Commercial Contracts – Your Rights & Obligations During Covid-19

24 March, 2020 | Nathan Tetzlaff

The novel coronavirus (“COVID19”) pandemic is impacting the national and global economy.  Changes in consumer spending and government requirements are likely to heavily affect business. This can limit or prevent a business’ ability to perform its contractual obligations.

As a business owner, what is your legal position in relation to the effect that COVID19 has on the performance of your business’ contracts? There a two possible legal remedies that might come into play in these circumstances — they are known as “contractual frustration” and “force majeure”.

• Can you rely on Contractual Frustration?
• Can you rely on a Force Majeure Clause?

Contractual Frustration 

Contractual Frustration is a legal remedy that allows for the early termination of a contract when an event happens that, by no fault of the parties, destroys the whole basis of the contract and makes further performance impossible or totally different.

If Frustration is invoked, its effects are automatic and all parties to the contract are absolved of any further performance obligations under the contract. This is referred to as “discharge” of the contract. However, parties must be cautious in asserting that Frustration applies. If Frustration is found not to apply, the party refusing to perform may be in breach.

Frustration was developed to alleviate the harshness of absolute contracts — where a party could not escape liability for damages, even if performance had become impossible.

The New Zealand Supreme Court has confirmed that Frustration cannot be relied on to terminate a contract when the main objective of the contract can still be accomplished.

Frustration is assessed at a very high threshold. Courts do not readily find that it has been reached. It is not enough to claim that future performance has been rendered more expensive, onerous or difficult. In most cases, Frustration depends on the courts’ interpretation of the terms of the contract — which will include its consideration of the nature of the contract and the relevant surrounding circumstances when the contract was made.

In assessing Frustration the court will consider whether the contract is, “on its true construction, wide enough to apply to the new situation: if it is not, then it is at an end”.

Examples of frustrating events:

• Unavailability of thing or person: Where a thing or person that was a fundamental object to the contract is missing, and this importance was understood by the parties;
• Unattainability of purpose: The non-occurrence of an event reasonably regarded as the basis for the contract results in the very purpose of the contract becoming unattainable;
• Supervening illegality:  A contract will be frustrated if further performance of the contract has been made illegal by legislation.
• Government Intervention:  Direct Government intervention in the dealings of the parties; and
• Long delay: Whether delays frustrate a contract depends on the circumstances of each case.

Some contracts have an express clause allocating the risk of a frustrating event. If so, this may prevent Frustration being applied for the specified frustrating event — if the provisions of the clause are sufficiently wide.

Whether the effects of COVID19 are sufficient to invoke Frustration will depend on the subject matter and background context of the contract in each case.

Matters are progressing very quickly. At the time of writing the government has declared a stage 3 response, moving to stage 4 from 11.59 pm on 25 March 2020.  For a business required to be closed, the “government intervention” category may apply.  However, the Government’s assistance package might also change matters, depending on the industry and circumstances, and the impact of this should be assessed in considering Frustration.

If a contract is frustrated and discharged, the Contract and Commercial Law Act sets out what may occur. Firstly, all money already paid under the contract is repayable, and all money payable under the contract before the time of discharge ceases to be payable. However, if either party has received some benefit or incurred some expenses up to the point of discharge, this can be accounted for. The Court has wide discretion to account for benefits or expenses incurred by the parties prior to discharge, so that neither party is unfairly disadvantaged.

Force Majeure 

Frustration can be relied on by any party to a contract if the circumstances allow for it (but remembering that it has a very high threshold). Beyond that, parties to a contract can agree to expand or change their rights if a certain event happens (usually one that is similar to a frustrating event). Such agreements are commonly referred to as Force Majeure clauses.

Because Force Majeure clauses differ from contract to contract, there is no general rule in determining their application. They can be used to provide relief where Frustration would not apply, or to offer a type of relief that Frustration would not provide.

Force Majeure clauses are designed to relieve a party from liability for late or non-performance of its contractual obligations upon the occurrence of specified events — often events that are outside the reasonable control of the parties. Force Majeure clauses often grant relief in cases of epidemics/pandemics.

A party may not rely on a Force Majeure clause just because its performance under the contract has become more expensive. Standard Force Majeure clauses require:

• The occurrence of a triggering event;
• By no fault of the parties;
• Performance under the contract has been delayed or rendered impossible due to the triggering event; and
• There were no reasonable steps that could have been taken to avoid/mitigate the consequences.

Whether you will be able to rely on the effects of COVID19 to utilise a Force Majeure clause will depend on the nature of your contract, the wording of the clause, and the impact of the pandemic on the positions of the parties.

It will also depend how your agreement deals with the effects of the Force Majeure event. The usual approach is that the contract is effectively suspended during the period of the event with the parties’ obligations to perform also suspended. In some circumstances agreements can provide for cancellation of the contract – it will depend on the specific wording of your agreement in each case.

Frustration and/or Force Majeure can apply to any kind of contract, whether for supply, service, or lease. If COVID19 has made it impossible for you or another party to perform a contract, we are available to provide practical advice and explain what legal options might be available to you.

If you’re wondering whether frustration or force majeure could be used where a contract you were party to was not fulfilled, contact expert Contract Dispute Resolution Lawyer, Nathan Tetzlaff by contacting his PA, Mikayla Sagar to set up a consultation. Phone 09 837 6890 or email mikayla.sagar@smithpartners.co.nz