COVID-19: Law of Frustration

As many businesses will be unable to perform their contractual obligations due to the restrictions imposed by COVID-19, Thomas O'Dwyer, partner in our Litigation and Dispute Resolution department, provides a helpful overview of the law of frustration and the leading cases in this area.  

Introduction

Contracts often contain a Force Majeure clause which makes provision for what is to happen if a contract cannot be performed due to intervening external circumstances. However, where no such clause is included in a contract, it is still possible that the contract may be deemed to be frustrated if it cannot be performed due to unforeseen circumstances which are beyond the control of either party.

Key points

• Frustration occurs when, without default of either party, a contractual obligation has become incapable of being performed.

• Frustration can only apply in limited circumstances.
• Events which make a contract more difficult or costly to perform will not lead to frustration.
• A contract deemed frustrated comes to an end – it cannot be partially frustrated, although parties can agree between themselves to vary a contract.

Test for Frustration

While the Courts are amenable to setting aside a contract on the basis that it has been frustrated, they will only do so in limited circumstances. The leading Irish case of McGuill v Aer Lingus Teoranta and United Airlines Incorporated[1] set out the test to be applied when considering whether a contract can be set aside on the basis that it has been frustrated. In this case, Mr McGuill was a tour promoter and entered into an agreement with both Aer Lingus and United Airlines to bring a group of passengers from Dublin to Hawaii. However, due to a strike by employees in United Airlines, it was unable to fulfill its side of the agreement and Mr McGuill had to make arrangements with an alternative airline company. When Mr McGuill sought to recover these costs from United Airlines, it argued that the contract was frustrated. Mr Justice McWilliam rejected United Airlines' argument and set out the following principles as applying when a claim of frustration is made:

1. A party may bind himself by an absolute contract to perform something which subsequently becomes impossible - i.e. the parties may agree that the contract must be performed regardless of any intervening circumstances that may arise.
2. Frustration occurs when, without default of either party, a contractual obligation has become incapable of being performed.
3. The circumstances alleged to occasion frustration should be strictly scrutinised and the doctrine is not to be lightly applied.
4. Where the circumstances alleged to cause the frustration have arisen from the act or default of one of the parties, that party cannot rely on the doctrine.
5. All the circumstances of the contract should also be strictly scrutinised.
6. The event must be an unexpected event.
7. If one party anticipated or should have anticipated the possibility of the event which is alleged to cause the frustration and did not incorporate a clause in the contract to deal with it, he should not be permitted to rely on the happening of the event as causing frustration.

More onerous obligations do not equate to Frustration

The mere fact that a contract is more onerous to perform, does not result in it being frustrated. This is best illustrated by the leading case of Tsakiroglou v Nobleee and Throl[2] which concerned a contract for the shipment of nuts from Port Sudan to Hamburg. If the shipment was undertaken via the Suez Canal, the freight charges would have been £7 per ton. However, due to the outbreak of war, the Suez Canal was closed to shipping which meant the ship had to sail via the Cape of Good Hope which cost £15 a ton. The House of Lords rejected an argument that the contract had been frustrated by the closure of the Suez Canal. Even though the longer route would take four weeks longer, the extra expense and time involved in completing the shipment did not amount to frustration.

A change in economic circumstances will not render a contract frustrated as was set out in the case of Davis v Fareham UDC[3]. In this case, contractors agreed to build houses for a price of £94,000. The work, which was expected to take 8 months to finish, took 22 months due to material shortages and labour difficulties and the cost escalated to £115,000. The contractors argued that these intervening events resulted in the contract being frustrated and instead of only being paid the agreed price of £94,000 should instead be paid on a quantum meruit basis, i.e. on the basis of the actual value of the services rendered. The House of Lords rejected the contention that the contract had been frustrated and found the mere fact that there was a change in the profitability of the contract did not render it frustrated.

Similarly, in Zurich Bank v McConnon[4] the High Court rejected the borrower's argument that his loan agreement with the bank had been frustrated simply because there was a dramatic collapse in property values.

Effect of Frustration

Where a contract is deemed to be frustrated, the contract comes to an end and each party is released from their future obligations under the contract from the date of termination. However, each party will remain liable for their obligations up to that date. In the case of Ringsend Property Limited v Donatex Limited and Bernard McNamara,[5] the High Court rejected the contention that a contract can be partially frustrated.  

Conclusion

If the parties to a contract don't have a Force Majeure clause setting out what is to happen in the event of an intervening circumstance (such as a pandemic like COVID-19) it may be possible to have the contract terminated in its entirety on the basis that it has been frustrated. This will depend on the factual matrix surrounding each contract and the length of the delays imposed by the COVID-19 restrictions will be of significant importance in any consideration. It is of course open to the parties to negotiate a mutually acceptable alternative solution to having a contract terminated.

[1] The High Court, Unreported 3 October 1983

[2] [1961]2 ALL ER 179

[3] [1956] AC 696

[4] [2011] IEHC 75

[5] [2009] IEHC 568

For more information please get in touch with Thomas O'Dwyer (Litigation).

To discuss any other COVID-19 related issues impacting your business, please get in touch with Damian Maloney (Corporate and Commercial), Edward Evans (Corporate & Commercial), Aidan Marsh (Commercial Property), Gerry Gallen (Commercial Property), Sandra Masterson Power (Employment), Paul Gough (Employment), Dorit McCann (EU, Competition & Procurement), Fidelma McManus (Housing), Barry Cahir (Litigation and Insolvency), Thomas O'Dwyer (Litigation), Sharon Delaney (Litigation), or your usual Beauchamps contact.