Second Wave of COVID-19 – Terminator 2, Judgement Day?
In this second instalment of our series of COVID-19 contract termination articles, we explore the Doctrine of Frustration and how a business may be able to terminate a contract.
The effects of the COVID-19 pandemic and the first Government interventions to control the spread of the pandemic were expected to be a short and swift shutdown of businesses across Australia. However, it’s now become clear from recent Government interventions, such as the closure of Queensland’s border and extension of the declaration of a State of Emergency in Victoria, that the effects of COVID-19 may no longer be temporary, and businesses may become unable to perform their contractual obligations.
- COVID-19 and Government interventions will affect different contracts in different ways (if impacted at all) and may affect the ability of a business to perform its contractual obligations;
- A business suffering more than a temporary inability to perform its contractual obligations because of COVID-19 and Government interventions, may be able to bring their contract to an end;
- A business may seek to rely on force majeure clauses in its contract for relief from performance of its contractual obligations (see our recent article, in which we discuss the avenue available for a business seeking relief from temporary performance of their contractual obligations or termination of a contract due to COVID-19, through the operation of force majeure clauses); and
- A business may be able to bring their contract to an end through the Doctrine of Frustration, if it can be demonstrated that COVID-19 or Government intervention has rendered performance of the contract radically different to that originally contemplated by the business.
What is the Doctrine of Frustration?
Unlike force majeure, frustration is a concept recognised by Common Law, is difficult to establish, and has a narrow scope. Frustration operates to bring a contract to an end in circumstances where, without default of either business, a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render the contract radically different from that which was intended .
Is COVID-19 a Frustrating Event?
Whether the Doctrine of Frustration will apply to COVID-19 or Government intervention will depend on the contract between both businesses, and the effect COVID-19 or Government intervention has had on the ability of those businesses to perform their obligations. Each business needs to consider whether the situation in which performance of the contract was originally contemplated has been rendered radically different. Each business will need to demonstrate more than disappointed expectations, hardship or inconvenience, or reduced profitability.
Some businesses may find that the ability to perform their contractual obligations is merely temporary or delayed, such as where a requirement of short-term self-isolation is imposed. It has yet to be established if temporary delay in the ability to perform will constitute a finding of frustration, however, it is in our view, unlikely.
What are Frustrating Events?
There is no fixed list of frustrating events, and therefore the options are non-exhaustive. Rather, it is necessary to consider the factual circumstances within the terms of the contract, and determine whether performance has become radically different from that which was undertaken by the contract. Similar to a force majeure event, a frustrating event requires a causative link between the supervening event, and the radical difference or impossibility of performance as undertaken by the contract. Once the causative link occurs, the Doctrine automatically terminates the contract.
The Courts have regularly concluded the following events have frustrated contracts:
- a change in law which renders performance as undertaken by the contract illegal (for example, performance by a supplier of alcohol would become radically different or impossible, if the supply of alcohol became prohibited);
- performance as undertaken by the contract would involve illegal acts (for example, under stage 4 restrictions in Victoria, persons were only allowed to leave their house for certain reasons. Non-essential business dependent on staff being ‘on-site’ would involve illegal acts and, if such acts are deemed more than temporary, this may render performance radically different);
- physical destruction of the subject matter of the contract (for example, the destruction of a one of a kind artwork);
- the subject matter of the contract becomes unavailable to the businesses (for example, lithium becomes unavailable to a business making lithium batteries);
- a person whose existence is essential to the performance of the contract may have died or otherwise become incapacitated; and
- where performance as undertaken by the contract remains possible, however, it is pointless because the common object or purpose of the businesses has been frustrated.
Courts have also found the following events do not frustrate contracts:
- the contract has an operative force majeure clause that can deal with the supervening event;
- performance as undertaken by the contract has only become more onerous or expensive; and
- the supervening event has only temporarily affected the performance of a business as undertaken by the contract.
What is the effect of frustration of a contract?
The ordinary consequence of a business successfully relying on the Doctrine of Frustration is that the agreement is automatically terminated by operation of law upon the occurrence of the frustrating event.
Because of this outcome, Courts will generally attempt to uphold the contractual obligations of a business, rather than risk undermining the entire foundation of a contract. The reason for this is that a business entering into a contract is assumed to have already considered the risk taken by that business under the contract, and Courts do not wish to provide an easy avenue for a business to get out of a contract, just because events play out differently than envisaged.
A business should carefully consider the effect of claiming that a contract has been frustrated. This is because, if a business takes the view that a frustrating event has occurred and it is later determined to be incorrect, the mistaken business may have repudiated the contract.
A business should also consider the impact of asserting that a contract has been frustrated, particularly if the contract is a long term contract on terms advantageous to the business asserting the frustration, or if the other contracting business is a particularly important commercial partner.
What you should do now
Businesses affected by COVID-19 and who are beginning to find that they are unable to perform their contractual obligations, or that because of COVID-19 their contractual obligations have become radically different, should carefully review their existing contracts, consider the application of any force majeure clauses (if they can seek to rely on such clauses), or consider if their contract has been frustrated. In such events, a business should determine which approach is most appropriate, taking into consideration their commercial relationships and their contractual rights and obligations.
Please contact us if you wish to discuss the impacts on your business.
Craig Higginbotham and Harrison Dobb
11 September 2020