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08 Nov 2005

What is a frustrated contract?

by Doug Jones

Hardship, even if severe, does not constitute frustration.

A frustrated contract is a contract that, subsequent to its formation, and without fault of either party, is incapable of being performed due to an unforeseen event (or events), resulting in the obligations under the contract being radically different from those contemplated by the parties to the contract.

The legal consequence of a contract which is found to have been frustrated is that the contract is automatically terminated at the point of frustration. The contract is not void ab initio ("from the beginning"); only future obligations are discharged. At common law, obligations which fell due for performance before the frustrating event are still in operation.

When will a contract be frustrated?

Delay can lead to the discharge of a contract where the commercial purpose of the contract has been frustrated. Further, commercial parties will not be expected to wait until the end of a long delay to find out whether in fact they are bound by a contract or not. A party to a commercial contract is entitled to act on reasonable commercial probabilities and may treat a contract as discharged where an event has caused a delay, even before the delay actually frustrates the contract.

Difficulty establishing a frustrated contract

Establishing frustration, however, can be difficult as it does not apply to hardship. Hardship, even if severe, does not constitute frustration. The fact that the method for performance contemplated by a contract has been affected, or the burden of performance has been increased, by an event or events occurring without fault, does not amount to frustration unless performance in accordance with the contract has become commercially impossible, that is, impracticable in a legal sense. This comes back to the issue of the contract becoming radically different from anything contemplated by the parties.

The doctrine of frustration is applied within very narrow limits. For a party to succeed in claiming frustration, they must show that, in the relevant contract, the parties never agreed to be bound in the fundamentally different situation that had unexpectedly emerged. It is not because the court thinks in its discretion that it is just and reasonable to qualify the terms of the contract. Rather, it is because on its true construction it does not apply in that situation.

A bad bargain

A contract will not be found to be frustrated where one party strikes a bad bargain or faces hardship, inconvenience or material loss.

Certain risks are deemed inherent to contracting. For example, delay in a construction contract due to a shortage of skilled labour was found not to have frustrated the contract because the delay did not result in a new state of affairs that the parties could not have reasonably foreseen (see Davis Contractors Limited v Fareham Urban District Council [1956] AC 969).

Event foreseen

Frustration will also not be found where the event in question has been foreseen by the parties or could reasonably have thought to have been foreseen. The reasoning of the courts in the case above was that the risk of labour shortages was apportioned to the builder because it was a possibility before the parties' eyes. Where there is an express provision in the contract that deals with the consequences of a particular event, the parties cannot then claim that that same event has frustrated their venture.

If parties to a contract can seriously foresee the occurrence of an event or events but make no provision for it in the contract, and then seek to rely upon the event as frustrating the contract, it may be inferred that the parties accepted the risk of the occurrence of the event and the contract not being found to have been frustrated.

Fault

Frustration will also not be found where one of the parties is at fault. For example, charterers who had failed to obtain a licence for a fishing trawler were not entitled to avoid their contract because the frustration was self-induced.

Often the conclusion that a particular contract has (or has not) been frustrated may be almost completely determined by what a judge or arbitrator sees as the commercial significance of the event relied upon as frustrating the contract.

Avoiding frustration

Notwithstanding that frustration of contract is difficult to establish, drafting contracts broadly enough to apply to new situations or circumstances can assist parties seeking to avoid a contract being found to be frustrated. For example, force majeure clauses are used in contracts to avoid frustration. These are clauses that suspend performance in the occurrence of supervening events not the fault of either party but maintain the existence of the contract. To avoid a contract being found to have been frustrated, parties should apportion risks, as far as possible.

The test of frustration

The classic test of frustration is from England, Davis Contractors Limited v Fareham Urban District Council [1956] AC 969. This English case was applied in the leading Australian case on frustration (which also concerned a construction contract) Codelfa Construction Pty Limited v SRA of New South Wales (1982) 149 CLR 337.

In Codelfa the construction company contracted with the Rail Authority to carry out extensions to Sydney's rail network by building track and stations in the eastern suburbs. Time was of the essence as construction had to be completed by a particular date.

To do so, work was conducted around the clock for each day of the week. The Authority and various legal advisers had represented to Codelfa, the construction company, that it was immune from any grant of injunctions that would limit its ability to do such work. Injunctions, however, were granted to the local council and residents when the work caused noise and vibration, showing the advice to be erroneous.

As a result, Codelfa could no longer work between 10pm and 6am during weekdays or Saturday, or on Sundays at all. Codelfa commenced proceedings, claiming for additional expenses as a result of the need to change working methods. In the alternative, Codelfa claimed that the contract had been frustrated by the granting of the injunction.

The High Court held that the contract had been frustrated. Crucial to the decision was whether the situation resulting from the grant of the injunction was fundamentally different from the situation contemplated by the contract on its true construction in light of the surrounding circumstances. Here, the injunction created a situation in which the contract work could only be performed in a manner radically different than that contemplated in the contract. Clearly, the contract did not envisage the granting of injunctive relief against the construction company. Further, performance was expected to be completed on a particular date. The supervening event, the injunction, made such performance impossible.

Frustrated Contracts Act

The common law will find a frustrated contract to be discharged. However, the Frustrated Contracts Act 1978 (NSW) alters this position slightly. (There is also similarly named legislation in Victoria and South Australia, however, none of the three pieces of legislation are uniform.) This Act does not apply, inter alia, to insurance contracts.

The Act provides that where a promise under a frustrated contract was due to be, but was not, performed before the time of frustration, the promise will be discharged, except to the extent necessary to support a claim for damages for breach of the promise before the time of frustration. The provision does not affect a promise due for performance before frustration is found, and which would not have been discharged by frustration if it had been due for performance after the time of frustration.

Parties can avoid the effects of the Act by contracting out of it. As such, parties can contract for potentially frustrating exigencies that come up. However, it may be impossible to deal with events that are, by definition, unforeseeable.

Additionally, some contractual promises may remain enforceable because they were not conditional upon further performance of the contract. Further, terms in the contract that are clearly intended to be operative after frustration can still bind the parties. For example, in Codelfa, a term requiring any contractual dispute to be submitted to arbitration still bound the parties, even after the frustrating event took place.

Where a contact is found to have been frustrated, damages can only be sought for breaches before the frustration of the contract, which can severely limit the amount of recovery. In addition, frustration may mean no indemnity under a relevant insurance policy.

Relief from restitution

Parties can claim some relief for a frustrated contract under restitution. Restitution claims do not arise from contract or tort, but protect parties from unjust enrichment at their expense. In the context of frustrated contracts this may apply when a party has made a pre-payment to the other party in return for their performance of the contract.

In Fibrosa Spolka Akcyjna v Fairburn Lawson Combe Barbour Ltd [1943] AC 32, the House of Lords held that a party that had pre-paid 1000 pounds could recover it after the contract had been frustrated because the other party had failed to perform any of the contract.

Such relief, however, can only be granted when the other fails to perform anything (partial performance will preclude any relief).

Again, however, the Act qualifies the common law position. Any amount paid prior to frustration must be returned to the payer irrespective of whether there has been performance. Further, a party that performs work after a contract has been frustrated may also be able to recover restitution.

Also, when there has been full non-monetary performance but no payment for the performance, the party that performed is entitled to the "value of the agreed return for the performance". The Act also provides relief in instances where there has been partial performance prior to frustration.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.