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29 April 2020

Frustration under English law – Key issues in a global pandemic

The extraordinary circumstances that Covid-19 has forced us to adapt to are demonstrated by the fact that we are routinely looking at an area of law which has developed, primarily, as a result of world changing events such as wartime shortages, the first Gulf War and the global financial crisis of 2008.

How does Frustration operate?
  1. Frustration discharges both parties from all of their future obligations pursuant to the contract.
  2. It operates automatically. It requires no positive act by either party.
  3. It requires there to have been an “outside event or extraneous change of situation” which has arisen without blame of the person seeking to rely on it.
  4. The key is whether the situation makes the obligation pursuant to the contract impossible to perform, not simply more difficult, or even financially catastrophic for one of the parties. 
  5. The circumstances that you must find yourself in have to be “radically different” from when the contract was concluded.
  6. The test has a high bar and requires you to prove that the contractual obligations have changed beyond what could have reasonably been anticipated at the time the contract was entered into. 
Key Points
  1. If the contract sets out what should happen in circumstances where there is a pandemic, a claim for frustration is likely to fail. The reason for this is that you are unlikely to get over the hurdle of finding yourself in a “radically changed” situation if such a circumstance (however unlikely) was considered at the drafting stage.
  2. The contract may provide an obligation for one party to insure against the risk. If so, the risk is likely to be deemed as having been assumed and again, frustration is likely to fail.
  3. Were the circumstances unforeseen and unforeseeable? This might be questionable where the contract has been entered into this year for example, after the outbreak of Covid-19 was announced. The courts have not yet considered the concept of whether, once announced, the spread was a likelihood and therefore foreseeable. Arguably, whilst a spread of the virus might have been likely, the magnitude of the interference and the damage that Covid-19 has caused could not have been foreseeable by anyone.
What contracts are most likely affected?
  1. Goods not being delivered.
  2. Services unable to be provided.
  3. Cancellation of events.

The key is that the performance of the contract becomes impossible. Note however that if the contract could be performed in a different manner, a claim for frustration is likely to fail.

Is the impossibility to perform temporary?

We can say with certainty that lockdown is temporary. That said, the duration of lockdown is uncertain as is whether its lifting will be phased and the likely incremental improvement of the economy.

Impossibility to perform will bite where you are looking at specific events which have had to be cancelled. The delay, however, isn’t always a “frustrating event” and if a part of a contract can be performed, then this must be considered. The key is whether it is proportionate to do so.

Illegality – is it illegal to perform it?

A prohibition which effects the main purpose of the contract is likely to be frustrated. The prohibition must however effect the means of performance for a claim for Frustration to be successful. If it can be carried out in a different manner, frustration will fail. It is also necessary to look at whether part of the contract survives, i.e. is it severable and still capable of performance? The extent of the effect of any illegality might be that any surviving clauses constitute a “radical change”. If so, the contract may be frustrated despite the possibility of the clauses being capable of severance.

Issues of public policy will also arise in circumstances where performance wouldn’t necessarily be illegal, but performance would not be in the interest of public policy because of the current restrictions.

What about if performance is now totally pointless?

There will be many contracts where parties have contracted to pay for goods or services for which they now have no use whatsoever. Arguably, the purpose of the contract has therefore been frustrated. Such an argument has rarely succeeded but the current circumstances may well see new cases on this point.

For example, Company A contracts to buy a new piece of machinery. Company A now has no need for that machinery. All of Company A’s factories are closed, all profits are now non-existent and the finance that Company A anticipated to obtain is no longer available. 

Performance of the contract is still possible. The fact that Company A now has no need for the machinery or the fact that it cannot obtain finance because of its lack of profits, is immaterial.

Conclusion

Covid-19 will undoubtedly result in an increase of frustration cases. Some will be clear cut such as the cancellation of events and supply contracts where time is of the essence. Where the situation is less clear, Covid-19 has demonstrated the importance of express contractual terms regarding force majeure and the allocation of risk to the parties. A cleverly drafted force majeure clause can allow for the suspension of obligations during temporary frustrating events, thus avoiding the potentially catastrophic consequences of frustration. In the absence of such a clause, the key will be whether any delay is sufficient to constitute the radical and fundamental change that frustration requires. 

A review of the scope of frustration of purpose also seems inevitable if we are to avoid a multitude of contracts being performed entirely unnecessarily, as a result of the commercial and economic consequences that Covid-19 has forced us to endure.

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