Frustration of a Contract Arising from the Coronavirus Pandemic

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Date Created: 23 Jul 2020
Last Update: 23 Aug 2020

A. Introduction

 

A contract is made to honour specific agreements between parties. However, when the previously agreed terms, for an unexpected reason (such as the Coronavirus / Covid-19 pandemic), can no longer be carried out, the contract becomes different to what it was when the agreement was first made.

 

Under contract law, force majeure may be invoked if a force majeure clause has been included as part of the contract. In the absence of such contractual provision, the party will have to rely on the common law doctrine of frustration to void the contract. 

 

The invoking of force majeure clause and frustration of contract under common law (also known as “frustration of purpose” in the U.S.) would now, more than ever be prevalent in all industries with the unprecedented arrival of Covid-19.

 

Due to lockdowns, social distancing restrictions and shut down of businesses, what was once an easy contractual transaction becomes a challenge. Hence, parties of a contract that is no longer able to be performed because of an unexpected event.

 

In this article, you will be able to understand the basic concept of force majeure and frustration of contract, the relevance it has on agreements due to the coronavirus crisis and the effect of applying frustration.

 

Most importantly, this article will discuss the success rate of applying these concepts in contract law and whether the pandemic is a good enough reason to invoke the force majeure clause or the common law of frustration.

 

Frustration of a Contract Arising from the Coronavirus Pandemic

 

B. Force Majeure

 

What is Force Majeure?

 

The term force majeure is taken from French meaning “superior force”. It is a common clause in a commercial contract to stipulate the consequences of an extraordinary or unforeseen event beyond the control of the parties, such as the event described as “Acts of God”.

 

The clause is intended to suspend the performance of the contract during the force majeure period, and in case of an extended force majeure event, free the responsibilities of the parties from their contractual obligations.

 

The force majeure clause helps allocate risks when unforeseen events adversely affect the ability of one or both parties to perform their contractual obligations on time or in full.

 

What are the Characteristics of a Force Majeure clause?

 

A Force majeure clause typically has the following characteristics:

  1. Defines certain events as force majeure events or events beyond the reasonable control of a party, it can be very general or include a non-exhaustive list detailing the instances of events covered by the clause (e.g. strike, lockout, other forms of industrial action, accidents, fires, explosion, failure of equipment or machinery, delays in transportations, war, civil commotions, riots, sabotage, epidemic, applicable legislation and regulations thereunder, interruptions by the government);

  2. Provides that a party can be exempt from fulfilling its contractual obligations when such force majeure event occurs;

  3. Notification by the affected party is required to the other party In the event of force majeure;

  4. Specifies the consequences of force majeure events, such as suspension, an extension of time for performance of obligations or termination of the contract after a period of time.

For examples of force majeure clauses, please refer to:

General Boilerplate Clause / Term Force Majeure
https://docpro.com/doc1647/general-boilerplate-clause-term-force-majeure

 

Is Coronavirus (COVID-19) a Force Majeure event?

 

There is no general concept of force majeure in English law. Therefore, any claim for force majeure must be based on the terms of the contract. Whether coronavirus constitutes force majeure depends on the wording of the clause itself and the interpretation of the terms by the court.

 

Generally, the affected party citing this clause generally must show:

  1. The clause should stipulate certain events that constitute force majeure, followed by a general and comprehensive application. If events such as “plague”, “pandemic”, “disease” and “quarantine” are clearly included in the list, then it is likely that coronavirus is covered by the force majeure

  2. Even if these wordings are not explicitly stated, arguably the coronavirus is beyond the reasonable control of the parties and would constitute a force majeure event if the clause is drafted in sufficiently general terms. The affected party will need to take extra caution in relying on "all other causes beyond reasonable control" since coronavirus must be similar in nature to the specific events listed in the article (ejusdem generis principle).

  3. The affected party is unable, prevented, or delayed in performing the contract because of the coronavirus. Whether there are related events will depend on the facts. The key is that there must be a causal relationship between the coronavirus and the prevention or hinderance of performance.
  4. The affected party fails to perform its obligations due to circumstances beyond its reasonable control. The affected party is required to prove that if coronavirus had not happened, it could have performed the contract.

  5. The affected party cannot take any reasonable steps to avoid or mitigate the incident or its consequences. Generally speaking, it is not enough to show that the incident has caused a delay. If the affected party can take reasonable steps to mitigate the impact of the event, such as fulfilling its obligations through another performance method, then these steps should be taken.

  6. The requirement of notifying the other party, including the time of the notification and the information, has been strictly complied with. The affected party might need to provide evidence with the notification. The court requires strict implementation of any requirements under the clause, otherwise, the notice will be invalid.

 

What are the Consequences of Force Majeure?

 

General force majeure clauses should stipulate the specific effect of force majeure, that is, the right to (i) postpone / suspend the performance of, (ii) claim an extension of time for performance of; or (iii) revoke / terminate the contract caused by force majeure.  

 

What is the difference between revoke and terminate?

 

There is a subtle but important difference between revocation and termination. To revoke a contract means to cancel the contract and bring the parties back to the beginning as if the contract was never entered into. To terminate means bringing a contract to the end, and certain compensation might need to be paid for the early termination.

 

If this clause does not provide for the right of revocation, even if effective force majeure occurs, the right of termination stipulated in this clause will not arise. The party seeking to get out of the contract will have to resort to the principle of frustration to avoid compensation for breach of contract.

 

Frustration of a Contract Arising from the Coronavirus Pandemic

 

C. The frustration of Contract / Frustration of Purpose

 

What is the Frustration of Contract / Frustration of Purpose?

 

If there is no force majeure clause in the contract, the common law principle of frustration should be considered. The frustration of purpose of a contract refers to where after an agreement had been made, an event or situation occurs that the parties did not anticipate and beyond their control, leading to the performance of the contract becoming practically or legally impossible.

 

Most importantly, there must be no fault of any party when this frustrating situation arises for the contract to be successfully frustrated. Frustration tends to be narrower in scope than contractual force majeure.

 

What does it mean for a Contract to be ‘Frustrated’?

 

Essentially, this refers to when a contract becomes void. When a contract becomes void, the agreement is no longer legally binding and is no longer valid.

 

This becomes a consequence because one party, as a result of the unexpected event, cannot carry out their obligated duties anymore, or the contract becomes entirely different from that which the parties intended to be.

 

If this is the case, the agreement becomes void. However, common law makes it clear that frustration cannot be used only to avoid a bad business transaction, or that the parties have foreseen relevant events.

 

For a Notice of Frustration of Contract to cancel / voiding of contract, please refer to:
https://docpro.com/doc1651/notice-of-frustration-of-contract-cancel-voiding-of-contract

 

What are the Main Elements for the Frustration of Contract?

 

The test of frustration requires the occurrence of significant changes to contract rights/ obligations, rather than the situation that the parties reasonably envisaged when entering into the contract. Therefore, it is unfair to require both parties to perform their original contractual obligations under the new change of circumstances.

 

Three main elements must be fulfilled for the contract to end and for the parties to be excused of all further performance.

  1. Has a particular event been foreseen by the party and allocated risks accordingly under the contract?
  2. Has the event resulted in a fundamental change of the original agreement?
  3. Was the fundamental change brought about by the fault of one of the parties?

Generally, if after the contract is made, an unforeseen event occurs that was beyond the control of either party, like the coronavirus, which makes the further performance of the contract;

  1. Illegal
  2. Impossible
  3. Fundamentally Different from the Original Underlying Purpose

then a party could invoke the frustration of contract.

Illegality

One requirement of frustration would be if it becomes illegal to carry out the activities previously legal from the agreement.

 

Example: If manufacturer A and distributor B entered into a trading contract to distribute certain products, and then a trade sanction is imposed by B’s country on goods imported from A’s country. The trading contract thus becomes illegal under the laws of B’s country and hence would be frustrated accordingly.

Impossibility

If it becomes impossible to carry out the agreement, frustration occurs. This means if the point of the contract is no longer able to be performed, it becomes an impossibility.

 

For example, there was a famous English case (Taylor v Caldwell) where there was a contract to hire a theatre for a musical. However, before the musical could take place, a fire broke out and destroyed the theatre. Thus, it becomes impossible to continue to perform under the agreement. The contract is thereby frustrated accordingly due to the destruction of the subject matter.

Fundamentally Different

This requirement to be fulfilled under the original contract agreed by both parties is now fundamentally different due to the unforeseen event.

 

On the grounds of fairness, the contract would be set aside (void) because the contract has become completely different from the original intended purpose.

 

Another famous English case (Krell v Henry) involves a contract to rent a room that overlooked a coronation for the purpose of viewing the coronation. However, the coronation was cancelled. Thus the rental agreement is frustrated because the underlying condition that was essential to the performance of the contract, i.e. to view the coronation, ceases to exist.

 

Other Examples of Frustration

 

Other examples of frustration events include delay rendering the performance of the contract impossible; and the death or incapacity of the parties.

 

However, courts are slow to find frustration outside of illegality and impossibility because the contract would need to be radically different. This makes it difficult to prove the frustration of a contract due to it being fundamentally different.

 

As such, the scope of application of this principle is very limited:

  1. If there is a force majeure clause in the contract, the contract will not be invalidated;
  2. It is not enough just because the performance of the contract is inconvenient or the performance of the contract becomes more difficult to obstruct performance;
  3. The performance cannot be performed due to the fault of any party.


Is Coronavirus (COVID-19) a Frustration event?

In the absence of a force majeure clause, frustration should apply to many contracts made before the coronavirus pandemic. Looking at the 3 elements:

  1. one would not have foreseen the coming of and the shutdowns caused by the coronavirus, which is a once in a lifetime event;
  2. the coronavirus is likely to result in a fundamental change to the performance of obligations under the contract due to the impact on everyday life; and
  3. the coronavirus was not due to the fault of either party.

For example, with coronavirus leading to multiple shutdowns of cities and businesses as ordered by the government, then that means most business activity would then be shut down as well.

 

Take manufacturing, for instance, where party X had a contract with party Y to manufacture goods in party Y’s city. However, if there was a major outbreak in party Y’s city that lead to a complete shutdown of the city by Y’s government, this would mean factories would need to close down as well.

 

In this example, there may be two grounds to call for the frustration of the manufacturing contract:

  1. Illegality - it is illegal for the factory to be running due to the government lockdown, and the contract cannot be legally performed due to government rules.

  2. Impossibility - it becomes an impossibility to perform the contract because the factory (and its workers and suppliers) would need to be closed for the foreseeable future, making it impossible for goods to be supplied/manufactured.

Therefore, if the main point of the contract was for party Y to manufacture and supply goods from their city for party X, then the contract would be frustrated.

 

Example of when frustration cannot arise despite the coronavirus pandemic

However, although the coronavirus pandemic would’ve brought contract stress to either performing parties, frustration does not always apply in certain situations where there is no fundamental change to the performance of the contract.

 

Using our previous example where party X had a contract with party Y to manufacture goods in party Y’s city, except in this case, there was a minor outbreak in party Y’s city, and the government did not impose a shutdown of businesses/factories.

 

If due to the abundance of caution, Party Y shuts down the factory anyway, it would unlikely to constitute frustration, since it is a self-induced shutdown. The frustration of contract only occurs when an event happens outside the control of the parties.

 

Party Y had the capability to perform the contract, but instead, decided to shut down the factory without being legally required to do so.

 

Frustration of a Contract Arising from the Coronavirus Pandemic

 


D. Making a Contract During the Pandemic

 

Although, if two parties were to make an agreement whilst the pandemic was brought to light, and still did not include anything in their contract that protects themselves from an instance where coronavirus hinders the possibility of not being able to perform the contract, the parties will bear the risks themselves.

 

If the contract is negotiated and concluded during the coronavirus pandemic, then it cannot fall into the category of unforeseeable. Then, frustration wouldn’t be applicable in this situation if there was foreseeability of a frustrating event.

 

Could Contract Stress Have Been Avoided During the Drafting Process?

 

It would be helpful to specifically include or exclude coronavirus from the list of events in the force majeure clause to show the parties’ intention on whether it should be included as a force majeure event.

 

This makes it easier to deal with contract stress when unexpected events occur because the contract would’ve already covered the consequences.

 

For example: if it was very clearly stated in the force majeure clause that under a pandemic crisis, the contract would be void (ended), then that is exactly what would happen in light of the situation.

 

Courts are reluctant to read the wording of the clause to cover frustration unless the wording is sufficiently clear to cover a pandemic.

 

E. Conclusion

 

To avoid potential legal dispute, the first port of call is always to include a force majeure clause in a contract. The wording is crucial in determining whether or not the clause will take effect.

 

A well-drafted force majeure clause will clearly define the events covered under the clause and show the intention of the parties on whether events like Covid-19 will be covered.

 

Should there be no force majeure clause, it is possible to rely on the frustration of contract to invalidate contracts affected by the coronavirus pandemic due to impossibility or illegality. However, as discussed in this article, the scope under the common law of frustration is generally narrower than that of a force majeure clause.

 

The success of pleading frustration will be dependent on the individual circumstances of the parties involved. The court will take into consideration the restrictions involved and how long the parties will be affected by the coronavirus.

 

Please note that this is just a general summary about the frustration of a contract under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your local legal advisor. 

Keywords:

Frustration, Contract Stress, Contract Help, Frustration Of Contract, Frustration Of Purpose

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