James Farmer


Covid-19 and Executory Contracts: Will the Doctrine of Frustration Apply?

Monday, April 06, 2020
“… frustration occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. Non haec in foedera veni. It was not this that I promised to do.”
Lord Radcliffe in Davis Contractors Ltd. v. Fareham UDC [1956] AC 696 (HL), 729; cited with approval by the Supreme Court in Planet Kids v. Auckland Council [2014] 1 NZLR 149 (SC), 170 [51].

Conditions can change frequently between the time a contract is entered into and the time when performance falls due. This is particularly so in the case of commercial and other contracts which have a market context. Market conditions at the time the contract is entered into may be quite different and either more or less favourable for one party or the other at the time that performance is required – for example, the payment of the purchase price for a house or some other asset or the delivery of goods or services. Sometimes market change is the result of an unanticipated event. Litigation may be the outcome.

By way of example, the share market crash in October 1987 gave rise to New Zealand’s largest civil case (both as to the amount of the Judgment and the length of the trial) - the Equiticorp case. The Crown had sold its 90% holding in New Zealand Steel to Equiticorp for $327 million the day before the crash. The problem was that payment was made by the issue of Equiticorp shares which, after the crash, plummeted to a fraction of their original worth. The Crown was protected by an agreement by a broker to underwrite the disposal by the Crown of its Equiticorp shares within 5 months. The shares were sold to a company (AI4), which it transpired had been formed by Equiticorp to be the purchasing entity to take the broker out. It was found by the High Court that the Crown had both actual and constructive knowledge that Equiticorp itself was the funder of last resort (prohibited by the Companies Act at the time). Judgment was entered against the Crown for restoration to the Statutory Managers of Equiticorp of the moneys that were paid for the sale of the Equiticorp shares to AI4.

The fact of the share market crash was not used by the broker or by those who funded the re-purchase to invoke the doctrine of frustration as a means of avoiding the contractual obligation to purchase the shares from the Crown. Could it have been? I think not. True, the Dow collapsed 22.6% in one day, a larger drop than the one preceding the 1929 Great Depression and much greater than when the Global Financial Crisis arrived in 2008. But share markets are known to be subject to volatile and unexpected shocks and investors who are cautious will adopt hedging strategies (currency exchange), insurance (to deal with a range of known risks), guarantees, and so forth. Or, if less cautious or not wanting to incur the cost of such measures, will in effect self-insure. The broker in the Equiticorp case had laid off its risk by arrangements with Equiticorp (of which the Crown was held by the Court to have actual or constructive knowledge) that ran foul of the statutory prohibition on a company financing the purchase of its own shares.

The caution with which the courts have approached the doctrine of frustration is exemplified in the Davis Contractors case itself from which I have quoted above. In that case, the contract was one in which a builder agreed to build 78 Council houses for a fixed price within 8 months. Because of a shortage of building supplies and labour, it in fact took 22 months to complete the contract with consequential increased costs. The builder argued that these costs should be recoverable by dealing with the whole contract on a quantum meruit basis on the ground that the contract was frustrated because of the supply shortage, one which had not been apparent at the beginning of the contract. That was rejected by the House of Lords which said that the fact that, without fault of either party, the contract had become more onerous than expected was not a ground for holding it to have been frustrated.

Is the situation that we all now face with Covoid-19 any different? Do the facts and consequences of Covoid-19 take the performance of executory contracts beyond the mere “more onerous” to Lord Radcliffe’s “radically different … this is not what I promised to do”.

Obviously, there is no general answer to this question, even taking full account of the unprecedented scale and rapid global spread of the virus and the number of depths that have followed – and with no vaccine likely to be available until 2021 at the earliest. Clearly, this is a situation where the facts and the nature of contracts and the impact of the Pandemic on the performance of the contract will require close examination. A contract may also have a force majeure clause or a material adverse change clause that would constitute a more direct exit from a contract.

The answer may also differ according to whether the contract is purely a local one, not dependent for example on the receipt of imported goods or components to manufacture goods locally, or whether it depends on access to foreign markets or inter-global services such as airlines. A few examples – no answers given, but assess them against Lord Radcliffe’s test for frustration (“It was not this that I promised to do”) - might illuminate the position. In considering them, it may be relevant to consider sections 60-69 and in particular section 61 of the Contract and Commercial Law Act 2017 which (replacing the previous Frustrated Contracts Act 1944) provide for the consequences of a contract found (at common law) to have been discharged by frustration. Section 61 provides for recovery of moneys paid under such a contract and also provides that moneys that were otherwise payable are no longer payable.

Example A: A residential house in Auckland is sold under a standard sale and purchase agreement on 15 January 2020 (when Corvid-19 had not spread beyond China, with settlement fixed for 30 March 2020). On the evening of 25 March, New Zealand enters into a lock-down which, among many other restrictions, prohibits removal carriers from operating and thus makes it impossible for the vendor to provide vacant possession on the contractual settlement date. The purchaser may be in a similar position if he or she also has a contract for the sale of his or her home due for settlement, the proceeds of which will also be required to meet the obligation to pay for the first house. Nor will family members or friends be able to pitch in and help by moving the furniture by private vehicles – transport is limited to visits to supermarkets, pharmacies, petrol stations and to local parks for exercise. In a valiant effort to address this situation, the Property Law Section of the New Zealand Law Society has recommended that the solicitors for the parties to such sales agree on a clause that defers settlement until after the lockdown reverts to Level 2 (from the present Level 4). But of course there is no obligation on either party to agree to that. What is the legal situation if no such agreement is reached?

Example B: A barge family tour of France is booked for April 20 with a local travel agent in Auckland on 15 January 2020 and 50% of the price of the tour (which includes return air fares with an Asian airline) is paid as a deposit. The first known case of Covid-19 in France occurs on 24 January 2020. By 28 March, France has over 33,000 known cases of the virus and more than 2000 deaths. New Zealand has gone into lock-down on 23 March and flights to and from France on the nominated airline have been suspended as has the barge tour. The travel agent says that both the airline and the French tour company will provide a credit against a similar tour in April 2021 but at whatever current prices will be then. That is not practical for the family as by then the eldest child will have started University. They seek a return of the deposit from the travel agent but this is refused on the grounds that the tour operator and airline are still willing to perform but in a year’s time when (it is said) the virus is likely to be under control.

Example C: A construction company enters into a contract on 15 January 2020 to build a 6 story apartment block to be completed not later than 15 December 2020 with a liquidated damages clause of 25% per annum of the contract price for every day past that date before completion is certified, that percentage being agreed between the parties as a genuine pre-estimate of the owner’s loss for late completion. As a result of the lockdowns both in New Zealand and in other countries the building company is unable to commence construction (which had been planned for 25 March) and will be unable to obtain Italian bathroom and kitchen fittings that the contract specified in the foreseeable future. The liquidated damages clause will undoubtedly be triggered and that and extra costs will completely eliminate any profit on the contract even if the current 4 week New Zealand lockdown is not extended. There is also a likelihood of the company becoming insolvent if the lockdown continues past that time and the company is held to the contract.

Example D: A daily newspaper in mid-2019 offers a discounted 2 year subscription which many readers have since taken up. As a result of the lockdown, the newspaper, which is dependent on both reader subscriptions and on advertising revenue (known as a 2-sided market) for sufficient total revenues to make a profit, quickly loses virtually all of its advertising revenue from retailers who can no longer sell goods from their stores. To cover its costs, the newspaper reduces its news coverage substantially and the size of the newspaper shrinks to about a quarter of its previous size (partly explicable by the lack of advertising but also by the paucity of news reporting and commentary). One example: those who enjoy the coverage of social events and the photographs taken at them of social identities are disappointed because there are no longer any such events. A large number of readers (represented by an entrepreneurial lawyer) seek to terminate their subscription contracts and to be refunded for the balance of the 2 year subscription period. The newspaper is not co-operative.

Just some mental exercises for lawyers to undertake while they sit at home in lockdown or to give them a break from walking the dog!

Jim Farmer

6 April 2020

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