Facing frustration: the relevance of frustration in modern day construction contracts

Introduction

“Frustration of contract” immediately releases contracting parties from performance of the contract if an event occurs beyond their control which renders further performance “impossible” or “substantially impossible”.

The test for proving that performance is “impossible” is not straightforward and comes with a high threshold. Furthermore, the application of frustration to modern day contracts, in particular construction contracts, is questionable. This article examines the doctrine of frustration and its continued relevance and application given that various contracts (particularly property and construction contracts) specifically address common frustration risk events.

Facing Frustration

The doctrine of frustration

The law of frustration is well settled in New Zealand. As recently affirmed by the Supreme Court in Planet Kids v Auckland Council (2014] 1 NZLR 149 (SC) at [51] citing Davis Contractors Ltd v Fareham Urban District Council [1956] AC 696 (HL)), frustration occurs “wherever the law recognises 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”. In order for a contract to be frustrated, the frustrating event must not be brought about by one of the contracting parties, and the contract must not make provision for such an event.

For example, in the High Court of Australia case of Codelfa Construction Pty Ltd v State Authority of NSW (1982) 149 CLR 337 the parties entered into a tunnelling contract for extension to Sydney’s rail network on the understanding that the contractor’s price was based upon continuous shift-working. This was reflected in the contractor’s programme, which formed part of the contract. Shortly after work commenced, members of the public obtained injunctions in order to restrict the contractor to two-shift daytime working and no work on Sundays. On appeal from arbitration, the High Court of Australia found that the arbitrator should have little difficulty in holding that the contract had been frustrated given that the completion of the works by the stipulated time for performance was impossible (without an agreed variation to shifts).

High threshold

Once a contract is frustrated it is terminated automatically and immediately, irrespective of the parties’ subjective intentions to continue (albeit on modified or renegotiated terms).

Given that the effect of frustration is to end the contract, the courts have been careful to confine the doctrine within narrow limits and do not invoke it lightly, so as to not interfere with a negotiated contract (Karelrybflot AO v Udovenko [2000] 2 NZLR 24 (CA) at [37]). Thus, the doctrine requires that the contractual obligation becomes impossible or incapable of performance.

This includes whether the purpose of the contract has become impossible to attain (for example in Krell v Henry [1903] 2 KB 740 where the defendant leased a flat from the plaintiff for two days, and both parties knew that the entire purpose of this was so that the defendant could view the coronation procession of Edward VII. The procession was cancelled, and it was held that the letting contract was frustrated). The result may have been different if the court found that the viewing was not the sole purpose of the letting contract and that the tenant would still have obtained some benefit out of the contract.

It will not be enough that the obligation has become more onerous, more expensive or slower (unless the delay is such that the purpose of the contract is frustrated). Therefore, cases where the doctrine has been successfully upheld in the construction context are usually of the kind where the work in the project has been destroyed, for example by fire or landslide (for example Appleby v Myers (1867) LR 1 CP 615).

The high threshold for a finding of frustration is also influenced by the fact that contracting parties are expected to bear the risk in contracts of certain kinds. So, for example, a contractor who provides a quote for certain works is expected to take the risk that the works will prove more difficult and more costly than expected.

In Davis Contractors (supra) shortages of labour and materials meant that performance of a contract to build 78 houses in eight months for £94,000 took 22 months and cost the contractor £115,000. Despite such severe obstruction to contractual performance, the House of Lords found that this was insufficient to frustrate the contract. The contractor had taken on the risk of lack of labour because it was not an unforeseen event for a contractor, and it could have been the subject of contractual stipulation if the contractor did not want to take on this risk.

Remedies upon frustrating event

The Frustrated Contracts Act 1944 (FCA) contains two major provisions to relieve injustice in a situation where one party has performed their contractual obligations before the contract is terminated due to a frustrating event.

The FCA provides that:

(a) Where money has been paid by one party before the frustrating event, it can be recovered and monies payable cease to be payable. If the party to whom these monies were paid has incurred expenses in performing his or her part of the contract before frustration, the court may allow him or her to offset a sum in respect of those expenses. For example, if a contractor has partly constructed a house and has received $50,000 in progress payments before the frustrating event, the owner will be entitled to recover this sum less the amount the court allows the contractor to keep as reimbursement for the works completed; and

(b) Where one party’s part performance has conferred a benefit on the other party before the contract is discharged, that other party may recover a “just sum” in compensation.

Parties can contract out of the FCA and specify what will happen upon termination due to a frustrating event. For example, clause 14 of the standard form construction contract NZS3910 provides that:

“In the event that either the Principal or the Contractor considers that the Contract has become impossible of performance or has been otherwise frustrated, one may notify the other that it considers the Contract to be terminated. If the other parties agree, or in the event of disagreement if it is so determined by the Engineer or by mediation or arbitration under Section 13, then 14.1.2 shall apply.”

This clause dictates the process if only one party considers that the doctrine is engaged by referring it to the Dispute process under clause 13 of NZS3910. If the contract is found to be frustrated, clause 14.1.2 provides for the costs that are payable by the principal to the contractor following the frustrating events (including the value of the work carried out at the date of termination less amounts previously paid).

In the context of construction contracts, contractors and principals often find themselves in situations where performance has become more onerous, more expensive or slower due to unforeseen circumstances. However, the fact that the bargain has become unworkable in a commercial sense because of an unforeseen event will not discharge the party from further performance on the grounds of frustration. Therefore, it is important that the contract is drafted to reflect the parties’ intention as to what should happen if such an event was to occur and this is what a force majeure clause is desired to do.

Force majeure clauses

Force majeure clauses are common in the construction sector and offer a commercial mechanism to clearly address unforeseen events. Parties can agree upon both the events that trigger the force majeure clause, and the consequences. Unlike the strict doctrine of frustration, where the threshold can be difficult to meet, parties can negotiate force majeure clauses in order to achieve flexibility for certain events. For example, parties to a construction contract may choose to suspend performance or extend time for performance upon the occurrence of a force majeure event.

Clause 10.3.1 of NZS3910 is a force majeure provision which provides that the engineer grant an extension of time to the contractor if the contractor is “fairly entitled to an extension” including by reason of flood, volcanic or seismic events, or any circumstances not reasonably foreseeable by an experienced contractor at the time of tendering and not due to the fault of the contractor.

Force majeure clauses are also included in the FIDIC suite of contracts (Red, Yellow and Silver Books) at clause 19 where “force majeure” is defined as an exceptional event or circumstance beyond a party’s control, which could not reasonably have been provided against before entering into the contract and which, having arisen, could not reasonably have been avoided or overcome and which is not substantially attributable to the other party. The categories listed as force majeure events include: (i) war and other hostilities; (ii) rebellion, terrorism and civil war; (iii) riots and strikes (by persons other than the contractor’s personnel and subcontractors); (iv) explosive materials and radioactive contamination; and (v) natural catastrophes such as earthquakes, hurricanes and volcanic activity.

Clause 19 of the FIDIC suite of contracts entitles the contractor to an extension of time if it is prevented from performing the contract by any of the force majeure events. However, it will only be entitled to recover the costs incurred due to the force majeure event if it is a category (i) to (iv) event (meaning that the contractor cannot recover costs arising in relation to natural catastrophes).

Relationship between frustration and force majeure

Where the parties have turned their minds to the frustrating event and contractually allowed for it in a force majeure clause, reliance on the common law doctrine of frustration is generally precluded. Given the prevalence of force majeure clauses in standard form construction contracts, a finding that the contract had been frustrated in Codelfa Construction Pty Ltd v State Rail Authority of NSW (supra) has been described by Hudson’s Building and Engineering Contracts (12th Edition) as an “exceptional result” (at [1- 059]).

Force majeure clauses are commonplace in the construction industry, such that the absence of one might be viewed as implied acceptance of risk by the contractor for certain events that would normally be covered by such a clause (and which therefore can no longer be described as “unforeseen”). As was recently confirmed by the Supreme Court in Planet Kids (supra) at [139]:

“Where risk is allocated to one of the parties under the contract, then the doctrine of frustration is excluded, in so far as it relates to the occurrence of one of the allocated risks. The allocation of risk can be express or by necessary implication …” (emphasis added).

Determining whether a contractor has impliedly taken on such risks in the absence of a clearly drafted force majeure clause will obviously depend on the particular facts and circumstances. Some events, such as earthquakes or other natural catastrophes, could be viewed as foreseeable risks which should have been clearly allocated in construction contracts, failing which the court may find that one of the parties has taken on the risk by necessary implication, for example through being reflected in the agreed price. In such a case, if the court finds the risk has been impliedly allocated under the contract, the doctrine of frustration may be excluded.

However, there may be other scenarios where the court determines that an event falls outside what the parties expressly allowed for in a force majeure clause (or implicitly allowed for in the absence of such a clause). In such a case, if it is not reasonable to place the risk of non-performance for the events which have occurred on one party or the other or neither, the contract may be frustrated.

For example, in Metropolitan Water Board v Dick Kerr & Co Ltd [1918] AC 119 (HL) contractors entered into a contract in July 1914 to construct reservoirs at an agreed price within six years. In February 1916 the government prohibited the continuance of work due to the outbreak of war. The contract provided the engineer power to extend time for completion in the event of any “difficulties, impediments, obstructions, oppositions…whatsoever and howsoever occasioned”. The House of Lords considered that this scenario could not possibly have been in the contemplation of the parties to the contract when it was made and therefore it fell outside the scope of the force majeure clause. The contract was therefore frustrated as the works were prohibited by law (at [126]).

Conclusion

The threshold for frustration is high, and the operation of frustration will be contractually constrained by what the parties have allowed for in their contract, in particular with reference to the force majeure clause. Increasingly, parties are already allocating risks or at least addressing some risks in their contract, such that the doctrine of frustration often does not apply.

However, it is arguable that a well-drafted force majeure clause assists the court in reaching a finding of frustration where there has been a truly frustrating event, as the court can clearly identify which risks the parties have foreseen and allocated accordingly.

How strong the doctrine of frustration will be in modern day contracting will continue to be tested by (most commonly unfortunate) catastrophic events.

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