The Law of Contract - Essay Example

When will a party be discharged from his contractual obligations by reason of a change in circumstances? The law of contract stipulates three fundamental requirements to establish a legally enforceable contract; namely offer, acceptance and consideration as highlighted by Lord Wilberforce in New Zealand Shipping Co Limited v A M Satterthwaite, The Eurymedon1. Additionally, it is a general principle that parties are bound to perform the agreed contractual terms on the basis of freedom of contract2. However, the strict rule regarding performance can be mitigated in certain specified circumstances. In particular the doctrine of frustration will enable a party to be discharged from their contractual obligations by reason of a change in circumstances3. A frustrated contract is a contract which subsequent to its formation becomes incapable of being performed as a result of unforeseen circumstances outside the fault of either party4. The intervention of the unforeseen event results in obligations under the contract being radically different from those contemplated by the parties to the contract at the outset5. The focus of this analysis is to critically evaluate the circumstances in which the law will enable a discharge of contractual obligations on grounds of a change in circumstances. To this end, this paper will evaluate the doctrine of frustration and how it has been applied in practice. The legal consequence of a contract found to be frustrated is that the contract is automatically terminated at the point of frustration6. This is an important distinction as the contract is not void “ab initio” (from inception) as solely future obligations are discharged on a strict interpretation of the doctrine of frustration7. However, this has created many problems in practice as the common law position law stipulates that obligations due prior to the frustrating event remain in operation8, which has fuelled conflict as to the nature of obligations that remain operative notwithstanding the applicability of frustration. On this basis, whilst the theoretical basis for the doctrine of frustration is clear regarding when parties will be discharged from contractual obligations; the lack of guidance or definitive list of frustrating events has led to the doctrine being developed on a case by case basis. On the one hand such a flexible approach is arguably necessary to consider change in circumstances fundamental to the heart of contractual obligations on a case by case basis. However, the result of this flexibility is that it is far from clear as to what constitutes frustration in reality9. Moreover, there has been much controversy as to when the doctrine should apply, the main issue being the fact that the courts determine when an event is sufficiently frustrating to merit judicial interference, which results in termination of the contract10. Indeed academic debate is polarised as to the circumstances in which frustration should be applicable11. Furmston highlights the five central theories advanced to clarify this area of law,12which is imperative to understanding the principles on discharging contractual obligations in the event of change of circumstances Moreover, in understanding when frustration will enable contract discharge it is also necessary to discuss the background and evolution of frustration as a doctrine in order to understand the complexities of its application today. Richards argues that during the 19th century, freedom of contract and equality of bargaining power were paramount from a judicial perspective and that courts were reluctant to imply terms, which would undermine fundamental contractual principles13. Indeed, court intervention in contracts was only utilised as a last resort with the absolute contracts doctrine being paramount. For example, the decision in Paradine v Jane14 the defendant had been evicted from his leased land by an invading Army for three years. The court held that the defendant was nevertheless liable to pay the rent, regardless of the intervening event15. The court further took the view that the contract itself should have made express provisions for the circumstances: “When a party by his own contract creates a duty or charge upon himself, he is bound to make it good, if he may, notwithstanding any accident by inevitable necessity because he might have provided against it by his contract16”. As such, this highlights the judicial propensity against the operation of frustration, which whilst understandable have arguably led to resulting injustices in practice, particularly when supervening events are unforeseen and outside the parties’ control17. Indeed, the judicial rationale directly contradicts the purpose of frustration in contract law. As a result, the 19th century case law demonstrates that the doctrine of frustration gradually evolved to remedy such injustices and exceptions were created18. Indeed Taylor v Caldwell19 is widely recognised as the first case which heralded the introduction of the doctrine departing from the absolute contract rule20. In the Caldwell case, Caldwell had entered a contract to hire a music hall in order to hold a series of concerts and events. However, fire destroyed the hall after the contract had been agreed but before the concerts had taken place, rendering the contract impossible of performance. No provision shad been made for the fire and Taylor sue to recover expenses under the principle in the Paradine case. However, the court held that the relevant consideration was the purpose of the contract21. In this case, the purpose had ceased to be operative and was impossible to perform thereby excusing both parties from existing contractual obligations. Blackburn J argued that in considering frustration judges could look to implied terms22: “… in contracts in which performance depends on the continued existence of a given person or thing, a condition is implied that the impossibility of performance arising from the perishing of the person or thing, shall excuse the performance… because from the nature of the contract ….the parties contracted on the basis of the continued existence of the particular person or chattel23.” Peel argues that Blackburn was making an assumption that the court was only doing what the parties really intended at the outset24. The “Officious bystander” test emerged from the Caldwell case and Blackburn’s assertions were criticised on the basis of selective interpretation and guessing of original intentions25. As such, subsequent determinations have been keen to highlight the limitations of the test. However, if the result of the Caldwell case had been to apply the principle in Paradine, this would clearly undermine what the contracting parties intended at the outset. Therefore, whilst the doctrine of frustration should not be applied with impunity, it should be viewed as a useful tool in preserving the absolute contracts tool by ensuring that parties are not subjected to onerous contractual conditions beyond their contemplation at the bargaining phase. There are various circumstances when a contract can be frustrated and often boilerplate clauses will address this directly in the contract26. However, the most common frustrating event will be delay, which can lead to the discharge of a contract where the commercial purpose of the contract has been frustrated. Furthermore, the commercial parties will not be expected to wait until the end of a long delay to find out if they are bound by the contract27. A party to a commercial contract is entitled to act on reasonable commercial probabilities and may treat the contract as discharged where an event has caused a delay, even before the delay frustrates the contract28. The most common difficulty is establishing frustration as general hardship will not constitute frustration, even if severe29. The fact that the method for performance contemplated by a contract has been affected, or the burden of performance has been increased by an event or events occurring without fault, does not amount to frustration unless performance in accordance with the contract has become commercially impossible in a legal sense, highlighting the central factor that contract must become radically different to what was contemplated by the parties in order to satisfy the definition of contractual frustration30. Moreover, the doctrine of frustration has been applied within very narrow limits31. For a party to succeed in claiming frustration, they must demonstrate that the parties never agreed to be bound in the fundamentally altered circumstances that have emerged32. It is irrelevant whether the court considers it just and reasonable to qualify the terms of a contract in an equitable sense, the relevant factor is the interpretation of the contractual terms33. Following the Caldwell decision the application of frustration gained momentum and appeared in cases where performance was rendered impossible due to many other socio-economic factors aside from destruction34. However, the problem is that whilst the range of circumstances covered by the doctrine of frustration has gradually evolved, there is a distinct lack of consistency in judicial interpretation. As such, it is inherently difficult to ascertain whether the doctrine has been applied widely enough in practice due to the case by case basis approach. On the one hand, this is arguably necessary to avoid the doctrine of frustration being utilised as a tool to get out of contractual obligations on a whim. However, perhaps the problem lies in the fact that the doctrine of frustration is viewed as undermining the absolute contracts rule. It is submitted that this is the incorrect approach and that the purpose of the contract should be the relevant consideration. To this end, the doctrine of frustration would in fact maintain the absolute contracts rule by focusing on the actual purpose and contractual intentions of the parties. Another fundamental principle of the doctrine is that a contract will not be frustrated merely in the event of a bad bargain, inconvenience or material loss35. This is particularly enforced in commercial scenarios otherwise it would undermine the core principles of freedom of contract. Indeed, certain risks are inherently assumed in contracting scenarios. For example, a delay in construction contract due to shortage of labour was found not to have frustrated a contract as delay did not result in a new set of affairs that the contracting parties could not have reasonably foreseen36. Moreover the decision in Davis Contractors Limited v Fareham Urban District Council37 highlights how the contractual purpose and nature of the contract should be the relevant considerations. This case involved a construction contract and delays are common in such contracts. Additionally, in the Davis case, Lord Radcliffe set out the factors that would justify frustration in “his radical change in the obligations test38”: “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… It as not this that I promise to do”39. On the basis of this case, frustration may only apply where performance would alter the fundamental nature of the contract. Richards asserts that this is not a radical change in circumstances, but rather obligations, which is completely different to hardship or difficulty40. As such, it appears that frustration currently operates under three broad categories, namely where an intervening act makes performance impossible, illegal or commercially sterile41. Impossibility will usually require the destruction of the subject matter preventing performance as in Caldwell, or where the service to be offered or exchanged no longer exists42. However, this is not a foregone conclusion as Peel suggests, frustration is still capable of applying where the subject matter does exist but becomes unavailable through illness or delay43. In the case of Robinson v Davidson44 and the Condor v Baron Knights45, both contracts were frustrated by illness. The courts took the view that performing was conditional on the basis of the availability of the parties central to the performance, even when there is only a risk that the party will be unable to perform. Delay may frustrate a contract where the commercial venture itself has been defeated and the court has to determine what constitutes a reasonable delay and ultimately depends on the case. For example in the case of Jackson v Union Marine Insurance Co Ltd46 a long unavoidable delay in loading a ship amounted to frustration, as it did in Pioneer Shipping Limited v BTP Tioxide Limited47. Frustration will also not apply in the event that the matter has been foreseen by the parties or could reasonably have thought to have been foreseen. The judicial rationale behind this approach as evidenced in the Davis case was that the risk of labour shortages was apportioned to the builder because it was a possibility in the parties’ eyes48. Moreover, where there is an express provision in a contract addressing consequences of a particular event such as delay, the parties cannot then claim that the same event has frustrated their venture49. If parties to a contract can seriously foresee the occurrence of an event or events but make no provision for it in the contract and then seek to rely on the event as a frustrating the contract, it may then be inferred that the parties accepted the risk of the occurrence of the event and the contract not being found to have been frustrated50. Nevertheless, whilst the case law provides some basic guiding principles on the applicability of frustration, often the conclusion that a particular contract has been frustrated will completely depend on subjective judicial determination of what the commercial significance of the event relied upon as a frustrating the contract51. Perhaps such an approach is inherently necessary, however the lack of consistency renders it impossible to address whether the doctrine of frustration is applied widely enough in practice. Notwithstanding the fact that the doctrine of frustration is difficult to establish, drafting contracts broadly enough to apply to new situations or circumstances can assist parties seeking to avoid a contract being found to be frustrated52. For example, force majeure clauses are utilised in contracts to avoid the doctrine of frustration and operate to suspend performance in the occurrence of supervening events not the fault of either party but maintaining the existence of the contract53. To avoid a contract being found to have been frustrated, parties should apportion risks to remedy the inherent problems of the doctrine. As highlighted above, the classic test of frustration was stipulated in the English case of Davis Contractors v Fareham Urban District Council54. This was then applied in the leading Australian decision on the doctrine of frustration Codelfa Construction Party Limited v SRA of New South Wales55. In Codelfa, ( which has distinct parallels with the Davis Case), the construction company contracted with the Rail Authority to carry out extensions to Sydney’s rail network by building track and stations in the Eastern Suburbs. Time was stipulated to be of the essence as construction had to be completed by a specified date. In order to do so, work was conducted around the clock each day of the week. The Authority and various legal advisers had represented to Codelfa, the construction company, that it was immune from any grant of injunctions that would limit its ability to do such work. Injunctions however, were granted to the local council and residents when the work caused noise and vibration, demonstrating the advice to be erroneous. As a result, Codelfa, could not longer work between 10pm and 6am during weekdays or Saturday, or Sundays at all. Codelfa commenced proceedings, claiming for additional expenses as a result of the need to change working methods. In the alternative, Codelfa claimed that the contract had been frustrated by the granting of the injunction56. The High Court held that the contract had been frustrated. Central to the decision was whether the situation resulting from the grant of the injunction was fundamentally different from the situation contemplated by the contract on its true construction in light of the extraneous circumstances. Moreover, the injunction resulted in the contract work being performed in a manner radically different than contemplated in the contract. It was evident that the contract did not envisage the granting of injunctive relief against the construction company. Furthermore, performance was expected to be completed on a particular date. The supervening event, the injunction, made such performance impossible. Under the common law, a frustrated contract will be discharged. Additionally, some contractual promises may remain unenforceable because they were not conditional upon further performance of the contract. Moreover, terms in a contract that are clearly intended to be operative in the event of frustration may still bind the parties57. For example, in the Codelfa case, the term requiring any contractual dispute to be submitted to arbitration still bound the parties, even after the frustrating event took place. When a contract is found to be frustrated, damages can only be sought for breaches before the frustration of the contract, which clearly limits the amount of recovery. In addition, frustration may mean no indemnity under a relevant insurance policy. Parties can also claim some relief for a frustrated contract under restitutionary principles, which applies outside the parameters of contract and tort law. Restitution protects parties from unjust enrichment. In the context of frustrated contract this may apply when other party in return for their performance of the contract. A prime example is the decision in Fibrosa Spolka Ackcyina v Fairburn Lawson Combe Barbour Limited58, the House of Lords held that a party that had been pre-paid 1000 pounds could recover it after the contract had been frustrated because the other party had failed to perform any of the contractual obligations59. It was highlighted that the court will not accept frustration where at the time of agreeing the contract the intervening act was a risk contemplated by the parties, which could lead to the contract not being fulfilled, unless it could be demonstrated that the event surpasses that which was expected60. Such relief, however, can only be granted when the other fails to perform anything (partial performance precludes any relief). However, the Law Reform (Frustrated Contracts) Act 1943 qualifies the common law position. Any amount paid prior to frustration must be returned to the payer irrespective of whether there has been performance. Further a party that performs work after a contract has been frustrated may also be able to recover restitution. The above analysis demonstrates that the doctrine of frustration covers the ability of parties to discharge contractual obligations where there has been a change in circumstances. Moreover, overall the doctrine of frustration has developed as and remains a patchwork of ad hoc judicial determinations purely determined on the basis of individual factual scenarios. The doctrine of frustration is inherently complex and on the one hand the very nature of frustration arguably merits a case by case determination reliant on the particular facts of the case. However, this creates a paradox by undermining the need for legal certainty. The result of this ad hoc development of the law renders it impossible to determine whether the doctrine has been applied too widely or not widely enough. The very nature of subjective judicial determination means that whilst some decisions have been appropriate to the circumstances, the overall judicial propensity against the operation of frustration has led to some unjust decisions. Whilst the Act attempts to address the deficiencies of the common law with detailed provisions on recovery, ultimately the decision rests on judicial interpretation. As such, it is submitted that clearly a balance needs to be struck. It is further submitted that judicial consideration needs to be given to the interrelationship between frustration and the absolute contracts rule in focusing on the contractual intention of the parties rather than viewing both principles as mutually exclusive. Whilst not a panacea to the inherent complexities of applying the doctrine of frustration, it would be a welcome step towards creating middle ground going forward towards legal certainty. BIBLIOGRAPHY M.P. Furmston (2006). Cheshire, Fifoot & Furmston’s Law of Contract. 145h edition Oxford University Press. J. Martin J & C. Turner, (2004) Unlocking contract law. Hodder & Stoughton. E. McKendrick, (2009) Contract Law, 8th Edition Palgrave Macmillan E. McKendrick (2010) Contract Law: Text, Cases and Materials. 4th Edition, Oxford University Press L. Mulcahy, L & J. Tillotson., (2005). Contract Law in Perspective. 5th Edition Routledge Cavendish. . J. Poole (2010) Textbook on Contract Law. 10th Edition, Oxford University Press J. Powell & R. Stewart, (2009) Chitty on Contracts. 30th Edition Sweet & Maxwell. P. Richards (2006). Law of Contract. 7th Edition, Pearson Education Limited. R. Stone, (2009). The Modern Law of Contract. 8th Edition Routledge-Cavendish M. Young, (2009). Understanding Contract Law. Routledge Read More