The unusual step of the central government invoking ‘act of God’ to appease the states on not being able to provide due cess compensation was unfortunate and unjustifiable, feel most legal experts and economists. Vijay L. Kelkar, chairman of the 13th finance commission, describes the finance minister’s stance as “bizarre”, while EY India chief policy advisor D.K. Srivastava says the analogy is most unfortunate. Balveer Arora, chairman, Centre for Multilevel Federalism, JNU, points out that there is no concept of ‘act of God’ in the Constitution and none in the GST Council Act. While states are continuing consultations with each other, many have written to finance minister Nirmala Sitharaman to convince her on the need for the Centre to take the initiative of borrowing and compensating the states for the shortfall in revenue due to the Covid lockdown that considerably halted economic activities across the country. So far indications are that the Centre is not willing to accommodate the states.
“The concept of ‘act of God’ is usually encountered in contract law,” says Arora. “It is a sort of escape clause for insurance companies when they seek to wriggle out of their commitment by invoking it. The GST is an act of Parliament, and federalism involves shared sovereignties. Just as Parliament is sovereign in the areas assigned to it, the states are sovereign in the areas assigned to them in terms of taxation powers. From their pool of sovereignty, the states have surrendered their powers in fiscal matters to the Centre. So, this whole business comes under constitutional law and not contract law. In fact, nowhere in the GST Council Act is it mentioned that this is a commercial contract where the finance minister can invoke ‘act of God’. So the only way you can get out of the responsibility you have acquired in the exercise of your sovereign power is by declaring bankruptcy.”
There have been cases where states and countries defaulted on sovereign debts, but India is far from that situation. Prior to the introduction of GST, though there was allocation or transfer of funds to the states, it was done through the Planning Commission. After the 14th finance commission’s recommendation of 41 per cent transfer of revenue to the states was adopted, it is no longer a discretionary allocation of funds, but a constitutional right of states to receive their predetermined due share. “The GST compensation is not something that the Centre gives to the states,” says Srivastava. “It is financed by the compensation cess, which is paid by the citizens of India. It is not something that accrues to the Centre, which is only a collection making body. The compensation cess collected is to be kept in a separate fund.”
Several states have written to FM Nirmala Sitharaman, asking the Centre to borrow and compensate them.
The pandemic has so far caused a revenue shortfall of around Rs. 2.35 lakh crore, but it is a phenomenon that started much before the health crisis hit the Indian economy because the revenue performance of GST was much less than what would have been obtained if revenue neutrality could have been ensured. Srivastava argues that the issue is not about the ‘act of God’, but the promise of 14 per cent growth in revenue over a base year that turned out to be “excessively unrealistic”. The expected kind of buoyancy could not be maintained. Thus the loss of growth rate in real terms as well as buoyancy is not an act of God, but due to government policies. Experts point out that a succession of events following demonetisation has led to slower economic growth as well as the designing and implementation of GST. In addition, the way the monetary policy was designed has led to excessive inflation as measured by the producer price index.
“Cess compensation is a commitment that the central government is bound to fulfil,” says Kelkar. “Covid spread may be deemed an act of God, but the government cannot shirk its commitment. It should borrow funds to compensate the states.” The financial expert, who has held several seniors posts in government, points out that in the framework of cooperative federalism, the Centre has stepped in several times in the past to bailout the states. In fact, in 2002-03, the then central government had come forward to help states pay off high interest loans to avail of new loans at lower interest rates. This happened at a time when the central government had no constitutional commitment unlike under the GST Council Act. Yet, it was done in the interest of the economy. The short-term impact of the Centre’s move will be that states will have to borrow from the market at high interest rates, which in the long term will impact the economy, administration and funds available for health and education.
N.R. Bhanumurthy, vice chancellor, Dr B.R. Ambedkar School of Economics (BASE) University, points out that post 14th finance commission, there were expectations that the fiscal situation would improve for the states. “If it has not happened, it is because of slowing economy and other shocks, including birth defects of GST design and implementation. Now that we have empirical evidence of what works and what does not, we should relook at the GST design and implementation and compensation issues, which should become part of the GST tax structure,” says Bhanumurthy, who favours states borrowing instead of placing the burden on the Centre. “Two months after Kerala borrowed from the market at around 9 per cent, states like Maharashtra, Karnataka and Gujarat borrowed from the market at less than 6 per cent. Markets decide on the rates based on your past performance and future expectations. For some reason, Kerala, West Bengal and Punjab face problems because they have been fiscally stressed in the past too,” the economist states.
According to legal experts, other than the disputes arising under commercial contracts, litigations can be seen in various other areas. For instance, with respect to employment matters, there may be disputes between employees and organisations over reduction of salaries and wages or, in some cases, lay-offs. “The force majeure clause is often a contractual provision under Indian law; unlike civil law countries where it is a concept of law,” says Mohit Saraf, senior partner of L&L Partners. “Therefore, different contracts in the Indian scenario may have different types of force majeure clauses. However, the government cannot be excused for non-payment of dues citing this clause.” He cautions that the onus of proving whether the delay has been due to the impact of COVID-19 will be on the contracted party that misses the deadline.
Various ministries have issued certain memoranda regarding the clause. For example, the ministry of new and renewable energy, the ministry of shipping and the ministry of finance have permitted its invocation in respect of construction/work contract, goods and services contracts and PPP contracts with government agencies, subject to fulfilling due procedures wherever applicable. However, these do not carry any actual legal significance, because only courts can interpret whether a certain event qualifies as being force majeure.
“The ramifications arising from invocation of force majeure in government contracts cannot be generalised as they would depend on the nature of the government contract and the parties to it,” says Prasenjit Chakravarti, partner, Khaitan and Company. However, some of the ramifications that may arise are delays in completion of the government contracts. But, in the case of states, lack of decision and resources will stall action on important commitments, particularly in health and education sectors.
