This article is the first in a series with a focus on problematic commercial contract issues and considers the effect of contractual frustration and force majeure on the parties’ contractual obligations to each other.
Part 1: Frustration
Under the common law doctrine of “absolute liability”, if a party voluntarily enters into a contract, that party must perform all its agreed obligations, even if performance is impossible, and failure to perform would render the non-performing party liable to compensate the other party.1 The justification for this was that a party could always negotiate for contingences. However a strict application of this can have unfortunate results if, for example, performance becomes impossible through neither party’s fault.
The “doctrine of frustration”
In 1863 the court2 acknowledged this hardship and found that there should be an automatic mutual discharge of the contract where performance becomes impossible, with neither party being at fault, and the obligations under the contract being “radically different” from those contemplated by the parties to the contract. This is called the doctrine of frustration. The legal consequence of a contract found to have been frustrated is that the contract is automatically terminated at the point of frustration. The contract is not void ab initio ("from the beginning"), it is only future obligations that are discharged. This means that, after the point of frustration neither party can demand further performance by the other. At common law, obligations which fell due for performance before the frustrating event are valid, and if the obligation is not performed the innocent party can seek a remedy. Furthermore, contractual promises that were not conditional upon further performance of the contract may remain enforceable, as may terms in the contract that are clearly intended to be operative after termination (whether or not by frustration). An example of this is an alternative dispute resolution process which, if drafted correctly, always binds the parties after termination.3
Examples of frustrating events
Some examples of frustration include:
- Physical destruction of the subject matter of the contract.4
- A change in the law rendering performance illegal.5
- Restraint by injunction.6
- Non-occurrence of an event which formed the basis of the contract.7
- Outbreak of war.8
Examples of non-frustrating events
A contract not will normally be found to be frustrated in the following situations:
- Construction delays, shortage of materials, and shortage of skilled tradespersons as these are inherent risks in construction, and therefore reasonably foreseeable.9
- A supervening event that was contemplated by the parties, even if the parties fail to anticipate the severity.10
- Self-induced frustration.11
- Hardship, inconvenience or a bad bargain.12
How to avoid frustration
If we draft a contract broadly enough to cover new situations, we may be able to avoid the contract being frustrated, but can instead codify the effect of a particular event in our contract. An example of this is a force majeure clause which avoids frustration by specifying that there will be a suspension of performance due to a supervening event where neither party is at fault. Performance can then usually resume when the event has passed. Examples of such an event are flood, bushfire, nationwide airline strike and so on. Force majeure clauses will be discussed in Part 2 of this article.
The law of restitution
The question of whether any contractual pre-payments are to be repaid in the event of frustration is not yet settled. However, it is considered that the High Court may follow the Fibrosa13 case and rule that where there has been a total failure of consideration, a prepayment is recoverable in quasi-contract. This is an attempt to prevent unjust enrichment.
The effect of statute
Under the common law doctrine of frustration losses lie where they fall. An example is where a venue hire deposit has been paid for an event for this Saturday night, but the venue burns down the day before the event. Under the common law, the contract has been frustrated and all obligations from the point of frustration will cease for both sides. However, subject to recovery under restitution (discussed above), the deposit would be forfeited. In Australia only three jurisdictions have created legislation to reduce this harshness: New South Wales (Frustrated Contracts Act 1978), South Australia (Frustrated Contracts Act 1988), and Victoria (Australian Consumer Law and Fair Trading Act 2012). Each statute operates slightly differently however the overarching aim is to provide a fair result where, for example, in the example case the deposit would be repaid.
Key frustration law takeaways
- Where further performance of a contract is impossible or futile due to a supervening event, the contract is frustrated and terminated by that event, discharging the parties from further performance.
- At common law, prior obligations still apply,14 as do those that would always survive termination (such as dispute resolution).
- Contracts are not terminated by frustration where there is a bad bargain, the events were foreseen, or there is hardship. However delay, destruction of the subject matter, and outbreak of war may result in frustration where the commercial purpose of the contract has been frustrated.
- If the return of a deposit etc is important, and you do not want to rely on the restitutionary remedy of total failure of consideration, then when drafting the contract you can: (1) ensure that your contract is subject to the laws of one of the three jurisdictions where the doctrine of frustration has been amended by statute (NSW, South Australia or Victoria); or (2) use an appropriate force majeure clause.
Part 2: Force Majeure
To overcome the limited application of the doctrine of frustration discussed in Part 1, a “force majeure” clause is often used. This is an express agreement in the contract as to how risk is to be allocated should part or non-performance occur as a result of certain specified events. The force majeure clause was borrowed from the French Civil Code, and means “superior force”. It operates to exclude liability where a party's failure to perform is caused by forces (either natural or human) beyond its control, and usually goes beyond “Acts of God” (for example tornado, flood, tidal wave etc). However, under the principles of ‘freedom to contract’ parties are free to define it and set its parameters as they see fit. Under a contract parties, cannot normally invoke a force majeure clause if they are relying on their own acts or omissions. The effect of a force majeure clause is that it enables the non-performing party to escape liability for failing to perform as a result of the force majeure event.15
What you need to show to get the protection of a force majeure clause
Generally there are three essential elements to force majeure:
- It can occur by forces either natural or human.
- It cannot have reasonably been foreseen by the parties.
- It was completely beyond the parties' control and they could not have prevented its consequences.16
Key parts of a force majeure clause
When drafting or reviewing a force majeure clause consider the following:
- Definitions: in addition to stating that the clause relates to acts beyond the reasonable control of the parties, specific events should be defined. Examples include electricity supply strikes, insurrections, riots, and wars. Key terms which have a degree of imprecision such as “Acts of God” should be defined and, with natural events, can be defined as including floods, bushfires and earthquakes.17
- Effect on obligations: the agreement should identify the obligation, how it will be affected by the force majeure event, and be clear as to the:
- Obligations on the parties arising when a force majeure event occurs. For example:
- Will there be an obligation of mitigation?
- Whether the buyer can engage another party to do the work if the seller cannot perform it due to a force majeure event, and whether the buyer can then charge the seller.
- Will payments to the vendor continue notwithstanding the delay?
- What will be the duration of the force majeure temporary period, for example 30 days, and then what happens after this maximum temporary period ends, that is after the 30th day? Will the contract be terminated or terminable by notice?
- What will happen to payments that ordinarily would have been incurred for late or non-delivery?
- Will the agreed number of units still need to be supplied, or is the contract terminated or terminable?
- Obligations on the parties arising when a force majeure event occurs. For example:
- Obligations on the parties after the force majeure event ceases. For example what does the non-performing party need to do to catch up with its obligations?
- Notice: the agreement should contain a requirement that the party unable to perform must advise the other party as soon as reasonably possible about the force majeure event, the expected duration of non-performance and what, if anything, can be done to ensure continuity of supply for the buyer (if the party unable to perform is the vendor).
Force majeure and the purchaser and vendor
Normally it is not in the interests of a purchaser to include a, force majeure clause in a contract because it seeks an uninterrupted service, and the effect of a force majeure clause is that the service may be temporarily interrupted without vendor liability. Consequently, if pressured by a vendor to include a force majeure clause the purchaser should consider the definition, effect on obligations and notice issues discussed above. Vendors normally seek to protect themselves through a wide definition for example: Neither party will be, or deemed to be, in default of, or in breach of any Agreement, as a result of the effects of Force Majeure. Force Majeure will include any cause beyond the reasonable control of either party, and include, but are not limited to, Acts of God, strikes, insurrections, riots, wars, terrorist acts and Government restrictions.
Matters that can affect the interpretation of a force majeure clause
As force majeure clauses are creatures of contract, their interpretation will be governed by:
- The agreed width of the clause. For example, the vendor will want to use the words “…and include, but not limited to …” but the purchaser will want to narrow the width by seeking to remove these words.
- The normal rules of contractual construction:
- According to the contra proferentem rule the clause will be construed strictly and in the event of any ambiguity the clause will be interpreted against the interests of the party that drafted it. The parties may contract out of this rule; and
- According to the ejusdem generis rule, when general wording follows a specific list of events, the general wording will be interpreted in light of the specific list of events. In this context it means that when a broad "catch-all" phrase, such as "anything beyond the reasonable control of the parties", follows a list of more specific force majeure events, the catch-all phrase will be limited to events analogous to the listed events. Wording such as "including, but not limited to, ..." seeks to subvert this rule.
Insufficient thought given to the force majeure clause
Clauses such as indemnity and capping of liability are often fiercely negotiated, but other clauses such as force majeure are not. Lack of thought as to the composition of the force majeure clause can be very costly.
Key force majeure law takeaways
- The effect of a force majeure clause is that it enables the non-performing party to escape liability for failing to perform contractual obligations as a result of the force majeure event.
- Parties cannot invoke a force majeure clause if they are relying on their own acts or omissions.
- The seller should insist on a force majeure clause, and then keep it a wide as possible.
- The buyer should resist the clause in the contract or keep it as narrow as possible, as non-compensated supply interruptions can be very damaging.
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Co-authored by Dr Cyril Jankoff at The Risk Doctor.