Clarkslegal LLP - Solicitors in Reading and London

Legal Updates

Escaping consequences of non-performance of contract obligations

26 March 2020 #Corporate #Commercial


Force Majeure, the Doctrine of Frustration of Contracts and Covid-19

It’s something of a given in English law that, if you enter into a binding contract and fail to perform your “side of the bargain”, you may well be liable to pay damages for breach to the other party. Generally, it’s irrelevant and no defence if the obligations you agree to in the contract subsequently become far more onerous, difficult or expensive than originally envisaged, and even the fact that it becomes impossible to perform some or all of those obligations may not help you in a damages claim. Applying this to current circumstances, the effect of Covid-19 on many commercial contracts will be very significant but it may well not be possible for an affected contract party to use it as a means of suspending or avoiding performance.

However, many contracts, particularly ones with specified deadlines for performance, make express provision for the occurrence of a supervening and unforeseen event beyond the reasonable control of the party through “force majeure” clauses (the expression itself has no legal meaning in English law, so the clause needs to set out the events or have general wording wide enough to capture any such event). A typical force majeure clause, when invoked by a party, effectively delays or removes entirely the requirement for performance of contractual obligations because of the occurrence of such an event. These events are frequently listed at length and may include “acts of God” (such as natural disasters), strike action, default by third parties who are critical to performance of the contract and so on. Because of rules as to how courts interpret lists of this nature, even a lengthy force majeure clause may not necessarily cover effectively the consequences of disease/epidemics/pandemics without specific mention of them.

What if there is no force majeure clause? Until the mid-19th century, there were no exceptions to the general position set out above. Then, in a landmark decision in the case of Taylor v Caldwell, the great (and later Baron) Judge Blackburn created an important, though narrow, exception. Caldwell and Bishop had agreed to hire a music hall to Taylor and Lewis for 4 nights for such obvious delights as “an efficient and organised military and quadrille band; fireworks and full illuminations; a ballet or divertissement, if permitted; a wizard and Grecian statues; tight rope performances; rifle galleries; air gun shooting; Chinese and Parisian games; boats on the lake”. Regrettably, the music hall burned down before the first night’s extravaganza, and Taylor and Lewis sued Caldwell and Bishop for failure to provide the hall, notwithstanding the impossibility of doing this. Whilst previously they would have won, even though the music hall was now ashes, they lost the case, Blackburn implying a term into the contract to support his decision and saying:

"The principle seems to us to be that, in contracts in which the performance depends on the continued existence of a given person or thing, a condition is implied that the impossibility of performance arising from the perishing of the person or thing shall excuse the performance.”

Blackburn’s approach has since been developed and honed by the courts to cover other eventualities and has become the doctrine of frustration. What we can say with relative certainty is that, for a defendant to plead frustration successfully, something needs to happen after the contract is entered into (i) which could not have been foreseen or envisaged by the parties at that time, (ii) which is not caused or worsened by the party relying on it and (iii) which has a fundamental effect on the contract, such that continued performance becomes impossible, unlawful or completely different from what the parties intended at the outset. What is that “something”? It could be a change in the law which makes performance unlawful or impossible, outbreak of war or cancellation of an event upon which the contract depends. The eventualities that the courts may recognise as potentially permitting the application of frustration have been set over time and continue to be very restricted. For example, and this is very relevant in current circumstances, the fact that a contract will become loss-making (as a result of economic conditions) would not be sufficient to allow a party to rely on frustration. Note also that, if you have a force majeure clause but it is not effective to cover the eventuality in question, then you are unlikely to be able to rely on the doctrine of frustration, as the courts will generally not seek to improve contract drafting.

So, to what extent might frustration be used to address contract performance issues arising from Covid-19? The doctrine has been previously applied in, for example, construction and supply of goods contracts and, in both these contract types, a party’s performance could be fundamentally affected by something unforeseen like the epidemic. What if, for example, government actions or restrictions brought in to control the spread of the virus lead to a party to a contract being unable to perform fundamental obligations in that contract? Assuming that there is no effective force majeure provision in the contract, could a party alleged to be in breach seek to be discharged from its obligations by virtue of frustration?

In July 1914, a firm contracted with a water company to build a reservoir, to be completed within 6 years, with provision for an extension for completion in certain circumstances. By government order given in February 1916, the contractors were required to cease work and did so. The order also compulsorily dispersed and sold plant used for the contract. The court held that the provision for extending the time did not apply to this prohibition; that the interruption created by the prohibition was of such a character and duration as to make the contract when resumed a different contract from the contract when broken off; and that the contract had ceased to exist (Metropolitan Water Board v. Dick, Kerr & Company Limited).

The judge’s view here is a useful way of assessing whether a supervening eventuality may effectively be pleaded as frustration. He asked the court to imagine that the contract gave the water company the right to do what the government order had done. If that was the case, “does anyone suppose that Dick, Kerr & Co. or any other contractor would have accepted such a clause? And the reason why they would not have accepted it would have been that the contract when resumed would be a contract under different conditions from those which existed when the contract was begun.”

Frustration provides a narrow and restricted defence, as we have seen, but it is certainly conceivable that it could be used in some cases arising from Covid-19-related default, in particular where a government order has a direct and fundamental effect on the ability of a party to comply, and there is no force majeure clause.

Where the courts accept a defendant’s argument on frustration, under the common law, the parties will be automatically discharged from that time from any further obligations and neither can claim damages from the other in relation to any previous non-performance. It may not be possible for one party to recover any advance payment, unless there has been “total failure of consideration”, and any monies spent by a party to date in performing the contract are irrecoverable. There is also a wartime statute still in force which provides that monies paid before the frustrating event can be recovered, but this does not apply to some types of contract.

While the doctrine of frustration may help a party whose ability to perform a contract is fundamentally affected by a supervening and unforeseen event, the better protection for a party to any contract where performance could conceivably be delayed or prevented by such an event remains a carefully drafted force majeure clause.

Clarkslegal, specialist Corporate lawyers in London, Reading and throughout the Thames Valley.
For further information about this or any other Corporate matter please contact Clarkslegal's corporate team by email at contact@clarkslegal.com by telephone 020 7539 8000 (London office), 0118 958 5321 (Reading office) or by completing the form on this page.
Disclaimer
This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

Read more articles

Jon Chapman

Jon Chapman
Senior Consultant

E: jchapman@clarkslegal.com
T: 0118 960 4683
M: 07979 591 627

Contact

Corporate team
+44 (0)118 958 5321