the Asian Financial Crisis in 1997/98.

This change is most clearly reflected in the Supreme Court’s 2005 decision in PT Pertamina (Persero) v PT Wahana Seno Utama, where the country’s highest court held that the economic disruption caused by the financial crisis constituted an event of FM.

While the Pertamina decision is well-known and frequently cited, there have been many other decisions where the Supreme Court has applied the opposite approach, ruling that economic disruption does not constitute a ground for FM. In this regard, it needs to be remembered that Indonesian law does not adhere to a strict system of precedent and that judicial decisions at all levels primarily turn on the facts. Thus, the particular facts of each case will be of the utmost importance in shaping the stance of the adjudicating judges.

Consequently, it should not be assumed that even the massive difficulties that are likely to be caused by Covid-19 will be treated as coming within the scope of FM by the courts, particularly where this is not specifically provided for in an FM clause.

5. Modification or Amendment of Contract by Indonesian Court in Case of Economic Disruption

As a civil law jurisdiction, Indonesian law recognizes the importance of good faith in contractual relations, as specifically provided for by Article 1338(3) ICC, which requires all contracts to be performed in good faith.

In the past, the principle of good faith has been used by the Supreme Court to mitigate the consequences of unforeseen events by amending or inserting contractual terms. For example, in a 1955 case, the Supreme Court considered the impact of currency devaluation on the amount a borrower was required to repay under a mortgage agreement that was entered into prior to the Second World War. According to the terms of the contract, the borrower was required to repay Rp 50. However, the value of the Indonesian currency had collapsed in the intervening period. In its decision, the Supreme Court held that the principle of good faith meant that risk of currency devaluation must be borne by both parties and thus increased the amount that should be repaid by the borrower based on the prevailing price of gold as a benchmark. More recently, in Haryo v Bank Pasar Dwimanda in 1996[4], the Supreme Court adjusted contractual provisions based on Article 1338(3) ICC by reducing the annual rate of interest under the contract from 39.6 percent to 15 percent.

Overall, the chances of success of any attempt to avail of Article 1338(3) to amend a contract in present circumstances are likely to be low. However, as we mentioned in Section 4 above, Indonesia’s lack of a developed system of precedent means that everything will ultimately turn on the specific facts of the case.

What Should I Do Now?

If you have a contract that is experiencing stress as a result of the Covid-19 pandemic and you are consequently considering declaring an event of FM, you should first carefully consider the following:

  • What law governs my contract (Indonesian or foreign)? If your contract is governed by Indonesian law, the following points apply.

  • Does the contract contain an FM clause that includes the usual formula on disasters (natural, non-natural and social disasters)? If so, then theoretically Covid-19 should be covered.

  • Under the contract, must performance be essentially impossible before the FM clause can be availed of or can it also be deployed in circumstances where performance is delayed or hampered?

  • The good faith requirement (as described in Sn 5 above) means that you must keep your counterparty fully informed of the difficulties you face in performing your contract and the impacts these difficulties are likely to have on performance. In this regard, you need to carefully consider and weigh up the precise extent of the information that you should provide to your counterparty.

  • You will need to diligently comply with all notice requirements so as to avoid any possibility of your counterparty claiming that you failed to keep them properly informed of the situation. Things that need to be considered in this regard include precisely when notice should be given? For example, should it be given upon the occurrence of an actual impact or when an impact becomes likely?

  • Mitigation – it is essential under Indonesian law that you do everything in your power to mitigate any reasonably foreseeable losses that will impact on your counterparty or a third party. Besides general mitigation, you should review the contract to see if there are any specific mitigation measures or actions that you are required to take.

Should you have any queries or require legal advice on how you can best protect your interests during this time of uncertainty, please contact the persons below, call us on +6221-2505125 or email us at info@abnrlaw.com.

Mr. Emir Nurmansyah (enurmansyah@abnrlaw.com)

Mr. Nafis Adwani (nadwani@abnrlaw.com)

Mr. Agus Ahadi Deradjat (aderadjat@abnrlaw.com)

[1] A party bound to another by a contract.

[2] Further, Article 47 of the Construction Services Law of 2017 (Undang-undang No. 2/2017 Tentang Jasa Konstruksi) provides that a construction contract should contain an FM clause covering “events that are outside the expectation and control of the parties that inflict losses on [one or more of the parties].”

[3] Undang-Undang Nomor 24/2007 Tentang Penanggulan Bencana

[4] Case No. 983.K/PDT/1991

This ABNR News and the contents hereof are intended solely to provide a general overview, for informational purposes, of selected recent developments in Indonesian law. They do not constitute legal advice and should not be relied upon as such. Accordingly, ABNR accepts no liability of any kind in respect of any statement, opinion, view, error, or omission that may be contained in thislegalupdate. In all circumstances, you are strongly advised to consult a licensed Indonesian legal practitioner before taking any action that could adversely affect your rights and obligations under Indonesian law.