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Covid-19 and current attempts to end contracts early

First published on Whichfranchise.com

 

The global coronavirus pandemic is going to make it difficult or impossible for franchisors and franchisees in a wide range of circumstances to fulfil their contractual obligations. It is likely that many such parties will seek to argue that they should be released from those obligations by virtue of a force majeure clause or under the doctrine of frustration.

Although they are often confused, frustration and force majeure are two distinct principles. Force majeure is not a stand-alone concept in English law but many contracts will incorporate it by way of a force majeure clause. In the absence of a force majeure clause, the parties will not be able to rely on force majeure but may be able to invoke the common law doctrine of frustration.

Force majeure

When a party is faced with an impossible situation preventing them from performing their contractual obligations, they should first review the terms of the contract to see if it contains a force majeure clause. Whether a party may be released from their obligations under a contract as a result of a force majeure event will be determined by the wording of the force majeure clause, which will be interpreted in accordance with usual contractual principles.  The burden of proof will be on the party seeking to rely on the force majeure clause.

Force majeure is a term taken from the French system and is not a recognised term in English law. As such a clause that just provides for a party to escape its obligations in the event of a force majeure event with no further definition or specificity may not have any force. For the most part, however, a force majeure clause will specify particular events or types of events which the clause is intended to cover. Although each case will turn on its own facts, there are a number of general points to consider when reviewing a force majeure clause:

  • Whether the clause expressly covers the event in question or, if not, whether it could be argued that the event is covered.
  • That the clause does not expressly exclude the event in question.
  • Whether the clause provides that performance must be prevented by a force majeure event as opposed to just hindered or delayed. If so then the performance of the contract must be physically or legally impossible, not just more difficult or less profitable.
  • If the clause says that it applies to events beyond a parties’ reasonable control, then that party will have to show that they have tried to mitigate the effects of the event or get around the difficulties caused by it.
  • Whether performance of the contract is suspended by the force majeure event or whether the contract can be terminated, either immediately or at a later date.
  • Whether there are any triggering requirements with which a party seeking to rely on the clause must first comply, for example, a requirement to give notice.
  • Whether the clause has general effect across the entire contract or has limited application.

Doctrine of Frustration

In the absence of a force majeure clause, a party may still avoid liability for failure to perform its obligations by invoking the doctrine of frustration. The doctrine of frustration applies when performance of a contract is rendered impossible by a supervening event for which neither party can be held responsible.  The contract is automatically discharged when that event occurs and the parties are no longer bound by their obligations.

The doctrine of frustration was first established in the case of Taylor – v- Caldwell (1863) in which a contract was held to be frustrated after fire destroyed a music hall which had been booked for a number of concerts.  The scope of the doctrine has developed over time to cover a wide range of circumstances where performance of a contract is rendered impossible. Contracts may be frustrated because:

  • Performance is impossible
  • The mutually agreed purpose of the contract is impossible
  • There has been a significant change to a mutually agreed state of affairs

In order for a contract to be frustrated:

  • The frustrating event must have occurred after the contract was formed.
  • It must strike at the root of the contract and go beyond anything that could have been contemplated by the parties when the contract was formed.
  • The frustrating event must not be either parties’ fault.
  • Performance of the contract must be impossible, illegal or radically different to that envisaged when the contract was formed.  In this regard, it is not sufficient for performance to be rendered more difficult or more expensive, if legal performance is possible then the contract is not frustrated.

Frustration is a common law principle which is applied on a case-by-case basis taking into account all of the circumstances, in particular the wording of the contract.  Examples of the types of event which have previously been held to have frustrated contracts and which may apply in present circumstances, are:

Supervening illegality:

  • Where a change in the law made after a contract is formed means that performance of the contract would be illegal under English law, the contract is frustrated.
  • Measures imposed by the Government in response to Coronavirus will render the legal performance of a number of contracts impossible, for example any that involve gatherings of a number of people such as music concerts.
  • Measures imposed by other countries may also provide a basis for frustration if they are given effect in English law, such as those imposed in other EU countries, or if they make performance of the contract illegal in the country in which it is to be performed.
  • It is important to ensure that performance is definitively illegal. If there is an element of discretion in the legislation or the contract could be performed legally in a slightly different manner then it could be that the performing party must take the necessary steps and the contract has not been frustrated.

Cancellation of an expected event:

  • A number of events will no longer be possible, the most obvious example being the 2020 Olympics.
  • Were an event to be delayed rather than cancelled entirely, provided the delay is so abnormal that it falls outside what the parties could have contemplated at the time of contracting then the contract may still be frustrated.

Illness/incapacity:

  • Generally applicable to the performance of a personal contract where the party is unable to perform their personal obligation as a result of their own incapacity.
  • In the current pandemic it could be that this ground is relied upon by suppliers or other companies who have been unable to perform their obligations under a contract as a result of the incapacity of a substantial portion of their workforce. In this regard, the Chinese government has apparently issued force majeure event certificates to Chinese companies affected by the pandemic.

Invoking Frustration

If you are considering invoking the doctrine of frustration, you should bear in mind:

  • It is important that a party does not delay as if they do so they could be prevented in relying on the doctrine.
  • It must be actually impossible to perform the contract, if an alternative method of performance is possible then the contract is not frustrated, even if it will be more expensive or difficult to perform.
  • The frustrating event must not be one which the parties should have foreseen at the time that the contract was formed.
  • Similarly, if an event is already apparent when a contract is entered into and gets no worse following formation of the contract then a party cannot rely on it as a frustrating event.  This is important to bear in mind when entering into new contracts; specific wording should be considered to deal with the coronavirus.

Effect of Frustration

If a contract is frustrated then it is automatically discharged and the parties are released from future obligations. If the entirety of the contract is yet to be performed the outcome is relatively simple. Many contracts will, however, have been part-performed. Under the common law, the loss would lie where it fell but as this can lead to unsatisfactory results, the Law Reform (Frustrated) Contracts Act 1947 (the LRA) steps in to allocate loss.

The LRA applies to many commercial contracts but there are specific exceptions for contracts relating to shipping, insurance and perishable goods. The LRA will also not apply where the parties have agreed to exclude its application. It is therefore important to check the legislation and the contract to ensure that the LRA applies.

Generally speaking, where the LRA does apply to the contract, payment that has been made in advance will be recoverable. Any recovery could, however, be less any expenses paid by the performing party if the court exercises its discretion to allow these to be retained. The court also has discretion to order any party who has gained a valuable benefit under the contract to pay a ‘just’ sum for that benefit.

If the LRA does not apply to the contract then the fall-back position is the common law. Under the common law, if there has been a complete failure of consideration then a party may recover any payment made but if there has been partial consideration then payments will not be recoverable. Similarly, the party who has rendered part performance will not be able to recover any expenses they have expended performing or preparing to perform the contract.

Summary
We expect there will be a wealth of cases relying on either frustration or force majeure or a mixture of the two as a result of the pandemic.  As above, the wording of the contract is key and we recommend checking yours without delay.  If you require any advice, or would like us to review your contracts, please contact a member of the Franchising team and Dispute Resolution team.

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