The UK Court of Appeal was recently asked to consider the vexed question of exactly when a commercial agreement will be frustrated.
A contract will be frustrated when an event occurs after the contract has been made which so fundamentally affects the essence of the contract that it makes it impossible for one or both parties to fulfil their contractual obligations. The contract is automatically discharged by the frustrating event and the parties are relieved from future performance. As the contract has been discharged by a supervening external event beyond the control of the parties, the parties may not sue each other for any losses that result.
There is some uncertainty around the exact scope of the doctrine of frustration and this ruling has brought some welcome clarity.
In this case, the claimant (C) franchised its business, which included a business telephone answering service. C decided to change its business model by centralising the telephone answering service and engaged the defendant (D), under the ‘contractor agreement’, to help deliver a successful business transition. The change to the operation of the telephone answering service had an adverse impact on the businesses operated by C’s franchisees. They voiced their opposition to the changes in various email exchanges, which ended with the franchisees terminating their franchise agreements and setting up rival businesses. D argued that the conduct of the franchisees had frustrated the purpose of the contractor agreement. It argued that there was, in effect, no real franchised business left to help transition.
The Court of Appeal disagreed. It held that the contract had not been frustrated. The court gave four main reasons for reaching that conclusion:
First, the court found on the evidence that the franchisees had been somewhat mistreated by C during the negotiations around the transition. The court observed that the correspondence between them “was never less than polite but it was not placatory, indeed it was to a degree confrontational”. The court did not go as far as saying that C was at fault but it did conclude that the “departure of the franchisees was promoted by the acts of [C]”. A frustrating event must be one entirely beyond the control or fault of the contracting parties and so this conclusion pointed against the contract having been frustrated.
Second, the court also found that the contractor agreement still had purpose. The court looked closely at how the services to be provided by D had been defined in the agreement. It found that D was not only obliged to help with C’s business transition in relation to the existing franchisees but also to help C get its business model in order so as to grow its business more generally by recruiting new customers and franchisees. D was still able to provide those services. Performance of the contractor agreement was not impossible.
Third, a frustrating event must be one entirely outside the contemplation of the contracting parties. The court held, however, that C and D must have foreseen the adverse reaction of the franchisees as a real possibility given the likely negative impact on their franchised businesses. The court found that the contractor agreement, placed in its context, must be taken to have contemplated that the franchisees might not be persuaded to accept the business transition and that that possibility was at C’s risk.
Fourth, the franchisees had all terminated their franchise agreements by 5 October 2011 but C and D had continued with the contractor agreement for five months, until February 2012. The court said that the parties’ delay in treating the contract as at an end, and the fact that D continued to provide services to C during that period of delay in return for payment, was consistent with the conclusion that there was no frustrating event.
This ruling confirms that the doctrine of frustration is narrow in scope. There can be serious financial and commercial consequences for one or both of the contracting parties where an agreement has been brought to an end automatically by operation of law, and so the courts will not allow contracts to be frustrated lightly.
There has been much speculation around whether Brexit itself, or certain Brexit related events, could frustrate commercial agreements. Given that Article 50 will be triggered on 29 March, businesses are again focusing on what exactly Brexit will mean for existing commercial relationships. Whether any particular contract is frustrated by a Brexit related event will depend on the particular terms and context of that agreement. However, contracting parties should be aware that they may have to overcome a high hurdle to convince a court that a Brexit event should operate to release them from their future contractual obligations.