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Mar 29, 2020

COVID-19 (Coronavirus) and its impact on contract performance

Contact: Maurice Falcetta

The impact of COVID-19 (coronavirus) has been devastating on the world-wide economy primarily due to its effect on major supply chains and a mass decrease in customer consumption. Small businesses or individuals who have signed contracts prior to this global pandemic may now be asking can COVID-19 be relied on to ignore their upcoming contractual obligations? Answering this question requires interpretation of the relevant contract’s force majeure clauses and if such clauses are absent, whether the common law doctrine of frustration may be implemented to mitigate the impact of the crisis on their business.

(1) Force Majeur Clauses

The primary purpose of a force majeur clause is to protect parties from events that are agreed to be outside ‘normal’ business circumstances. Common examples include acts of God, war, riots, natural or other disasters. Force Majeur clauses are generally not recognised by the common law as a ‘standalone legal concept’. [1] They are better characterised as a ‘product of commercial agreement between contracting parties’.[2] As a result, when interpreting these clauses, a case-by-case approach with reference to the wording of the clause and the relevant facts is necessary.[3] However, there are many common law cases that are still relevant, particularly in the context of a global pandemic.

First, the party seeking to rely on the force majeur clause has the burden of proving the event itself.[4] These clauses will also be subject to the contra proferentem rule, which essentially means that a force majeur clause will be construed very strictly and in the event of any ambiguity it will be interpreted against the interests of the party that relies upon it.[5]

Second, it is generally an express term that a force majeur event is an event beyond the reasonable control of either party.[6] Where no such express term exists, the courts may imply it into the contract.[7]  There also many limitations when considering the overall scope of a force majeur clause. For example, the fact that there is a shortage of particular materials is generally not a good enough reason for a seller of goods to be relieved by a force majeur clause.[8] This rule is further solidified where the shortage of materials can be overcome at a cost.[9]

When considering the cumulative effect of all these rules, it is likely that COVID-19 will be able to effectively trigger the availability of a contract’s force majeur clause. This is made far easier for contracts that already have clauses that list out specific events such as ‘epidemics, quarantine, biological contamination or entry and exit restrictions’.[10] However, broader and more vague force majeur events such as ‘natural disaster’ may also be able to cover COVID-19.

 (2) Common Law Doctrine of Frustration

In the case where your contract lacks any force majeur clauses, the COVID-19 event may still be viewed as a ‘frustrating’ event and therefore trigger ‘frustration of contract’.

Frustration is able to prospectively terminate a contract where performance of the contract becomes impossible, with neither party being at fault, and the obligations under the contract being ‘radically different’ from those contemplated by the parties to the contract.[11] Common examples include: a change in the law rendering performance illegal;[12] physical destruction of the subject matter of the contract;[13] and restraint by injunction.[14]

The threshold for frustration is extremely high and the test is strict. For example, a contract is generally not frustrated where the impossibility of performance is the fault of either of the parties or where performance has merely become more onerous or expensive.[15]

Furthermore, a key limitation that is directly linked to an event such as COVID-19, is the principle that a contract cannot be frustrated where the change is temporary or transient.[16] This principle was used in a hong-kong case, Li Ching Wing v Xuan Yi Xiong,[17] where a tenant was required to comply with a 10-day isolation order because of the SARS outbreak. As a party to a lease, the tenant sought to invoke frustration. The court rejected this argument by claiming the isolation order was of a short duration when viewed in the context of the 24-month lease.

 A further issue of using frustration is the fact that termination is prospective. This means that the rights accrued at the time of frustration are not affected, including the right to sue for damages for any breach that occurred prior to frustration,[18] or to recover a payment fallen due under the contract.[19] In relation to a recovering losses or legally seeking a right to restitution, the traditional approach has been ‘the loss lies where it falls’.[20] This means that neither recovery of money paid nor compensation for partial performance is allowed.[21] However, the UK has taken a different approach by holding that payments made under a a frustrated contract could be recovered ‘where the consideration, if entire, has entirely failed, or where, if it is severable, it has entirely failed as to the severable residue’.[22] This essentially means that relief may be granted where the other party fails to perform anything. It is not clear whether this approach has been widely accepted in Australia. Nevertheless, Mason CJ in Baltic Shipping Co v Dillon has noted that the UK decision correctly reflects the law in Australia and, to the extent that it is inconsistent should be preferred to the decision of this court in Re Continental C&G Rubber Co Pty Ltd.[23]A further complication to the law of frustration is the effect of legislation which has been enacted to mitigate the economic harshness caused by the law of frustration. This legislation has been enacted in NSW,[24] SA,[25] and Victoria.[26] Accordingly, parties seeking a right to restitution may be able to get a fairer outcome under one of these acts.

In summary, when considering COVID-19 in the context of frustration of contract, it is important to ask yourself whether one or both of the following scenarios apply:

  • (1) Has COVID-19 made it impossible for you to perform your contractual obligations and not simply more expensive or onerous?
  • (2) Has COVID-19 transformed your contractual obligations into ‘radically different’ obligations?

If they do, you have a strong case for frustration of contract. However, it is always important to remember that frustration is a very high threshold and your likelihood to recover any losses or payments made prior to frustration is very low.

[1] Navrom v Callitsis Ship Management SA (The Radauti) [1987] 2 Lloyd’s Rep 276 at 282 per Staughton J (affirmed [1988] 2 Lloyd’s Rep 416, CA)

[2] Plaimar Ltd v Waters Trading Co Ltd (1945) 72 CLR 304.

[3] Ben Davidson et al, ‘Legal consequences of the COVID-19 outbreak on contracts: force majeure and frustration’, Corrs Chambers Westgarth (Report, 17 February 2020) <https://corrs.com.au/insights/legal-consequences-of-COVID-19-outbreak-on-contracts-force-majeure-and-frustration#_ftn19>.

[4] Channel Island Ferries Ltd v Sealink UK Ltd [1988] 1 Lloyd’s Rep 323; and Brauer & Co (Great Britain) Ltd v James Clark (Brush Materials) Ltd [1952] 2 All ER 497.

[5] Hong Guan & Co Ltd v R Jumabhoy [1960] AC 684; and Fairclough Dodd & Jones Ltd v J H Vantol Ltd [1957] 1 WLR 136.

[6] Naylor Benzon & Co Ltd v Krainische Industrie Gesellschaft [1918] 1 KB 331; and see Ambatielos v Anton Jurgens Margarine Works [1923] AC 175.

[7] Ibid.

[8] P J van der Zijden Wildhandel NV v Tucker & Cross Ltd [1975] 2 Lloyd’s Rep 240 Atisa SA v Aztec AG [1983] 2 Lloyd’s Rep 579; and Exportelisa SA v Guiseppe Figh Soc Coll [1978] 1 Lloyd’s Rep 433.

[9] Ibid.

[10] Ben Davidson et al, ‘Legal consequences of the COVID-19 outbreak on contracts: force majeure and frustration’, Corrs Chambers Westgarth (Report, 17 February 2020) <https://corrs.com.au/insights/legal-consequences-of-COVID-19-outbreak-on-contracts-force-majeure-and-frustration#_ftn19>.

[11] Taylor v Caldwell (1863) 122 ER 309; see Scott Alden, ‘Dealing with the unkown in contracts – Frustration and Force Majeur’, Holding Redlich (Report, 21 June 2017) < https://www.holdingredlich.com/blog/dealing-with-the-unknown-in-contracts-frustration-and-force-majeure#_edn2>.

[12] Scanlans New Neon Ltd v Tooheys Ltd (1943) 67 CLR 169

[13] Taylor v Caldwell (1863) 122 ER 309.

[14] Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337

[15]  Nicholas Dennys and Robert Clay, Hudson’s Building and Engineering Contracts 13th Edition, page 69 at 1-072.

[16] Stephen Furst and Sir Vivian Ramsey, Keating on Construction Contracts 10th Edition (2016), page 713; [1918] AC 119, 128.

[17] [2004] 1 HKLRD 754

[18] Baltic Shipping Co v Dillon

[19] Hirsch v Zinc Corporation Ltd (1917) 24 CLR 34.

[20] Re Continental C&G Rubber Co Pty Ltd (1919) 27 CLR 194.

[21] Ibid.

[22] Fibrosa Spolka Akcynja v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32

[23] Re Continental C&G Rubber Co Pty Ltd (1919) 27 CLR 194.

[24] New South Wales (Frustrated Contracts Act 1978)

[25] South Australia (Frustrated Contracts Act 1988)

[26] Victoria (Australian Consumer Law and Fair Trading Act 2012)

The information in this document represents general information, and should not be relied for your specific circumstances. If you require legal advice and assistance on the matters contained or associated in this document you should contact Trinity Law. Subject to the limits of the law, Trinity Law disclaims any liability on persons relying on this document.

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