Contractual obligations during COVID-19: Force Majeure and Frustration

The spread of the coronavirus (COVID-19) pandemic is significantly impacting the performance of contracts and the ability of businesses to carry out their contractual obligations. We have received questions from our clients as to how the impact of COVID-19 could affect their contractual obligations, particularly as they are becoming increasingly difficult to perform.

This article considers how a force majeure provision and the doctrine of frustration may be interpreted in the context of COVID-19.

Force Majeure

Force majeure will only operate if a contract expressly provides for it. The effect of a force majeure clause is that a party is relieved of its contractual obligations and is exempted from liability relating to non-performance given that performance of the contract is rendered impossible due to the occurrence of a certain specified event.

Force majeure clauses often define the specific events that will trigger the application of the clause. A “force majeure event” is often colloquially referred to as an “act of God”; however, a force majeure clause is likely to include an exhaustive list of specific triggering events – such as outbreak of war, acts of terrorism, industrial strikes, and natural disasters.

If the force majeure event only constitutes a temporary interruption to a party’s performance of the contract, it will normally only allow a suspension of contractual obligations. If the force majeure event is of indefinite duration, consequently rendering completion of the contract impossible, the contractual obligations may be terminated entirely. However, it should be noted that rights and obligations accrued before termination on the basis of force majeure are not affected. For example, where goods and/or services have been provided, and not yet paid for, prior to the occurrence of the force majeure event, payment for such goods and/or services will be an accrued right and the relevant party can seek enforcement of that payment following the invocation of the force majeure clause.

To successfully invoke a force majeure clause in the context of COVID-19 the following elements must be present:

• the contract must contain a force majeure clause;
• COVID-19 must fall under the definition of a force majeure event; and
• the force majeure clause must be triggered.

Because there is no overriding doctrine of force majeure in common law, whether COVID-19 constitutes a force majeure event depends upon the interpretation of the relevant clause.

As the World Health Organisation has declared COVID-19 as a pandemic, if the contract includes ‘epidemics’, ‘pandemics’ and other such health-related events, the current circumstances may be sufficient to activate the force majeure clause.

As the Federal Government continues to implement rules and regulations in an attempt to alleviate the implications of COVID-19, if a force majeure clause includes or makes reference to government regulation, this may also trigger a force majeure clause. The Federal Government has enacted guidelines restricting both the movement of people (such as the indefinite 14-day quarantine period for individuals traveling to Australia and broader travel bans) and the operation of non-essential services.

If COVID-19 falls within the relevant definition of a force majeure event, the party seeking relief from performance will generally be required to demonstrate that:

• it was prevented or delayed from performing its obligations under the contract as a result of COVID-19;
• COVID-19 and the relying party’s inability to perform was beyond its control; and
• there were no reasonable steps the relying party could have taken to avoid the consequences of COVID-19 (that is, mitigation).

Force majeure clauses often expressly require the party seeking relief to use reasonable efforts to mitigate the consequences of the force majeure event. This requires the relying party to demonstrate that it exhausted all reasonable avenues to mitigate or prevent the impact of the force majeure event and to keep the contract on foot. Where the relying party fails to mitigate the impact of the force majeure event, it may be liable for reasonable costs incurred by the other party as a result.

Where a contract does not contain a force majeure clause, or where a force majeure clause does not cover an event such as COVID-19, parties may be able to rely on the doctrine of frustration.

Contractual Frustration

Establishing frustration can be difficult as it does not apply to hardship – the fact that an event causes delay or increased costs does not amount to frustration. The doctrine of frustration provides that where performance of contractual obligations becomes “impossible” or “radically different”, there should be an automatic mutual discharge of the contract.

Frustration will be satisfied where:

• performance of the contractual obligations become radically different from those originally contemplated by the parties to the contract; and
• an intervening event occurred through no fault of either party.

Usually, frustration results in the automatic termination of a contract at the time of the frustrating event. As all parties are discharged from future obligations, neither party can demand further performance by the other. However, as with the force majeure clause, any accrued rights leading up to the frustrating event will still be enforceable.

Similarly, to the contractual mechanism of force majeure, the affected party must show that it took steps to mitigate the impact or consequences of COVID-19 on its performance of the contract. If a party fails to take reasonable steps to avoid the frustration, it will potentially render the claim of frustration invalid or void, which will then open the claiming party up to repudiation or breach of contract and be liable for associated costs.

Whether COVID-19 has frustrated a contract will depend on the impact on performance under the contract.

Examples of situations where frustration has arisen include:

• a change in the law rendering performance illegal;
• physical destruction of the subject matter of the contract; and
• restraint by injunction.

Examples of how COVID-19 may result in frustration of a contract include:

• a venue contract for an indoor wedding for 130 guests can no longer go ahead as weddings are limited to a maximum attendance of 5 people;
• where a supplier fails to deliver or perform under a contract due to the Federal Government’s closure of non-essential services; and
• a performer falls ill and is required to self-quarantine for 14 days and therefore is unable to perform in a week’s time at a concert as required under the contract.

It is important to note that each situation must be analysed on its facts.

What next?

With the uncertainty of COVID-19, parties to a contract may attempt to escape their obligations and liabilities. Before businesses seek to enact the force majeure clause or determine frustration, they should carefully consider the consequences, particularly as there may be significant financial consequences if a party wrongly repudiates or breaches a contract.

Given the constant updates and daily announcements in Australia and internationally, it is important businesses keep up to date with all relevant information and be prepared to respond appropriately.