Frustrated Contracts in the COVID-19 World

Published on: March 2020 | What's Trending

Two people discussing a contract in front of them with the legal scales in the background

With COVID-19 upending lives and business, one question on people’s minds is likely to include whether they have to honour their contractual arrangements. Those can include anything from commercial leases and supply agreements to contracts for the purchase of residential real estate.

One of the purposes of contracts is the allocation of risks and who bears the burden of losses from improbable events, if they should arise. This kind of risk shifting is often expressly bargained for. That means the starting point to answer the question of whether contractual obligations have to be honoured in this environment, or in any environment, are the words of the contract itself.

So-called “force majeure” clauses typically set out in which extraordinary circumstances the parties have agreed they will be released from their obligations. Whether what is unfolding today with the COVID-19 outbreak is caught by any given contract, or any given “force majeure” provision, is a question of interpretation which will generally turn on the words themselves used in the specific contract.

But what happens if there is no “force majeure” clause or if the contract is silent on the issue, as will likely be the case with a great number of contracts. For example, the standard OREA Agreements of Purchase and Sale for re-sale residential real estate does not have a “force majeure” clause and they do not expressly speak to what happens if a pandemic breaks out. In this case, can a purchaser back out of a real estate deal because of COVID-19? In the vast majority of cases the answer will likely be “no”, but every case will turn on its own specific circumstances.

When contracts are silent on when the parties will be released from their obligations, the common law of “frustration” will play an important role. A contract is said to be “frustrated” when, without default of either party, a contractual obligation has become incapable of being performed because the circumstances in which the performance is called for would render it a thing radically different from that which was undertaken by the contact (See. e.g.  Davis Contractors Ltd. v. Fareham UDC, [1956] A.C. 696, cited in Naylor Group Inc. v. Ellis-Don Construction Ltd., [2001] 2 S.C.R. 943].

Relying on Davis Contractors, our top Court in Naylor has said that to relieve the parties of their bargains, there has to be a supervening event that has occurred without the fault of either party. It appears COVID-19 would meet that standard. That supervening event, however, would have to alter the nature of the contractual obligation to such an extent that to compel performance, despite the new and changed circumstances, would be to order something radically different from what the parties agreed to under the contract.

The general question to be asked in considering “frustration” can then be seen as whether the occurrence of the event, in the present context, the COVID-19 outbreak, makes carrying out the substance of the thing bargained for impossible. Every case will turn on its own facts, and regard will generally be made to: 1. the foundation/substance of the contract/bargain, 2. whether the performance of the agreement was prevented and, 3. whether the event which prevents the performance of the contract was of such a character that it cannot reasonably be said to have been in the contemplation of the parties when the contract was entered into (Krell v. Henry, [1903] 2 K.B. 740).

In the context of COVID-19, in most cases, the key questions are likely to be the first and second, being what was the substance of the bargain and whether carrying out that thing was truly prevented by the outbreak in the sense that the nature or character of the thing agreed to had “radically” changed because of the event. If this happens, the contract is at an end and the parties are discharged from their contractual obligations.

The circumstances in which contracts will be “frustrated” in the legal sense will be limited based on the standard established by the Courts. In most cases, parties will have to look to “force majeure” clauses, if any, for protection, or risk liability for breach of contract for failing to carry out the things they agree to do in their contracts. This said, how Courts will ultimately apply these principles to the fallout from the COVID-19 pandemic in any given case remains to be seen.  Those with contractual obligations to perform should still carefully consider whether “frustration” might apply to their situations and be prepared to invoke it if faced with a breach of contract lawsuit arising from the COVID-19 fallout.