The scope of the doctrine and remedies for frustration of contract in English law Essays

The scope of the doctrine and remedies for frustration of contract in English law Essays The scope of the doctrine and remedies for frustration of contract in English law Paper The scope of the doctrine and remedies for frustration of contract in English law Paper Essay Topic: Law The courts have interpreted the scope of the doctrine of frustration narrowly, in accordance with the principle pacta sunt servanda agreements must be kept. If the courts readily held that a contract was frustrated, it would cast significant doubt on an array of agreements that make commerical enterprise possible. As Lord Radcliffe advised in Davis Contractors Ltd v Fareham UDC, [f]rustration is not to be lightly invoked as the dissolvent of a contract.i This discussion will first examine the underlying reasons for the narrowness of the doctrine before considering the specific limitations. Here it will be argued that in some instances the courts decisions have been inconsistent and in others they have been unduly harsh. The following part of the discussion will examine the remedies available to parties of a frustrated contract, as found under the Law Reform (Frustrated Contracts) Act 1943. The deficiencies in the statute will be explored, amongst them ambiguity, which has led to the rare use of the Act. Instead, parties have opted to draft out the Act and include provisional clauses of their own. These force majeure and hardship clauses provide for a solution if a supervening event occurs which makes it impossible or more onerous for one party to perform. With the unsatisfactory state of the law governing frustration, it will be posited that these clauses are vital to retain an element of certainty in commercial contracting. The scope of the doctrine of frustration Contract law is founded on the principle that liablity for non-performance is strict. While this seems particularly severe, it is substantiated with the belief that parties receive valuable consideration for taking risks. The allocation of risks provides a major function of the law of contract: it enables individuals and corporations to plan for the future with a moderate degree of certainty and hence to maximise their freedom of action.ii A contract can only be frustrated when performance becomes impossible, or a supervening event takes place that would make performance radically different to that which was contracted to by the parties. If frustration is sufficiently pled, its result is to bring the contract to an end. Given this drastic outcome, the courts have interpreted the scope of the doctrine narrowly in order to preserve the sanctity of contract.iii Paradine v Jane is most frequently cited to demonstrate this: When a party by his own contract creates a duty or charge upon himself, he is bound to make it good, if he may, notwithstanding any accident by inevitable necessity, because he might have provided against it by his contract.iv Furthermore, if a party feels that they would be unable to perform if a supervening event occurs, they should provide for it in the contract. Many supervening events that can impede performance are foreseeable and parties should construct their contracts accordingly. There are several circumstances that may qualify for discharging the contract on grounds of frustration. These include the subject matter of the contract being destroyed; illness or incapacity of a contracting party; the non-occurrence of an event that formed the foundation of the contract; supervening illegality.v It is certainly not a rule that these circumstances will frustrate a contract. As Lord Sumner stated in Bank Line Ltd v Arthur Capel and Co, ultimately the frustration of an adventure depends on the facts of each case.vi There are three main limitations to the doctrine. Firstly, if there are provisions in the contract that provide for a solution if an event occurs, then an argument based on frustration is unlikely to be entertained as the parties have already provided for the occurrence.vii Secondly, if the event is foreseeable, the parties are unable to avail of the doctrine of frustration. In Amalgamated Investment and Property Co Ltd v John Walker Sons Ltdviii the claimants sought to set aside a contract for sale of a property, when they found that a day after they had signed the contract, the property became listed and could not be redeveloped. This reduced the value of the property by approximately 90%. The court held that the contract was not frustrated because the claimants were aware of the risk, as evidenced by a pre-contract enquiry as to whether the building could be listed. The supervening event did not fulfill the test set by Lord Radcliffe in Davis Contractors Ltd v Fareham UDCix it did not render [the performance] a thing radically different from that which was undertaken by the contract.x In Krell v Henryxi Vaughan Williams LJ expressed the foreseeability test in terms of whether the event was anticipated or not. Despite the logic of this proposition, it has not been without challenge. In The Eugenia, Lord Denning stated that: It has frequently been said that the doctrine of frustration only applies when the new situation is unforeseen or unexpected or uncontemplated, as if that were an essential feature. But it is not so.xii In stating this, Lord Denning relied upon the judgement in WJ Tatem Ltd v Gamboaxiii where a charterparty was held to be frustrated, even though it was foreseeable that the ship would be seized. It is difficult to reconcile these judgements with previous ones that have been decided, and it is indeterminable as to how future courts will rule on this test. A third limitation on the doctrine of frustration is if the event is self-induced. In Taylor v Caldwell, Blackburn J stated that frustration applied where performance had become impossible without default of the contractor.xiv The way in which the courts have interpreted a self-induced event is not free of controversy. In J Lauritzen AIS v Wijsmuller BV The Super Servant Two Bingham LJ stated that frustration had to arise from some outside event.xv In this case, the defendant contracted to transport an oil rig with either the Super Servant One or the Super Servant Two carrier. The defendant intended to use the latter, but it sank, and the Super Servant One had been allocated to other contracts. The Court of Appeal held that the contract was not brought to an end because of the sinking of Super Servant Two, but because of the defendants election not to use Super Servant One, therefore the contract was not frustrated. Treitel has criticized the reasoning of this judgement on the grounds that after the loss of the ship, it became impossible for the defendants to perform all its contracts during the period in question with only one operable carrier. Treitel further argues that in such a circumstance, where a party has entered into a number of contracts with other parties, and a supervening event does not permit him to satsify all those contracts, he can, provided he acts reasonably, elect to perform some of the contracts, and claim that the others have been frustrated by the event.xvi This argument certainly has merit and would lead to a far more just result than that decided by the court. The Law Reform (Frustrated Contracts) Act 1943 In cases where a contract was frustrated, the common law was ill-equipped to provide a remedy. This lead to unjust decisions, such as Chandler v Websterxvii where a contract was frustrated but the aggrieved party was still liable to pay. The rights of the parties were determined solely on when the obligation to pay arose before or after the frustrating event. If they arose before, then there was still an obligation to pay, regardless of whether there had been a total failure of consideration. In 1943, the Law Reform (Frustrated Contracts) Act [hereinafter the Act] was passed primarily to resolve this situation.xviii Shortly before the enactment of the Act, the House of Lords reversed Chandler in the case of Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd.xix Money paid before the event was recoverable when there was a total failure of consideration. This was an improvement in the state of the common law, but it was still not satisfactory as it did not allow the payer to recover money where there was only a partial failure of consideration, and furthermore, the payee could not set off expenses that he legitimately incurred. Under s.1(2) of the Act, money paid before the frustrating event is recoverable and money payable before the event ceases to be payable, subject to legitimate expenses incurred before the event. Section 1(3) further provides that if one party has derived a valuable benefit from anything done by the other party, then the judge may order that party to pay a sum in respect of it. In BP v Hunt, Goff J stated that the fundamental principle underlying the Act itself is prevention of the unjust enrichment of either party to the contract at the others expense and its purpose was not to apportion the loss between the parties.xx As McKendrick points out, this interpretation is not without challenge, and an alternative analysis is that the Act is designed to provide a flexible machinery for the adjustment of loss.xxi The purpose of the Act is therefore still in doubt. There are more specific criticisms levelled by McKendrick.xxii Whilst they cannot all be addressed here, it is important to identify the primary difficulties. Firstly, s.1(2) does not cover money paid after the event; the payor would have to resolve this at common law where there is little respite. Secondly, it is difficult to ascertain how loss will be calculated between the parties. If the payor has given the payee à ¯Ã‚ ¿Ã‚ ½20,000 which has been expended in performance of the contract, how much can the payee retain? McKendrick states that the subsection is not well drafted and that inadequate consideration has been given to the apportionment of any losses.xxiii Section 1(3) is the most controversial part of the Act and was critical in the case of BP v Hunt. The word benefit has been given an unnatural and artificial meaning, and the way in which Goff J resolved the matter in BP can lead to less desirable results. The value of the benefit and the just sum to be awarded is totally left to the discretion of the trial judge, which is liable to lead to inconsistency in the future.xxiv Ultimately this creates further uncertainty and ambiguity, making it difficult for parties to determine their actual remedies under the Act. Force majeure clauses As the law currently stands, it is uncertain as to whether the courts will discharge a contract on the ground of frustration due to a supervening event, and if they do, the remedial position of the parties is entirely unclear. Parties can reduce this uncertainty by agreeing on a list of events beforehand which constitute force majeure. Parties can also widen the parameters of these clauses beyond the scope that the courts would ordinarily allow. For instance, price fluctuations would not ordinarly be held to frustrate a contract in the courts, whereas parties can state in their contract that it will constitute a force majeure event. The importance of force majeure clauses cannot be overstated in the drafting of commercial contracts. In Bremer Handelsgesellschaft mbH v Vanden Avenne-Izegem PVBA,xxv Mocatta J believed that there was much to be said for Counsels submission that there was no room for the doctrine of frustration to apply when elaborate provisions, by way of force majeure clauses, were in place. During uncertain economic times, businesses will try to rely on the doctrine of frustration and force majeure clauses inserted into their contracts that provide for such events. This was the case in the wake of the terrorist attacks in the US in 2001, when businesses sought to discharge their contractual obligations through reliance on force majeure clauses.xxvi However, they will only be successful if their provision has the clear intention of resolving the consequences that arise out of the supervening event. If a provisional clause is not drafted to properly account for the event, the court will not give it affect. In Thames Valley Power Ltd v. Total Gas Power Ltd xxvii the defendants entered into a 15-year contract with the claimant for the supply of gas, which contained a force majeure clause. In July 2005, due to the sharp increase in gas prices, the defendants informed the claimants that this constituted a force majeure event and they would be unable to supply the gas until the prices fell. The claimants argued that the increase in prices did not fall into the scope of force majeure, and the event had not rendered performance impossible; it merely made it less profitable. In his judgement, Clarke J ruled that the force majeure clause which the defendants relied upon did not sufficiently cover the increase in gas prices. He cited another force majeure case, Tennants Lancashire Limited v Wilson CS Co Ltd, where Lord Loreburn observed that: The argument that a man can be excused from performance of his contract when it becomes commercially impossible seems to me to be a dangerous contention which ought not to be admitted unless the parties plainly contracted to that effect.xxviii In order to make sure that every event is covered under force majeure, some parties draft the clauses in very general terms. However, the courts will not necessarily interpret a force majeure clause to cover every event, despite the wording of the contract. In Metropolitan Water Board v Dick Kerr Coxxix a contract to build a reservoir in six years contained a provision that allowed for an extension in the event of time delays, whatsoever and howsoever occasioned. The courts interpreted this to mean that it gave the builder a period of grace for non-frustrating delays. It did not cover the actual event government intervention in WWI which required him to halt work and sell his construction plant. Hence the builders plea of frustration was successful. Therefore, force majeure clauses can be seen to cover events that have the possibility of resolution within a short period of time, but obviously cannot cover an event that renders performance impossible. When the court rules that a contract is frustrated, it is terminated. As Treitel notes, this inflexibility leads to all or nothing solutions,xxx which is often not what the parties want. Provisional clauses therefore have the further benefit of allowing the parties to stipulate a modification to the contract, allowing for extra time or for an alternative mode of performance at an additional cost. Conclusion The effect of a supervening event is to throw a contract off course. Rather than mitigate the ensuing uncertainty that is caused, the law in its current state creates further ambiguity. The indefinite wording of the 1943 Act creates further uncertainty when it comes to the remedial standpoint of the parties. As McKendrick observes, it is perhaps fortunate that a frustrated contract is a comparative rarity in commercial practice and so the deficiencies in the Act [] rarely come to light.xxxi In light of this, force majeure and hardship clauses provide for a degree of certainty and flexibility in commercial contracting. Not only can parties make provisions for what constitutes a force majeure event, but they can stipulate the consequences of such an event. With contracting parties realising these benefits, it is common for even small businesses to incorporate provisional clauses into their agreements. However, contracting parties must be diligent in drafting these clauses so that they sufficiently account for the supervening event, otherwise they may find that they are still subject to the courts determination and the uncertainty that ensues.