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Legal » October 09

Is Your Contract Frustrated Enough?

It was far from obvious, less than a year ago, that we were about to enter into a global recession which would result in a sharp drop in international trade, rising unemployment and slumping commodity prices. It is certainly not comforting to have the current economic situation compared with the Great Depression of the 1930s. In short, a lot has changed relatively quickly. For many businesses, at the very least, certain contracts which they entered into in the recent past now appear far less desirable than they once did. In some cases, it now may be impossible for a party to meet its legal obligations under a contract, or such obligation may now be very different from what was originally contemplated. A legal doctrine known as "frustration of contract" may be applicable in certain circumstances and potentially provide a way out, but overall its application is rather narrow.

In general, a contract may be discharged on the ground of frustration when something occurs after the formation of the contract which renders it physically or commercially impossible to fulfill the contract or transforms the obligation to perform into a radically different obligation from that undertaken at the moment of entry into the contract.

The doctrine of frustration currently operates within narrow confines for two primary reasons. First, the courts will not allow the party to escape what has proved to be a bad bargain. In other words, frustration will not be invoked where the change in circumstances has meant that it would be more expensive or onerous for the contract to be performed, or where the contract has ceased to be advantageous for one of the parties. Second, the parties to commercial contracts commonly insert force majeure, hardship or intervener clauses. Such clauses contemplate that if certain events occur, parties will not be held to their obligations. The effect of these clauses is to reduce the practical significance of the doctrine of frustration because the doctrine is concerned with unforeseen, supervening events, not events which have been anticipated and provided for in the contract itself. In other words, the wider the ambit of contractual clauses, the narrower the practical scope of the doctrine of frustration.

Although the existence of the doctrine is now firmly established, its juristic basis and tests are not. The test for frustration is an objective and not a subjective inquiry into the actual or presumed intentions of the parties, since the discharge of a contract on the ground of frustration occurs automatically upon the happening of the frustrating event, and does not depend upon any repudiation or other act of volition on the part of either party.

One of the ways to establish frustration of contract is for the party claiming it to show that performance of the contract, as originally agreed, would be impossible. The court will conclude with relative ease that a contract is at an end, if the subject-matter of the contract has been lost or destroyed. In the leading cases on this point, a fire destroyed premises that were the subject-matter of a contract, which resulted in frustration. Similarly, a contract to prepare textbooks was impossible to fulfill once a school curriculum was changed.  The state of the law at the time the parties made the contract is considered to have been in the parties' contemplation. Hence, any subsequent change rendering performance legally impossible (even though it still may be physically possible) may lead to frustration. For example, a change in planning legislation preventing a land development, frustrated a contract between the parties to develop those lands.

Test of radical change in the obligation is formulated as follows: If the literal words of the contractual promise were to be enforced in the changed circumstances, would performance involve a fundamental or radical change from the obligation originally undertaken?  The doctrine may result from the frustration of the "commercial purpose" of the contract, through no fault of either party. The origin of this kind of frustration occurred as a result of the postponement of the coronation procession of King Edward VII because of the his illness. A defendant agreed to book rooms that overlooked the procession route, at a rate which was much higher than a regular rate. The written contract made no express reference to the processions, but it was clear from the circumstances that both parties regarded the viewing of the processions as the sole purpose for booking of the rooms.  As a result of the this unforeseeable postponement, the court held that the contract was frustrated and the defendant's refusal to pay for the rooms was upheld, but the defendant could not recover the deposit that was already paid.  However, if there is more than one purpose to a contract, and at least one purpose could be fulfilled, there will be no frustration. Once again, the courts were clear that significant financial change in the surrounding circumstances, for example, the inability of a party to obtain a requisite loan is not enough to claim frustration. It is easy to see why courts are cautious when applying a doctrine of frustration of "purpose". It would be easy for parties to escape the obligations which are no longer considered seen as valuable.  If it can be said genuinely that the foundation, root or fundamental assumption underlying the contract has disappeared so that it would be fruitless to continue to be bound by the contract, then it is reasonable to treat the contract as terminated.

It is a long established legal principle that a party cannot rely on its own wrongdoing to excuse it from liability. Therefore, frustration of contract is not available in cases where the party seeking to rely on it has itself created the event or occurrence which it now claims as the basis for termination of the contract. An obvious example is provided by a case where a football player could not rely on terms of his contract guaranteeing him a salary if he was injured or unable to play, when his inability to play resulted from the player's undertaking to play for another club.

In the context of sale of goods contracts, special mention must be made of the Sale of Goods Act which to certain extent deals with frustration.  The contract is terminated where the subject goods are destroyed without any fault of either seller or the buyer before the risk passes to the buyer. However, this only applies to a sale of specific goods.

Overall, in deciding whether a contract has been frustrated, the courts will look at the construction of the contract, the effect of the changed circumstances on the parties' contractual obligations, the intentions of the parties (objectively construed) and the demands of justice. No one factor is conclusive. However, it has been established that the court does not have a broad absolving power to set a contract aside whenever a change of circumstances causes hardship on one of the contracting parties, as that would give the courts too much discretion.