COVID-19 — Why You Might be Entitled to End Your Contracts

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By Warren Scott, Partner, and Scott Colvin and Holly White, Lawyers

With business disrupted by the outbreak of COVID-19, many companies want to understand what rights they have to terminate or leave contracts.

Along with force majeure clauses, it might be possible to terminate or leave contracts under the common law doctrine of frustration.

What is contractual frustration?

Frustration excuses performance of a contract without default of either party where an external event makes the contract impossible or illegal to perform, or makes the obligations radically different from what was contemplated by the parties.

That external event must not have been caused by the parties, and the contract itself must not deal with what is to happen in the face of such an event (for example, where a force majeure clause confirms what is to happen where there is a natural disaster).

If a contract is frustrated, the contract is automatically ended, and the losses will generally lie where they fall. However, if one party has made a payment to the other without receiving the associated goods or services, they likely have a claim for the return of those monies.

Is COVID-19 a frustrating event?

Whether COVID-19 will frustrate a contract depends on its impact on the ability to perform the contractual obligations – does performance become impossible or merely more difficult?

Generally, a contract will not be frustrated if performance is still possible, even if performance may need to be delayed and/or will be more expensive. Who will bear the cost of delay will mostly depend on the terms of your contract.

However, there is a good deal of grey area. A contract for an event for over 100 people, for example, may require that the event take place on a specified day — which would be illegal under current social distancing requirements. Arguably, this contract is impossible to perform as it requires the event take place at a certain time.

The list of things that may make performance impossible is long, but may include labour shortages, business shutdown due to government intervention, inability to source materials and others.

Seeking legal advice can be important to determine whether your contract has been frustrated.

The example of SARS

The frustration of contracts was considered during the SARS epidemic.

In Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754, a tenant in a 2-year lease was denied access to the premises for 10 days due to a government isolation order and argued the lease was frustrated. The Court held the duration was insignificant in the context of the term of the lease with Judge Lok stating:

the outbreak of SARS may arguably be an unforeseeable event, however, such supervening event did not, in my judgment, significantly change the nature of the outstanding contractual rights or obligations from what the parties could reasonably have contemplated at the time of the execution of the Tenancy Agreement.

This demonstrates that COVID-19 could be considered as a frustrating event, as long as it renders performance of a contract impossible, illegal or radically different — but not merely delayed.

Statutory Frustration in Victoria and COVID-19

In Victoria, contracts may also be frustrated under the Australian Consumer Law and Fair Trading Act 2012 (Vic) (the Act).

The Act applies to certain contracts where parties are discharged from further performance because performance becomes impossible, the contract is otherwise frustrated, or the contract is avoided by the operation of s 12 of the Goods Act 1958, which covers goods that are destroyed prior to sale without fault of either party (see section 35(1) of the Act).

Under the Act, if a contract becomes frustrated, all amounts paid under a frustrated contract before the frustration event are to be repaid to the party that paid (see section 36(1) of the Act), and all unpaid amounts cease to be payable (see section 36(2) of the Act).

In the COVID-19 environment, this could mean if a contract becomes frustrated in Victoria, it may be easier to recover amounts paid to a party under a frustrated contract, before the contract became frustrated.

Conclusion

If you are unable to perform your contracts as a result of COVID-19, those contracts may be frustrated, and you may be entitled to end them and seek recompense for any amounts paid. You may also be able to avoid paying or providing any relevant goods and services.

These are not easy issues to grapple with, and we encourage you to get in touch with any member of our Corporate Advisory team to determine your contractual rights.

For further information, please do not hesitate to contact us.

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