Covid-19 and your business: Frustration of contracts and other considerations

By Sarah Slevin
26 March 2020

In practice, force majeure clauses, which are agreed between the parties by way of the contract itself, are preferable to relying on the doctrine of frustration. There are a number of reasons for this, but primarily these are the lack of certainty in relying on a legal doctrine that may or may not apply, the need to involve lawyers and/or the courts in order to determine if the contract has, indeed, been ‘frustrated’, and the limited remedies that frustration can offer.

In reality, however, we know that contracts may not have been drafted with such scenarios in mind. Parties, particularly where legal advice was not sought in advance of signing/drafting the contract, will likely not have considered providing for a situation in which the contract may not be capable of being performed as intended due to prevailing circumstances outside of the control of the parties. The current Covid-19 crisis is a prime example of one that was certainly not foreseeable and thus may not be covered by provisions in your contracts.

Our Insight considers the application of ‘force majeure’ clauses in commercial contracts to the global pandemic that is COVID-19. However, many businesses may be finding that their commercial agreements do not adequately provide for force majeure events, if at all, or are otherwise unable to rely on such a clause (if desired) to address the implications of COVID-19 on the obligations of the parties under that agreement.

In such circumstances, the common law (being ‘judge-made’ law) provides for a separate mechanism that may be worth examining in the context of particular agreements and circumstances, being the doctrine of frustration. Below we will consider how what this doctrine provides for, what conditions are necessary in order for the doctrine to apply, and what consequences it would have for the parties.

Frustration: What it is

‘Frustration’ of a contract occurs where circumstances beyond the control of the parties mean that the contract can no longer be performed. It may also be the case that the obligations under the contract have become radically different from those originally envisaged due to those prevailing circumstances.

The event in question must also fall outside the control of either party, and must not have arisen due to fault on the part of the party seeking to rely on the doctrine (i.e. ‘self-induced’). The foreseeability of the event is also a relevant consideration, as where the parties could have anticipated an event but have failed to provide a mechanism for dealing with same in the contract, frustration will not be found and the contract will remain in place.

Frustration: What conditions are needed

The threshold for the frustration of a contract is very high. The key point here is that the obligations must become impossible to perform. It will not be sufficient that the obligations simply become more difficult, more costly and/or more time-consuming to perform.

For example, if it became illegal to provide a particular service (as may be the case in Ireland in light of legislation passed by the Oireachtas last week) this may trigger frustration of a contract to provide such services. In contrast, a significant drop in revenue/business due to COVID-19 would not allow a party to refuse to make any payments due under and agreement.

Frustration: What happens when it applies

A contract becomes frustrated when the future obligations of the contract can no longer be performed. Because these obligations cannot be performed, the parties are discharged from them. Unless there are obligations that are clearly separate under the contract and can be severed from the contract as a whole, frustration discharges the obligations with respect to the entire contract.

As is clear from the above description of the conditions needed for frustration to arise, it differs significantly from force majeure, which can, depending on how the clause is drafted, cater for a wide range of scenarios, such as partial frustration, suspension, etc. rather than solely the full termination of the contract, which frustration would cause.

Having regard to the limited scope of frustration as set out above, there are other contractual mechanisms which may provide assistance to businesses in these uncertain times:

• Force Majeure events – (see here).

• Termination for Convenience – a contract may contain a right to terminate for convenience on notice which allows either party to terminate the contract at any time or without giving any reason. Any such provisions should be reviewed to determine if there are other means by which the contract could be ended.

• Variation Mechanisms – usually, contracts may be amended by following the procedure set out in the contract. Appropriate amendments could be agreed between the parties to accommodate current circumstances.

• Service/Price Variation Mechanisms – agreements may also contain specific protective measures in clauses allowing the contracting parties to vary the selling price or service levels under certain conditions. Service agreements and SLAs, in particular, may make provision for changes in the nature/amount of services provided and or amounts payable where certain criteria are met. It is important to review any such price variation mechanisms in contracts at this stage and, if present, whether difficulties arising from the COVID-19 outbreak, will trigger such provisions.

• Contract Management Mechanisms – certain “softer” provisions may be embedded in your contracts e.g. change control mechanisms or the ability for example cancel orders. While change control mechanisms will not relieve a party of liability in circumstances such as the COVID-19 outbreak, they may compel an obligation to engage in good faith discussions on changes which should be made to the contract in light of any difficulties affecting the supply chain. At the very least, these mechanisms should bring the contractual parties to the table and kick-start a resolution process. In respect of these softer provisons the parties should be aware that their contract may in fact be in terms and conditions attached to any purchase order and when looking for other remedies, it is worth scrunitising these terms and conditions.

• Dispute Resolution Mechanisms– if necessary, contracts will often provide for mechanisms (outside of the courts) to resolve disputes.

• Insurance – businesses should also review their insurance policies to determine if losses incurred would be insured losses (particularly if business interruption insurance is held).

Conclusion

Whilst it is possible that we will see a resurgence in the doctrine of frustration as a relevant part of the law of contract for the foreseeable future, the extent to which is successfully claimed given the narrowness of its scope remains to be seen.

In any case, we strongly suggest that you review your key contracts now to determine what effect COVID-19 may have and what can be done now to best protect your business. RDJ can assist you in considering your particular circumstances and advising on the best course of action.

Regarding your own business relationships, maintaining communication and good relations is obviously crucial in a time of increasing economic and social uncertainty. Into the future, post-COVID-19 world, businesses should seek to provide for and set out the circumstances beyond the control of the parties that need to be addressed in contracts and also set out the consequences for the contracts of those circumstances arising, including performing the contract to the extent possible and/or exiting the contract.

For more information on the content of this Insight, please contact:
Sarah Slevin, Solicitor | E. sarah.slevin@rdj.ie | T. +353 1 6054259
Maria Walsh, Solicitor | E: maria.walsh@rdj.ie | T: +353 1 6054236