Frustration Of Contract: How To Navigate Them?

Content

• What is frustration of contract?
• What types of events can cause contract frustration?
• What are the limitations of frustration of contract?
• Force Majeure vs. Frustration of Contracts
• Conclusion

Mutual consent is the foundation of contracts. Parties enter and exit contracts of their violation. But, sometimes, external factors such as contract law, market climate, or even geographical conditions can hinder the smooth sailing of contractual relationships. They prevent the parties from carrying out their obligations. Consequently, have a detrimental impact on core business operations and financial results. 

Contract frustration refers to such events beyond the parties' control. When navigating commercial contracts, companies of all sizes and sectors are likely to run into them. Because of this, we will discuss the complexities of the frustration of a contract and how to deal with them with contract law.  

What is frustration of contract?

Frustration of a contract occurs when it becomes impossible for the involved parties to perform their function due to unforeseen events. Such obstacles must be unpredictable and beyond the parties' control. Due to these intervening circumstances lacking in the written contract, either party may invoke frustration. After that, the contractual agreement is deemed null and void, and neither party is liable for its obligations.

Frustrating events are grounds for immediate discharge of the contract. Since it occurs without the fault of either party, breach of contract or compensation isn’t a part of the solution. However, it can be challenging to establish contract frustration, and courts evaluate each claim individually. The following are the main factors that determine the validity of contract frustration.

• Impossibility

Contract frustration may result if unforeseen circumstances render contract performance objectively impossible. For instance, if a band signs a contract to play a particular date at a venue. A natural disaster, such as an earthquake, destroys the venue before the event, making it impossible to hold the concert. In this case, the contract is frustrated due to the impossibility of performance.

• Illegality

Unlawfulness occurs when an event makes the performance of the contract illegal or contrary to public policy. It could be due to changes in laws or regulations after the contract execution, rendering the contract's purpose illegal. For instance, if a company contracts to provide a specific chemical. Subsequently, a government agency bans the chemical due to environmental concerns. Then the contract performance is unlawful, and the parties can invoke frustration with the contract.

• Significant Changes

In situations where the nature of the contract's obligations drastically changes due to unforeseen events and renders the contract's purpose and intended outcome fundamentally different, parties can claim frustration. For example, if you rent a venue for a particular date. But before the event,  a severe storm causes extensive damage to the property, leaving it in a state that is unsuitable for hosting events. Then if the property could still physically host the event, the significant change in its condition makes the contract's purpose fundamentally different, thus leading to frustration.

What types of events can cause contract frustration?

A contract is frustrated if the parties cannot carry out their obligations under it because of an unforeseen circumstance or if such performance will be wholly inconsistent with their agreed-upon terms. Under contract law, several uncontrollable events can lead to challenges or disruptions in the performance of a contract. Such as:

• Death or incapacity

It is grounds for contract frustration if any parties involved who are essential to contract performance are incapacitated or pass away. This justification is only acceptable if a specific person's skills or abilities are necessary to the contractual arrangement; it cannot excuse an entire company or other legal entities.

• Impossibility of Performance

It occurs when an unforeseen event renders the performance of the contract impossible. It could be due to an act of God (such as a natural disaster), war, riot, or a change in the law that makes the contract illegal. If the performance becomes objectively impossible, the parties have grounds for discharge from further performance and can establish contract frustration. 

• Change of Circumstances

If the circumstances during contract execution have drastically changed, making it fundamentally different from what the parties originally agreed upon, the contract might have grounds for frustration. The drastically different circumstances could be due to evolving market conditions, technology, or other factors.

• Supervening Illegality

It might be frustrating if something happens after the contract execution that makes it illegal to carry out the terms of the contractual agreement. For example, by introducing a new law that prohibits the type of transaction agreed upon in the contract, the contract could become frustrated. Or even banning a particular product or service can cause legal concerns.

• Delay

In some cases, a delay in performance due to unforeseen events might result in the frustration of the contract. It is especially true if the delay renders the contract's objectives obsolete. However, courts typically require a significant and unforeseen delay to invalidate a contractual agreement; a simple delay is rarely sufficient.

What are the limitations of frustration of contract?

There is no sure-cut test to establish the frustration of a contract. The legal system and courts are typically strict while granting frustration for a specific circumstance. They do not want to release parties from their contractual obligations too easily or without good reason. They consider whether the event was predictable, whether it is impossible to carry out the contract terms, and whether the agreement contains clauses to address the upsetting event. Other limitations on contract frustration include: 

• Economic hardship

The mere fact that an unexpected event makes contract performance difficult or expensive is not a viable reason to declare the agreement frustrated. Parties cannot forego contractual obligation if the difficulty or cost rises to an extreme degree that they did not anticipate. For instance, in the Transatlantic Fin. Corp. v. United States case, the Plaintiff sued the defendant for expenses related to the ship's deviation from the usual sea route as a result of the Suez Canal's closure. Since an alternate route was available and the Suez Canal closure did not make it impossible to carry out a shipping contract, the court rejected the impracticability defense. In general, there are not many instances of impracticality brought on by elevated costs.

• Self-induced events

The parties cannot assert contract frustration if either of them in any way contributed to the supervening event. The frustrating event has to be beyond their control, not a result of their actions. These self-induced events that lead to non-performance fall under breach of contract rather than frustration of a contract. The Louisiana Superdome Commission, for instance, signed a deal with Merrill Lynch for a complex financial transaction involving interest rate swaps. However, the Commission's actions caused the financial market situation to change, leading to significant losses. The court ruled that the Commission's actions amounted to self-induced contract frustration. As a result, in Superdome v. Merrill Lynch (1998), Merrill Lynch was relieved of its obligations under the contract.

• Foreseeability

Claims of contract frustration may not come to fruition in circumstances where the involved parties can foresee the supervening event. Even if a risk is foreseeable, a party may choose not to account for it because they do not deem it critical enough to be a topic of negotiation. Foreseeability and "conceivability" are not synonymous. Or else everything becomes predictable. That is why courts use the qualified expression “reasonable foreseeability.” For example, in Nebaco, Inc. v. Riverview Realty Co., a lessee entered a lease to construct a four to five-million-dollar building on the site. In the end, Nebaco decided against it because a federal administrator prohibited the bank from making the loan and sought to set aside its obligations under a lease with Riverview Realty because performance on its part had become impossible. But the court denied the claim stating that Nebaco should have foreseen the event and made a contingency plan, therefore, this defense is unavailable to them.

Force Majeure vs. Frustration of Contracts

"Force majeure" and "frustration of contracts" are legal concepts that deal with unforeseen events that make it difficult or impossible for parties to fulfill their contractual obligations. Force majeure clauses address how the parties should handle situations where certain events beyond their control occur. These uncontrollable circumstances, such as war, riots, government actions, epidemics, or pandemics, are typically stated in contractual agreements. In the case of force majeure, the affected party can temporarily suspend, delay, or even excuse the performance, depending on the contract terms and governing law.

On the other hand, frustration is a common law doctrine that can apply even without a specific force majeure clause in the contract. But the event causing frustration must be so significant that it undermines the fundamental purpose of the contractual agreement. It typically leads to the contract termination automatically, and both parties are relieved from their ongoing obligations. 

Conclusion

Courts generally apply a strict standard when considering this defense. It is insufficient to prove frustration simply because a contract has grown more complicated or expensive. The event must substantially make performance impossible or radically different from what the parties originally intended.

If the involved parties successfully prove frustration of the contract in court, the consequences typically include the discharge of both parties from their obligations under the contractual agreement. The contractual agreement only becomes void as of the moment of the frustrating event, not from the very beginning. Any pre-performance payments or considerations need to be returned or compensated for.

In any case, businesses must exercise extreme caution when handling contracts in order to avoid frustration and subsequent consequences. Taking control of your contract management process through Dock 365’s contract management software can go a long way toward addressing contract frustration and associated risks.