Dealing with Frustration and Force Majeure in Contracts
DEALING WITH FRUSTRATION AND FORCE MAJEURE IN CONTRACTS
When entering into a contract with another party, you always hope that the other party will uphold their contractual obligations. However, we do not live in an idealistic world and there will be instances where an unforeseen event will occur which will lead to a contract becoming frustrated. This can potentially lead to delays or termination of the contract, which can be costly and time consuming. The best way of minimising any delay, frustration or further expenses to your contract, is to make sure contractual clauses are properly drafted which identify, assess and allocate the risks and unforeseen events that are associated with the contract.
This article will focus on the effect of contractual frustration and force majeure on parties’ contractual obligations to one another.
Under the common law doctrine of “absolute liability”, where a party voluntarily enters into a contract, that party must perform all its agreed obligations, even if performance is impossible. If the contracting party fails to perform their obligations, they will be liable to compensate the other party. The justification for this was that a party could negotiate for contingences. However, a strict application of this justification could lead to unfavourable results, if for example, performance is impossible through neither fault of the parties.
In 1863, an English Court acknowledged this hardship and held that there should be an automatic mutual discharge of the contract where performance becomes impossible, where neither party are at fault and the obligations under the contract are different to what the parties anticipated under 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 termination at the point of frustration. The contract is not void from the beginning (“ab initio”). It is only the future obligations that are terminated. Therefore, after the point of frustration, neither party can demand further performance to other party. However, at common law, obligations which were required before performance of the frustrated event, are still considered valid, and if the obligation is not performed, the innocent party can seek a remedy against the other.
Any contractual promises that were not conditional upon further performance of the contract may remain enforceable. This may also relate to terms in the contract which were clearly intended to be effective by the parties after termination – irrespective of frustration.
Should you wish to avoid frustration, De Marco Lawyers can draft a contract broadly enough to apply to new situations or circumstances which can assist parties seeking to avoid the contract being frustrated. For example, force majeure clauses can be drafted into contracts to avoid frustration. Force majeure clauses suspends performance in the occurrence of supervening events which are not the fault of either party, but will maintain the existence of the contract. To avoid a contract being found to have been frustrated, parties should assign risks, as far as possible.
Physical destruction of the subject matter of the contract
A change in the law rendering performance of an obligation illegal
Restraint by injunction
Shortage of materials
The question still remains as to whether any contractual pre-payments are to be repaid in the event of frustration. However, it is considered that the High Court may follow the ruling in the Fibrosa case and determine that where there has been a total failure of consideration, a prepayment will be recovered in quasi-contract. The purpose of this to avoid any unjust enrichment.
An example of this, is where a deposit has been made to hire a venue for an event. However, prior to the event the venue burns down. Under common law, the contract has been frustrated and all obligations from the point of frustration will end for both parties. However, subject to recovery under restitution, the deposit would be forfeited. There are only three jurisdictions in Australia that have created legislation to reduce this harshness: in New South Wales, South Australia and Victoria. In Victoria, it is governed under the Australian Consumer Law and Fair Trading Act 2012. The purpose of these statutes is to be provide a fair result and to avoid unjust enrichment by one party.
To overcome the limited application of the doctrine of frustration, a force majeure clause is often drafted into contracts. A force majeure clause is an agreement in the contract as to how the risk is to be dealt with, due to part or non-performance occurring as a result of certain specified events. A force majeure clause operates to exclude liability where a party’s failure to perform is a result of forces beyond its control. However, under the principles of ‘freedom to contract’ parties are free to define the events and set the parameters as they see fit. The effect of having a force majeure clause is that it enables the non-performing party to be discharged from liability for failing to perform as a result of the force majeure event.
There are three essential elements to enforce a force majeure clause:
It cannot have reasonably been foreseen by the parties.
It can occur by either natural or human forces, such as acts of God.
It was beyond the control of the parties and the parties could not have prevented its consequences.
When drafting a force majeure clause, in addition to stating that the clause relates to acts beyond the control of the parties, it should also define specified events. Examples such as floods, bushfires, electricity supply strikes and wars etc. The agreement should also identify the obligations of the parties when a force majeure event occurs, how the parties will be affected by the force majeure event occurs and the obligations on the parties after the force majeure event ends.
It is not normally in the interests of a purchaser to include a force majeure clause in the contract. This is because this will seek an uninterrupted service and the effect of such a clause is that the service may be temporarily interrupted without vendor liability. However, if a purchaser is pressured by a vendor to include a force majeure clause, the purchaser should consider the definition and the effect of the parties’ obligations. Vendors on the other hand, will want to protect themselves by including a force majeure clause that has a wider definition. They would want to use words such as “… and include, but not limited to...”
As a force majeure clause is a creature of contract, the interpretation of the clause is dependant by the following:
The agreed width of the clause by the parties. The vendor would want to use words that would widen the meaning of a force majeure event, but a purchaser would want to narrow the width of the words used.
The rules of contractual construction. Firstly, according to the contra proferentem rule, the force majeure clause will be construed strictly and in the event of ambiguity, the clause will be interpreted against the interests of the party that drafted the clause. Secondly, under the ejusdem generis rule, where general words are followed by a specific list of events, the general words will be interpreted in accordance with the specific list of events.
Given the numerous ways that can affect the interpretation of a force majeure clause and the elements that will enforce the clause, it is important that it is drafted carefully. Should you wish to include a force majeure clause into a contract, De Marco Lawyers can assist you in providing you with the appropriate legal advice relating to laws of force majeure and to guide you as how to properly draft a force majeure clause into a contract.
This article is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. No reader should act on the basis of any matter contained in this article without first obtaining specific professional advice.
DISCLAIMER: We accept no responsibility for any action taken after reading this article. It is intended as a guide only and is not a substitute for the expert legal advice you can get from De Marco Lawyers and other relevant experts.