Navigating the Unforeseen: How to Use the Frustration of Contract Clause to Exit a Contract Due to COVID-19

Due to the coronavirus/COVID-19 pandemic, many contracts could not be performed by both parties. In legal terms, This is referred to as frustration of contract, where a contract cannot be performed due to unforeseeable circumstances that render the obligations under the contract fundamentally different from how they originally were. While this fundamentally contradicts the idea of contracts, as contracts are entered to honour specific agreements between parties, In the case of COVID-19, previously agreed contract terms may simply be impossible to enforce.

By the end of this article, you will have a better understanding of the basic concepts of force majeure and frustration of contract, the relevance it has on agreements due to COVID-19, and the consequences of frustration.

Most importantly, we will also be discussing 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. 

A. Can I get out of a Contract because of Coronavirus/COVID-19?

Yes so long as the following conditions are fulfilled. 

If a force majeure clause has been included in the contract, the force majeure can simply be invoked. In the absence of a force majeure clause, the party will have to rely on the common law doctrine of frustration to void the contract. The use of force majeure clauses and the frustration of contracts (also known as “frustration of purpose” in the U.S.) is likely to be more important across all industries as COVID-19 is unlikely to go away soon. 

Due to lockdowns, social distancing restrictions and shutting businesses, entering and enforcing contracts is no longer straightforward. To make a contract void due to frustration, parties will have to introduce evidence showing that the unforeseen event (eg: the coronavirus outbreak) has fundamentally changed the contract - it cannot just be a matter of avoiding a bad business transaction.

B. What is a Force Majeure/Act of God clause?

The French term force majeure means “superior force”. It is a common clause in a commercial contract that stipulates the consequences of an extraordinary or unforeseen event beyond the control of the parties, such as events called “Acts of God”.

The clause is included 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 Act of God/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/Act of God clause?

A force majeure clause has the following characteristics:

1. Defines certain events as force majeure events or events beyond the reasonable control of a party. This can be a very general or non-exhaustive list detailing the instances of the relevant event covered by the clause (e.g. strike, lockout, other forms of industrial action, accidents, fires, explosion, failure of equipment or machinery, delays in transportation, 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 the 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 our customisable template here.  

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.

A few things should be taken into consideration: 

1. The clause should stipulate certain events that constitute force majeure, followed by its general and comprehensive application. If events such as “plague”, “pandemic”, “disease” and “quarantine” are included in the list, coronavirus is likely covered by the force majeure.
   
   
2. Even if these wordings are not explicitly stated, it is reasonable to argue that the coronavirus is beyond the reasonable control of the parties and would constitute a force majeure event. The affected party would 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 or prevented/ delayed from 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 hindrance 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 alongside 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 revoking and terminating? 

There is a subtle but key difference between revocation and termination. Revoking a contract means cancelling the contract and bringing the contracting parties back to the beginning as if the contract was never entered into. Terminating means bringing a contract to the end, however, a certain amount of compensation may 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.

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 the purpose of a contract refers to instances where after an agreement has been made, an event or situation occurs that the parties did not anticipate and is 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’?

A frustrated contract is one that becomes void. When a contract becomes void, the agreement is no longer legally binding or valid.

Frustration occurs where one party, as a result of the unexpected event, is unable to carry out their obligated duties, or where the contract becomes entirely different from what the parties intended it to be.

If this is the case, the agreement becomes void. However, under the common law, frustration cannot be used to avoid a bad business transaction, or in the case of foreseeable events.

For a Notice of Frustration of Contract to cancel/void of contract, please refer to our customisable template here. 

What are the Main Elements for the Frustration of Contract?

The frustration of a contract requires the occurrence of significant changes to contract rights/ obligations; the parties reasonably envisaged when entering into the contract cannot exist. The idea is that under these circumstances, it would be unfair to require both parties to perform their original contractual obligations. 

Three main requirements must be met for the contract to end and for the parties to be excused from 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 to the original agreement?
   
   
3. Was the fundamental change brought about by the fault of one of the parties?
   
   

Generally, if after the contract is entered, an unforeseen event beyond the control of either party occurs(such as COVID-19), which makes the performance of the contract either

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

then a party could invoke the frustration of the contract.

Illegality

One circumstance permitting frustration would be where it becomes illegal to carry out the activities previously legal from the agreement.

A clearer example to help you understand: If manufacturer A and distributor B entered a trading contract to distribute certain products, 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 

Frustration also occurs when it becomes impossible to carry out the agreement. Impossibility simply refers to the circumstances where the contract is no longer able to be performed. 

There is a famous English case (Taylor v Caldwell) involving a contract to hire a theatre for a musical. Before the musical could take place, a fire broke out and destroyed the theatre. Impossibility applies here - it became impossible to continue to perform the agreement. The contract is thereby frustrated accordingly due to the destruction of the subject matter.

Fundamentally Different 

This refers to the circumstance in which the agreement under the original contract is now made fundamentally different due to an 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 to view the coronation. However, the coronation was cancelled. The rental agreement was considered to be 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 events that constitute frustration include a delay in rendering the performance of the contract impossible and the death or incapacity of the parties.

You should note that courts are slow to find frustration outside of illegality and impossibility because the contract has to be radically different. This standard makes it especially difficult to prove the frustration of a contract. 

As such, the scope of application of this principle is limited to a few circumstances: 

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, in theory, apply to many contracts entered before the coronavirus pandemic hit. Here are some key reasons: 

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, it means most business activity would be shut down as well regardless of the parties’ intentions. 

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

In this particular example, two possible two grounds apply and 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, the contract would be frustrated.

Example of when frustration cannot arise despite the coronavirus pandemic

While the coronavirus pandemic inevitably brings a lot of stress on performing parties, frustration may not always apply. This is the case in situations where there is no fundamental change to the performance of the contract.

Let’s take our previous example where party X contracts with party Y to manufacture goods in party Y’s city. Now let’s alter the circumstances a little - let’s say there is only a minor outbreak in party Y’s city, and the government does not impose a shutdown of businesses/factories.

If due to an abundance of caution, Party Y shuts down the factory, this cannot constitute frustration as it is a self-induced shutdown. The frustration of a contract only occurs when an event happens outside the control of the parties.

In this scenario, Party Y could perform the contract, but instead, decided to shut down the factory despite any legal restraints or requirements. 

D. Entering a contract during the COVID-19 pandemic

If parties are to make an agreement with knowledge of the pandemic and fail to include anything in their contract that protects themselves from the impact of COVID-19, parties must bear the risks themselves.

If the contract is negotiated and concluded during the coronavirus pandemic, it cannot fall into the category of unforeseeable events. Importantly, frustration wouldn’t be applicable in this situation, as the frustrating event is not only foreseeable but highly likely. 

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 legal disputes, the first port of call is always to include a force majeure clause in a contract. The wording is important, as it is crucial to determining whether or not the clause will take effect.

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

Should there be no force majeure clause, it may be possible to rely on the frustration of the 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. For COVID-19, the court will take into consideration the restrictions involved and how long the contracting parties will be affected by the coronavirus.

Please note that this is just a general summary of 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.