COVID-19 and Frustration of Contracts

The impact that COVID-19 will have on the Australian and global economy is becoming more apparent, with supply chains and other commercial arrangements being placed under increasing strain. Notably, Australia’s response to COVID-19 may enliven contractual force majeure provisions, which refer to the exercise of Government powers, or the doctrine of frustration. If you wish to read our guidance in relation to force majeure provisions, please click here.

If a contract does not include a force majeure clause that has been triggered by circumstances arising from COVID-19, a party may be able to look to the doctrine of frustration to determine if the contract may be terminated for frustration.

What is frustration? 

• Frustration is a common law concept and generally occurs when circumstances have arisen, through no fault of either party, which either result in the obligations under the contract becoming incapable of being performed or renders the obligations radically different from those contemplated by the parties at the time of contracting.
• For frustration to occur, the following criteria need to be satisfied[1];
  • The frustration event causes the contractual obligation owed by a party under the contract to become impossible to perform or radically different from the obligation contemplated at the time that the parties entered into the contract;
  • The frustration event was not caused by either party; and
  • The contract does not otherwise deal with what will happen on the occurrence of the alleged frustration event.

Is COVID -19 a frustration event?

• Not necessarily.  This will require analysis of the relevant contractual obligation and whether the obligation originally contemplated is rendered impossible to perform, illegal or radically differentt due to events associated with COVID -19.
• Performance of the contract must be impossible, as opposed to ‘merely difficult’[2]. For example, if the coronavirus pandemic makes the performance of a contractual obligation more costly, this is unlikely to be sufficient to frustrate the contract.
• Any change which is considered temporary, transient or foreseeable would not usually constitute a frustrating event. By way of illustration, it was held that a tenancy agreement was not frustrated where the premises was subject to an isolation order due to the outbreak of Severe Acute Respiratory Syndrome (SARS)[3].  On the other hand, even a temporary change may constitute frustration if performance was to occur at a given time and time of performance was an essential condition of the contract.
• However, the Government’s response, through state-wide shutdowns, gathering restrictions and isolation orders, may render performance of certain contracts impossible or illegal. In such circumstances it may well be the case that the contract is frustrated.

What is the legal effect of frustration of a contract?

• A contract which is taken to be frustrated will be terminated automatically at the time the frustrating event occurs and outstanding obligations will be discharged.
• Parties should carefully consider the effect of claiming that a contract has been frustrated since, if a party takes the view that a frustrating event has occurred which is later determined to be incorrect, the mistaken party may have repudiated the contract and be liable for damages.
• Additionally, a frustrated contract is terminated, rather than suspended. Parties should consider this effect, especially if the contract is long-term or advantageous to the party claiming frustration.

What about prior payments made under a subsequently frustrated contract?

• Under common law, the general position is that ‘losses lie where they fall’, meaning amounts paid prior to frustration will not be recoverable.
• A party may make a claim in restitution to recover the reasonable value of partial performance if it would be unjust to allow the receiving party to retain the benefit of that performance.
• As the common law position is considered relatively harsh, Victoria[4], New South Wales[5] and South Australia[6] have legislated to provide for ‘fair adjustment’ where a contract is frustrated.

Conclusion

COVID – 19’s global disruption is uncertain, with continual business implications arising every day. Businesses should carefully consider their current contractual arrangements before performing or refusing to perform a contract.

References

[1] Davis Contractors Ltd v Fareham Urban District Council [1956] UKHL 3

[2] Nicholas Dennys and Robert Clay, Hudson’s Building and Engineering Contracts 13th Edition, page 69 at 1-072

[3] Li Ching Wing v. Xuan Yi Xiong [2003] HKDC 54 (Hong Kong)

[4] Australian Consumer Law and Fair Trading Act 2012 (Vic)

[5] Frustrated Contracts Act 1978 (NSW)

[6] Frustrated Contracts Act 1988 (SA)

Nicholson Ryan delivers expert advice across all areas of corporate and commercial law and is assisting clients on a broad spectrum of legal issues in relation to COVID – 19. If you have any queries as to the matters addressed in this article, please contact us at (03) 9640 0400 or email us at admin@nrlawyers.com.au

This memorandum is intended as general information only. It does not purport to be comprehensive legal advice. Readers must seek professional advice before acting in relation to the aforementioned matters.