Case highlights dangers of umbrella agreements for security of payment regimes in Australia
Out-Law Guide | 23 Jul 2020 | 10:29 am | 8 min. read
Frustration of a contract under English law can be difficult to establish, and the circumstances in which the doctrine can be invoked are narrow. If established, the parties will be able to walk away from the contract.
Before invoking the doctrine of frustration, parties should:
This guide should be read alongside our guide to Covid-19 and force majeure.
Frustration will occur when:
It is not enough that performance is made more costly or more difficult: the frustrating event should be so fundamental that it strikes to the root of the contract and is entirely beyond what was contemplated by the parties when entering into the contract.
When deciding whether a contract is frustrated, the courts will consider the specific contract terms; the factual background; the parties' knowledge; and the parties' ability to perform the contract in light of Covid-19 restrictions. There have been no English court cases to date dealing with a pandemic in the context of frustration.
It can be difficult to establish that a frustrating event was truly unforeseeable. This is because most commercial contracts now contain force majeure clauses. In addition, the courts have held that something as simple as taking out an insurance contract demonstrates that the parties have agreed who should assume the risk, meaning they are unable to rely on the doctrine of frustration.
It is unlikely that the outbreak of Covid-19 would itself be held to be unforeseeable. However, the same is not necessarily true of the far-reaching restrictions put in place by governments around the world in response to Covid-19.
In 2019, the court was asked to consider whether Brexit frustrated the lease by the European Medicines Agency (EMA) of its premises at Canary Wharf, London. This was a particularly important issue for the EMA, as a decentralised agency of the EU. Although the judge concluded that the UK's departure from the EU was not something that was "relevantly foreseeable" when the parties agreed the lease in 2011, he found that the EMA had "assumed the risk of change" over the 25-year term of the lease. The EMA had "quite consciously entered into the lease without a break clause" and negotiated alienation provisions defining the circumstances in which it could depart the premises, which did not include the UK leaving the EU.
As a result, despite the extreme circumstances, the lease was not frustrated. The parties had anticipated that it was foreseeable that the lease might have to be terminated early, for any reason; and the tenant still decided to enter into a long lease with no break clause on that basis.
It is unlikely that the outbreak of Covid-19 – or, indeed, any pandemic – would itself be held to be unforeseeable, since there have been numerous other outbreaks that had the potential to develop into pandemics, and scientists have been warning that it was only a question of when and not if a pandemic occurred. However, the same is not necessarily true of the far-reaching restrictions put in place by governments around the world in response to Covid-19. These could potentially be held to be unforeseeable, depending on the circumstances.
The date that the contract was entered into will also be relevant to foreseeability. Whether or not the impact of Covid-19 could have been foreseen will depend on the point at which the parties contracted. Parties who entered into a contract after Covid-19 started to receive media attention will be unable to rely on the doctrine of frustration.
A contract may be impossible to perform where staff, materials, transport, supplies, premises or anything else essential for contract performance becomes unavailable. For example, service contracts might require performance by employees in person - which raises questions about 'impossibility' in the event people are confined to their homes, and the extent to which remote service aided by technology is adequate to fulfil the terms of the contact.
A contract will not be frustrated where an alternative method of performance is possible, and where there is no fundamental difference between the two methods of performance. For example if, as a result of Covid-19, goods under a supply contract are supplied by a different supplier or warehouse, even if this made performance of the contract more difficult or more expensive, the contract will not have been frustrated.
A delay in contractual performance as a result of Covid-19 will be temporary and, one would hope, relatively short term. Temporary impossibility or delay is not by itself a ground for frustration. However, it may frustrate a contract in two circumstances:
A contract may be discharged for temporary impossibility where it can be performed only at the time of the temporary impossibility. For this to apply the date, time or period for performance must be specified in the contract; and it must be clear from the contract terms or surrounding circumstances that performance at that time is a condition of the contract.
The issue facing many businesses at the moment is uncertainty as to the length of the delay caused by Covid-19, and lack of clarity as to when a number of services will resume - for example, the reopening of closed premises. This makes it difficult to predict whether the delay caused by Covid-19 will frustrate contracts.
However, there are a few principles to keep in mind. The length of the delay in proportion to the contract as a whole is likely to be a relevant factor. For example, if a party to a three-year contract for shared office space was unable to access the space for two months, it is likely to be regarded as insignificant and would not amount to frustration. However, if the contract was for six months and occupation was prohibited by the government for five months, it is possible that this might be held to have frustrated the contract.
A contract will not be frustrated where an alternative method of performance is possible, and where there is no fundamental difference between the two methods of performance.
A contract may also be frustrated where a delay goes on for so long that, by the time the contract can be performed, performance is meaningless or market conditions have been radically altered. In a case dating back to the first world war, a building contract was frustrated after the government directed that the builder cease work, due to the war, for an indefinite period. Here, the delay was of such duration as to make the contract when resumed a different contract from that which was originally entered into. It is a question of whether delay in light of Covid-19 is likely to be significant enough to amount to frustration, and much will depend on the nature of the contract and the length of the lockdown.
One issue that has not yet been tested is illegality under the 2020 Health Protection (Coronavirus Restrictions) England Regulations, which give legal force to the coronavirus lockdown. It might be arguable that any contract would be frustrated on the basis of illegality if its performance would have breached these regulations. However, much will depend on whether it is possible to perform the contract in substantially the same form that was originally agreed now lockdown has been eased, and whether time was of the essence of the contract.
It is also worth considering the interpretation of such concepts in the regulations as "reasonable excuse". This could be tested where one party argues that the contract is frustrated while the other argues that there is a reasonable excuse not to adhere to the lockdown and performance under the contract is still expected – although it is difficult to think of a situation in which this might arise.
A party may also be able to argue that the contract has been frustrated when they can demonstrate that the unforeseen frustrating event transformed performance of the contract into something so radically different from the intended purpose that it would be unfair for the court to hold them to their contract.
This can be done by analysing the original obligation, and comparing that to the performance of the obligation under the new circumstances. If the obligation is radically different to the original obligation, then it is likely that the contract will have been frustrated. This is viewed objectively, and an increase in cost or inconvenience will not normally be enough to make the new obligation radically different from that previously agreed.
Frustration brings the contract to an end. The effect is automatic and does not depend on any act of either party. As a result, it is not recommended that parties try to invoke the doctrine lightly, particularly at the start of a long term contract. In many cases, it will make better commercial sense for the parties to negotiate an alternative way of resolving the issue - for example, in the Canary Wharf case, the EMA agreed a sublease.
Frustration should usually be a last resort, particularly in circumstances where the parties wish to continue a commercial relationship, continue the contract in future, or where it may be difficult to find an alternative buyer or supplier.
The 1943 Law Reform (Frustrated Contracts) Act allows the recovery of prepaid sums under most commercial contracts when the contract has been frustrated. Under the Act:
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Case highlights dangers of umbrella agreements for security of payment regimes in Australia