Contractual Obligations in the Age of COVID-19: Frustration of Contract

Amidst the chaos of the coronavirus pandemic, contracting parties may find themselves in need of a means to avoid – or enforce – the (ordinarily strict[1]) requirement to perform their obligations. This article is the second of two dealing with force majeure and frustration; two areas of the law that are likely to be important in the coming months. In the force majeure article, we explained the effect of force majeure clauses, which operate to keep a contract alive despite a supervening event or course of events that dramatically affects a party’s ability to perform the contract as contemplated.  In this article, we address the common law doctrine of frustration, which can operate to terminate an agreement in such a scenario.

Non haec in foedera veni: ‘it was not this that I promised to do’

Force majeure clauses are a function of private agreement. Frustration is different: it is a consequence imposed by law. It is most commonly invoked by a party as a defence to a claim for breach, or as a basis for claiming restitution upon termination.

The doctrine has historically been justified on various grounds, including:

as a device by which the rules as to absolute contracts are reconciled with a special exception which justice demands, as an implied term, as a matter of construction of the contract, [or] as a total failure of consideration.[2]

Relative to the flexibility which might be afforded where parties have included force majeure clause in their contract, frustration is comparatively strict. Save in the occasional case where the relevant obligation may be severed,[3] the ordinary consequence of frustration is that the agreement is terminated. Because of this extreme outcome, frustration is not readily found. Courts will strive to uphold parties’ bargains rather than risk undermining the entire institution of contract. [4] In almost every circumstance, making a contract or agreement involves collaboration and risk allocation by the parties in the face of some degree of uncertainty.[5] Providing a mechanism by which parties can avoid the obligations they take on in this process because events play out differently to the way expected, by its nature, tends to undermine the bargaining process.

The test for frustration

A party seeking to establish that a contract has been frustrated must prove an event (or series of events) causing[6] a situation radically or fundamentally different from that contemplated by the contract on its true construction in light of the surrounding circumstances.[7] It will need to demonstrate more than ‘disappointed expectations’[8], ‘hardship or inconvenience’[9] or reduced profitability. Some authorities suggest it is the nature or significance of the parties’ rights and obligations (not merely the expense or onerousness of them) which must be altered by the supervening event.[10]

Are there established categories of frustration?

The coronavirus pandemic is undoubtedly affecting us all, but not all in the same way. Legally, we are not so much ‘all in this together’ as we are ‘all in this at the same time’. COVID-19 will – and already has begun to – generate consequences familiar in frustration cases: for example, executive, legislative and regulatory intervention by the state;[11] and the cancellation of expected events.[12] However, these events will impact different contracts in different ways (if they impact them at all), and they cannot be assumed always to frustrate affected agreements. While earlier cases identify situations constituting frustration that will have analogies with current events, the test identified above must be applied to contemporary facts and the specifics of each case.

In practice, the difficulty with determining whether a given situation has been radically or fundamentally altered is that it involves first identifying what the parties’ situation was at the time they struck their bargain, and then determining the impact of the supervening event on that situation – including on the benefit of performance,[13] and relatedly, the commercial purpose for which the contract was made.[14] This invariably involves questions of degree.[15]

A variety of factors must be considered. These include the text, context and purpose of the agreement; its background and surrounding circumstances (including mutual and objective knowledge, assumptions, expectations and assumptions, particularly as to risk); any reasonable and objectively ascertainable calculations as to the possibility of performance and allocation of risk; and the ‘demands of justice’.[16] Express statements to the effect that a specified contingency will not affect performance will preclude a finding of frustration.[17] Similarly, there might be an implied assumption of risk on absolute terms – particularly where the allegedly frustrating event can be attributed to a normal vicissitude of commerce.[18] The determination of whether a contract is frustrated cannot be divorced from the construction of the contract itself and an assessment of its commercial purpose and objectives. Accordingly, different cases can throw up different results, even in the face of common events.

Frustration in the face of a force majeure clause

If, as a matter of interpretation, a force majeure clause contemplates and provides for the relevant event and there is a causal link to the breach of a contractual obligation, then the legal effect of the event will ordinarily be determined in accordance with the parties’ agreement. However, inclusion of a force majeure clause in an agreement does not exclude the doctrine of frustration.[19] In determining whether a contract is terminated by frustration, regard must be had to any force majeure clause.[20] The clause may itself provide for termination – for example, where an event is prolonged. However, where such provision is not made, the contract may nonetheless be frustrated where a delay could last for a long time or forever.[21]

Need performance be impossible?

Even if impossibility of performance is clearly established this alone does not necessitate a finding of frustration.[22] Similarly the possibility of performance does not preclude such a finding.[23] As noted, the test does not focus on impossibly but on a situation that is ‘radically or fundamentally different’ to what was contemplated. In many cases, impossibility of performance may well have been in contemplation and provided for, even if the parties did not focus specifically on the prospect of a pandemic.

It is notable that the coronavirus pandemic is a temporary – albeit persistent – event. So too are its flow-on effects. Some parties may find that the ability to perform contractual obligations is merely delayed, such as where a requirement of short-term self-isolation is imposed. Temporary delay in the ability to perform will tend to make a finding of frustration less likely.

Consequences of frustration

Frustration does not render a contract void ab initio. Rather, where applicable its effect is to terminate the agreement prospectively.[24] Accordingly, at common law, accrued rights to recover debts[25] or sue for damages in respect of breaches[26] arising prior to termination may survive. Dispute resolution and arbitration clauses are also unaffected.[27]

In New South Wales,[28] South Australia,[29] and Victoria,[30]  legislation also operates to regulate the consequences of frustration. In Victoria, the legislation provides, amongst other things, statutory rights to recover money paid,[31] and to receive payment for partial performance.[32]

Conclusion

As with the invocation of force majeure clauses, the decision as to whether or not to allege frustration must be approached with care. On the one hand, a party may forego the right to assert a contract has been frustrated if they continue to behave as if it is still binding, notwithstanding the supervening event.[33]  On the other hand, a wrongful assertion of frustration may amount to repudiation or anticipatory breach. Any decision to assert that an agreement has been frustrated must be based on careful assessment. Even an event as significant as the current pandemic will not operate generally to frustrate all contracts, or even all contracts of a particular type. However, in specific cases, the extraordinary events which now affect commerce around the globe may provide a basis for relieving a party from further performance of its obligations under an agreement.

[1]   Paradine v Jayne (1674) Aleyn 26; 82 ER 897. See also Ibbetson, D., ‘Absolute Liability in Contract: The Antecedents of Paradine v Jayne’ in Rose, F.D. (ed), Consensus ad Idem: Essays in the Law of Contract in Honour of Guenter Treitel (Sweet & Maxwell, 1996); Simpson, A.W.B., A History of the Common Law of Contract: The Rise of the Action of Assumpsit (Oxford University Press, 1975), 525-32. However, see e.g. Robinson v Davison (1871) 19 WR 1036; [1861-73] All ER Rep 699 (impossibility of performance of personal service obligations during illness).

[2]   National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675, 693 (Lord Wilberforce). See also Codelfa Construction Pty Ltd v State Rail Authority (NSW) (1982) 149 CLR 337, 376-378 (Aickin J).

[3]   This proposition is not settled at common law: see Ardee Pty Ltd v Collex Pty Ltd [2001] NSWSC 836, [55]; cited with approval in Deutsch v Deutsch [2012] VSC 227, [78]; but compare Aurel Forras Pty Ltd v Graham Karp Developments Pty Ltd [1975] VR 202 for the traditional view that frustration terminates the entire contract. In some states, severance is contemplated by legislation: Frustrated Contracts Act 1978 (NSW), s 6(3) and Frustrated Contracts Act 1988 (SA), s 5.

[4]   Scanlan’s New Neon Ltd v Tooheys Ltd (1943) 67 CLR 169 (Scanlan’s New Neon), 187 (Latham CJ).

[5]   See generally, Robertson, D., ‘Force Majeure Clauses’ (2009) 25 JCL 62, 67-69 (discussing the institution of contracting under uncertainty).

[6]   As to the requirement of a causal link between the relevant event and the situation said to give rise to frustration, see Thors v Weekes (1989) 92 ALR 131, 142.

[7]   Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337 (Codelfa), 360 (Mason J); compare 377-8 (Aickin J), 407-8 (Brennan J); Davis Contractors Ltd v Fareham Urban District Council [1952] AC 696 (Davis Contractors), 729 (Lord Radcliffe).

[8]   Ross v IceTV [2010] NSWCA 272, [78] (Sackville AJA, McColl and Macfarlan JJA agreeing).

[9]   Brisbane City Council v Group Projects Pty Ltd (1979) 145 CLR 143 (Brisbane City Council), 161 (Stephen J); cited with approval in Codelfa, 380 (Aickin J). See also Scanlan’s New Neon; Lindsay-Owen v Associated Dairies Pty Ltd [2000] NSWSC 1095 (Lindsay Owen), [11]. Compare, however, Articles 6.2.1-3 of the UNIDRIOT Principles of International Commercial Contracts which expressly address hardship.

[10] Davis Contractors, 729 (Lord Radcliffe); Brisbane City Council, 162 (Stephen J); cited with approval in Codelfa, 380 (Aickin J).

[11] See, e.g. Maine v Lyons (1913) 15 CLR 671; R S Howard S Sons Ltd v Brunton (1916) 21 CLR 366; Re de Garis & Rowe’s Lease [1924] VLR 38 (statute passed making contract illegal or void); Ardee Pty Ltd v Collex Pty Ltd [2001] NSWSC 836 (ministerial decree rendering performance illegal). Note however that supervening illegality is a conceptually distinct basis for discharge of contract: Gerratry v McGavin (1914) 18 CLR 152, 162, 165; Ringstad v Gollin & Co Pty Ltd (1924) 35 CLR 3030, especially at 308; Municipal Council of Sydney v Australian Metal Co Ltd (1926) 37 CLR 550; Scanlan’s New Neon, 186.

[12] Krell v Henry [1903] 2 KB 740 (frustration where coronation procession cancelled). See also Penrith District Rugby League Football Club Ltd v Fittler (Unreported, Supreme Court of New South Wales, Santow J, 8 February 1996) (frustration of footballers’ contracts where club ceased to play in the contemplated league).

[13] See, e.g. Lindsay-Owen (frustration where government abolition of a milk quota scheme led to the dramatic reduction in the price of milk and of dairy farms); but compare City of Subiaco v Heytesbury Properties Pty Ltd [2001] WASCA 140 (no frustration where town-planning legislation changed to preclude lessee from using premises for manufacturing, but where leases had been acquired with a view to development and real estate value had not been diminished by the alleged supervening event).

[14] See, e.g. Brisbane City Council (frustration where part of the land being the subject of the relevant agreement was compulsorily acquired by the government).

[15] Brisbane City Council, 162-3 (Stephen J), 164 (Murphy J); Codelfa, 380 (Aickin J); Lindsay-Owen, [12] (Hamilton J).

[16] Edwinton Commercial Corp v Tsavliris Russ (Worldwide Salvage and Towage) Ltd (The Sea Angel) [2007] Lloyd’s Rep 517; [2007] EWCA Civ 547, [111]-[112] (Rix LJ); Planet Kids Auckland Council [2014] 1 NZLR 149; [2013] NZSC 147, [8]-[9], [61]-[62] Elias CJ, McGrath, Glazebrooke and Gault JJ).

[17] Horlock v Beal [1916] 1 AC 486, 525 (Lord Wrenbury); Claude Neon Ltd v Hardie [1970] Qd R 93 (obligation to pay rent even if interest in the premises ‘extinguished or transferred’); Smith Bros Trade and Transport Terminal Pty Ltd v Pacific Power [1998] NSWSC 392; (Unreported, Supreme Court of New South Wales, Court of Appeal, Mason P, Meagher JA and Fitzgerald AJA, 31 July 1998) (contract negated any warranty for suitability of land licensed).

[18] Hirsch v Zinc Corporation Ltd (1917) 24 CLR 34, 52-3; Russo v Resource Developments International Pty Ltd (No 3) [2003] NSWSC 838, [16].

[19] National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675, 700; cited with approval in Codelfa, SDS Corporation Ltd v Pasdonnay Pty Ltd [2004] WASC 26, [354].

[20] See, e.g., Bangladesh Export Import Co Ltd v Sucden Kerry SA [1995] 2 Lloyd’s Rep 1, 5 (inability to import goods held not be a frustrating event where there was an obligation to obtain a licence to import and the contract provided that inability to obtain the licence was not a force majeure event). Compare Finch v Sayers [1976] 2 NSWLR 540 (provision for payment during illness did not deal with prolonged incapacity of employee). In the context of an allegation of frustration, see especially Scanlan’s New Neon Ltd v Toohey’s Ltd (1943) 67 CLR 169, 191-2 (Latham CJ).

[21] See, e.g., Chapman v Taylor [2004] NSWCA 456, [35] (building contract frustrated by builder falling into a coma, notwithstanding the provision for a ‘fair and reasonable extension of time’, because there was no indication whether the builder would regain capacity, if at all).

[22] In Victoria, see however s 35(1) of the Australian Consumer Law and Fair Trading Act 2012 (Vic) defining the circumstances in which Part 3.2 of that Act (dealing with frustrated contracts) will apply: that is, in circumstances including where parties are ‘discharged from the further performance of the contract because – (a) performance of the contract becomes impossible…’.

[23] See, e.g., Codelfa and Brisbane City Council.

[24] Re Continental C&G Rubber Co Pty Ltd (1919) 27 CLR 194, 201 (Knox CJ and Barton J, Gavan Duffy J concurring).

[25] Hirsch v Zinc Corporation Ltd (1917) 24 CLR 34. However, as to the prospect of restitution see Fibrosa Spolka Akcynja v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32; approved in Baltic Shipping Co v Dillon (1993) 176 CLR 344, 355 fn 55 (Mason CJ, Brennan and Toohey JJ agreeing) (and disapproving the prior decision in Re Continental C&G Rubber Co Pty Ltd (1919) 27 CLR 194 to the effect that ‘losses lie where they fall’), 375, 377, 379 (Deane and Dawson JJ), 385 (Gaudron J), 389 (McHugh J).

[26] Baltic Shipping Co v Dillon (1993) 176 CLR 344, 356 (Mason CJ).

[27] Codelfa, 364-5 (Mason J). As to the survival of arbitration clauses, see generally Ferris v Plaister (1994) 34 NSWLR 474; and Rizhao Steel Holding Group Co Ltd v Koolan Iron Ore Pty Ltd (2012) 287 ALR 315; [2012] WASCA 50, [165]-[166] (Murphy JA) (treating arbitration clauses as a separate contract from the main agreement).

[28] Frustrated Contracts Act 1978 (NSW).

[29] Frustrated Contracts Act 1988 (SA).

[30] Australian Consumer Law and Fair Trading Act 2012 (Vic), Part 3.2 (replacing the Frustrated Contracts Act 1959 (Vic)).

[31] Australian Consumer Law and Fair Trading Act 2012 (Vic), s 36(1).

[32] Ibid, s 38.

[33] City of Subiaco v Heytesbury Properties Pty Ltd [2001] WASCA 140.

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