COVID-19 DISPUTE RESOLUTION – Applying the Principle of Frustration to Cancellations Caused by the Virus

Carl Troman |

What happens where a contracting party no longer wishes to perform their obligations because of COVID-19?   This is likely to be a major source of disputes in the near future as contracts become uneconomic or difficult to perform because of the virus and the unprecedented disruption it is causing.   What are the rights of the parties where an event has been cancelled because of COVID-19 but one of the parties has paid a deposit and the other has spent money preparing for it?

A look back to the principle of frustration, first developed in the 19th century but out of fashion for a long time, provides the litigator with a vital tool when advising and assisting their client.   Here are some key points…

What is Frustration?

Originally the common law insisted on holding contracting parties to their bargains come hell or high water but the doctrine of frustration was recognised as long ago as 1863 in Taylor v Caldwell (1863) 3 B & S 826 to mitigate the harshness of such an approach.   Classic statements of the principle are to be found in Davis Contractors Ltd v Fareham UDC [1956] AC 696:

“… frustration occurs whenever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. Non haec in foedera veni. It was not this that I promised to do … There must be … such a change in the significance of the obligation that the thing undertaken would, if performed, be a different thing from that contracted for.

Lord Radcliffe

The question is whether the contract which they did make is, on its true construction, wide enough to apply to the new situation: if it is not, then it is at an end.

Lord Reid

A more modern formulation of the doctrine is to be found by Lord Simon in National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675:

Frustration of a contract takes place when there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances; in such case the law declares both parties to be discharged from further performance.

When Does Frustration Apply?

This, naturally, is the critical question.   In each case it calls for a close analysis of the facts and the exercise of professional judgment in the light of the applicable legal principles.

First, it is easy to say when it will not apply, which is where: (1) one party has made what has turned out to be a bad bargain in the light of events; or (2) where the parties have provided in their contract for the events which have occurred whether by way of a force majeure clause or otherwise.

Second, guidance was given by Bingham LJ in J Lauritzen AS v. Wijsmuller BV, The “Super Servant Two” [1990] 1 Lloyd’s Rep 1 as to when the doctrine would apply:

  1. The doctrine of frustration was evolved to mitigate the rigour of the common law’s insistence on literal performance of absolute promises. The object of the doctrine was to give effect to the demands of justice, to achieve a just and equitable result, to do what is reasonable and fair, as an expedient to escape from injustice where such would result from enforcement of a contract in its literal terms after a significant change in circumstances.
  2. Since the effect of frustration is to kill the contract and discharge the parties from further liability under it, the doctrine must not be lightly invoked and must be kept within very narrow limits.
  3. Frustration brings the contract to an end forthwith, without more and automatically. It does not require an act by the parties to the contract.
  4. The essence of frustration is that it should not be due to the act or election of the party seeking to rely on it.
  5. A frustrating event must take place without blame or fault on the side of the party seeking to rely on it.

Third, it helps to look at the possible theoretical bases for the application of the doctrine, which are:

  • An implied term or condition
  • A total failure of consideration
  • A “frustration of the adventure” or “frustration of the foundation of the contract
  • Construction of the contract
  • Performance rendered radically different by fundamental change in circumstances

The last in that list is currently the most popular with the judiciary and is called the ‘multi-factorial’ approach.   It involves consideration of:

the terms of the contract itself, its matrix or context, the parties’ knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed mutually and objectively, and then the nature of the supervening event, and the parties’ reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances. Since the subject matter of the doctrine of frustration is contract, and contracts are about the allocation of risk, and since the allocation and assumption of risk is not simply a matter of express or implied provision but may also depend on less easily defined matters such as “the contemplation of the parties”, the application of the doctrine can often be a difficult one. In such circumstances, the test of “radically different” is important: it tells us that the doctrine is not to be lightly invoked; that the mere incidence of expense or delay or onerousness is not sufficient; and that there has to be as it were a break in identity between the contract as provided for and contemplated and its performance in the new circumstances.

Edwinton Commercial Corporation v Tsavliris Russ (Worldwide Salvage and Towage) Ltd, The “Sea Angel” [2007] EWCA Civ 547per Rix LJ

Finally, it is not a question of fitting a case into a particular category but various situations have over the years been recognised as potential candidates for a frustrated contract.   These include:

  • a change in the law or subsequent illegality
  • outbreak of war
  • cancellation of an expected event
  • delay
  • destruction by fire or other cause of the subject matter of the contract
  • an explosion or stranding disabling a ship
  • requisitioning of the subject matter of the contract by the government
  • seizure of a ship
  • expropriation of an oil concession by a foreign government
  • incapacity or death of a person obliged to perform personal services

What is Frustration Worth?

Originally, the common law allowed losses to lie where they fell if a contract was frustrated.   That operated to create substantial unfairness and so Parliament intervened with the Law Reform (Frustrated Contracts) Act 1943 which now covers most frustrated contracts.   Broadly speaking it provides that all sums paid or payable under a frustrated contract have to be returned subject to the Court’s discretion to allow a party who incurred expenses for the purposes of the contract to deduct those from those sums paid or payable.

Perhaps inevitably the operation of the Act is not entirely satisfactory leaving gaps, uncertainties and the difficulty of a broad judicial discretion.   Indeed, the most difficult part of the Act is section 1(3) which allows a party to recover a sum (which the Court considers just) if that party has conferred a benefit upon their counter-party.

Does Frustration Still Work?

In short, yes.   Just over a year ago Marcus Smith J gave judgment in Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch), in which the EMA argued that Brexit had frustrated the agreement into which it had entered to lease premises for its head office in Canary Wharf in circumstances where the EMA’s headquarters was relocated to Amsterdam by Regulation (EU) 2018/1718.   The EMA’s argument in that case failed but the decision (which contains a very helpful exposition of the legal principles) shows the doctrine of frustration is alive and kicking albeit challenging to rely upon.

© Carl Troman. The author assumes no responsibility to any party in respect of this article. Specific legal advice tailored to specific problems should always be obtained.

Carl Troman

April 2020