Contracting and Coronavirus (3/3)

This article, the third in a series of three articles, considers the effect of the common law principle of frustration in the context of the impact of Coronavirus on the contract regimes applicable to JCT and NEC forms of contract. Other articles cover relevant JCT and NEC terms.

Contracting with Coronavirus: JCT and NEC contract regimes and frustration

John Denis-Smith 39 Essex Chambers

The Background I have considered the contract terms applicable to JCT and NEC contracts in two separate notes. However, I focus here on common law principles which are not set out explicitly in those contract forms, in particular the principle of frustration.

The modern doctrine of frustration was summarised by Lord Simon of Glaisdale in National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675 at 700:

"Frustration of a contract takes place when there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances; in such case the law declares both parties to be discharged from further performance."

Thus frustration brings the contract automatically to an end, but cannot be self-induced, nor can it apply where the risk is expressly contemplated by the contract's provisions.

Thus, a form of force majeure clause specifically applying to disruption by reason of shortage of materials may apply, and the doctrine of frustration has no application.

However, its application is more complex. Delays and difficulties of supply causing cost increases do not give rise to frustration as such, as was held in a construction case, Davis Contractors v Fareham Urban DC [1956] A.C. 696, in which an 8 month contract was extended to 22 months by reason of late demobilisation of the armed forces from which the workforce was obtained. The House of Lords in that case indicated that it would be difficult to see how frustration could ever arise by reason of events occurring pre-contract (a view shared by the Court of Appeal in McAlpine Humberoak Ltd v McDermott International Inc (No.1) (1992) 58 B.L.R. 1). That appears logical but another ground relied upon, that the contract expressly allocated risk for delayed completion, means that there will be uncertainty as to at what point the doctrine does apply such that it can be said, as Lord Radcliffe put it "the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract."

That said, there comes a moment when difficulties can become so acute as to give rise to frustration:

1. A change of law which renders performance impossible will normally amount to frustration but a shorter period of delay may amount to frustration if he interruption is so long as to destroy the identity of the work and service when resumed, with the work and service when it was interrupted;
2. A contract for the shipping of maize from a given country by a different date was frustrated when the government of that country acted in such a way that, although there was no prohibition of export in the sense that any export was absolutely forbidden, there was on the facts as found a de facto prohibition which prevented the sellers from exporting the goods. Such a contract is discharged if a supervening event not contemplated by the contract renders that performance impossible or fundamentally different from what was originally envisaged;
3. In Asia, a ban on the export of sand from the only practically available site has been held to amount to a frustrating event.

It would seem dangerous to assume that frustration by reason of the existence of the Coronavirus itself would apply to contracts entered into in future: as in Davis Contractors v Fareham Urban DC [1956] A.C. 696, the existence of the threat is already known and it has been held that frustration cannot apply to existing risks, at least where they do not worsen following entry into the contract.

It may however be that future changes in law could give rise to frustration, if performance becomes impossible or is so changed in character that it has become "radically different". However, the test to be met will be demanding.

It might be said that large scale disruption, can give rise to frustration, whether by reason of an absolute inability to source materials (analogous to the sand ban scenario) or government prevention (in practice, even if not directly in law, as in the shipping case above). The argument may be that a contract contemplates that work will be carried out regularly and diligently and that, if labour shortages become prohibitive such that one cannot carry out work in that way, performance has been rendered fundamentally different.

The effect of frustration at common law is that the contract is automatically discharged and the parties are excused from their future obligations. No further sums would be payable and payment would only be due to be repaid where there had been no performance of any value such that the Employer could establish failure of consideration. Under the Law Reform (Frustrated Contracts) Act 1943, section 1 provides that, where the Employer has obtained a valuable benefit from the works, the Contractor may recover from the Employer such sum not exceeding the value of the benefit as the court having regard to all the circumstances of the case considers just, while the Employer is entitled to recover sums already paid and is not liable to pay sums due but unpaid. Given the uncertainties as to valuation, it is unlikely that relying on frustration is preferable to other routes to recovery under the NEC or JCT terms.

Frustration and NEC 4/JCT It is not clear if and to what extent frustration can apply to the NEC or JCT contracts in respect of Coronavirus. If the impact of the virus falls within the scope of Clause 61.19 and the force majeure provisions of those forms respectively, one would not expect frustration to apply but, taking into account that an extended prevention of any activity on site might be held to be outside the scope of the variation provisions, this is not certain to be the case. Hence, in principle, frustration may apply although, as set out above, the burden to establish frustration is high.

Clause 91.5 of the NEC 4 contract provides that either party may terminate "if the Parties have been released under the law from further performance of the whole of this contract." It is not clear whether this could apply to frustration for, as already stated, the effect of frustration is automatically to discharge the parties from performance.

The JCT contract contains no equivalent provision to Clause 91.5 of the NEC form. Common law principles therefore would apply.

CONCLUSION It seems likely that the Coronavirus and its impact on construction projects may be considerable. The provisions of the JCT and NEC contract forms do not necessarily afford complete relief: the impact of the virus under the JCT form may give rise to an entitlement to an extension of time but not money (at least where there is no termination or the Employer did not issue instructions amounting to a Variation) while, under the NEC form, the definition of Compensation Events does not readily apply to contracts entered into in future. Parties are likely to address the impact of pandemic or epidemic by way of amendments to the forms and there may be considerable dispute before the position becomes clear. The principle of frustration is not explicitly excluded from operation in NEC or JCT forms but it remains to be seen whether that principle is prevented from coming into play by the provisions relating to force majeure and Compensation Events.