The Coronavirus (COVID-19) is affecting many businesses’ ability to perform their contractual obligations. Some may be able to rely on a force majeure clause to relieve one or both parties from their obligations under the contract, without incurring liability for non-performance.
If, however, a force majeure clause does not cover an event such as a pandemic, or the contract does not include a force majeure clause at all, then a business may wish to consider the contract as being frustrated.
For more information of force majeure, please see our article on COVID-19 and Force Majeure.
What is frustration?
A contract is frustrated when an event occurs after formation which renders it, without fault of either contracting party, impossible to perform, illegal or transforms the obligations under the contract into something which is radically different from those intended by the parties.
If a contract is successfully found to be frustrated, then it is automatically terminated. Upon termination, the parties are no longer bound to fulfil their obligations and the non-performing party cannot be sued for damages for breach of contract.
What is the test for frustration?
For a party to successfully claim frustration, they must demonstrate:
- The frustrating event occurred after the contract had been formed;
- The event is so fundamental that it strikes at the root of the contract and goes beyond what was contemplated by the parties upon entering the contract;
- The event makes performance of the contractual obligations impossible or radically different; and
- The event is entirely beyond the parties’ control.
It is important to note that a contract will not be frustrated if performance merely becomes more onerous or more expensive to perform.
Whether an event is found to frustrate the contract is determined on a case by case basis. As such, careful interpretation of a contract is required in order to determine how specific events may affect a party’s ability to perform their obligations.
Whether Coronavirus will frustrate a contract depends on whether the virus renders performance of the contract impossible, illegal or radically different. The fact that the virus has affected the method of performance contemplated or increased the burden does not automatically amount to frustration.
How could Coronavirus frustrate a contract?
The Coronavirus has seen various political and non-political changes which may adversely affect a contract. The types of events that may frustrate a contract are: quarantine areas, travel bans, illness and death, and changes in legislation.
Types of frustrating events include:
- Change in the law: The Coronavirus has seen the government pass the Coronavirus Act 2020. This act gives the Secretary of State a variety of powers including but not limited to the suspension of relevant port operations and the issue of directions prohibiting the holding of events or gatherings.
- Illegality: If performance of a contract becomes illegal after formation but before the obligations are performed, the contract is found to be frustrated. This may be the case for some business’ following the introduction of new government decrees and legislation both in the UK and overseas.
- Cancellation of an expected event: The cancellation of an expected event may result in a contract being frustrated, but only in exceptional circumstances. The Coronavirus has seen many events being cancelled. This may have a knock on effect for business’ resulting in non-performance.
- Delay: Unexpected delay due to an unexpected event may frustrate a contract. However, in order to successfully claim a contract has been frustrated due to delay, the delay must be so abnormal that it falls outside of what the parties could have reasonably contemplated at formation.
- It is important to note that whilst delay is capable of frustrating a contract, it will not always do so.
- Death, illness and incapacity: This generally applies to contracts for personal services or employment contracts where a contract is to be performed by the original contracting party.
- When frustration is not available: Historically, the courts have been reluctant to rule a finding of frustration, especially if the relevant event is foreseeable. It is therefore important to note that any contracts entered into after the Coronavirus began to gain more media coverage may face difficulty in claiming frustration as a result.
Furthermore, if parties are not shown to have exhausted all options available to them to enable performance to take place, then it is highly unlikely that the courts will consider the contract as being frustrated.
The effects of frustration
Upon frustration, the contract is automatically brought to an end and the parties will be discharged from further performance of their contractual obligations. Some contracts may have express provisions for what happens if the contract is frustrated. If there are no express provisions, then the Law Reform (Frustrated Contracts) Act 1943 provides that a pre-payment or deposit is recoverable less any expenses incurred before termination for the purpose of performing the contract.
If a contract has been part-performed before termination and a party has obtained a valuable benefit (other than a payment of money), such as the building of an extension on a property, then there may be recoverable the sum of the value of that benefit.
Frustration is similar to force majeure, however, the test is stricter and the relevant event must result in performance being made impossible or radically different as opposed to making the obligations more difficult.
A business should carefully consider whether any of its contractual obligations are affected by Coronavirus and to what extent. It should consider:
- Whether the test criteria are met.
- Whether the contract was formed before or after the outbreak of Coronavirus.
- Whether the affected party took reasonable steps to mitigate the impact of the event on its performance.
- Whether there are any sums recoverable such as a pre-payment, deposit or monies recoverable for part-performance.