Force majeure and frustration in a coronavirus context

Force majeure and frustration in a coronavirus context

Force majeure and frustration in a coronavirus context

Many contracting parties have found themselves unable to meet their contractual commitments due to the impact of COVID-19. The coronavirus can compromise the ability of service providers and suppliers to deliver on time or at all, whilst many customers have found themselves unable or unwilling to accept delivery. The inability to perform may be attributable to illness, preventative isolation or government restrictions.

Force Majeure

Contracting parties have traditionally felt more secure if their trade agreements include a “force majeure” clause, exempting a party from the obligation to complete the agreement in circumstances where an unexpected disaster, natural or man-made, renders performance by that party impossible.

The term “force majeure” is derived from the Napoleonic Civil Code and is not fully recognised by our courts. It is essentially a contractual remedy, not a common law remedy. For this reason, it is common for force majeure clauses to list the various events which will give rise to the operation of the relief in the context of the transaction in question, as a court may be unwilling to imply any meaning to the expression.[1]

Force majeure events generally listed in a contract include acts of God, strikes, wars, embargos and supervening legislation. The list tends to broaden in response to current events.  Over the years, “internet failure” and “acts of terrorism” have become common inclusions.  “Earthquakes”, “floods” and “fires” are often listed, although it is generally assumed (rightly or wrongly[2]) that these will be embraced by “acts of God”.

The Severe Acute Respiratory Syndrome (SARS) virus of 2003 caused many template definitions to be updated to include “epidemics” and, for the far-sighted, “pandemics”. This leads us to a consideration of the relevance of a force majeure clause in a coronavirus situation.

As stated above, force majeure is, in Australia, a contractual remedy, not a common law remedy.  The effect of an event falling within the category of “force majeure” is dependent upon what the contract says will happen in those circumstances.  The contract will probably say that performance is excused, and it will likely say that if the event continues to prevent performance for a specific period of time – say, 30 days – either party can terminate.

It is most important for parties to closely analyse the wording of the contract in a number of respects.

Does the definition of “force majeure” make specific reference to epidemics or pandemics?  If not, is it of a similar nature to other events listed (known as the ejusdem generis rule)?  Does the wording of the contract excuse performance altogether, or merely suspend a party’s obligations?  Do either or both parties have a right of termination if the non-performance continues? 

More subtly, does the contract say that an activity must be directly prevented by the impact of force majeure, or that an activity must be hindered by the existence of a force majeure event?  In the former case, consider whether a business which is unaffected directly by the virus, but which chooses to suspend operations out of concern for its employees, is in fact “directly prevented” from completing the contract – arguably, it was not impossible to perform the contract.

Frustration

There is a clear overlap between force majeure clauses and the common law doctrine of frustration. The doctrine of frustration allows for the automatic termination of a contract if an event, beyond the control of the contracting parties, occurs after a contract has been made and affects the performance of contractual obligations. The critical issue to be determined by a court is whether the situation resulting from the event is fundamentally or radically different from the situation contemplated by the parties at the time the contract was made.[3] This involves considering the terms of the contract and the circumstances of the particular case.

At common law, the threshold for establishing frustration is high. This is evident from the circumstances of cases that have invoked the doctrine of frustration, such as state intervention;[4] compulsory acquisition; destruction of physical subject matter; death or incapacitation; non-occurrence of expected events[5] and war.

There are numerous factors of varying weight to consider when determining frustration.[6] The mere existence of hardship and impossibility to perform a contract does not necessarily establish frustration. Hardship may invoke a duty to renegotiate the terms of the contract pursuant to the implied duty of good faith prior to frustration. Performance does not need to be literally impossible to frustrate a contract, it can be commercially impracticable.[7] Even if it is literally impossible, the contract may not be frustrated if the promisor assumed the risk of the event in question.

For the doctrine of frustration to be invoked, the subject matter of the contract must be identified with precision by the terms and the subject matter must be incapable of supply.

One practical distinction between the effect of a contractual force majeure provision and the common law doctrine of frustration is that frustration will automatically terminate the contract, whereas force majeure clauses generally involve a staged approach to dealing with the adverse event.

The harshness of the common law in this regard has been modified in some jurisdictions – New South Wales, Victoria and South Australia have enacted legislation that allows the court to adjust the position of the parties to prevent unfairness that could arise under common law where the traditional approach is “losses lie where they fall”. The legislation provides that money paid under a frustrated contract can be recovered;[8] and that partial performance is compensable.[9] Those seeking to rely on the legislation need to consider whether it applies to their contract as the legislation excludes certain contracts, such as contracts for the carriage of goods by sea.[10]

Against this background, it is appropriate to consider whether COVID-19 is or may be a frustrating event.

COVID-19 may frustrate a contract where a supplier fails to deliver or perform due to government shutdowns as these circumstances are clearly beyond its control. It would be important to establish no other commercially practicable opportunity was available to supply the goods, as was the case in Cornish & Co v Kanematsu (1913) 13 SR (NSW) 83. It would also be important to establish that the aspect of non-performance was significant in the context of the agreement as a whole.[11]  An attempt to renegotiate the terms may also be relevant. If a contract was entered into post COVID-19, it may prevent the frustration of the contract on those grounds as the existence of the virus was a factor the parties would have contemplated/accepted when entering the contract.

Interaction between force majeure and frustration

Because the doctrine of frustration will not be activated if the contract expressly deals with the frustrating event, the common law doctrine is often precluded by the existence of a force majeure clause.  In one sense, this is not a huge risk, because it will generally be easier to interpret and enforce a force majeure clause, by virtue of its contractual nature, than to establish a cause of action in frustration.  Frustration nevertheless remains a helpful “back-up” argument for a party which is prevented from performance due to a pandemic, but which lacks the protection of a force majeure clause. 

[1] A court may, on the other hand, interpret individual words used in the contractual definition of “force majeure”, such as Boast v Firth [1868-69] L.R. 4 C.P. 1 in which the court considered whether an illness could be an Act of God.

[2] The threshold for an event being classified at common law as an “Act of God” is likely to be higher than if the specific event, such as a flood or fire or epidemic, had been separately listed: see, e.g. Nugent v Smith [1876] 1 C.P.D. 423.

[3] Codelfa Construction Pty Ltd v State Rail Authority (NSW) (1982) 41 ALR 367.

[4] In Codelfa Construction Pty Ltd v State Rail Authority (NSW) (1982) 41 ALR 367 a court injunction was granted that reduced work hours to perform obligations for a contract relating to excavating tunnels for a railway line.

[5] In Cornish & Co v Kanematsu (1913) 13 SR (NSW) 83 the contract for onions to be shipped by P&O steamer was frustrated because the P&O steamer failed to sail as the result of a strike and no other opportunity of shipping direct to Sydney existed.

[6] Brisbane City Council v Group Projects Pty Ltd (1979) 145 CLR 143, 164.

[7] See, for example, Codelfa where the injunctions meant more time and expense were required to perform the contractual obligations, not that it was impossible.

[8] Australian Consumer Law and Fair Trading Act 2012 (VIC) s 37; Frustrated Contracts Act 1978 (NSW) s 12.

[9] Australian Consumer Law and Fair Trading Act 2012 (VIC) s 38; Frustrated Contracts Act 1978 (NSW) s 11; Frustrated Contracts Act 1988 (SA) s 7.

[10] Australian Consumer Law and Fair Trading Act 2012 (VIC) s 35(3); Frustrated Contracts Act 1978 (NSW) s 6; Frustrated Contracts Act 1988 (SA) s 4(2).

[11] See Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754, a Hong Kong case dealing with the impact of SARS on a leasehold.