Termination of contract on the grounds of frustration

NB THIS TOPIC WILL NOT BE COVERED IN THIS SEMESTER'S CONTRACT COURSE.

NB REFERENCES TO "HPH" OR JUST TO A PAGE NUMBER ARE TO HEFFEY, PATERSON AND HOCKER CONTRACT COMMENTARY AND MATERIALS 8TH ED 1998 (LBC INFORMATION SERVICES)

We now come to the last phase of the contracting process. We are now concerned with things going wrong, either because some disaster has overtaken the contract which cannot be said to be any one’s fault (the subject of the doctrine of frustration) or because one of the parties has committed a breach. We will certainly pay some attention to breach which is a very common problem and of great practical significance. But before we look at breach it is necessary to look at the doctrine of frustration.

It is important to understand the effect of either frustration or serious breach which brings a contract to an end. The contract is terminated by, for example, frustration. This should be distinguished from rescission.

Termination occurs during the running of a contract and the contract just stops so that rights and liabilities in the future no longer apply. Accrued rights and liabilites (those that have already fallen due before the terminating event) are perfectly enforceable.

This is to be contrasted with rescission where the contract is treated as if it had never been. It is a pre-requisite of rescission that it must be possible to go back to the situation before the contract was made. It is logically impossible to sue for breach of a contract that is successfully rescinded.

Remember, rescission is the remedy available when something has gone wrong during the negotiations for the contract, such as misrepresentation or misleading conduct, unconscionable dealing, undue influence, duress or mistake. Termination is the remedy available where either the contract has been frustrated or one party has committed a breach which is so serious that it justifies the other party putting an end to the contract by terminating it.

Having said all this, it must be pointed out that the usage of these two terms (termination and rescission) is often muddled. Judges quite frequently talk of rescission when they mean termination.

The doctrine of frustration - which is effectively a court order that the contract is no longer binding on either party (the contract just stops in its tracks) - is very rarely considered by the courts. The usual way in which the doctrine is raised is where some disaster has overtaken the contract and one party then fails to perform. The other party then complains that the first party is in breach. The answer to this may be that failure to perform is not a breach because the contract has been frustrated as a result of the disaster. In short, frustration, if successfully argued, is an excuse for failure to perform.

The doctrine, as I have said, is rarely argued successfully. This is because the courts have taken the view that one function of contract is to allocate risk and that, if something does go badly wrong, then this is just a risk which the contract ought to have contemplated. See the passage on p 724 last para from the case of Paradine v Jane in 1647 which reflects the idea that contract promises should be kept, whatever the circumstances. In other words, at the very moment that one party finds it very hard to perform, the other party wants an assurance of performance, or at least damages in lieu, because this is what contract is all about. People are paid to take the risk of difficult performance. The law nevertheless did allow some softening of this absolute principle and developed a doctrine of frustration.

This treatment of frustration will not be as detailed as most of the other areas of the law of contract which we have examined. This is partly because, as already noted, it is a rare in practice and also because we are limited in the time left to deal with the remaining topics in the course.

The development of the doctrine of frustration

HPH 724-727

The case book outlines briefly the history of the development of frustration. The beginning of the doctrine is said to be the case of Taylor v Caldwell in 1863, a case involving the hire of a hall. Before the day on which the hirer was to use the hall, it burnt down. This was held to be a frustrating event which caused the contract to be terminated and neither party was in breach. Frustration cases since then have involved a number of different types of frustrating event. The key question is always: is this an event which excuses the parties from further performance or is it an event which is the type of risk which the contract expressly or impliedly contemplated? If the latter then the contract is not frustrated and, if a party does not perform, he or she is in breach.

The theoretical basis for frustration

The courts over the years have had a great deal of difficulty in deciding what is the proper theoretical basis for the court intervening in the contract and declaring it to be frustrated. The theories have varied and there have been fashions over the years. The three headings below reflect the three phases or fashions, with the last one being the one which courts tend to adopt to-day.

Implied term The first theory was that declaring a contract to be frustrated was simply another aspect of the court’s ability to imply a term into the contract. If an officious bystander had asked the parties just before they committed themselves to the contract: "What is the result if such and such happens?" the parties would have dismissed the bystander, testily, with an "Of course our contract would be at an end." This was the basis for the decision in Taylor v Caldwell   HPH 734 You can see that the judgment of Blackburn J on pp 734-736 is centred on an implied term analysis. He concludes on p 735 2nd last para that the existence of the subject-matter of the contract is an implied basis for the continuing of the contract. You can see that this has some parallels with the mistake cases. As was pointed out when we studied mistake, the difference between frustration and mistake is when the disaster struck. If before formation, then it is a mistake case; if after, then a frustration case.

The problem, as always, with implied terms is that it may be very difficult to arrive at a clear conclusion as to what the alleged implied term should be. Remember that it has to be capable of clear expression and it must be so obvious that it goes without saying. Of course the parties will differ about these matters.

As a matter of construction The second theory is based on construing the obligations in the contract and limiting them to normal circumstances and not to extraordinary circumstances. This is really not very different from implying a term. But instead of adding an implied term, the technique is to construe the express terms. This approach is described by Mason J in his judgment in the Codelfa case, the leading High Court case on frustration. He refers to Lord Reid’s approach in Davis Contractors v Fareham UDC Lord Reid HPH 749 where the implied term theory is rejected and instead it is said that the parties never agreed to carry out their obligations in the type of circumstances which have eventuated. This is a matter of construing the principal obligations of the contract. The same idea is reflected in the words of Lord Wright in Denny Mott and Dickson Ltd v James B Fraser & Co Ltd    HPH 751 2nd (indented) para. It is appropriate at this stage to return to Codelfa Construction Pty Ltd v State Rail Authority of NSW    HPH 740 at 749 We looked at this case before when we were examining implied terms. It will be recalled that the building of the eastern suburbs railway in Sydney was overtaken by disaster when residents obtained an injunction which prevented work being done at night. Codelfa, the contractor, had quoted on the basis of being able to work a three 8-hour shift day. It attempted unsuccessfully to argue that an implied term should meet the new circumstances whereby Codelfa obviously could not finish on time and there were extra costs incurred as a result of the new arrangements. The High Court was however prepared to order that the contract had been frustrated. The result was that the contract came to an end once the injunction was granted. In fact Codelfa finished the work. This work had to be paid for on the basis of a fair and reasonable remuneration, that is, on the basis of restitution, because there was no longer any contract to determine how much Codelfa should be paid for the work.

In the course of discussion about the proper basis for the operation of the doctrine of frustration, Mason J made it clear that the court’s task is to compare performance of the contract under the new conditions with the performance contemplated by the contract before the changed circumstances. If performance is radically different, then the contract is frustrated. In this case, this was so even though there was a clause - cl 8(2)(c) discussed on p 752 - which appeared to cover the events which arose. But Mason J said that it was not intended to cover such a radically disruptive event - a court injunction - which prevented the basic system of work from being employed.

As a matter of justice and reasonableness This is really another way of expressing the previous theory. The court will intervene and declare the contract to be frustrated when it would be quite unreasonable to expect the parties, or one of them, to perform under the changed circumstances. The key to this is found at the end of the 1st para on p 758 in an extract from Lord Radcliffe’s judgment in Davis Contractors v Fareham UDC "It was not this that I promised to do."

Just completing the examination of the Codelfa case, note that Mason J examined the question whether an arbitration clause survives the termination of the contract because of a frustrating event. There was a mistaken view that termination of the contract meant that everything came to a halt, including an arbitration clause. This view is now not correct. There are certain matters provided for in the contract which do survive the termination of the contract.

Some examples

We cannot possibly canvass all the frustration cases. Instead we can only get a feel for the sorts of events which might be argued to be frustrating events. You will see a list on pp 788-789 of the casebook. Particular caution must be exercised in relation to number 3. It is not enough to argue that performance has turned out to be difficult or even extremely difficult. For example in Davis Contractors v Fareham UDC (described on p 787) the contract was to build 78 houses for a fixed price in 8 months. Because of labour shortages and bad weather the time it took to build the houses was 22 months. It was held by the House of Lords that the contract had not been frustrated.

Krell v Henry   HPH 736 This is generally regarded as the high water mark of frustration cases, that is, the court taking the most liberal view of the operation of the doctrine. The contract was for the hire of a room overlooking the coronation route for the coronation of King Edward VII. The coronation was cancelled because of the King’s illness. This was held to be a frustrating event. You can see from this case that it is necessary to adduce extrinsic evidence in order to argue frustration, a point specifically made by Mason J in Codelfa. On the face of it this was just a contract to hire a room. The defendant got what he bargained for. Yet he was successful in arguing frustration with the result that he did not have to pay the balance supposedly owing under the contract.

Krell v Henry has been the subject of critical comment but probably it would be decided the same to-day in the light of what was said in the High Court in Codelfa. Nevertheless, it is by no means easy to say what is the correct solution to these kinds of cases. In Krell v Henry one might ask: who should take the risk of the coronation being cancelled - the landlord or the person hiring the room? The answer is not self-evident but it would not be harsh to suggest that the person hiring the room should take the risk (with the consequence that a court would say that the contract had not been frustrated). After all we all risk disappointment when we buy tickets to events, particularly outside events. On the other hand, in the Codelfa case, involving a large infrastructure project, it seems only fair that the government body should bear the risk rather than the contractor (and so the ruling that the contract had been frustrated produced the right result).

Brisbane City Council v Group Projects Pty Ltd    HPH 762 In this case Group Projects (GP) owned some land which it wanted to develop. The land needed to be rezoned. It came to an agreement with the Brisbane City Council that GP would carry out certain work both on the land and off the land when the land was rezoned residential. What happened was that the land was compulsorily resumed by the government for use as a school. The Brisbane City Council argued that, to the extent that GP had promised to do development work off the land, it was still bound to do so. GP argued that the whole deal had been frustrated because the very basis for its ability to make a profit had been removed when the land was compulsorily resumed. This case raises the interesting question whether it can be said that frustration exists when the commercial underpinnings of the contract have been removed. Those members of the High Court who considered the issue had no difficulty in this case in holding that the contract had been frustrated because of the resumption of the land. You can see the conclusion of Stephen J on p 766 4th para and an interesting commentary in the next para on p 766 on the law about frustration and how uncertain it is. He talks of the cases providing little more than single instances of solutions to the question of frustration. National Carriers Ltd v Panalpina (Northern) Ltd    HPH 789 This case was important because, before it was decided, it was generally thought that the doctrine of frustration could not apply to real estate, including leases. This is because real estate is land and land is for ever. The National Carriers case involved a commercial lease of a warehouse. The only access to the warehouse was cut off by a local authority order which closed the street because of the unsafe state of a building in the street. The lease was for 10 years. The street would be closed for about 18 months. The tenants argued that the lease was frustrated.

Why should the doctrine of frustration not apply to real estate (the traditional position)? In this case, the tenant had the premises the subject of the lease agreement. It does not matter what happens, it could be argued - even if a building is totally destroyed - the interest in the land continues on. But this is a somewhat unrealistic view of the commercial realities. In the National Carriers case the House of Lords said that the doctrine of frustration could indeed apply to a lease but stressed that such cases would be rare. On the facts of this case they came to the conclusion that the lease was not frustrated because the tenant’s deprivation was relatively small compared with the term of the lease (18 months in 10 years).

Self-induced frustration

One limitation on the doctrine of frustration is that a person cannot argue frustration if he or she has caused the frustrating event. This is called self-induced and is no frustration in law. It may be possible to escape this rule if the person who has apparently caused the event can argue that it was not his or her fault. The rule about self-induced frustration is discussed in a rather odd setting in

FC Shepherd & Co Ltd v Jerrom    HPH 767 The case is odd because of the way the argument was put. The contract in question was a contract of apprenticeship. The apprentice was convicted of an offence which had nothing to do with his work. He was sentenced to a term in Borstal - a type of prison for young offenders. When he got out he asked to resume his training but the employer refused. The apprentice then brought an action for unfair dismissal. The employer argued that the contract had been frustrated by the sentence to Borstal and that therefore he had not been dismissed. The apprentice argued that frustration could not work because it was self-induced frustration.

The usual way in which self-induced frustration arises as an argument is illustrated by the Joseph Constantine case which is mentioned on p 768 2nd last para. In that case a ship exploded. The owners argued that the contract of chartering had been frustrated. The charterers argued that the explosion was caused by the negligence of the owners and that therefore the contract had not been frustrated. In fact it was not clear what caused the explosion. It was held that the onus of proving self-induced frustration rests on the person alleging fault and that in this case the charterer must prove that the explosion was caused by default on the part of the owner. This the charterer could not do and so the argument that the frustration was self-induced failed.

Of course, the present case does not really raise the issue of self-induced frustration and, indeed, Lawton LJ said as such in the 2nd para of p 769. What the apprentice was trying to argue here was that the contract was not frustrated so much as it was subjected to a default by himself which would then require some response by the employer viz dismissal. In other words this case was about breach. This, at least, so it was argued, prevented the employer from arguing frustration because breach and frustration are mutually incompatible. Alternatively, frustration could not be argued because the event which was the basis for frustration was self-induced. It is said in the cases that frustration can only work if the event in question happened without fault on either side. This is turning around the self-induced frustration argument. In the end, these arguments did not work. The court resorted to basic statements of principle such as a person cannot take advantage of his own wrong.

There are still unresolved questions relating to self-induced frustration: what degree of fault is required to attract the rule? Is negligent conduct enough? For example, it was never suggested in the Codelfa case that that was a case of self-induced frustration. But why not? The contractor caused the event which was held to be a frustrating event by making sufficient noise to constitute a legal nuisance (a tort). This merely illustrates that the concept of self-induced frustration has not been fully worked out.

The consequences of frustration

At common law If it is established that there has been a frustrating event, then the contract stops from that moment on. That means that all obligations up to the moment of frustration are enforceable and that all obligations relating to performance after that moment are no longer binding. Some contract terms survive frustration, as we saw in the Codelfa case where Mason J held that an arbitration clause survived. Other types of terms which would survive would be an exclusion clause and a clause imposing a duty of confidentiality.

If the contractor is permitted to do further work after the frustrating event, then, unless a fresh agreement is made, the contractor is not doing work pursuant to the contract. Nevertheless, the contractor must be paid a fair remuneration for any work done, on the basis of quantum meruit or restitution. This may be more or less than the contract rate. This is in fact what happened in the Codelfa case.

Basically, then, the loss lies where it falls. This can cause hardship. For example, suppose a periodic payment is due to be made on the 10th October and this payment relates to work that has been done over the last month. Suppose the contract is frustrated on the 8th October. This means that the amount is no longer due and payable and yet the work has been done.

Another situation which can cause injustice is where money is paid in advance and then the contract is frustrated before the person who has paid the money gets any return for it. Some of these problems are illustrated by

Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd    HPH 796 In this case a Polish company ordered a machine from an English company. The Polish company was obliged to pay £1600 up front when it sent in its order. It paid £1000 of this. The English company started work on making the machine. Then war broke out and the contract was frustrated. The Polish company claimed its £1000 back. The English company said that it had already done a considerable amount of work on the machine.

The House of Lords applied a restitutionary principle which dictates that if there has been what is called a total failure of consideration, then any money paid in advance can be recovered. The expression "total failure of consideration" has nothing to do with the doctrine of consideration. It does not mean that there is no consideration so that no contract has been formed. What it means is that one party has got nothing under the contract. In that circumstance, if he or she has already paid money up front, the money can be recovered. We have come across this idea before when we looked at the judgment of Lord Atkin in Bell v Lever Bros. The principle only applies if the party has got nothing under the contract. The failure must be total. If the party has got something under the contract, however small, then the principle does not work and any money paid up front cannot be recovered, even if it far exceeds the value of what has been received.

So, in this case, the Polish company had received nothing for its money and it could therefore recover the £1000. But this was not a satisfactory result for the English company because it had performed work. Maybe it could find another buyer for the machine but this would depend whether it was a one-off machine or one which was readily saleable.

So the overall result of the common law principles which apply if a contract is frustrated are sometimes not very satisfactory. It is always possible for the parties to specify in the contract what should be paid if the contract is terminated but often the parties do not enter into a commercial relationship with a view to it failing and so they do not provide for such events.

It is because the common law consequences of frustration can be unfair that legislation has been passed in some jurisdictions to attempt to allow adjustments to be made.

Statutory modifications     HPH 799-800 In three jurisdictions in Australia legislation has been passed to try and deal with the problem of frustrated contracts, that is, the "mopping up" after a contract has been frustrated. The legislation attempts to allocate the consequences of the contract being frustrated in a way which is more satisfactory than the piecemeal common law. Each Act is different from the other. The Victorian Act is modelled on the English legislation; the South Australian Act is modelled on the legislation of British Columbia (Canada); and the New South Wales Act is a thing unto itself and is virtually incomprehensible. The best and simplest model is the South Australian Act.

The legislation is described very briefly on p 799. A full exploration of each Act would be a very time-consuming exercise. We cannot embark on such an examination. Basically, the legislation is designed to achieve a fair and just settlement between the parties to a frustrated contract.