Given the economic dislocation caused by the rapid spread of COVID-19 across the world, many parties facing difficulties in performing contracts will be considering their legal situation. Can they be held liable for damages for a breach of contract or losses suffered by third parties due to circumstances beyond their control or does the law provide a relief mechanism for dire circumstances such as these? Although Indonesian law provides a relief mechanism known as force majeure, it is a difficult one of which to avail.
Indonesian law does not define 'force majeure' in detail. However, clear indicators as to its general scope are provided by Articles 1244 and 1245 of the Civil Code, which read as follows:
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 1244.)
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. (Article 1245.)(2)
In light of the above provisions, for force majeure to be recognised under Indonesian law, the obligor must prove that:
- an unforeseen event occurred;
- the unforeseen event was not within its control; and
- it acted in good faith.
In accordance with the principle of freedom of contract, the parties to a contract can agree on what precisely constitutes force majeure for the purposes of their contract and whether it can be invoked in case of late or non-performance. Thus, generally speaking, whether a particular event will be recognised as a force majeure event will depend on the agreement of the parties, as reflected in a force majeure clause in the relevant contract.
Force majeure and disasters under Indonesian law
In general, many commercial contracts governed by Indonesian law will contain a force majeure clause. Further, the force majeure clause will often specifically refer to three types of disaster (among other events) in line with the disaster classifications set out in the Law on Disaster Response (24/2007) – namely:
- natural disasters;
- non-natural disasters; and
- social disasters.
A 'non-natural disaster' is defined in Law 24/2007 as a disaster that is caused by, among other things, an epidemic or plague (the categorisation of epidemics and plagues 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 force majeure, on 14 March 2020 President Joko Widodo declared COVID-19 a national non-natural disaster. Consequently, this should afford a sound legal basis for declaring a force majeure event, given that, as mentioned above, almost all force majeure clauses in contracts governed by Indonesian law often specifically cover non-natural disasters.
Nonetheless, before rushing to send out a force majeure notice, it should be noted that Indonesian law requires each force majeure event to be considered on the facts, having regard to the three requirements described above (ie, the actual occurrence of an event that was beyond the control of the obligor in a situation where the 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, attempt to avail of the disaster to shirk their contractual obligations.
Force majeure and economic disruption under Indonesian law
Given that significant economic upheaval seems unavoidable as a consequence of the COVID-19 pandemic, Indonesian law's approach to force majeure in relation to losses caused by economic disruption should be considered.
The Indonesian courts have traditionally interpreted force majeure narrowly, allowing the defence only where performance was rendered completely impossible by the force majeure event. If performance was possible, the force majeure argument would normally be dismissed, even if this placed an excessively onerous or unjust burden on the party pleading force majeure. However, this strict interpretation changed somewhat in the wake of the economic dislocation caused by the Asian financial crisis of 1997-1998.
This change is most clearly reflected in the Supreme Court's 2005 decision in PT Pertamina (Persero) v PT Wahana Seno Utama, in which the country's highest court held that the economic disruption caused by the financial crisis constituted an force majeure event.
While Pertamina is well known and frequently cited, there are many other decisions in which the Supreme Court applied the opposite approach, ruling that economic disruption does not constitute a ground for force majeure. In this regard, it should be noted 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 utmost importance in shaping the stance of the adjudicating judges.
Consequently, it should not be assumed that the courts will treat the significant difficulties that are likely to be caused by COVID-19 as coming within the scope of force majeure, particularly where this is not specifically provided for in a force majeure clause.
Modification or amendment of contract by courts in case of economic disruption
As a civil law jurisdiction, Indonesian law recognises the importance of good faith in contractual relations, as specifically provided for by Article 1338(3) of the Civil Code, 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 that a borrower was required to repay under a mortgage agreement that had been entered into before World War II. According to the terms of the contract, the borrower was required to repay Rp50. 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 the risk of currency devaluation had to 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 (1996),(3) the Supreme Court adjusted contractual provisions based on Article 1338(3) of the Civil Code by reducing the annual rate of interest under the contract from 39.6% to 15%.
Overall, the chances of success of any attempt to avail of Article 1338(3) to amend a contract in the present circumstances are likely to be low. However, as mentioned 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 contractors do now?
Parties to a contract that is under stress as a result of the COVID-19 pandemic and which are consequently considering declaring a force majeure event should first consider the following:
- What law governs the contract (Indonesian or foreign)? If the contract is governed by Indonesian law, the following points apply.
- Does the contract contain a force majeure clause that includes the usual formula on disasters (ie, natural, non-natural and social)? If so, COVID-19 should theoretically be covered.
- Under the contract, must performance be essentially impossible before the force majeure clause can be availed of or can it also be deployed in circumstances where performance is delayed or hampered?
- The good-faith requirement means that contractors must keep counterparties fully informed of any difficulties that they face in performing the contract and the likely impact of these difficulties on performance. In this regard, contractors should carefully weigh up the precise extent of the information that they should provide to counterparties.
- Contractors must diligently comply with all notice requirements so as to avoid any possibility of counterparties claiming that they failed to keep them properly informed of the situation. Considerations in this regard include precisely when notice should be given (eg, upon the occurrence of an actual impact or when an impact becomes likely?).
- It is essential under Indonesian law that contractors do everything in their power to mitigate any reasonably foreseeable losses that will affect counterparties or a third party. Besides general mitigation, contracts should be reviewed to see whether any specific mitigation measures or actions must be taken.
Endnotes
(1) An 'obligor' is a party bound to another party by a contract.
(2) Further, Article 47 of the Construction Services Law (2/2017) provides that a construction contract should contain a force majeure clause covering "events that are outside the expectation and control of the parties that inflict losses on [one or more of the parties]."
