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Covid-19 and commercial contracts: Frustration

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The Covid-19 pandemic is likely to lead to a wave of disputes as to which party bears the risks of non-performance.  There are some key principles which commercial parties should consider in order to assess the likely outcome of any dispute before risking litigation, as highlighted in this series of blogs.

Has the contract been frustrated by the Covid-19 pandemic?

It may be that the contract has been ‘frustrated’ as a result of the Covid-19 pandemic such that performance of the contract has become legally or physically impossible through no fault of the parties. 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”.  In practice, it is unusual to see a contract frustrated in law and the last time multiple contracts were frustrated was during WW2 when it became legally impossible to trade with the enemy.   However, it is worth considering as an option as a frustrated contract ends automatically and immediately, without any action by the parties, who then have only limited rights of redress.

Cases on frustration broadly fall into three subcategories:

  1. impossibility of agreed performance;
  2. the mutually agreed purpose of the contract becoming impossible (i.e. impossibility of the “commercial adventure”); and
  3. a significant change to a mutually agreed state of affairs (i.e. destruction of the subject matter of the contract or cancellation of an event).

If contract performance has become illegal due to the Covid-19 pandemic, is the contract frustrated?

If some aspect of performance of a contract has become a crime (or something very close to a crime), then public policy will not allow a party to enforce it through the courts. So, for example, 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 performance of a contract has become legally or physically impossible then the contract is frustrated. However, note that a contract is not frustrated if:

  1. a valid contract term deals with the situation; or
  2. the parties should have foreseen (or actually did foresee) the frustrating event, when they made the contract.