Commercial Contracts: The Covid-19 Frustrater
Covid-19 is undoubtedly the biggest practical and financial challenge facing today’s businesses in living memory. It has also meant innumerable businesses have found themselves unable to comply with their contractual obligations as a direct result of the pandemic; and if they have not yet been in that position – they may well do in the coming months.
The question is, what happens next?
Where a business cannot fulfil its contractual obligations, the parties will need to try to reach a mutually agreeable compromise. Failing that, litigation may become necessary. The basis of any litigation will depend on the nature of the dispute and the contract terms, and it’s probably not an exaggeration to suggest that we can expect plenty of covid-19 related commercial disputes reaching the courts in the coming year.
The legal principles that are most likely to feature are force majeure and frustration.
Force majeure: if a business cannot fulfil its contractual terms, it might be able to rely on the existence of a pandemic as its ‘get out card’. However, as we explained in our earlier article, the ability to rely on force majeure will depend on factors such as the wording of the contract and whether the pandemic situation completely prevented performance of the obligations.
Frustration: a party defaulting on its contractual obligations might be able to rely on the common law doctrine of frustration. This is a stricter test than in the case of force majeure; and it is not about fault or intended breach on the part of one or more parties but about impossibility (or, in some cases, illegality).
Frustration arises where there has been a change in circumstances after the formation of the contract which prevents a party physically or commercially performing its contractual obligations; or its performance will be significantly different to the intended performance. However, if it is still possible to perform the contract but, for example, it will be more costly or onerous to do so, the party might not be able to rely on frustration.
Whether or not a contract has been frustrated as a matter of fact depends on the particular contract. To successfully rely on frustration, case law demonstrates that the party must prove on balance that:
The frustrating event (the pandemic in this case) arose after the formation of the contract. So if the contract was formed in March 2020 and it quickly became apparent you could not actual perform the contract, you might not be able to rely on the doctrine of frustration. However, a change in the law (the Coronavirus Act) could amount to a frustrating event – though it could be argued that was not beyond the parties’ contemplation at the time the contract was formed (see 2, below); The event is so fundamental that it goes to the very essence, the root of the contract and was beyond the parties’ contemplation at the time they concluded the contract; The frustrating event makes performance of the contractual obligations impossible or radically different; and The frustrating event is completely beyond the control of the parties.
If a party is successful in relying on frustration in light of the contract terms and the effects of covid-19 on those terms, they can then be discharged from the contract. The contract itself is then ended.
Note that some contracts will provide expressly for what happens if a contract is frustrated, but it is important also to check if the contract is governed by the laws in another jurisdiction as the position may be different.
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