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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:

  1. Impossible; or
  2. 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:

  1. Has the contract allocated the risk of the particular event occurring
  2. Has there been a radical change in obligations
  3. 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:

  1. Non-occurrence of an event
  2. Increased expense
  3. Destruction of subject matter
  4. Illegality
  5. Alteration of manner of performance or impossibility by one party
  6. Outbreak of war
  7. 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:

  1. The advertisement of the room expressly advertised a viewing of the coronation, not a regular letting of the room
  2. The use of the room was only during the day, and not the night
  3. 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:

  1. Where the money is paid in advance
  2. 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

  1. Does not exceed the intended advance payments, and is a form of insurance for the contract; or
  2. 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:

  1. It cannot exceed to value of the benefit conferred to the other party;
  2. The court must consider the expenses incurred by the party receiving the benefit
  3. 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:

  1. Identify and value the benefit to the party receiving the benefit, this becomes the upper limit of award
  2. 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)

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