COVID-19 and Your Contracts

Partner Philip Edmondson, Head of our Commercial Litigation Team, takes a look at COVID-19 and Your Contracts. Can the virus release your or other parties from important contractual obligations?

In her article of 8 April 2020, my colleague Emily Steed discussed the issue of force majeure clauses in contracts and how they might be triggered by the current pandemic. As Emily made clear, force majeure is not a standalone concept of English law and you will need an express force majeure clause in your contract if you wish to rely on that concept to be released from obligations.

In this article I discuss the concept of “frustration”. Frustration is a concept you might need to consider if you or another party believes that a contract cannot be performed. It is a totally separate legal concept to force majeure but unlike force majeure, you do not need an express clause in a contract in order to rely on the doctrine of frustration.

Accordingly, if you believe that the COVID-19 pandemic or some other circumstances render your contract meaningless or pointless or impossible to enjoy the benefits of, then you should consider whether the doctrine of frustration may assist you.

What is legal frustration?

Frustration arises because of the effect of a supervening event on performance, or on the reason for bargaining for that performance in the first place. The best expression by a court of the general test is probably as follows:

"Frustration occurs whenever the law recognizes 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……..[i.e.] It was not this that I promised to do."

Could the COVID-19 pandemic frustrate a contract?

The common law doctrine of frustration may apply, if, as a result of the Coronavirus pandemic, performance of the contract has become legally or physically impossible through no fault of the parties.

War time provides analogies and examples which might help us understand this. During certain wars (such as World War II) many contracts were frustrated because it became legally impossible to trade with certain parties (such as enemy countries or those associated with or supporting them).

Clearly, in the current climate, it has become illegal for certain parties to do certain things. An obvious example being that a pub can no longer operate as a pub and another being that a stadium or venue cannot host a large sporting event or concert. All of this activity is illegal and cannot be done, because the government has legislated to ban it.

One has to be very careful though before jumping to the conclusion that the pandemic leads to the frustration of multiple types of contract. A truly frustrated contract is a very rare beast in normal times. It is important to understand that a frustrated contract ends automatically and immediately (without anyone needing to do anything such as serve notice or the like). A truly frustrated contract will leave the parties with very limited remedies as a result.

If contract performance becomes illegal due to emergency COVID-19 laws (or some related reason), is it frustrated and can the parties agree that the non-performing party must pay damages?

If, after parties entered a valid contract, new legislation is made that prohibits making or performing such a contract, the legislation's effect on the contract is a question of statutory interpretation and may be expressly stated in the statute.

If the legislation does not prohibit making the contract, but some aspect of performance has become a crime (or something very close to a crime – like the pub and stadium examples given above), then public policy will not allow a party to enforce it through the courts. Accordingly, a party could not get an injunction to compel performance of an illegal act, or claim damages for the failure to perform it. The same public policy affects payment duties triggered by illegal acts and, in principle, could affect a payment duty triggered by the failure to perform an illegal obligation.

If, without offending public policy, performance of a contract has become legally or physically impossible then, the contract is truly frustrated. However, a contract is not frustrated if:

• A valid contract term was agreed which addresses, expressly, the situation. Accordingly, if your contract expressly tries to address pandemics or supervening legislation then you may not be able to rely upon the doctrine of frustration and instead may have to rely only on the express words of the contract.
• The parties should have foreseen (or actually did foresee) the frustrating event, when they made the contract. Accordingly, if your contract was made during the pandemic or when it was foreseeable then a party may argue that you cannot rely upon the doctrine of frustration.

Comparison with Force Majeure

The consequences of a contract being frustrated are very different from those of a force majeure event discussed in Emily’s article. For example:

1. If the contract is “frustrated”, parties become released entirely from their contractual obligations. The contract is not just suspended (as it often is as a result of a force majeure) it actually ceases and ends. This gives rise to very material consequences for parties in many cases. The courts are therefore very cautious when applying the principles of frustration. You therefore need to think very carefully indeed before claiming that a contract has been frustrated.
2. In general (but you need to check your contractual terms to be sure), the other things that result from frustration but not necessarily from force majeure are:

• Sums paid to another party before the frustrating event occurred can often be recovered from the recipient and if money was due to be paid at the time of the frustrating event then said sums are not due.
• Parties might have the right to recover costs incurred in performing contractual obligations before the frustrating event. In such circumstances the parties may be entitled to retain some (or all) of any payment they have received from the other party to reflect those costs.
• Where a party has obtained a valuable benefit from the other party’s performance, before the frustrating event, the value of that benefit might be recoverable from the party that benefited.

Frustration is a highly complex area of law. The simplest way to think about it is that it is a concept which can “fill the gaps” if a force majeure clause does not exist or does not deal with the circumstances created by COVID-19.

Conclusion

All businesses would be wise to consider whether they or their counterparties will be able to continue to perform their contractual obligations. If performance may be significantly affected, it is crucial to review the terms of your contracts so you understand your rights and obligations and to allow you to plan and strategise. The key thing is to understand the contract to put yourself in the best possible position in negotiations and to be ready to deal with any situations where agreement is impossible.

For further information on this subject, please contact Philip Edmondson at p.edmondson@mccormicks-solicitors.com.