Sometimes an unexpected event will make the continued performance of a contract impossible or of a completely different nature to that originally agreed. Where this occurs, the doctrine of frustration may provide relief.
What is frustration?
Frustration happens when a supervening event occurs, after the contract has been entered into, which renders performance of a contractual obligation radically or fundamentally different from that contemplated by the parties.
The doctrine of frustration involves a comparison between the contemplated situation, as revealed by the terms of the contract, and the situation that actually results from the supervening event.
However, the doctrine will not apply where the risk of the event is foreseeable, the contract deals with the event or the event was caused or brought about by one of the parties.
When will an event frustrate a contract?
Whether a particular event frustrates the contract depends on how the contract is interpreted and the particular circumstances of the case. To successfully claim that an event frustrates the contract, it must be shown that the parties never agreed that they would be bound by the radically different situation brought about by the event.
The standard of proof required to make out frustration is very high. Increased hardship alone will not be enough. The fact that the burden of performance has been increased or that the method for performance originally contemplated by the contract has been affected, will not of itself amount to frustration.
The doctrine of frustration has been applied to the following events:
- commercial reasons underpinning the contract were removed;
- source of supply not being available;
- performance of the contract rendered illegal by a change in legislation;
- the subject matter of the contract ceases to exist; and
- inordinate delays or greatly increased burden of performance.
The above are merely examples, and the determination as to whether an event frustrates a contract must be considered on its own merits.
When is an event foreseeable?
Where an event is claimed to have frustrated a contract, as a general rule, that event must not have been foreseen by the parties. This is based on the presumption that where an event is foreseeable and the contract does not deal with it, the parties have agreed to bear the risk of that event occurring.
For an event to be foreseeable, the parties must be found to have foreseen the occurrence of the event as a serious possibility. The fact that the parties foresaw the possibility that the event may interfere with or interrupt the performance of the contract does not necessarily prevent that event from frustrating the contract. This is because the extent of the actual interference or interruption may be much greater than what was contemplated.
The case of Ooh! Media Roadside Pty Ltd v Diamond Wheels Pty Ltd provides a good example of how the courts will determine whether an event is foreseeable. The case concerned a license agreement over a billboard located in Melbourne’s CBD, it was held foreseeable that ongoing development in the surrounding area could lead to the billboard becoming obscured. This meant that such an event could not be relied upon to claim that the contract had been frustrated.
When does a contract deal with an event?
Where a contract contains express provisions which sufficiently indicate how the risk of an event will be allocated between the parties, the doctrine of frustration will not apply. The rights of the parties will be governed by the express terms of the contract.
Whether or not a contractual provision will exclude the doctrine of frustration depends upon how the contract is interpreted. For example, even where a contractual provision deals with the consequences of an event, as a matter of interpretation, it may be found to be insufficient to preclude the application of the doctrine of frustration.
A force majeure clause is a good example of a contractual provision that may exclude the operation of the doctrine of frustration. A force majeure clause usually sets out a list of events and provides that a party affected by one of the listed events will be relieved from the performance of contractual obligations or will be entitled to an extension of time.
Courts have held that the existence of a force majeure clause is evidence of the fact that the parties have put their mind to a specific situation. Therefore, if a supervening event is captured by a force majeure clause, then there will be no room for the doctrine of frustration to operate.
Effect of frustration
The effect of frustration automatically discharges the contract 'in futuro'. This means that the parties are released from the obligation to continue performing the contract. The discharge does not affect rights and liabilities that are not contingent upon the future performance of the contract, which accrued before frustration. Those accrued rights and liabilities can be relied upon and enforced by either party.
Under the common law, where a contract is frustrated, neither party can make a claim against the other for the loss occasioned by frustration. Essentially, the loss lies where it falls. For instance, where a contract is frustrated, a contractor will not have any entitlement to claim demobilisation costs or for the loss of profits on the remaining works which have been discharged (contractual provisions and legislation can alter this, which we discuss below).
Unlike the situation where a contract can be terminated for breach of contract (discussed here) or for repudiation (discussed here), there is no ability for a party to insist on the continued performance of a frustrated contract. However, this does not prevent the parties from entering into a new contract.
Contractual and legislative intervention
The effects of frustration can be altered by the parties. Many contracts feature a ‘termination by frustration clause’ which provides for an adjustment to the parties obligations where a contract is discharged due to frustration.
For example, in relation to a frustrated contract, clause 40 of AS 4000 states:
If the Contract is frustrated:
a) the Superintendent shall issue a progress certificate for WUC carried out to the date of frustration, evidencing the amount which would have been payable had the Contract not been frustrated and had the Contractor been entitled to and made a progress claim on the date of frustration;
b) the Principal shall pay the Contractor:
i) the amount due to the Contractor evidenced by all unpaid certificates;
ii) the cost of materials and equipment reasonably ordered by the Contractor for WUC and which the Contractor is liable to accept, but only if they will become the Principal’s property upon payment; and
iii) the costs reasonably incurred:
A) removing temporary works and construction plant;
B) returning to their place of engagement the Contractor, subcontractors and their respective employees engaged in WUC at the date of frustration; and
C) by the Contractor in expectation of completing WUC and not included in any other payment; and
c) each party shall promptly release and return all security provided by the other.
Under AS 4000, in the event the contract is frustrated, the contractor is entitled to payment on the basis that a progress claim had been made on the date of frustration, together with payment of other costs incurred.
Generally, the operation and consequences arising from frustration are governed by the common law. However, in New South Wales, South Australia and Victoria, statutory provisions apply to most frustrated contracts. The legislation requires adjustments to be made between the parties where the contract is frustrated and provides an avenue for the recovery of amounts paid prior to frustration. The purpose of these pieces of legislation is to ameliorate the harshness of the common law doctrine of frustration.
There are three key messages here:
- the standard required to prove frustration is very high, you must have regard to the terms of your contract and the circumstances of the case;
- if you think your contract might be frustrated, consider whether your contract deals with the event, such as through a force majeure clause; and
- at common law, losses lie where they fall, but the contract itself or legislation can alter this position.
If you believe that your contract has been frustrated, we would always suggest seeking legal advice before you take action. This is because if you mistakenly insist that a contract is frustrated, you may end up inadvertently repudiating the contract.