09 Nov Covid-19 Pandemic and the doctrines of Force Majeure and frustration of Contract: Impact on Commercial Contracts
The Covid-19 pandemic has become one of the most serious threats to global markets and international trade seen in recent times with the attendant job losses and many businesses facing insolvency or bankruptcy coupled with the crash of the global stock exchanges. The pandemic has squeezed both supply and demand with vast numbers of businesses experiencing a collapse in revenue — and in many cases a complete suspension of operations — there is an acute risk of inability to fulfill contractual obligations due to the widespread bankruptcies and business closures.
Given the supply chain disruption caused by the Covid-19 pandemic, it is likely that performances under many contracts will be delayed, interrupted, or even cancelled. Counterparties (especially suppliers) to such contracts may seek to delay and/or avoid performance (or non-performance liability) of their contractual obligations and/or terminate contracts, either because Covid-19 has legitimately prevented them from performing their contractual obligations, or because they are seeking to use it as an excuse to extricate themselves from an unfavorable deal. Principally this will be by activating Force Majeure clauses and invoking the doctrine of Frustration.
As additional restrictions are imposed on gatherings, work, and travel, businesses’ ability to perform their contractual obligations may be impaired or altogether precluded. Fortunately, businesses may have contractual recourse as a result of a force majeure clause or the common law doctrine of frustration of contract.
This paper seeks to examine the impact of the pandemic vis-à-vis the impracticability or impossibility of fulfilling contractual obligations and how the doctrines of force majeure and frustration of contract can provide relief to a party prevented (or hindered, impaired or adversely affected) from performing its obligations under a commercial contract.
Black’s Law Dictionary and the Merriam Webster Dictionary define force majeure —as an event or effect that can be neither anticipated nor controlled. The term is commonly understood to encompass both acts of nature, such as floods and hurricanes, and acts of man, such as riots, strikes, and wars. In the Nigerian context, the Court of Appeal in GLOBE SPINNING MILLS (NIG) PLC v. RELIANCE TEXTILE INDUSTRIES LTD defined it as:
“a clause inserted in a contract which allows parties to rescind a contract upon the occurrence of certain specified events beyond the control of parties making performance unrealistic and impossible”.
From a contractual perspective, a force majeure clause provides temporary reprieve to a party from performing its obligations under a contract upon occurrence of a force majeure event. A force majeure clause in a contract would typically include an exhaustive list of events such as acts of God, war, terrorism, earthquakes, hurricanes, acts of government, explosions, fire, plagues or epidemics or a non- exhaustive list wherein the parties simply narrate what generally constitute force majeure events and thereafter add “and such other acts or events that are beyond the control of parties”.
Frustration of contract, on the other hand, is a defence available to a defendant who would otherwise be liable for breach of contract for non-performance of contractual obligations but for the occurrence of a fundamental event that makes it impracticable or impossible to perform the contract. Simply put, once an event occurs capable of rendering performance of a contract impossible and different from what the parties contemplated and strikes at the substratum of the contract, the doctrine of frustration applies. Hence, frustration is the happening of an act outside the contract and such act makes the completion of performance of a contract impossible.
In Nigeria, it has been held in judicial decisions that a “frustration” occurs wherever 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 radically different from what was undertaken by the contract .
In A. G. CROSS RIVER STATE v. A. G. FEDERATION , the Supreme Court held that frustration of contract occurs:-
“where it is established to the satisfaction of the court that due to a subsequent change in circumstances, the contract has become impossible to perform. Frustration of contract arises where a supervening event destroys a fundamental assumption for the contract. In other words, frustration of contract occurs whenever the law recognises 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 what was undertaken by the contract.”
Frustration brings a contract to an end immediately and automatically: MARITIME NATIONAL FISH LTD. V. OCEAN TRAWLERS LTD.
Ordinarily, the law takes legally binding contracts seriously. It is difficult to get out of contracts and escape liability for performance, even when something happens that makes it harder, more expensive or onerous to perform. Frustration of contract is the general law’s method of allowing parties to be relieved of their legal obligations. Historically, there had been no way of setting aside an impossible contract after formation; it was not until 1863, and the case of Taylor v Caldwell that the beginnings of the doctrine of frustration were established. Here, two parties contracted on the hire of a music hall, for the performance of concerts. Subsequent to contracting, but prior to the dates of hire, the music hall burned down. It was held the contract was impossible to perform.
Hardship, even if severe, does not constitute frustration. This was put in perspective in the classic test of frustration from England, DAVIS CONTRACTORS LIMITED v. FAREHAM URBAN DISTRICT COUNCIL . In that case, Davis Contractors agreed with Fareham UDC to build 78 houses over eight months for £92,425. It ended up taking 22 months, because Davis was short of labour and materials. It cost £115,223. Davis submitted the contract was frustrated, void, and therefore they were entitled to quantum meruit for the value of work done. The House of Lords held that although the performance of the contract had become more onerous it was not frustrated.
Difference between force majeure and frustration of a contract :
Under the doctrine of frustration, impossibility of a party to perform its obligations under a contract is linked to occurrence of an event/circumstance subsequent to the execution of a contract and which was not contemplated at the time of execution of the contract. However, in the case of a force majeure, parties typically identify, prior to the execution of a contract, an exhaustive list of events, which would attract the applicability of the force majeure clause.
For frustration of a contract to be invoked and applied requires that the entire subject matter or underlying rationale for the contract be destroyed. Doctrine of Frustration renders the contract void and consequently all contractual obligations of the parties cease to exist. Frustration of a contract is the end result of events arising after the contract was executed. Whereas a force majeure is a contractual provision contemplating an event, which can result in deferment of performance of contractual obligations and therefore rights of parties thereunder until such event continue and typically does not absolutely excuse parties from performing their obligations.
Typically, where a force majeure event is not specifically covered under a contract, frustration of a contract may be claimed by the affected party, however, if the case is opposite and a particular event is covered as a force majeure event under a contract, frustration of such contract cannot be automatically claimed.
Force majeure clauses in a contract suspend performance in the occurrence of supervening events not the fault of either party but maintain the existence of the contract unlike frustration of contract which puts an end to the contract because it has become impossible to perform.
Difference between impracticability of performance and impossibility of performance:
Force majeure clause does not give a blanket protection against any non-fulfillment of contractual terms. In practice, most force majeure clauses do not excuse a party’s non-performance entirely, but only suspend it for the duration of the force majeure. It is important to note that force majeure clauses do not generally provide for termination of an agreement; rather, they generally suspend a party’s obligation to perform under the agreement for the duration of the force majeure event. Where the supervening event was contemplated as noted above, the doctrine of frustration will not apply and recourse will be had to the force majeure clause if not parties may have recourse to frustration of contract if the circumstances permit.
In business contracts, the language of the specific force majeure provision is the key factor in determining whether the force majeure clause will apply in a pandemic situation, such as the current COVID-19 situation. Some force majeure provisions will expressly exclude pandemics or global health crises from the application of the force majeure clause, while others will expressly include such health events, and still others will be silent on the issue.
Whether performance is excused depends on the event that makes performance impossible or unfeasible, and whether that event was contemplated under the contract. If the event was so unusual and unexpected that the parties could not reasonably have foreseen it, and if it is unfair to place the risk of its happening on either party, then a Court may excuse further performance of the contract on both sides. On the other hand, if the risk that such an event could happen was one that the parties should reasonably have anticipated, or if the contract assigned that risk to one of the parties, then a court normally would not excuse further performance. Known risks assigned by contract will not excuse performance no matter how disastrous the consequence of that risk.
There are at least three levels of impossibility including :
Impossibility of performance:
Where performance becomes physically impossible, further performance would almost certainly be excused. For example, a roofing contractor would not be in breach for failing to complete a roof on a building destroyed by fire through no fault of his.
Frustration of purpose:
Where the principal purpose of a contract is destroyed, further performance would probably be excused, absent a contract provision to the contrary. For example, the roofer who contracts to buy material for use on a building destroyed by fire may be able to cancel that material contract. While the purchase of roofing material is not rendered impossible by the fire, the purpose for which the materials were contracted is impossible to achieve through no one’s fault.
Where performance becomes so difficult or costly that the value of the contract to one party is destroyed, continuing that performance to completion may be financially impractical.
However, despite severe economic consequences, further performance may not be legally excused unless the direct cause of the difficulty could never have been foreseen. Absent extraordinary circumstances, losing money is not a legal defence to a breach of contract action.
Where performance is excused after work has begun, recovery will usually be allowed for the fair value of work actually performed based on quantum meriut, but not for lost profits on work not done as could be recovered in a breach of contract action.
In summary, unanticipated circumstances may excuse a failure to perform contract work completely but only where:
• an unexpected event occurs without the fault of the party invoking the defence;
• that event makes further performance impossible or so difficult or expensive as to frustrate the purpose of the contract or destroy its value; and
• Impossibility of performance is often raised as a defence for breach of contract. For example, the party that is accused of breach may be excused from the breach if they can prove that it would have been impossible to perform the contract.
Conversely, impracticability is similar in some respects to the doctrine of impossibility because it is triggered by the occurrence of a condition which prevents one party from fulfilling the contract. The major difference between the two doctrines is that while impossibility excuses performance where the contractual duty cannot physically be performed, the doctrine of impracticability comes into play where performance is still physically possible, but would be extremely burdensome for the party whose performance is due. Thus, impossibility is an objective condition, whereas impracticability is a subjective condition for a court to determine.
In regards to frustration of contract, a contract does not become frustrated merely because it has “become difficult to perform” as against “become impossible to perform”. A contract is not frustrated merely because the circumstances in which it was made are altered. The Courts have no general power to absolve a party from the performance of its part of the contract merely because its performance has become onerous on account of an unforeseen turn of events.
In an instructive English judgment namely, TSAKIROGLOU & CO. LTD. V. NOBLEE THORL GMBH , despite the closure of the Suez canal, and despite the fact that the customary route for shipping the goods was only through the Suez canal, it was held that the contract of sale of groundnuts, in that case, was not frustrated, even though it would have to be performed by an alternative mode of performance which was much more expensive, namely, that the ship would now have to go around the Cape of Good Hope, which is three times the distance from Hamburg to Port Sudan. The freight for such a journey was also double. Despite this, the House of Lords held that even though the contract had become more onerous to perform, it was not fundamentally altered. Where performance is otherwise possible, it is clear that a mere rise in freight price would not allow one of the parties to say that the contract was discharged by the impossibility of performance.
Flowing from the foregoing, a contract is not frustrated merely because its execution becomes more difficult or more expensive than either party originally anticipated and has to be carried out in a manner not envisaged at the time of its negotiation .
Secondly, if the obligation under a contract was due before the frustrating event, the subsequent occurrence of the frustrating event does not discharge that contract. Thus, all legal rights already accrued or money already paid, which has become payable before the frustrating events occurred remains intact, while obligations falling due for performance after the event are discharged .
In addition to the above two instances, it is pertinent to note that the doctrine of frustration also does not occur where:
(i) the intervening circumstance is one which the law would not regard as so fundamental as to destroy the basis of the agreement.
(ii) the terms of the agreement show that the parties contemplated the possibility of such an intervening circumstance arising.
(iii) one of the parties had deliberately brought about the supervening event by his own choice .
Whether a contractual obligation can be avoided on the grounds of force majeure or frustration of contract is a factual determination based on the specific terms of the contract or the alleged frustrating event. The courts would examine, whether in each case, impact of Covid-19 pandemic prevented the party from performing its contractual obligation.
As we have seen above, the terms “force majeure” and “frustration of contract” are not one and the same thing in law as they have differing connotations and legal implications. Simply put, frustration of contract puts an end to a contract whereas force majeure only defers the performance of the contract until the supervening event abates or is extinguished.
The relationship between both doctrines is such that force majeure clauses are used in contracts to avoid frustration. To avoid a contract being found to have been frustrated, parties should apportion risks, as far as possible in a force majeure clause embedded in the contract.
Also impracticability of performance may not excuse a party from performance unlike impossibility of performance which will.