Does Covid 19 frustrate my contract?
Covid 19 has worldwide effects and it will affect millions of existing contracts, whether it is a supplier unable to obtain goods, factories no longer wanting the raw materials they ordered, hotels cancelling bookings, removal businesses unable to take furniture to a new house and hundreds of other situations. Will parties be required to carry on regardless, (or pay the penalty if they don’t), or will they be released from doing the impossible?
Many contracts have “force majeure” terms that come into play here.
What if there is no force major term or the wording does not cover this situation?
The law of “frustration of contract” may save of the day, (or deprive someone of a remedy, depending on your point of view).
Until now, frustration cases have been rare, usually concerning wartime or unusual one-off events. The classic textbook examples arise from the postponement of Edward VII’s coronation due to his illness.
It is likely that the universal effects of Covid 19 will result in many cases and/or government interventions and the law will develop fast. This article may need to be rewritten within weeks.
What are the landmarks now?
Frustration of a contract arises when something occurs outside the control of the parties, making it physically (sometimes commercially) impossible, or illegal, to fulfil the contract, or which transforms the obligation into something radically different.
The general rule is that if a defendant, is unable to meet his side of a contract then he will be liable to pay compensation to the claimant. This will change if the contract has been frustrated. Until now, the Courts have seen very wary of finding that a contract is frustrated; if it’s too easy it might open the floodgates and everyone will try to wriggle out of their responsibilities.
A few examples illustrate the point.
The case starting the principle concerned a contract to hire a music hall for a 4 day event. Shortly before then, the venue burned down. There was no fault on either side. The contract could not possibly go ahead. It was an implied term of the contract that it depended on the continued existence of the music hall. The hirer did not have to pay the fee. The owner was left to claim on his insurance. Whether that insurance included business interruption and loss of fees is not recorded. It is likely that a similar result will apply to the numerous events cancelled as the result of Covid 19. (Postponement may be different matter, depending on circumstances).
The “coronation cases” show contrasting results. In one, a one day hire by an individual of a flat overlooking the route of the coronation procession was frustrated. The fact that the procession was not taking place completely undermined the whole purpose of the deal. On the other hand, the commercial charter of a boat (to carry paying passengers to get a good view while the King inspected the assembled Fleet) was not frustrated. It was still possible for the boat to take the same trip and view the fleet, even if it was not sharing the event with His Majesty. There is debate over whether there is any real distinction between the cases. One argument is that the flat hire was by an individual, whereas the rate charter was by a business. If the boat case had been brought by someone who had paid for a ticket, rather than the business who chartered the boat, then the court may well have found that the contract was frustrated. It remains likely that courts will be more sympathetic to consumers than businesses in the Covid crisis.
Modern courts look at all the circumstances of the case at time when the contract was entered. It then asks whether the intervening event is fundamental, something that strikes at the root of the contract and is beyond the reasonable contemplation of either party at the time. Is there no fault of either side? Has performance been made impossible, illegal or radically different? Does the wording of the contract affect this?
If a force majeure term applies, then “frustration” is irrelevant. The wording of that term will be applied. However, if the event is outside the circumstances spelt out in the force majeure term then the court is likely to say that other events will not frustrate the contract.
If a contract has become illegal, then it will be frustrated. This applied, for example, to a contract entered in 1938 to import goods only available in Germany. Government action may make performance impossible, so the commandeering of a wheat crop in 1915 to support the war effort frustrated a contract to deliver that wheat to a buyer.
A mere change of economic circumstances, such as the 2008 financial crash, it will not be a “frustrating event”. The fact that a party could not get the finance to fulfil a contract because of the crash did not release him – even if it meant financial ruin. It is likely that a crash due to Covid will not be seen as a pure economic downturn. The courts will probably say that it is Covid that caused the contract to become impossible rather than economics. It may depend on the facts of each case.
The fact that a contract has become much more difficult to perform may not lead to frustration. For example, a contract where both parties envisaged that the Suez Canal would be used to ship goods from A to B was not frustrated by armed conflict during the Suez crisis, meaning that the ship had to go all the way round Africa. It was still possible to perform the contract.
In the context of Covid, these points may lead to numerous arguments, for example, over whether a delivery journey was “essential”. If it is not essential, then it may be illegal and therefore the contract frustrated. If it is essential, even though it may be more difficult, then the contract probably stands.
The nature of the contract is also important. Is it essential that it is performed by a particular person? A contract to deliver PEP may stand even if your driver is off sick: there is nothing stopping you from getting another driver to perform essential work. A contract requiring the attendance by a particular person, for example to do a TV broadcast on a particular day, may well be frustrated if that person is seriously ill.
The length of the contract may a factor. A one day hire of a flat was frustrated as seen above. On the other hand, a 2 year contract to make deliveries to a school was not frustrated by a ten day lock down due to influenza.
Frustration will not occur when the event was actually foreseen. Amazingly, an insurance company tried to say that its contract was frustrated when a ship was badly damaged by a storm at sea, because the storm was a “frustrating event”. The Court dismissed that argument; that was exactly the sort of event that the policy was intended to cover.
Equally, the courts will not allow frustration to cancel a contract where the parties should have foreseen the relevant events. One case involved a contract for an IT company to assist with the technical requirements for a group of franchised businesses to be amalgamated into one business with a single owner. It should have been obvious that the individual franchisees might not agree so the fact that they all refused did not frustrate the contract. The IT company could still install systems and was entitled to be paid.
These points will have important consequences for those with recent contracts, and those seeking to re-negotiate terms as a result of the corvid crisis. If both sides were fully aware of the likelihood of a major lockdown when they entered the contract it will be very difficult for one party to argue that the lockdown has frustrated the contract; the court will assume that each party had taken it into account and was willing to take the risk of being unable to fulfil its promise. As I have said in relation to force majeure terms, it remains to be seen how far back the courts will go. When the first reports started coming out of China, few were predicting such far reaching effects and major events, such as the Cheltenham Festival, were still going ahead several weeks later.
What is the effect of frustration?
The law used to say that the loss lies where it falls. This could lead to some very unfair results. For example, in an old case, an engineering company part way through the installation of machinery in a building had its contract frustrated when the whole building burnt down and the machinery with it. They were not entitled to anything, although the work was nearly complete, because the contract as drawn provided for payment only on completion. The loss lay where it fell.
In a sense, any frustrated contract will lead to an unfair loss for someone, because the “frustrating event” happens without the fault of either party; someone is inevitably going to miss out.
The Law Reform (Frustrated Contracts) Act 1943 attempted to do some justice. In theory, parties can predict where they might fall from the outset and have the chance to take out insurance if they choose to do so.
In brief the rules are as set out below, with each rule being subject to the later ones:
- Money paid before the frustrating event is repayable.
- Money payable before the frustrating event, but unpaid, is no longer payable.
- If a party has incurred expenses before the frustrating event then these can be deducted from money received before it is refunded, if the Court sees fit.
- If a party has acquired valuable benefit before frustration then the court may if it is “just” to do so require that party to pay a sum up to the value of that benefit.
- Whether or not a party has insurance covering any such loss is ignored, unless the taking out of such insurance was a condition of the contract.
The act does not apply to insurance contracts or to sales of specific perishable goods.
Would the “unfair” case mentioned above have had a different result after the Act? No money was paid or payable before the frustrating event, the fire which destroyed the building, so 1, 2 and 3 would not help. It would come down to whether the building owner had received any “valuable benefit” before it burned down. That, in turn, may depend on whether the contract was seen as “divisible”. A contract with stage payments for each completed part of the works, (typical in many construction contracts), would be divisible. However, this contract provided for payment only on completion and before that happened everything was destroyed by fire, so arguably the building owner did not receive any valuable benefit. It may also have been arguable that the machinery was “substantially complete” so the contractor was entitled to the whole of the price. However, “substantially complete” is treated narrowly. It would apply where the whole job is finished, except for any final snagging or testing, but not if the installation is unfinished, even if nearly complete. It may turn on whether a court would think this “just”.
Every contract is unique, made in its own circumstances and may be affected by Covid 19 in a multitude of ways. It is important to take legal advice on the consequences and effects to determine whether the contract is frustrated, can it be renegotiated and what payments can be secured. If you need advice on any such points, please contact us on 01752 203500.