Force Majeure clauses and Frustrated Contracts in a Pandemic

Business Law: 29 March 2020

The ways in which parties may deal with their legal obligations when a contract becomes difficult or impossible to perform, apart from termination, are generally limited to reliance on a force majeure clause or on the doctrine of frustration.

Force Majeure

Temporary or permanent relief, or partial relief, from a party's obligations under a contract may be available under a force majeure provision included in the contract. There is no implied entitlement to be relieved of obligations in the absence of such a clause. Typical clauses will give rise to relief where a party is not able to fulfil all, or some of its, obligations due to circumstances beyond its control, which could not reasonably have been foreseen or overcome by the exercise of due diligence.

The fact that the event, or act of force majeure, has made the contract less profitable for a party, albeit it can still perform its obligations, would not normally be enough to justify enlisting the force majeure clause. Parties generally cannot rely on their own acts or omissions to invoke a force majeure clause. Any emergency legislation enacted by the Government may prevent performance, and this will likely constitute an act of force majeure.

Each force majeure provision must be considered to see whether the necessary criteria are met to enable a party to have the benefit of the clause. Pandemics are not usually specifically referred to, and it will be a question of interpretation as to whether the current circumstances are covered in each case.

If the clause can be read to include the COVID-19 pandemic, it is important to ensure compliance with the applicable requirements in the event of force majeure e.g. the giving of notice (within the specified timeframe) to the other party about the circumstances.

The party seeking to rely on the force majeure clause has a responsibility to limit the extent to which its obligations are affected by the force majeure event.

Once it is determined that a force majeure clause may be invoked, it will be important to ensure to comply with the specific requirements of the clause. Clauses are likely to include notification obligations and may enable suspension of obligations, non-liability for non-performance, extensions of deadlines while the event continues and, ultimately, termination.

Clauses will usually provide that the relief will last for only as long as the force majeure event and if it is protracted, the parties will have a right to terminate after a particular time.

In the absence of a force majeure clause sufficient to cover the current circumstances, the party not in breach of its obligations under the contract is likely to be able to terminate for breach. Consideration should be given to other alternatives including amending the agreement by consent to allow an appropriate moratorium on the affected party's obligations.

Other provisions in a contract may be able to be invoked including price adjustment clauses and limitation, or exclusion, of liability clauses.

When considering termination, the termination clause, together with any liquidated damages clause specifying the appropriate remedy, should also be considered.

Outside the contract or agreement, termination may occur by reason of repudiation by one party, where, by its behaviour, it has indicated that it does not intend to perform the contract.

Frustrated contracts

Where the COVID-19 pandemic renders performance of contractual obligations impossible, illegal (e.g. a government direction precludes performance) or radically different from what was intended by the parties, frustration may allow the parties to discharge the contract.

The ability for a contract to be discharged for frustration arises at common law and, in New South Wales, South Australia and Victoria, under statute. No provision providing for discharge or frustration is required for the principle to be invoked.

The scope of the doctrine of frustration is very narrow and will not be successfully invoked where there has been mere hardship, however severe; where the event in question has been foreseen, or could have been foreseen; or where the change is only temporary or transient.

A contract may become frustrated when an event outside the party's control makes a contractual obligation "incapable of being performed because the circumstances in which performance is called for would render a thing radically different from that which was undertaken by contract.The event must be fundamental to the contract, and not simply a minor temporary issue or something which makes performance more difficult or costly. Shortages of materials or personnel will not in themselves justify termination of a contract due to frustration. This will however be a factor in determining whether a contract has been frustrated in the current pandemic environment.

Where the contract has been frustrated in this way, it is automatically terminated at the point in time when it is frustrated, not from the beginning, but only as to future obligations, so that no party can demand further performance. Obligations prior to the point of frustration must be met and, if not, the other party is entitled to appropriate relief.

Some contractual promises may remain enforceable because they were not conditional upon further performance of the contract. Further, terms in the contract that are clearly intended to be operative after frustration can still bind the parties e.g. alternative dispute resolution clauses. For example, in a leading case in the area, Codelfa Construction Pty Limited v SRA of New South Wales (1982) 149 CLR 337, a term requiring any contractual dispute to be submitted to arbitration still bound the parties, even after the frustrating event took place.

Parties are not required to wait-and-see the effect of the problem occurrence and can rely on a fair assumption as to the consequences of a particular event on their ability to perform their obligations. In considering this, account must be taken of the effects on both sides of the chain of responsibility.

Part 3.2 of the Australian Consumer Law and Fair Trading Act (Vic) 2012 deals with contracts whose performance has become impossible or which are otherwise frustrated. New South Wales and South Australia have their own frustrated contracts legislation.

Section 36 provides that all amounts paid to any party under a discharged contract before the discharge are recoverable and all amounts payable to any party under such a contract before the time of discharge cease to be payable.

Courts may allow parties to a discharged contract to whom amounts are payable or who have incurred expenses before the discharge, to retain or recover the appropriate amounts. They may also order parties who have received benefits under a discharged contract to repay those benefits to the other party but where a part of the contract has been wholly performed that part of the contract can be enforced e.g. to recover payment for services provided.

With Julie Maxfield

For more information please contact Stephen Curtain - 03 8600 6042 or 0417 373 545