By Law Teacher
6.2.1 Frustration Lecture – Introduction
Welcome to the sixth lesson of this module guide – frustration! This is the final way in which contractual obligations can cease. A contract may become frustrated where, post-contract creation, a change in circumstances occurs that makes the contract impossible to perform or become radically different. Frustration essentially allows a remedy in changes of circumstances, discharging each party from future obligations under said contract.
The chapter begins by defining the doctrine of frustration and laying out the test. The chapter then moves on to a more detailed exploration of the three test elements, with a focus on the “radical change” element. Key cases are discussed here relating to the circumstances under this element. Following this, the legal effect of frustration is discussed, before providing a practical example.
Below are some goals and objectives for you to refer to after learning this section.
Goals for this section
- To understand the importance of frustration as a remedy in contract law
- To understand what the test is for establishing frustration
- To understand the different principles governing frustration
Objectives for this section
- To understand what is meant by a contract becoming frustrated
- To understand the difference between each of the elements needed to establish frustration
- To understand the developed case law behind the circumstances in which “radical change” may apply
- To be able to understand the legal effects of frustration, both financially and on the contract
- To understand how the Law Reform (Frustrated Contracts) Act applies
- To be able to apply the remedy of frustration to a scenario
6.2.2 Frustration Lecture
What is Frustration?
The doctrine of frustration discharges both parties from their contractual obligations where following the formation of the contract, performance of the contractual obligations become either:
- Impossible; or
- Radically different
Essentially, what the doctrine of frustration allows for is a remedy in case of a change of circumstances. The case which established the doctrine of frustration was Taylor v Caldwell(1863) 3 B & S 826.An important quality of frustration is that it must be based on an assumption made by both parties.
The test for frustration
There are three main elements when assessing whether frustration applies to a contract:
- Has the contract allocated the risk of the particular event occurring
- Has there been a radical change in obligations
- Was the radical change due to the fault of one of the parties?
Has the contract allocated the risk of the particular event occurring?
Frustration can only operate where the parties have not themselves allocated the risk of loss between themselves in the contract. In other words, where a party has agreed to bear the risk/loss of some sort.
There is no requirement that the allocation of risk has to be exact or definite, just that there is at least some mechanism for dealing with particular changes in circumstances.
Has there been a radical change in obligations?
There are a variety of ways in which the obligations under a contract can change. Previous case law has created distinct categories that provide for different presumptions and rules relating to the application of frustration. Therefore, this chapter will cover them each in turn. They are as follows:
- Non-occurrence of an event
- Increased expense
- Destruction of subject matter
- Illegality
- Alteration of manner of performance or impossibility by one party
- Outbreak of war
- Delay or interruption
Non-occurrence of an event
The operation of frustration in such circumstances is best understood with reference to two of the most famous cases on frustration, known as the ‘coronation cases’.
In Krell v Henry, the coronation was the foundation of both parties entering into the contract, they had both made the assumption that the coronation event would go ahead. However, in Herne Bay, only the defendant was concerned with the naval review, there were no assumptions from the claimant.
To recap, the three points from Krell v Henry which identify that the coronation was the foundation of the contract were:
- The advertisement of the room expressly advertised a viewing of the coronation, not a regular letting of the room
- The use of the room was only during the day, and not the night
- The claimant was not in the business of renting his room out regularly, he had only done it on this particular occasion
These factors show that there was a joint assumption by the parties that the event would go ahead, and it was not just one of the parties making the assumption, which is one of the key requirements of frustration.
Increased expense
The courts have tended to rule that an increased expense for one party can never frustrate a contract – Davis Contractors Ltd v Fareham Urban District Council.
In Tsakiroglou & Co Ltd v Noblee Thorl GmbH [1962] AC 93 it was suggested that an increased expense, no matter how onerous, could never frustrate a contract. Only one judge, Lord Reid, disagreed with this notion. He argued that in the case of extreme increases in expense, the contract should be frustrated.
Destruction of subject matter
Similar to the non-occurrence of an event, a contract may be formed with a particular subject matter in mind. This section covers what will happen where the subject matter is destroyed – Taylor v Caldwell (1863). Generally speaking, where the subject matter of a contract has been destroyed due to no fault of either party, the contract will be frustrated.
See Appleby v Myers (1867) LR 2 CP 65.
In these cases, the parties have both made an assumption that the subject matter will exist at the time of the contract. You ensure that this is the case, and that the destroyed thing is the actual subject matter of the contract.
Illegality
Illegality refers to where the parties form a contract, and subsequently, before or during performance, the contract becomes illegal to perform. The general rule is that this will frustrate the contract if the effect on the contract is serious enough. If the effect is minimal and only partial, the doctrine of frustration will not apply.
It is important to remember that the rules of illegality, will apply where the contract is illegal at the time of formation. Frustration here only applies where the contract becomes illegal following its formation.
The most common example of illegality is where legislation is enacted which renders the contract illegal (Denny, Mott and Dickson v James B. Fraser & Co Ltd [1944] AC 265).
In some cases, the illegality of the contract is temporary. If the length of time is short enough, the contract may not be frustrated and the parties will simply have to wait out the period of time before continuing the contractual obligations. The courts which consider the length of time the contract will operate for, combined with the length of time of the illegality – National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675.
Alteration of manner of performance or impossibility by one party
Where an event results in a change in obligations or impossibility for one party, there will not be frustration of the contract – Blackburn Bobbin Co Ltd v Allen (TW) & Sons Ltd [1918] 1 KB 540.
One party conducts their business is their problem, and they bear the risk of any business decisions they make which result in circumstances such as in Blackburn Bobbin.
Outbreak of war
Where both parties have assumed performance will be done in a specific way which is rendered impossible by the outbreak of war, this may amount to frustration – Tsakiroglou & Co Ltd v Noblee Thorl GmbH [1962] AC 93.
Delay or interruption
As mentioned concerning temporary illegality, there may be a delay or interruption that is impossible to avoid. The issues with such delays is that the parties cannot be certain how long the delay will last, it could be ten days, which would not frustrate the contract, but it could be ten years, which almost definitely would frustrate the contract.
The courts will also consider these factors in deciding whether a contract may be frustrated for delay (The “Sea Angel [2007] EWCA Civ 547)
- How did the delay arise
- Was the delay foreseeable
- How does the contract distribute the risk in other similar circumstances
Was the radical change due to the fault of one of the parties?
If one party is at fault for the frustrating event, it is less likely that the contract will be frustrated. The Super Servant Two [1990] 1 Lloyd’s Rep 1 explained that a frustrating event should be uncontrollable and an extraneous change of situation.
Importantly, if one party is at fault for the frustrating event, although that party may not make a claim for frustration, the innocent party can do so and will be able to claim damages for any loss that resulted from the contract.
As well as a breach of contract, a negligent act which results in the frustrating event will amount to fault – Taylor v Caldwell.
DGM Commodities Corporation v Sea Metropolitan SA [2012] EWHC 1984 (Comm) confirmed that ‘fault’ has a very loose definition in this context. There does not need to be an element of breach of contract or negligence, it can just be a positive action from the party or an individual whom the party is responsible for.
The legal effect of frustration
Effect on the contract
Hirji Mulji v Cheong Yue Steamship Co Ltd [1926] AC 497 confirms the effect of frustration is that it brings the contract to an immediate end, whether or not the parties wish this to be the result. In other words, it is void, not voidable (as is the case for repudiatory breaches).
Financial effects
Previously, under the common law, all obligations under the contract ceased in event of frustration. This included both primary obligations of the contract, and secondary obligations in relation to breaches, such as damages. Therefore, the general rule was that the loss lies where it falls – Fibrosa SA v Fairbairn Lawson Combe Barbour Ltd. There are two different circumstances for these purposes:
- Where the money is paid in advance
- Where the money is paid on completion
Where money had been paid in advance, the advance payments could be recovered if there was a total failure of consideration by the other party.
Where money is paid on completion, there was an unfair effect on the party who have partially completed their obligations – Appleby v Myers (1867) LR 2 CP 651.
As a result of these financial implications of frustration under common law, the Law Reform (Frustrated Contracts) Act 1943 (LRA) was formed.
Law Reform (Frustrated Contracts) Act
Section 1(2)
Section 1(2) of the act applies where money has been paid in advance or is payable in advance. It states that money already paid is recoverable, and money that is payable need not be paid. There must be a total failure of consideration in order for this to apply.
The courts have the discretion to allow the other party to retain any advance payment to cover any expenses incurred, so long as the amount of money
- Does not exceed the intended advance payments, and is a form of insurance for the contract; or
- Does not exceed the actual value or the actual expenses incurred
Essentially, this section prevents advance payments from automatically being forfeited in the event of frustration.
In deciding whether to allow the retention of any advance payments, the court will consider whether the expenses incurred may be recovered in an alternative way.
Section 1(3)
Section 1(3) states that where no advance payment has been made or will be made under the contract, there can be no compensation for expenses incurred in the performance of a frustrated contract.
However, if the performance has conferred a valuable benefit on the other party prior to the frustrating event, the court has the discretion to allow a claim for the incurred expense. The amount will be assessed as follows:
- It cannot exceed to value of the benefit conferred to the other party;
- The court must consider the expenses incurred by the party receiving the benefit
- The court must consider the benefit received and how the frustration has affected such benefit.
See Gamerco SA v ICM/Fair Warning (Agency) Ltd [1995] 1 WLR 1226.
The case of BP Exploration Co (Libya) Ltd v Hunt (No. 2) [1979] 1 WLR 783 saw an application of Section 1(3). Robert Goff J confirmed the correct approach to calculate the amount allowed for expenditure:
- Identify and value the benefit to the party receiving the benefit, this becomes the upper limit of award
- Within the limit from (a), decide what sum is just with reference to fairness, the effect of frustration, and the expenses incurred by the party receiving the benefit.
Contracts which the LRA does not apply to
The LRA does not apply to certain contracts. In most cases, the common law rules will then apply.
- Where the contract has made express provision for the consequences of frustration (Section 2(3))
- Where the contractual obligations have been wholly completed (Section 2(4))
- Contracts for the carriage of goods by sea (Section 2(5)(a))
- Contracts for insurance (Section 2(5)(b))
- Contracts for the sale of specific goods which are frustrated due to the perishing of goods (Section 2(5)(c)
Frustration Scenario
Sasha is an entrepreneur and is experimenting with a number of different business ideas. She has had some awful luck and there has been a number of events which may leave her in a difficult position as far as her contractual obligations are concerned.
Contract one is with an artisan cheese shop. She has contracted to sell them £10,000 worth of Swedish cheese. There is only one supplier of Swedish Cheese, who is located in Sweden. Unfortunately, before the delivery of the cheese, a war has broken out between Sweden and England. All trading between the countries is to be ceased and is now illegal.
Can Sarah use the doctrine of frustration to release herself from the contract?
Contract two is a contract for the hire of a large wooden market stand in the centre of the towns market. Subsequent to the making of the contract, the owner of the market stand was cleaning it. After taking a break for a cigarette, he accidently dropped the still lit cigarette, resulting in the market stand being destroyed by a fire.
Would the destruction of the stall mean the contract for the rental of the stall is frustrated?
Contract three is made with Joe, who is paying Sasha £3000 for her to build his business a website. Sasha was concerned he may not pay her, so took an advance payment of £1,500. The contract has now been frustrated due to a law which renders the creation of this particular type of website illegal. Joe is now trying to claim his advance payment back. Sasha has spent over fifty hours working on the website, and her usual hourly rate is £20.
Following the frustration of the contract, can Joe claim the advance payment back? If so, will he be entitled to the entire £1,500 or just part of it?
- The subsequent illegality of a contract may render a contract frustrated dependent on the length of time the contract would be illegal. In this case, it would be uncertain how long the war will last, therefore it is more likely that frustration would be able to be successfully argued.
However, in this case, the contract between Sasha and the artisan cheese shop is not illegal, only Sasha’s supply contract for the Swedish cheese is illegal. This is similar to the case of Blackburn Bobbin Co Ltd v Allen (TW) & Sons Ltd [1918] 1 KB 540. In that case it was held that the original contract was not frustrated just because of the impossibility of the one party. Only one party, Sasha, had made the assumption that the supply of cheese would be legal. In order for frustration to operate, both parties must make the assumption, which is not the case here. Therefore, the contract would not be frustrated.
- The second contractual issue relates to the destruction of the subject matter. In Taylor v Caldwell(1863) 3 B & S 826 it was confirmed that where the subject matter of a contract is destroyed, the contract will be frustrated. However, in this case there is an element of fault. It was the owner of the stalls fault the subject matter was destroyed, due to their negligent act of dropping a lit cigarette on the wooden stand. Where one party is at fault, the contract will not be frustrated (Maritime National Fish Ltd v Ocean Trawlers Ltd [1935] AC 524). Taylor v Caldwell confirms a negligent act will be sufficient to amount to fault.
- The Law Reform (Frustrated Contracts) act gives guidance what happens in the event that there has been an advance payment made for a contract that is subsequently frustrated. Section 1(2) of the act rules that an advance payment may be retained, so long as the amount does not exceed the specified advance payment under the contract, and does not exceed the expenditure of the party who has received the payment.
In this case, Sasha’s expenditure can be calculated by multiplying her hourly rate, £20, by the number of hours she spent creating the website. Therefore, Sasha’s expenditure amounts to £1,000. This means Sasha can retain a maximum of £1,000 from the advance payment, meaning Joe will be entitled to a return of the remaining £500