Performance and Discharge of a Contract PDF

5 Performance and Discharge of a Contract LEARNING OUTCOMES When you have completed this chapter, you should be able to: explain and apply the rule relating to complete performance and the exceptions; identify and explain situations whe...

5 Performance and Discharge of a Contract LEARNING OUTCOMES When you have completed this chapter, you should be able to: explain and apply the rule relating to complete performance and the exceptions; identify and explain situations when a contract may be discharged; demonstrate a thorough knowledge and understanding of the nature and effects of frustration and apply the law to factual situations; understand the nature of a force majeure clause and explain why parties may wish to insert such a clause into their contract. 5.1 Order of performance The parties may state in their contract when each party must perform their contractual obligations. Taking a commercial sale of goods contract as an example, what might the parties agree in relation to the order of performance? The parties might agree that: the buyer will pay after delivery of the goods, eg payment within 21 days of delivery of the goods or issue of an invoice (have a look again at clause 6 of the Specimen Conditions of Sale which we dealt with in Chapter 4; the clause makes it clear that payment will be made only after the goods have been delivered); the buyer will pay on delivery; the buyer will pay before the goods are delivered. If the parties do not make the order of performance clear in their contract, then there may be some statutory provision which can assist. For example, the Sale of Goods Act 1979 provides that unless otherwise agreed, in a contract for sale of goods, payment and delivery are concurrent provisions. The order of performance is important when considering the doctrine of complete performance which we examine next. 5.2 The doctrine of complete performance The contract may make it clear that one party only has to perform their obligations when the other party has performed their part of the contract. For example, suppose you enter 119 Contract into a contract to have your house decorated. You may agree that the decorator will do the work first and you will pay when the decorating has been completed. Your obligation to pay arises only when the decorator has completed the work. If the decorator does a little work but then abandons the job, the general rule is that the decorator will not be entitled to any payment. Your obligation to pay was dependent on the decorator completing the work in its entirety and the decorator has not done so. The decorator’s obligations are said to be ‘entire’. The doctrine of complete performance would apply in this situation to prevent the decorator getting any payment. The case of Cutter v Powell (1795) 6 TR 320 illustrates how the doctrine works. Cutter was employed as second mate on a two-​month voyage from Jamaica to Liverpool. The contract provided that Cutter would be paid 30 guineas 10 days after the ship reached Liverpool provided ‘he proceeds, continues and does his duty’ from Jamaica to Liverpool. Cutter died about two weeks before the ship reached Liverpool, and his widow brought an action claiming payment for the work he had done on a quantum meruit basis (ie a reasonable sum in restitution for what he had done). We looked at restitution in Chapter 4. The court decided that, as Cutter had not performed his obligations completely, the widow could not receive any money. The wording of the contract indicated that her husband would be paid a lump sum at the end of the voyage provided he completed it, but he had not done so. The court also took into account the fact that the sum he would receive if he completed the voyage was far more than a seaman would receive if he was paid at a monthly rate. Cutter had accepted the risk of only being paid if he completed the voyage. To sum up, the doctrine of complete performance provides that performance of contractual obligations must be precise and exact. If one party has to pay only after the other has performed their obligations under the contract, then if performance is not precise and exact, the payer does not have to pay any part of the price (although the payer will not be able get back any money already paid unless there has been a complete failure of the consideration). 5.2.1 Exceptions to the doctrine of complete performance 5.2.1.1 Introduction This doctrine could produce unfair results if applied in all circumstances and so there are exceptions. If an exception applies then some payment (albeit not the price) can be recovered, even though the contractual obligations have not been performed precisely and exactly. The exceptions are: (a) divisible obligations; (b) substantial performance; (c) wrongful prevention; (d) voluntary acceptance of part performance. 120  Performance and Discharge of a Contract Examples Situation Entitled to some payment –​reason 1. Vince agrees to cut down the five trees in Elnora has wrongfully prevented Vince from Elnora’s garden for £900, payment on completion. completing the work. She has broken the He cuts down two trees but then Elnora says that contract by telling him to stop. she has changed her mind and she tells him to stop work. 2. AD Removals contract to transport two It seems that Parke Co agreed to accept computers for Parke Co from Newcastle to delivery in Wolverhampton, ie the company Birmingham for £300, payment on completion. agreed to accept partial performance of the At Wolverhampton, AD Removals’ van starts to contract by AD Removals, so AD Removals overheat. Parke Co tell AD Removals that they should be entitled to some payment, ie a will meet the driver at Wolverhampton and take reasonable sum for taking the goods to delivery there. Wolverhampton. 3. Benjamin has built a small extension to Although Benjamin has not performed his Michael’s restaurant. The contract price is contractual obligations precisely and exactly, £10,000, payment on completion. Michael has he has substantially performed his obligations discovered some minor defects, caused by faulty as the defects are only minor. It will cost only workmanship which will cost £100 to put right, and £100 to put them right compared to a contract is refusing to pay Benjamin any money. price of £10,000. We shall now consider the four exceptions in more detail. 5.2.1.2 Wrongful prevention of performance by the other party We saw in situation 1 above that Vince was entitled to some payment because Elnora changed her mind about having the trees cut down and wrongfully prevented him from completing his contractual obligations. It was not Vince’s fault that he did not perform his obligations precisely and exactly, and it would be unfair if he was prejudiced because Elnora had changed her mind. Elnora is in breach of contract and Vince could bring a claim to recover damages. As you have seen in the previous chapter, the aim of the court in awarding damages would be to put Vince in the position he would have been in if the contract had been properly performed, ie if Elnora had allowed him to complete the work (Robinson v Harman (1848) 1 Ex 850). Therefore, Vince would be able to recover his lost profit (ie the contract price less any expenses saved) subject to a duty to mitigate his loss by taking reasonable steps to look for alternative work. Alternatively, Vince could claim a quantum meruit, which is a reasonable amount for the work he has done (Planché v Colburn (1831) 8 Bing 14). This is a claim in restitution, which we considered in Chapter 4. It is often better to claim damages rather than a quantum meruit, as this usually enables a larger sum to be recovered. This is because the damages claim is for all losses arising from the breach which are not too remote (such as lost profits), whereas a quantum meruit represents a reasonable amount for the work actually done. Also remember from Chapters 3 and 4 that it is only in very limited circumstances that a non-​ defaulting party may be justified in terminating the future performance of a contract, ie where there has been a repudiatory breach (ie breach of a condition or otherwise a very serious breach of an innominate term). 121 Contract The term implied by s 13 of the SGSA 1982 into business-​to-​business contracts that service/​ work will be carried out with reasonable care and skill is an innominate term (see Chapter 3), and it is in relation to breach of this term that problems may arise. How bad does the work have to be before the other party is justified in terminating the contract? If the other party terminates in circumstances falling short of a serious enough breach, then that will be wrongful prevention and a repudiatory breach. The other party has to make a judgement call. Example Wessex Builders Ltd agreed to build an extension to Sonia’s cafe for £10,000, payment on completion. Halfway through the project, Sonia dismissed the builders because the work was very seriously defective. As the builders have committed a very serious breach of the term implied by s 13 of the SGSA 1982 to exercise reasonable care and skill, Sonia was justified in dismissing them. Sonia will have got the work done for nothing. However, if circumstances had been different and the work had not effectively deprived Sonia of the whole benefit she expected to receive under the contract then it would have been wrongful prevention by Sonia and she would be liable to the builders for breach of contract. 5.2.1.3 Voluntary acceptance of partial performance by the other party We saw in situation 2 above that AD Removals would be entitled to some payment as Parke Co had voluntarily accepted partial performance of the firm’s contractual obligations. Note, however, that the non-​defaulting party must have a genuine choice whether, or not, to accept the part performance. If they have no choice (eg because the supplier built something on the non-​defaulting party’s land and then abandoned the job), the non-​defaulting party will not have to pay anything for what was done. This is illustrated by Sumpter v Hedges 1 QB 673. In that case a builder agreed to construct two houses and a stable on the defendant’s land for £565. However, he abandoned the project after completing £333 worth of work. The defendant had to complete the work himself and he used materials left behind by the builder. The builder claimed a reasonable sum for work done and materials supplied. The claim for the work failed as the defendant had no choice but to accept what had been done. However, the defendant did have a choice whether, or not, to use the materials that had been left behind and so was ordered to pay a reasonable sum for those. This is a claim in restitution, which we considered in Chapter 4. Voluntary acceptance of part performance is reflected in the Consumer Rights Act (CRA) 2015 and the Sale of Goods Act (SGA) 1979. Section 25(1) of the CRA 2015 provides that where a trader delivers to a consumer a quantity of goods less than the trader contracted to supply, if the consumer decides to accept them then the consumer must pay for them at the contract rate. Similarly, s 30(1) of the SGA 1979 says, ‘Where the seller delivers to a buyer a quantity of goods less than he contracted to sell, the buyer may reject the goods, but if the buyer accepts the goods so delivered he must pay for them at the contract rate.’ 5.2.1.4 Substantial performance A party who substantially performs their obligations may be able to claim some money for the work. For substantial performance to apply, the work must be ‘finished’ but slightly defective. 122  Performance and Discharge of a Contract For example, suppose Tom agrees to build a garden wall for John at a price of £500, payment on completion. He builds 75% of the wall but then abandons the job. Tom could not argue that he has substantially performed his obligations as he has not finished the wall. We shall now look at two cases where this topic was considered. In Hoenig v Isaacs 2 All ER 176, CA, the defendant employed the claimant to decorate and furnish the defendant’s flat for the sum of £750. The defendant paid £400 but refused to pay the balance on the ground that some of the work was defective. The contract provided that the balance was payable on completion. At first instance the official referee found that, although some of the work was defective (a wardrobe door needed replacing and alterations had to be made to a bookcase), there had been substantial performance. He ordered that the defendant should pay the claimant the balance less the sum needed to remedy the defects (about £55). The official referee had relied on an earlier case of H Dakin & Co Ltd v Lee 1 KB 578. The defendant appealed. The Court of Appeal (per Somervell LJ) held as follows: The learned official referee regarded H Dakin & Co Ltd v Lee as laying down that the price must be paid subject to set-​off or counterclaim if there was a substantial compliance with the contract. I think on the facts of this case where the work was finished in the ordinary sense, though in part defective, this is right. The learned official referee found that there was substantial compliance. Bearing in mind that there is no appeal on fact, was there evidence on which he could so find? The learned official referee having, as I hold, properly directed himself, this becomes, I think, a question of fact. The case on this point was, I think, near the border line, and if the finding had been the other way I do not think we could have interfered. I now come to the final question; the measure of damages … The measure he (the official referee) applied was the cost of putting the work in accordance with the contract. The defendant is bound, he held, to pay for the furniture supplied less the cost of putting right the defects. This I think is, as the learned official referee thought, in accordance with H Dakin & Co Ltd v Lee. I therefore think the appeal must be dismissed. [The other two Court of Appeal judges also dismissed the appeal.] So, in Hoenig v Isaacs, the decorator was entitled to the balance of the contract price less the cost of remedying the defects. It was not a clear case of substantial performance. The cost of remedying the defects was £55 compared to a contract price of £750, and this was regarded as borderline. So, if the cost of remedying the problem is more than 1/​14 of the contract price (which was the case in Hoenig v Isaacs), it probably would not be deemed to be a case of substantial performance. Having looked at a case where the court decided there had been substantial performance, we will now consider Bolton v Mahadeva 1 WLR 1009, CA, a case where the Court reached the opposite conclusion. Here, the claimant agreed to install central heating in the defendant’s house for the sum of £560. The claimant completed the work, but it was defective. The system did not heat the house adequately and fumes were given out which made the rooms uncomfortable. The Court held that the contractor had not substantially performed their contractual obligations. The heating system did not perform effectively its primary function. The defects were extensive and 123 Contract could not be remedied by some slight amendment of the system. The contract price was £560 and it would cost £174 to remedy the defects, ie about one-​third of the contract price (unlike in Hoenig v Isaacs where the defects could be put right at a cost of about one-​fourteenth of the total price). Before resorting to litigation to try to recover the money, the contractor would have been well advised to offer to remedy the defects. If he had remedied the defects, he could then have justified claiming the full contract price. 5.2.1.5 Divisible obligations The final situation where a party may be able to recover some money for work they have done, even though they have not performed their contractual obligations exactly, is if the obligations are divisible, eg if the parties have agreed payments for a distinct part or stage of the work. Each part or stage is treated like a separate contract. Example Situation Entitled to some money –​reason Brooks agrees to decorate some rooms in Sarah’s It was agreed that Brooks would get house. It is agreed that he will be paid £200 for painting £200 for painting the kitchen and £400 the kitchen, £400 for the dining room and £300 for for painting the dining room, so he a bedroom, payment to be made as each room is should be able to recover payment for completed. He paints the kitchen and dining room and the rooms he has finished; but nothing starts work on the bedroom. Brooks then abandons the for the bedroom. job for a more lucrative project. The decorator was entitled to be paid for the rooms completed, even though the decorator did not finish the job but abandoned the work for a more lucrative project. The obligations were not entire as in Cutter v Powell, where a lump sum was payable only if the voyage was completed. The work had been divided, with completion of each stage giving rise to the right to some payment. This often happens in building contracts. Example Nasser agrees to build a house for Keith for £160,000. Payment is to be made in three stages as each stage is completed: Stage 1: £60,000 Stage 2: £60,000 Stage 3: £40,000 Nasser completes the first stage, does a little work on Stage 2, but then abandons the project as he has been offered more lucrative work elsewhere. Keith has not yet paid any money to Nasser. Keith gets another builder to finish the work for £80,000. (a) Nasser is entitled to £60,000 for Stage 1, which he has completed. The obligations in the contract were divisible and the completion of each stage gives rise to the right to 124  Performance and Discharge of a Contract payment. He is not entitled to any money for Stage 2 as he did not complete this part of the contract. Keith is also in breach of contract as he has not paid for Stage 1 after completion. It is possible to have situations where both parties have broken the contract. (b) It is not worth suing Nasser as Keith has not suffered any loss. Keith would have paid Nasser £100,000 for Stages 2 and 3, and he has arranged for someone else to finish the job for only £80,000. However, suppose that Keith had only been able to get another builder to finish the work for £120,000. If Keith pays Nasser £60,000 for Stage 1, he would end up paying £180,000 altogether. In that case he could sue Nasser for damages. The aim would be to put Keith in the position he would have been had his contract with Nasser been properly performed. If Nasser had performed the contract, Keith would have paid £160,000 for the house; therefore he should be awarded £20,000 in damages. Figure 5.1 Exceptions to the doctrine of complete performance –​summary Divisible obligations Voluntary Doctrine of acceptance of complete Substantial part performance – performance performance exceptions Wrongful prevention We have now covered the four exceptions to the doctrine of complete performance. But what if both parties perform all of their contractual obligations? Then the contract will be discharged. The contract is said to be discharged by performance, and this is the way most contracts come to an end. 125 Contract However, there are other ways in which a contract may be discharged. We looked at one of these in Chapter 4, when considering remedies. You saw then that if there is a breach of a condition or a breach of an innominate term and the effects are major, the innocent party may terminate the future performance of the contract. If the innocent party does terminate then the contract is discharged and neither party need perform any future obligations, although the innocent party may still sue for damages for loss suffered. As you worked through the material on the doctrine of complete performance and the exceptions, you may have noticed that there is a link with breach of contract. Let’s revisit a couple of situations we looked at earlier. Situation Entitled to some money –​reason Benjamin has built a small extension to Michael’s Although Benjamin has not performed his restaurant. The contract price is £10,000, payment contractual obligations precisely and exactly, on completion. Michael has discovered some he has substantially performed his obligations minor defects, caused by faulty workmanship as the defects are only minor. It will cost which will cost £100 to put right, and is refusing to only £100 to put them right, compared to a pay Benjamin any money. contract price of £10,000. You can see that Benjamin is in breach of the term implied by s 13 of the Supply of Goods and Services Act 1982 as he was performing a service in the course of a business for a business customer (Michael) and did not use reasonable care and skill. Section 13 is an innominate term which means that Michael may only terminate the contract if the effects of the breach are major. Here the defects are only minor so Michael cannot terminate the contract. Therefore, technically, Michael should pay the contract price, although he can recover damages for loss suffered. If Michael does not pay then Benjamin can bring an action for the contract price. There are two possible approaches. First, Michael may try to rely on the doctrine of complete performance –​ie argue that Benjamin has not performed the work precisely and so is not entitled to the money. In this case, Benjamin could rely on the substantial performance exception. This is what happened in Hoenig v Isaacs which we considered earlier. However, there is another possible approach, ie Michael might argue that Benjamin is not entitled to be paid as he is in breach of the term implied by s 13 of the Supply of Goods and Services Act 1982. Benjamin would counter this by arguing that it is only a minor breach of an innominate term which does not justify Michael refusing the whole contract price. Either way, Benjamin will be successful, and the court would order Michael to pay the contract price less an amount needed to remedy the defects. Situation Entitled to some money –​reason Wessex Builders Ltd agreed to build an No. extension to Sonia’s cafe for £10,000, payment The builders have committed a very serious on completion. Halfway through the project, breach of the term implied by s 13 of the SGSA Sonia dismissed the builders because the work 1982 to exercise reasonable care and skill. So was very seriously defective. Sonia was justified in dismissing them. Sonia will have got the work done for nothing. If Wessex Builders sue Sonia for the contract price, Sonia could argue that Wessex had not performed its obligations exactly. Wessex could not rely on substantial performance (or any other exception to the complete performance doctrine). This was the line of argument adopted in Bolton v Mahadeva. 126  Performance and Discharge of a Contract However, there is another approach. You can see that Wessex Builders has committed a major breach of the implied term that it will carry out the work with reasonable care and skill. Therefore, Sonia could terminate the contract which means that she is released from all future obligations. If Wessex Builders sue for the price, Sonia could argue that she has rightfully terminated the contract and does not have to pay the contract price. Either way, Sonia will be successful and would not have to pay any part of the contract price. These points bring together several areas of law. You have seen then that a contract may be discharged by performance and (in some cases) by breach. A contract may also be discharged by agreement and by frustration. We shall now examine each of these in more detail. 5.3 Discharge by agreement The parties to a contract may agree to release one another from outstanding obligations, in which case the contract will come to an end. The basic rule is that, in order to bind the parties, the agreement to end a contract (or to vary its terms) must itself contain all the elements of a contract, so there must be offer, acceptance, consideration and contractual intention. Sometimes it can be difficult to establish all of these elements. For example, suppose that Marcus owes Ace & Co £2,000. Marcus says he can pay only £1,600, and Ace & Co agrees to accept this in full payment of the debt. Marcus pays £1,600, but Ace & Co then wants Marcus to pay the balance. The agreement by Ace & Co to accept just £1,600 will be binding only if all the elements of a contract are present. Thinking back to Chapter 2, which essential element is missing here? The missing element is consideration. Marcus has not given any consideration for Ace & Co’s promise to release him from the balance of the debt. Consideration can be defined as the price one party pays for the other party’s promise. Marcus has not paid the price for Ace & Co’s promise. He has not done or promised to do anything in return. Marcus has only paid part of his debt and this is usually insufficient consideration for a promise to forgo the balance (Pinnel’s Case, Foakes v Beer). To establish that Ace & Co’s promise was binding, Marcus would have to show that an exception to this rule applied, either a common law exception or the doctrine of promissory estoppel. You covered these points in Chapter 2. 5.4 Discharge by frustration 5.4.1 What constitutes frustration Frustration only operates in limited circumstances. The supervening event or change of circumstances must: make performance of the contract impossible, or radically different; be something beyond the ordinary risks that the parties can be treated as having taken on board when entering into their contract (ie something unexpected); and be something that was beyond the control of either party. So where an unforeseen event occurs after the contract was formed, then generally if the parties are not at fault and such an event renders the performance of the contract very different, or even impossible to perform, a contract will be terminated by frustration as a matter of law. It is an exception to the general rule that requires complete performance of obligations to avoid being in breach of contract. We considered the doctrine of complete performance above. 127 Contract 5.4.1.1 ‘Radically different’ Most of the cases that have considered frustration have been placed into convenient categories of circumstances that render performance of the contract ‘radically different’. These categories include: (a) government intervention; (b) unavailability of a specific person crucial to the contract; (c) illegality; (d) destruction of the subject matter; (e) non-​occurrence of a fundamental event. But in all cases, it will be a question of degree. Examples Situation Frustrated –​reason Shahid agrees to hire the local community centre for The subject matter of the contract (the 1 June so his amateur dramatic group can perform centre) is accidentally destroyed so it is a play. Before 1 June someone breaks into the impossible to perform the contract. centre and starts a fire. The centre is completely destroyed. Shirjel has agreed to write a book for Bharat. The Shirjel is not going to be able to complete book must be completed in six months’ time. Shirjel the book in six months’ time because of writes a couple of chapters but then falls ill. He will his illness. The contract is impossible to not be able to work for at least a year. perform. Note: Shirjel was vital to performance of the contract. Someone hires a room for two days (not the nights) The whole purpose for hiring the room had for the sole purpose of viewing the coronation been to watch the procession and that is no procession of Edward VII. The procession is longer possible. cancelled due to the illness of the King. Situation Not frustrated –​reason A 10-​year lease of a warehouse. For 18 months of Whilst frustration may apply to leases the 10-​year term the local authority closes the street of land, here the relative length of the giving the only access to the warehouse. interruption would not be sufficiently grave to amount to a frustrating event. Sheila enters into a contract with Beautiful Interiors The contract has not become impossible Ltd to have her house decorated. Mike, an to perform or radically different. Beautiful employee of Beautiful Interiors, works on her house Interiors can still do the work by using Phil for a couple of days but then goes down with flu rather than Mike. and is replaced by Phil, another employee. Sheila Sheila makes her contract with Beautiful is looking for an excuse to end the contract as she Interiors, and the identity of the employee would like to finish the decorating herself with the who will do the work is not important so help of friends. long as one of their employees can do it. Someone agrees to hire a ship for two days to take The royal Naval Review had not been people out to view the royal Naval Review and for the sole purpose of the contract. A day’s a day’s cruise round the fleet. The Naval Review is cruise round the fleet is still possible and cancelled due to the King’s illness. so performance has not become radically different. 128  Performance and Discharge of a Contract Figure 5.2 Consequences of non-​performance Frustration Contract Non- performance Breach Frustration If a contract is frustrated, there is no breach of contract in relation to the frustrating event. The contract comes to an end automatically at the time of the frustrating event and the parties do not have to perform their future obligations. As there is no breach of contract when a contract is frustrated, the remedies associated with breach of contract (eg damages) will not be available. It is for the above reasons that the party alleging frustration will almost invariably be the party who would otherwise have been in breach of contract for non-​performance. They will be using it as a defence to an allegation of breach of contract (Figure 5.2). You should now have a very general idea of when a contract will be frustrated, and we shall look in detail at when frustration will occur and the effects of frustration later. However, before we do that, we shall consider the original position at common law so you can see how this area of law has developed. 5.4.2 The original common law rule The idea that a contract will be frustrated if it becomes impossible to perform has not always been the legal position. Originally, at common law, if a party assumed an absolute obligation in a contract (ie the obligation was not qualified or modified in any way), then if circumstances made performance of the obligation impossible, the party would still be liable. The party concerned should have protected itself by making sure a suitable provision was included in the contract. This approach was adopted in the case of Paradine v Jane (1647) Aleyn 26. In this case the claimant was claiming arrears of rent from the defendant. The defendant had been forced off the land by a hostile army and so argued it should not have to pay. The argument did not succeed. The court held that the defendant was still liable to pay the rent. This approach came to be seen as harsh and was modified in the mid-​nineteenth century. 5.4.3 Modification of the original common law rule 5.4.3.1 Implied term theory The modern law of frustration is often said to date from the decision in the case of Taylor v Caldwell (1863) 3 B & S 826. In this case the claimants hired a music hall from the defendants for a few days for the purpose of giving a series of concerts. Before the date of the first 129 Contract concert, the music hall was destroyed by fire and the concerts could not take place. Neither party to the contract was at fault. The contract was discharged by frustration. Blackburn J justified the decision by saying that the existence of the music hall was essential for the fulfilment of the contract. He thought that there was an implied condition in the contract that the parties would be excused if performance became impossible because, without the fault of the parties, the music hall perished. Note it was the party who would have been in breach by non-​performance (ie the hirer of the music hall) who alleged the contract had been terminated by the supervening event. As you will see shortly (when we consider the effect of frustration), frustration of a contract yields a much more desirable result than liability for breach. 5.4.3.2 Construction theory The idea of frustration resting on a term implied between the parties was dismissed as a fiction by the House of Lords in Davis Contractors Ltd v Fareham Urban District Council AC 696, as in most cases the parties could not have had such an intention. Lord Radcliffe said: The legal effect of frustration ‘does not depend on the [the parties’] intention or their opinions, or even knowledge as to the event.’ On the contrary, it seems that when the event occurs ‘the meaning of the contract must be taken to be, not what the parties did intend (for they had neither thought nor intention regarding it) but that which the parties, as fair, and reasonable men, would presumably have agreed upon if, having such possibility in view, they had made express provision as to their several rights and liabilities in the event of its occurrence.’ … By this time it might seem that the parties themselves have become so far disembodied spirits that their actual body should be allowed to rest in peace. In their place there rises the figure of the fair and reasonable man. And the spokesman of the fair and reasonable man … is and must be the court itself. 5.4.4 Review We have established that a contract is frustrated if an event occurs after the contract has been formed which makes the contract impossible to perform or radically different, and this event is outside the control of the parties to the contract. We shall now look in detail at the situations which will cause a contract to become frustrated. 5.4.5 Events which will frustrate a contract 5.4.5.1 Unavailability of a specific thing or person vital to the contract We saw at 5.4.1.1 that the unavailability of a specific thing or person vital to the contract can cause frustration. Three factors which determine whether a person not being available leads to frustration of the contract are: (a) the length of the contract; (b) the length of the period of absence; and (c) whether the contract must be performed by that particular individual or whether a substitute can do the work. 130  Performance and Discharge of a Contract Examples Situation Frustrated Not frustrated 1. Elsie works as a √ Short periods of illness in computer programmer and a long employment contract will has a five-​year contract not frustrate the contract. It is of employment. She has assumed that the employee may a bad cold and takes two have some time off because of days off work. illness, and usually there will be express contractual provision covering it. Short periods of illness do not make a long-​term employment contract radically different from what the parties envisaged. 2. Two weeks ago Dipa √ Looking at the length of the entered into a contract of contract and the period of employment for six months. sickness, the contract will be She has now been taken regarded as impossible seriously ill and will not be to perform. Dipa has only fit for work for at least nine worked two weeks of her six-​ months. month contract. This is very different from a short period of illness in a long contract, which was illustrated in situation 1 above. Unavailability of a person vital to the performance of the contract caused frustration in Morgan v Manser 1 KB 184, where a music-​hall artist, ‘Cheerful Charlie Chester’, was called up for military service. Also, the contract was frustrated in Condor v Barron Knights 1 WLR 87, when a drummer with a pop group was taken ill and was capable of working for only three or four nights a week, whereas the group had engagements for seven nights a week. The contract was frustrated as the drummer was not capable of performing the contract in the way intended. We are now going to look at another situation which may frustrate a contract, and that is the non-​occurrence of a fundamental event. 5.4.5.2 Non-​occurrence of a fundamental event If a particular event taking place is essential to the contract (ie the contract is dependent on it), and the event is cancelled, then this may frustrate the contract. To give you a better idea of how this concept works, we shall look at two cases where an event was cancelled. Both cases involve the postponement of the coronation of Edward VII due to the King’s illness. In the first case, the court decided that the contract had been frustrated, whereas in the second case the court came to the opposite conclusion. 131 Contract In Krell v Henry 2 KB 740, CA, the defendant saw a notice in the window of the claimant’s flat to the effect that windows to view the coronation procession of Edward VII were to be let. The defendant subsequently agreed to hire the flat for the two days (not the nights) when the coronation procession would take place. The contract contained no express reference to the procession or any other purpose for which the flat was taken. The defendant paid a deposit. When the procession was cancelled due to the King’s illness, the defendant refused to pay the balance of the rent. Vaughan Williams LJ said: In my judgment the use of the rooms was let and taken for the purpose of seeing the Royal procession. It was not a demise of the rooms, or even an agreement to let and take the rooms. It is a licence to use rooms for a particular purpose and none other. And in my judgment the taking place of those processions on the days proclaimed along the proclaimed route, which passed 56A, Pall Mall, was regarded by both contracting parties as the foundation of the contract … … in the case of the coronation, there is not merely the purpose of the hirer to see the coronation procession, but it is the coronation procession and the relative position of the rooms which is the basis of the contract as much for the lessor as the hirer; and I think that if the King, before the coronation day and after the contract, had died, the hirer could not have insisted on having the rooms on the days named … The rooms had clearly been hired for the sole purpose of seeing the Royal procession. Neither party in Krell v Henry was in breach of contract because the contract was frustrated. The postponement of the coronation procession frustrated the contract because the foundation of the contract was not just to hire rooms but to hire rooms in order to view the procession and this was not possible. In the case of Herne Bay Steamboat Co v Hutton 2 KB 683, CA, the defendant agreed to hire a ship from the claimant for two days to take out a party ‘for the purpose of viewing the Naval Review and for a day’s cruise round the fleet’. The Naval Review was cancelled due to the King’s illness. The Court of Appeal decided that the cancellation of the review did not discharge the defendant from his obligations under the contract, ie it did not frustrate the contract. Vaughan Williams LJ said: The defendant when hiring this boat had the object in view of taking people to see the Naval Review, and on the next day of taking them round the fleet and also round the Isle of Wight. But it does not seem to me that, because those purposes of the defendant became impossible, it is a legitimate inference that the happening of the Naval Review was contemplated by both parties as the foundation of the contract, so as to bring the case within the doctrine of Taylor v Caldwell. On the contrary, when the contract is properly considered, I think that the purposes of the defendant, whether of going to the review or going round the fleet or the Isle of Wight with a party of paying guests, do not make those purposes the foundation of the contract within the meaning of Taylor v Caldwell. Having expressed this view, I do not know that there is any advantage to be gained by in any way defining what are the circumstances which might or might not constitute 132  Performance and Discharge of a Contract the happening of a particular contingency the foundation of the contract. I will only say I see nothing to differentiate this contract from a contract by which some person engaged a cab to take him on each of three days to Epsom to see the races, and for some reason, such as the spread of an infectious disease or an anticipation of a riot, the races are prohibited. In such a case it could not be said that he would be relieved of his bargain. So in the present case it is sufficient to say that the happening of the Naval Review was not the foundation of this contract. How can the decision in Herne Bay Steamboat Co v Hutton be distinguished from the decision in Krell v Henry, ie why was the contract in Krell v Henry frustrated whereas in Herne Bay Steamboat Co v Hutton the court came to the opposite decision? One view is that Krell v Henry can be distinguished from Herne Bay Steamboat Co v Hutton on the basis that, in Krell v Henry, the cancellation of the procession meant that the foundation or basis of the contract could not be accomplished. The purpose was not just to hire rooms but to hire rooms in order to see the procession. (This was apparent from the terms of the contract. The room was hired out by the day; the night was not included in the hire.) By contrast, in Herne Bay Steamboat Co v Hutton, the defendant’s motive in entering into the contract may well have been to see the review, but this was not the foundation of the contract. In addition, Stirling LJ emphasised that a cruise round the fleet was still possible. Also, as Roger Brownsword says in his article, ‘Henry’s lost spectacle and Hutton’s Lost Speculation. A Classic Riddle Solved?’ (1985) 129 Solicitors Journal 860–​62, Hutton was engaged in a business venture, Henry was not, and this may explain the different attitudes of the court. Having looked at non-​occurrence of a fundamental event, we shall now go on to consider other situations in which a contract may be frustrated. 5.4.5.3 Government intervention It is not every form of government intervention which will frustrate a contract. It depends on the effect which the intervention has on the contract. The case of Metropolitan Water Board v Dick Kerr AC 119 involved a contract to build a reservoir. Not long after the work had started, the government requisitioned the workforce and machinery because of World War I. Such a substantial interruption could not have been in the contemplation of the parties at the time the contract was made. The delay was such that the contract, if resumed, would be radically different from the contract the parties had originally made. In Metropolitan Water Board v Dick Kerr, there had been a clause in the contract dealing with the possibility of an extension of time in the case of delay. However, the court decided that it was meant to cover temporary delays and not an interruption of such character and duration as World War I. As a matter of construction, therefore, the delay clause did not cover the situation which had arisen, and the court held that the contract had been frustrated. We shall now look in more detail at when delay may cause a contract to be frustrated. 5.4.5.4 Delay: when will this cause frustration? The case of Metropolitan Water Board v Dick Kerr is not just a case about government intervention; it is also a case about delay and when this will cause frustration. It is not every case of delay which frustrates the contract. In fact, a delay is more likely to mean that a party is in breach of contract. For example, if it is a term of the contract that the 133 Contract seller delivers goods on 3 March but then does not do so, the seller is likely to be in breach of an express term of the contract and frustration would not apply. Factors which are relevant when deciding if delay frustrates the contract include: whether the contract provides for what should be the consequences of the delay; the likely length of the delay; any time set in the contract for the obligations to be performed; if the contract is resumed after the delay, whether it is radically different from the contract the parties had originally made. In the Metropolitan Water Board case, the delay was such that the contract, if resumed, would be radically different from the contract the parties had originally made. It can sometimes be difficult to distinguish situations where delay frustrates the contract because the contract becomes impossible or radically different to perform from situations where the contract merely becomes more difficult to perform or less profitable. For example, the closure of the Suez Canal in 1956 led to many voyages being re-​routed and the new voyage was longer and more expensive. The courts were reluctant to say that the contract was frustrated unless the route had been specified in the contract, or a precise delivery date had been agreed or the goods were perishable. This is illustrated by the case of Tsakiroglou & Co Ltd v Noblee Thorl AC 93. Sellers agreed to ship groundnuts from Port Sudan to Hamburg. At the time of the contract, the parties assumed that the shipment would be via the Suez Canal, although the route was not specified in the contract. The closure of the Canal meant that the goods had to be shipped via the Cape of Good Hope. The sellers claimed that the contract was frustrated. The House of Lords found that the contract was not frustrated. The contract had become more difficult and expensive for the sellers, but the contract could still be performed (as no route had been specified) and had not become radically different. Can you think of any policy reason why mere increased difficulty or expense does not frustrate a contract and bring it to an end? Many contracts can become more difficult or more expensive to perform, eg if the cost of materials goes up. It would be very unsatisfactory if this could bring a contract to an end. It would open the floodgates to litigation with many claims that contracts had been frustrated. It would also lead to uncertainty if a party could say the contract was at an end just because performance had become more difficult or less profitable. It would be unfair to the other contracting party who would never know when this argument was going to be raised. Some contractors might underestimate the cost of their work, and it would be unreasonable if they could say that the contract was at an end. Given that the cost of labour and materials often goes up, a party who wishes to protect itself against such increases should foresee the possibility and make express provision in the contract, eg by including a price escalation clause. Having seen the reason behind the approach the court adopts, let us now look at the case of Davis Contractors Ltd v Fareham Urban District Council AC 696, HL. Davis Contractors agreed to build 78 houses within a period of eight months for Fareham UDC. Davis Contractors experienced a number of difficulties, mainly caused by shortages of labour and materials. The contract took over 22 months to complete. Davis Contractors argued that the contract had been frustrated and that they should be entitled to be paid 134  Performance and Discharge of a Contract a reasonable sum for work done after the frustrating event. (If the contract was frustrated then the contractors would not be liable for breach of contract for taking longer than specified to finish the houses.) The House of Lords held that the contract was not frustrated. Lord Radcliffe held: Frustration occurs whenever 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. … it is not hardship or inconvenience or material loss itself which calls the principle of frustration into play. There must be as well such a change in the significance of the obligation that the thing undertaken would, if performed, be a different thing from that contracted for. The other reason given by Lord Radcliffe as to why the contract should not be frustrated was the fact that the parties could have foreseen the cause of the delay. He said that the possibility of enough labour and materials not being available was before their eyes and could have been the subject of special contractual stipulation. We will consider this idea further when we look at the restrictions on the doctrine of frustration. The final event we are going to consider which may cause frustration is illegality. 5.4.5.5 Illegality The performance of a contract may become legally impossible, and this can frustrate the contract. This can occur as a result of a change in the law. Also, the outbreak of war will frustrate a contract where the other party is in enemy-​occupied territory, as in time of war it is against the law to trade with the enemy. This principle is illustrated by Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd AC 32, HL. The respondent (an English company) had agreed to manufacture machinery for the appellant (a Polish company) and to deliver to Poland. Before the manufacture had been completed, the German army occupied Poland. The House of Lords held that the contract was frustrated. Note that the effect of illegality is not something that can be expressly provided for in the contract. If performance of a contract subsequently becomes illegal, the contract will be frustrated. Events which can cause frustration –​summary Unavailability of a specific thing vital to the contract (Taylor v Caldwell). Unavailability of a specific person vital to the contract (Morgan v Manser, Condor v Barron Knights). Non-​occurrence of a fundamental event (Krell v Henry, contrast Herne Bay Steamboat Co v Hutton). Government intervention (Metropolitan Water Board v Dick Kerr). Illegality (Fibrosa). 135 Contract These are some of the events which could lead to a contract being frustrated. Other events, eg strikes, could also have this result. However, remember that the crucial thing is not the event itself, but the effect of the event on the contract. The contract will be frustrated only if a supervening event (ie one that happens after the contract has been formed) makes performance of the contract impossible or radically different from that originally envisaged. If the event simply makes the contract more difficult or more expensive to perform, as in Davis Contractors v Fareham UDC, the contract will not be frustrated. We shall now consider some restrictions on frustration. 5.4.6 Restrictions on the doctrine of frustration We have already considered the general conditions which must be fulfilled before a contract will be frustrated. You know that you are looking for a supervening event which makes performance of the contract impossible or radically different from that envisaged. If a restriction applies, then the contract will not be frustrated. We are going to consider two possible restrictions. The first is where the frustrating event was foreseen by the parties, and the second is where the frustrating event was ‘self-​induced’. 5.4.6.1 The event must not be foreseen by the parties The parties may have made express provision in the contract covering the event which has occurred and explaining how any loss caused by the event will be borne by the parties. Alternatively, the court may feel that the parties foresaw or should have foreseen the event even though there is no express provision in the contract. We shall look at each possibility in turn. Express provision in the contract covering the event which has occurred A term known as a ‘force majeure’ clause may be inserted to cover events outside the control of the parties. If the parties have made express provision in the contract covering the event which has occurred, then this may be binding on the parties. (Note, however, that a clause cannot prevent frustration applying in the event of the contract becoming illegal, eg because of outbreak of war as in the case of Fibrosa which we looked at earlier.) Have a look at the Specimen Conditions of Sale (Reading 1 in the Appendix) and see if you can spot the force majeure clause there. The clause is clause 4.3 in the Specimen Conditions. You can see that the seller states that the seller will not be liable for any failure to deliver goods arising from circumstances outside the seller’s control and then goes on to give a list of examples of such circumstances, including war, riots, strikes, fire, abnormal weather conditions and government action. Why do you think it is advisable to insert such a clause? Inserting such provision in a contract brings greater flexibility than relying on the doctrine of frustration. For example, the parties can include events which would not normally amount to frustrating events. In clause 4.3 of the Specimen Conditions, the list of events includes shortage of labour and materials. You have seen in Davis Contractors v Fareham UDC that shortage of labour and materials did not cause the contract to be frustrated as the contract had not become radically different. The parties can specify what should happen if such an event occurs and how the loss should fall. See, for example, clauses 4.3.2–​4.3.4 of the Specimen Conditions. As you will see later at 5.4.9, the effect of the Law Reform (Frustrated Contracts) Act 1943 can be very uncertain. A force majeure clause can also provide a greater degree of certainty as it may often be difficult to decide whether a contract has been frustrated. The parties can list events which will be regarded as force majeure events and this will reduce the uncertainty. A well-​worded clause will mean that disputes are avoided. 136  Performance and Discharge of a Contract However, it is important to draft the clause carefully so that it does in fact cover all events which the parties intend. For example, you looked at the case of Metropolitan Water Board v Dick Kerr where the contract contained a clause covering delay. In this case the court decided that the delay clause in the contract did not actually cover the event which had occurred. The clause was meant to cover temporary delays and not an interruption of such a character and duration that it fundamentally changed the conditions of the contract. Note also that a force majeure clause in a business-​to-​business contract limiting and/​ or excluding liability may be subject to s 3 of UCTA 1977, in which case it will need to be reasonable in order to be upheld. We considered exemption clauses and UCTA 1977 in Chapter 3. No express provision in the contract but the event is foreseen If the parties have not made any express provision in the contract, there is a conflict of opinion as to whether there can still be frustration if the event is foreseen. In the case of Davis Contractors v Fareham UDC, which we considered earlier, Lord Radcliffe took the view that if the event was foreseen, the contract would not be frustrated. In the case of The Eugenia 2 QB 226, Lord Denning MR said, obiter, that the contract could still be frustrated even if the event was foreseen –​the only essential thing was that the parties should not have made provision for the event in the contract. We shall now consider the second restriction on the doctrine of frustration. 5.4.6.2 Event must be beyond the control of the parties The event which makes the contract impossible or radically different must be beyond the control of the parties. A party whose own act or election has given rise to the frustrating event cannot rely on the doctrine of frustration. The frustration is said to be ‘self-​induced’ and the contract will not be at an end. The party will be in breach of contract if it cannot perform its contractual obligations. As you can see, therefore, ‘self-​induced frustration’ is not frustration at all. It would be unreasonable if a party could cause the event to occur and then plead frustration to end the contract and effectively defend an action for breach. In essence, the law takes the view that you should not be excused from what is your own fault. This is illustrated by two cases: Maritime Fish Ltd v Ocean Trawlers Ltd AC 524 and The Super Servant Two 1 Lloyd’s Rep 1. In Maritime Fish Ltd v Ocean Trawlers Ltd, the claimants hired a trawler from the defendants. Both parties knew that the trawler could only be used with an otter trawl and that a licence was needed for this. The claimants had four other trawlers and applied for five licences. They were only granted three licences. They could have used one for the trawler they had hired from the defendants but decided not to do so. The court decided that the contract was not frustrated as it was the claimants’ own election which had caused the problem. In The Super Servant Two, the defendants agreed to transport the claimants’ drilling rig from Japan to Rotterdam. The contract said the rig was to be carried using a ‘transportation unit’, defined as meaning Super Servant One or Super Servant Two. The defendants intended to use Super Servant Two, but it sank before the date due for delivery. The defendants had entered into other contracts that they could only perform using Super Servant One, and so two weeks after the sinking they informed the claimants that they would not be able to transport the rig. The Court of Appeal decided the contract had not been frustrated. What had happened was ‘self-​induced’. It was the defendants’ decision to use Super Servant One for other contracts that had made performance of their contract with the claimant impossible. The impossibility of performance resulted from their own act and the choice they had made. 137 Contract The decision that it was self-​induced frustration can be criticised on the basis that the defendants did not have a genuine choice about the allocation of Super Servant One. The sinking of the other transporter left the defendants with only Super Servant One, and Super Servant One could not be allocated to all the contracts the defendants had made. Performance of some of these contracts had been made impossible by the sinking of Super Servant Two, regardless of how Super Servant One was allocated. The contract would have been frustrated if the contract had provided for carriage by Super Servant Two with no alternative vessel and Super Servant Two had been lost without fault. On the basis of the decision in The Super Servant Two, it seems that any act by a party which contributes to the event will prevent the contract from being frustrated. This shows the narrow limits within which the doctrine of frustration operates and the advantage of inserting a force majeure clause in the contract to avoid liability. In fact, in The Super Servant Two, there was a force majeure clause in the contract. The defendants argued as an alternative defence that, if the contract was not frustrated, the loss of the ship was covered by the force majeure clause allowing them to cancel the contract. The clause referred to ‘perils or danger and accidents of the sea’. The court held that the clause covered the sinking of Super Servant Two provided this was not caused by the negligence of the defendants. Finally, on the topic of self-​induced frustration, if one party alleges that the other party has caused the frustrating event then it seems that the burden of proving fault is on the party alleging it. This was stated in the case of Joseph Constantine Steamship Line Ltd v Imperial Smelting Corporation Ltd AC 154. We have now looked at the two restrictions on the doctrine of frustration: self-​induced frustration and events foreseen by the parties. We shall now go on to consider whether frustration can apply to leases of land. 5.4.7 Frustration and leases of land For many years, it was thought that frustration could not apply to a lease of land because a lease actually created an interest in the land, and this interest endured even if you could not use the land for the intended purpose. An interest in land was not a perishable commodity like goods. You may be thinking that the idea that frustration cannot apply to a lease of land does not accord with the decision in Taylor v Caldwell. We looked at this case at 5.3, and we saw that a contract for the hire of a music hall was frustrated. However, the problem of whether a lease could be frustrated did not arise in Taylor v Caldwell because the agreement was just a licence to occupy the premises. It was not a lease which created an interest in the land. The House of Lords looked at whether frustration might apply to leases of land in the case of National Carriers Ltd v Panalpina (Northern) Ltd AC 675. Here, the appellants leased a warehouse from the respondents for a term of 10 years from 1 January 1974. In May 1979 the local authority closed the street giving the only access to the warehouse. This was because of the dangerous condition of a building opposite the warehouse. It was envisaged that the street would be reopened in January 1981. The closure of the street prevented the appellants from using the warehouse. The appellants argued that the lease was frustrated by the closure of the street giving access to the warehouse. The House of Lords said that the doctrine of frustration was capable of applying to a lease of land so as to bring the lease to an end if a frustrating event occurred during the currency of the term. However, the circumstances in which the doctrine of frustration could apply to a lease of land were rare. On the facts of Panalpina the House of Lords decided that the lease was not frustrated. 138  Performance and Discharge of a Contract Although by the time access to the warehouse was restored, the appellants would have lost two out of 10 years’ use of the warehouse and their business would have been severely disrupted, the closure of access to the warehouse was not sufficiently grave to amount to a frustrating event since there would be a further three years of the lease remaining after the access was re-​established. Having considered when a contract may be frustrated, we shall now consider the effects of frustration at common law and the extent to which the common law rules have been altered by statute. 5.4.8 Effect of frustration at common law 5.4.8.1 Introduction If a contract is frustrated, the future performance of the contract is terminated automatically as a matter of law. Therefore, both parties are released from all future obligations (ie obligations arising after the frustrating event) and neither party will be in breach of contract in respect of the frustrating event. It is for this reason that it will be the party who would otherwise be in breach by not performing, who will allege that the contract has been frustrated. Note that discharge of the contract happens as a matter of law –​the non-​defaulting party does not have a choice whether, or not, to terminate the contract. If you recall, this is very different to the position where there has been a repudiatory breach of contract where the innocent party has a choice whether to affirm it or accept the breach as ending the contract. We looked at repudiatory breaches earlier in this chapter. Having reviewed some of the effects of frustration, we shall now go on to consider some further points. It may be that one party has already paid money to the other, or has incurred expenses in performing the contract, or has received a benefit under the contract. We shall consider whether money paid can be recovered and whether compensation can be claimed for expenses incurred, or a benefit conferred on the other party. We shall look first at the original common law rules and then at the changes made by legislation. 5.4.8.2 The original position at common law when a contract was frustrated Originally, at common law, if one party had paid money to the other before the frustrating event, it could not be recovered. Also, if any money was due and payable before the frustrating event, it still had to be paid. Therefore, it was necessary to examine the terms of the contract to decide when the money was due or payable. Think back to the facts of Krell v Henry 2 KB 740, which we looked at in 5.4.5.2 when we were dealing with the non-​occurrence of a fundamental event leading to frustration. In Krell v Henry, the defendant agreed to pay £75 for the hire of rooms overlooking the route of the coronation procession. The defendant paid a deposit of £25. The coronation procession was then cancelled. This happened before the defendant was due to pay the balance of £50. Applying the principles set out above: The defendant could not recover the £25 as this was money paid before the frustrating event. The defendant did not have to pay the outstanding £50 as the obligation to pay arose after the frustrating event, ie after cancellation of the coronation procession. We are now going to compare the above outcome with another coronation case, Chandler v Webster 1 KB 493, where the claimant agreed to hire rooms for £141 to view the 139 Contract coronation procession. The contract stipulated that the entire sum was payable immediately, although the claimant had paid only £100 when the procession was cancelled. The court held: The claimant could not recover the £100 as this was money paid before the frustrating event. The claimant did have to pay the outstanding £41 as this was money due before the frustrating event occurred, ie before the coronation procession was cancelled. The common law rules did not produce a fair outcome in cases like Krell v Henry and Chandler v Webster. In each case, the party who had hired the rooms paid money but received nothing in return when the coronation was cancelled. Clearly, the cancellation of the coronation was not their fault, so they were being severely prejudiced by an event outside their control. In both cases, money paid before the frustrating event could not be recovered. Also, in Chandler v Webster, the claimant was still liable to pay more money as this payment was due before the frustrating event occurred. The injustice of this situation was addressed to a certain extent by the House of Lords in Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd AC 32. In Fibrosa, the House of Lords stated that if there had been a total failure of consideration then money already paid could be recovered and money due and payable before the event need not be paid. This meant that if the payer had received absolutely no benefit under the contract, the payer could recover money paid and did not have to pay money that was due before the event. However, if any benefit had been received, the money could not be recovered or still had to be paid. Viscount Simon LC thought that, even after the decision in Fibrosa, certain problems still remained. The decision did not address the problem of a party who had incurred expenses carrying out their contractual obligations before frustration occurred. Also, a party may have done almost all the work under the contract but would not be compensated for it. Viscount Simon LC thought that it was up to the Parliament to deal with the problems which remained. We are now going to look at the legislation which was passed to deal with these issues. 5.4.9 The effect of frustration under the Law Reform (Frustrated Contracts) Act 1943 The Law Reform (Frustrated Contracts) Act 1943 tries to do justice between the parties when a frustrating event has occurred. The Act deals with the following: money paid and/​or payable by a party before the frustrating event; expenses incurred by the payee; and valuable benefits obtained by either party. Section 1(2) contains three key points: Money paid before the event can be recovered. Money that should have been paid before the event need not be paid. At the court’s discretion, expenses incurred by the payee in performance of the contract can be recovered out of the total sums paid/​payable before the event. Section 1(2) deals with payments already made, or payments that should have been made but had not been made, before the frustrating event. Pre-​payments can be returned. Also, money that should have been paid before the event need not be paid. But under the proviso to s1(2), there is a very wide discretion afforded to the courts to allow a payee to recover expenses out of the total money paid and payable before the frustrating event. Note that there are effectively two maximum sums a court can award the payee under the proviso for expenses incurred. If the expenses incurred are less than the total pot of money 140  Performance and Discharge of a Contract available under the proviso, then the most the payee can recover is the amount of expenses incurred; otherwise the maximum that can be awarded is the total sum paid and payable before the frustrating event. However, the courts have a very wide discretion when it comes to awarding sums under the proviso to s 1(2) for expenses incurred by the payee, and this was made clear in Gamerco SA v ICM/​Fair Warning (Agency) Ltd 1 WLR 1226. In that case the defendant payee had incurred expenses of $50,000 in performing the contract before the frustrating event. Garland J said that there was no obligation on the court to award total retention or equal division. He said the court has a broad discretion and its task is to do justice in a situation which the parties had not provided for and to mitigate the possible harshness of allowing all loss to lie where it fell. In the event, Garland J did not make an award for expenses under s 1(2) as the payer’s expenses were considerably higher than those of the payee. The common law did not deal with the problem of expenses at all, so s 1(2) is an improvement on the position at common law. However, if no money was paid and/​or payable before the frustrating event, s 1(2) does not help. Section 1(3) of the Law Reform (Frustrated Contracts) Act 1943 applies where one party has conferred a valuable benefit on the other party before the frustrating event. Where this is the case, the court may order the party obtaining the benefit to pay such sum (if any) as the court considers just, but not exceeding the value of the benefit. All of the circumstances must be taken into account, in particular any expenses that the party who receives the benefit may have incurred before the frustrating event. This includes any expenses which the court has ordered that party to pay to the other under s 1(2). Also, the court must consider whether the frustrating event itself affected the benefit. The court considered s 1(3) of the Act in BP Exploration Co (Libya) Ltd v Hunt 1 WLR 783. Here, Goff J said that, in the case of an award under s 1(3), there are two distinct stages: First, the benefit has to be identified and valued and this then forms the upper limit of the award. Any expenses incurred by the party obtaining the benefit must be deducted from the value of the benefit (including any money ordered to be paid by that party to the other under s 1(2)). Secondly, the court has to assess the just sum (which must not exceed the value of the benefit). When assessing a just sum, the court may have regard to the consideration in the contract as evidence of the appropriate level of remuneration. Goff J also said that the benefit under s 1(3) is the end product of what the claimant has provided, taking into account the frustrating event, and not the value of work that has been done. To illustrate this argument, he uses the following example: ‘Suppose that a contract for work on a building is frustrated by fire which destroys the building and which therefore destroys a substantial amount of the work already done by the [claimant] … The effect of s 1(3)(b) will be to reduce the award to nil …’ To sum up, s 1(3) provides that if one party has received a valuable benefit before the frustrating event because of something done by the other party in performance of the contract then the court may order the recipient to pay such sum as the court considers just, but not exceeding the amount of the benefit. The common law did not deal with the provision of a valuable benefit at all, so s 1(3) is an improvement on the common law position. Section 2 of the Act allows the parties to put a clause in the contract excluding the Act and making their own provision about the effects of frustration on their contract. We have considered force majeure clauses earlier in this chapter. Section 2 also lists contracts to which the Act does not apply, eg certain charterparties and insurance contracts. In relation to insurance, s 1(5) of the Act specifically provides that the 141 Contract court shall not take into account insurance payments unless there was an express term of the contract imposing an obligation to insure. In the Gamerco case, both parties had taken out insurance cover against the particular risk, but as neither party had been bound to do so under the contract, the court ignored any sums paid out by the insurance companies when determining what to do about expenses under s 1(2). Before we leave the Law Reform (Frustrated Contracts) Act 1943, we shall consider some of the weaknesses of the Act and some of the difficulties which may arise in applying it. Section 1(2): expenses The amount recoverable is limited to the total of the sums paid and payable before the frustrating event. Expenses incurred above this amount cannot be recovered. If no money was paid or payable before the frustrating event, s 1(2) does not help at all. Section 1(2) does not make clear the basis on which an award for expenses is to be calculated. Garland J, in Gamerco SA v ICM/​Fair Warning (Agency) Ltd, said that the court had a broad discretion. The absence of guidelines as to how this discretion is to be exercised could lead to inconsistencies. Section 1(3): valuable benefit It can be difficult to predict how much will be awarded under s 1(3). Also, is it reasonable for the valuable benefit to be the end product of what the claimant has provided rather than the value of the work done (BP Exploration (Libya) Ltd v Hunt)? Goff J’s interpretation of s 1(3) can produce undesirable results, eg where fire destroys a building on which work had been done, the award under s 1(3) would be nil. (The person who had done the work could claim expenses under s 1(2), but this award would be limited to the amount of money paid and/​or payable to that person before the frustrating event.) It is because of the limitations and uncertainties identified above that parties to a commercial contract prefer to rely on a force majeure clause (such as clause 4.3 in the Specimen Standard Conditions of Sale (Reading 1 in the Appendix)). To appreciate how the common law and the 1943 Act operate in practice when a contract has been frustrated, we are now going to consider a particular set of facts. Example Moira agrees to hire a boat from Jane for six weeks beginning on 1 August. Moira pays a £200 deposit and agrees to pay a further £400 on 15 July and the balance of £2,400 on 1 August. They agree that Jane will install some extra bunks. Jane has spent £800 installing the bunks when a fire destroys the boat on 16 July. Moira has not yet paid the £400 due on 15 July. Assume that the contract has been frustrated. 1. Moira does not have to pay the balance of £2,400. Frustration of the contract discharges future obligations. 2. Section 1(2) says that money paid before the frustrating event can be recovered and money payable before the frustrating event need not be paid. So Moira could recover her £200 deposit and need not pay the £400 (but this is subject to any award that the court makes for Jane’s expenses (see below)). 3. Under s 1(2) the maximum the court can award for expenses incurred by the payee is a sum equal to the total paid and payable before the frustrating event or the 142  Performance and Discharge of a Contract amount of the expenses incurred (whichever is the lower sum). In this situation, the total money paid and payable before the frustrating event was £600 (ie the £200 deposit and the £400 due on the 15 July); whereas £800 had been spent by Jane (the payee) in performance of the contract. Therefore, Jane could be awarded a maximum of £600 under s 1(2) and so would not be compensated in full. The court has a broad discretion when it is contemplating an award for expenses under s 1(2). Its task is to do justice and it is not obliged to award the maximum amount. 4. Jane has done some work installing extra bunks in the boat. This would constitute a valuable benefit under s 1(3) but, as the frustrating event completely wiped out the work Jane had done before Moira could benefit from it, a ‘just sum’ might be nil. If the fire had destroyed the boat on 8 August, Moira would have had use of the boat for one week and a court may decide that this amounts to a valuable benefit. The court would have to identify and value the benefit taking into account any expenses incurred by Moira, including any money that Moira has to pay Jane under s 1(2). Having done this, the court would then have to decide on a just sum (if any) that Moira should pay. The court could have regard to the consideration (ie the amount Moira agreed to pay for the hire). The above example was focusing on the effect of frustration and so worked through on the basis that the contract had been frustrated. But where it is unclear on the facts, the first issue will be to determine whether the contract had been frustrated or indeed breached. Only if it has been frustrated will you need to consider the effects of frustration; otherwise you will be advising on the remedies for breach. Set out below is a suggested structure for tackling issues involving alleged frustration of a contract. Structure for approaching problem questions on frustration 1. Identify which party which will wish to claim frustration, ie the party which would otherwise be in breach for non-​performance. 2. General rule in Paradine v Jane. Contractual obligations are absolute, ie a party must perform its contractual obligations. If a party does not, it will generally be in breach of contract. 3. Frustration is an exception to this. Define frustration. 4. Go through the definition and apply each part to the facts. For example, has there been a supervening event which makes the contract impossible or radically different to perform? Is there a term in the contract covering the event? Is one of the parties at fault? 5. Effect if the contract is frustrated: The contract comes to an end automatically at the moment of the frustrating event. Neither party is in breach. Each party is completely discharged from all future obligations. Apply to the facts. 143 Contract Does the Law Reform (Frustrated Contracts) Act 1943 apply? Yes, unless excluded. Consider s 1(2) and (3) of the Law Reform (Frustrated Contracts) Act 1943. Look at each subsection in turn, explain what it says and apply to the facts. 6. If the contract is not frustrated then a party may be in breach of contract. If so, the innocent party can claim damages for breach of contract and may be able to terminate the contract. (We considered how damages are awarded and when a party can terminate in Chapter 4.) So having looked at how to approach problem questions on frustration, let’s now think about essay questions on the topic. Essays test your knowledge, but also your ability to critically evaluate a statement or quotation on a particular topic and to express a reasoned conclusion as to whether, or not, you agree with the statement/​quotation. We looked at how to approach answering an essay question in Chapter 2 in the context of downward contractual variations and in particular promissory estoppel. Set out below is an essay question focussing on the effects of frustration and feedback on how you might approach answering it. Sample essay question While mitigating some of the harshness of the common law approach did not solve all the problems, the Law Reform (Frustrated Contracts) Act 1943 makes some attempt to solve these problems. (Wheeler and Shaw, Contract Law: Cases, Materials and Commentary) Explain and comment on the law of frustration in the light of this statement. In your answer you should demonstrate that you can: explain what is meant by frustration; refer to the rule of absolute obligations (Paradine v Jane). Frustration is an exception to this rule. Define frustration and give examples; explain the effect of frustration. The contract comes to an end at the moment of the frustrating event, the parties are discharged from all future obligations, and damages cannot be recovered as no breach of contract. Consider the common law rules and Krell v Henry and Chandler v Webster. Originally, at common law, if one party had paid money to the other before the frustrating event, it could not be recovered, and if money was payable prior to the frustrating event, it still had to be paid. You should look critically at the decisions in Krell v Henry and Chandler v Webster and express an opinion on the fairness of the result. Consider the modification of the common law position by the decision in Fibrosa. You should explain the decision in Fibrosa v Fairbairn Lawson and look at any problems which remained. The decision in Fibrosa only applied where there had been a total failure of consideration. If this condition was not satisfied then the money could not be recovered or still had to be paid. 144  Performance and Discharge of a Contract The decision did not address the problem of a party who had incurred expenses before frustration. Also, a party may have done almost all the work under the contract but would not be compensated for it. Set out the provisions of the Law Reform (Frustrated Contracts) Act 1943 and express an opinion on the extent to which the Act solves the problems which remained after Fibrosa. You should refer to relevant cases, eg Gamerco SA v ICM Fair Warning (Agency) Ltd and BP Exploration (Libya) Ltd v Hunt. Section 1(2) is not dependent on a total failure of consideration. The expenses provision in s 1(2) is an improvement on the common law which did not deal with the problem of expenditure. However, the amount recoverable is limited to the sum paid and payable to the payee before the frustrating event. Expenses above this amount cannot be recovered, and if no money was paid or payable to the payee before the frustrating event then s 1(2) does not help at all. It does not help the payer who may have incurred expenses. Also, s 1(2) does not make clear the basis on which an award for expenditure will be calculated. Garland J in Gamerco said that the court had a broad discretion. Section 1(3) –​valuable benefit. The common law did not deal with the provision of a valuable benefit, so this section is an improvement. You should discuss the difficulty of valuing the benefit and the decision in BP Exploration v Hunt. You might point out that the parties may make their own provision about the effects of frustration and discuss the advantages of doing so. You might also mention that the common law continues to apply to contracts excluded from the Law Reform (Frustrated Contracts) Act 1943. Figure 5.3 Frustration –​summary Contract Force Non- majeure performance Self-induced, Frustration