Coronavirus and commercial contracts – No force majeure clause? Can the doctrine of “Frustration” assist?

As the coronavirus (COVID-19) pandemic continues to spread, more and more parties are finding themselves in a position where they are unable to carry out their contractual obligations. Our previous article looked at the role of a force majeure clause in potentially assisting parties to suspend or be excused from the performance of their contractual obligations. In this article, we examine the common law doctrine of frustration and consider how it may apply to the coronavirus pandemic, particularly in light of the recent government bans that have been proclaimed by state and federal government.

What is the difference between force majeure and frustration?

A force majeure clause will ordinarily provide that a party affected by an unforeseeable event will be relieved from having to perform a contractual obligation or will have the timeframe for the performance of the relevant obligation extended. Force majeure is not a common law doctrine, but rather, a commercial construct. In other words, it will only operate if your contract specifically provides for it.¹

Frustration, on the other hand, is a common law doctrine which does not require a contractual right of termination due to an unforeseeable event. For parties that do not have a force majeure clause in their contract, or have one which is clearly only meant to deal with temporary delays or interruptions, frustration may be of use.

What is frustration?

Australian courts will generally accept the test put forward by Lord Radcliffe in Davis Contractors Ltd v Fareham Urban District Council² when determining whether a frustration event has occurred. According to Lord Radcliffe, frustration will be satisfied if:

• The frustration event causes the contractual obligation owed by a party under the contract to become impossible or radically different from the obligation contemplated at the time that the parties entered into the contract;
• The frustration event was not caused by either party; and
• The contract does not otherwise deal with what will happen on the occurrence of the alleged frustration event (e.g. by way of a force majeure clause).

Can the coronavirus pandemic frustrate a contact?

The answer depends on the impact of the coronavirus pandemic on performance under a contract.

The key question is whether the coronavirus pandemic makes performance of a contract impossible as opposed to merely more difficult. If the performance is only more difficult it will likely not be classified as a frustration event. For example, if the coronavirus pandemic makes the performance of a contractual obligation more costly or causes a significant delay, this is unlikely to be sufficient to frustrate the contract.

The recent government decision to impose bans on non-essential services (including cinemas, theatres, restaurants,  cafes, play centres, fitness centres, zoos, museums, galleries, churches and auctions) will impact parties that have entered into contracts connected with such service industries. If the impact of these bans is such that it is now impossible for parties to honour their contractual obligations, a party may be able to show that their contract has been frustrated. This may also be the case for contracts that are impacted by the government’s general prohibition on non-essential indoor gatherings.

What consequences flow from frustration?

While a force majeure event may not result in the contract being terminated (although it may), frustration will usually result in the automatic termination of a contract (although severance may be possible in some cases). Where frustration is made out, the contract is terminated at the time of the frustrating event, and all parties are ‘discharged’ from their future obligations under the contract.

What if payments have been made under a contract that is subsequently frustrated?

The general position under common law is that ‘losses lie where they fall’ when a contract is frustrated, meaning that amounts paid before the frustrating event are not recoverable (unless an examination of the contract reveals that the intentions of the parties were to provide for recovery in this case).³ While common law frustration precludes any remedy for recovering amounts paid, there may still be an option for parties to seek restitution for unjust enrichment under common law. Where one party has performed in whole or part under the contract (e.g. through the payment of a deposit) but has received nothing in return as a result of a frustrated contract, that party can seek redress based on a total failure of consideration.

What about state law?

It is recognised that the general position at common law can result in harsh economic consequences for contracting parties. As a result, some states have legislated to provide for ‘fair adjustment’ where a contract is frustrated – these are Victoria, New South Wales and South Australia.⁴ While the state based legislations differ in substance, they have a shared goal of restoring balance and fairness to parties post-frustration.

The main benefit of the state legislation is that it provides parties (in the case of Victoria and New South Wales) with the avenue to recover amounts paid prior to frustration. While this is not expressly stated in the South Australian equivalent legislation, it provides for a general ‘fair adjustment’ so that no party is ‘unfairly advantaged or disadvantaged’ as a result of frustration. It is thus likely that in each of the states mentioned, a party is entitled to seek recovery of amounts paid under the relevant provisions of statute.

Consequences of asserting frustration

The consequences of wrongfully asserting frustration may lead to unforeseen consequences and therefore the doctrine should be asserted with caution. If your obligations can still be performed and you are unable to support a frustration argument, this may amount to an anticipatory or repudiatory breach of the contract, which may result in the counterparty itself terminating the contract and claiming damages.

Key takeaways

1. Parties that are unable to comply with their contractual obligations because of the coronavirus pandemic may be able to argue that the contract should be terminated under the common law doctrine of “frustration”;
2. Frustration will not ordinarily apply if parties have a force majeure clause in their contract, however in some circumstances, frustration could still be argued if the force majeure clause deals only with temporary delays or interruptions;
3. To establish frustration on the grounds of the coronavirus pandemic, you must show that the coronavirus pandemic has caused the contractual obligations that you owe to the other party to have become impossible or radically different from the obligation contemplated at the time that you entered into the contract;
4. Where a contract is frustrated, the contract is terminated and parties are discharged from the performance of all future obligations. They may not, however, be automatically entitled to recover any amounts paid prior to frustration unless state laws provide otherwise; and
5. The common law directs that ‘losses lie where they fall’, but state legislation in Victoria, New South Wales and South Australia may provide for fair adjustment. It is necessary to consider which (if any) of the state legislation applies in each case.

This article was written by Teresa Torcasio, Partner, Basimah Memon, Solicitor and Zoe Vise, Law Graduate.

^1. Please see the article titled ‘Does your force majeure clause apply in the case of coronavirus‘ by Teresa Torcasio and Basimah Memon for more information.

^2. [1956] AC 696 at 729.

^3. As outlined in Codelfa Constructions Pty Ltd v SRA or NSW (1982) 149 CLR 337 p720-721.

^4. Australian Consumer Law and Fair Trading Act 2012 (Vic); Frustrated Contracts Act 1978 (NSW); Frustrated Contracts Act 1988 (SA).

^5.Frustrated Contracts Act 1988 (SA), s7(1).