knowledge 31 March 2020 |

COVID-19: Commercial Contracts and Frustration

An obligation under a valid contract governed by Irish law is enforceable in accordance with its terms in all but the most exceptional circumstances.  The parties to a contract may have specifically agreed in their contract what is to happen in certain specified eventualities (such as strikes, natural disaster or as here a pandemic).  Often, they will have agreed that performance is suspended or excused or that the contract will or may be terminated. Such a provision is known as a force majeure clause.  We considered force majeure clauses in a recent briefing (available here).

Even where the parties have not reached such an agreement in their contract, there are exceptional circumstances in which the courts may say that the contract has been frustrated and this may be relevant in the current crisis.

When is a contract frustrated?

A contract will be frustrated only where performance of the contract:

• becomes impossible,
• becomes illegal, or
• would be so radically different from what the parties had originally intended when they contracted that to hold the parties to their contract would be unjust.

The courts have repeatedly emphasised that a contract will only be terminated by frustration in exceptional circumstances. While general principles have developed over time, application of the doctrine of frustration is extremely fact-specific and will depend on a number of factors, including construction of the relevant contract. The courts will be guided by the facts of every individual case. Therefore, obtaining tailored legal advice at an early stage is essential.

Generally speaking, a contract will not be frustrated where an alternative method of performance is possible, or where the contract is merely more expensive, more difficult or more onerous to perform. For example, the courts concluded that contracts for the purchase of property which became much less attractive financially in the wake of the 2008 financial crisis remained in force. The courts concluded that those contracts had not been frustrated simply because they had proved to be bad bargains for one party or the other.¹

Similarly, delays to the performance of a contract will only frustrate an agreement where performance is excessively burdensome or completely impossible.

Organisations must be mindful that temporary restrictions, including those imposed in response to COVID-19, will by no means guarantee that relevant contracts have been terminated by frustration. The facts of each case will need to be carefully considered in order to determine whether there is any prospect of successfully relying on the doctrine.

What is the effect of frustration?

Where a contract is terminated by frustration from a particular date, each party to the contract is released from its future obligations under the contract, from the date of termination.  However, each party remains liable in respect of that party’s obligations up to that date.  Questions can arise as to whether money paid under a contract that has subsequently been frustrated must be returned and again, this may depend on all the facts of the particular case.

Once a contract is “frustrated,” it comes to an end permanently.  By contrast, depending on its terms, a force majeure clause may allow for the temporary suspension of obligations.  Frustration also applies to the entire contract whereas a force majeure clause may apply to specific obligations, leaving the remainder of the contract to be performed.

General principles

The following general principles were set out with respect to the operation of the doctrine of frustration in McGuill v Aer Lingus and United Airlines,² the key points of which are synopsised here, together with our commentary on each.

1. “A party may bind itself by an absolute contract to perform something which subsequently becomes impossible.”  This means that, depending on the terms of a contract, it may be that a party has agreed to carry out certain obligations or to pay damages for failure to do so, come what may, so that it cannot later argue that its contractual commitment to do so has been frustrated.
2. Frustration occurs when, without default of either party, a contractual obligation has become incapable of being performed.
3. The circumstances constituting frustration should be strictly scrutinised and the doctrine is not to be applied lightly.
4. Self-induced frustration automatically precludes reliance on the doctrine.  In other words, a party may not rely on its own conduct as a basis on which to argue that a contract has been terminated by frustration.
5. All of the circumstances of the contract should be scrutinised strictly.
6. The frustrating event must be unexpected.
7. If one party did or should have anticipated the possibility of the event alleged to cause the frustration and did not incorporate a clause in the contract to deal with it, that party should not be permitted to rely on the happening of the event as causing frustration.

Frustration v Force Majeure

Where a contract includes a force majeure clause, the courts are generally reluctant to apply the doctrine of frustration. The specific facts of the case will be key having regard to (i) the scope and precise wording of the force majeure clause, and (ii) whether the parties anticipated or should have anticipated the possibility of the extenuating circumstance (which is claimed to have frustrated the contract) occurring.

Even if the contract has not been frustrated and/or a force majeure clause is not applicable, it may be that the contract can be terminated for other reasons, including a termination clause or non-compliance with conditions in the contract. It is therefore important to take advice on the specific contract in question at an early stage.

How can we help?

The Disputes Group at McCann FitzGerald can assist organisations in addressing their concerns about the enforceability of contractual obligations in light of the rapidly evolving COVID-19 pandemic. Alternatively, your usual contact in McCann FitzGerald will be pleased to provide further information.