The doctrine of frustration is a common law concept, and Australia has no legislation to determine when a contract is frustrated. Frustration of a contract is a complex area of the law, and it is often up to the courts to determine if a contract is frustrated - and it is not a finding that the courts make lightly.
The pandemic raised many questions about the doctrine of frustration and when a contract is frustrated, especially in the commercial lease arena.
Frustrated clients often want to know, "But isn't the contract frustrated?" Unfortunately, it is not a straightforward answer, especially not regarding lease agreements. Each contract is different, and the answer depends on the merits of each situation.
It is important to note that the doctrine of frustration is not the same as a force majeure clause.
This article will explore the doctrine of frustration and attempt to answer some of the questions about its application in Australian law.
What is the doctrine of frustration?
Frustration is a common law doctrine which recognises that an unforeseen event may occur through no fault of either party to the contract, which makes it impossible to perform or radically changes the nature of any obligations that the parties intended under the contract.
The definition of frustration is a mouthful, and we need to look at each element to understand its operation fully.
In Codelfa Construction Pty Ltd v State Rail Authority of New South Wales(1982)149 CLR 337, the Australian courts adopted the English House of Lords definition that read:
"… 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 was not this that I promised to do".
From this definition, we can say:
Neither party must be at fault
You cannot rely on frustration if the frustrating event was due to any act or omission of one of the parties to the contract. So, a breach of contract will not constitute frustration. The party must not be at fault.
The event must be unforeseen
If the parties assumed specific risks (expressly in the contract or by implication), they cannot later rely on that event (risk) to claim frustration. Often certain risks are specified in force majeure clauses, meaning those events might not be grounds for frustration since the parties anticipated them. They were not unforeseen.
The event must be unforeseen to qualify for frustration, and the onus of proof is on the party making the frustration claim.
Performance must be impossible
This could be literally impossible; for example, you rent a property, and the property burnt to the ground. There is no more property to rent.
It could also be commercially impossible. You must make rugby jerseys for the team before a specific match, and all the fabric is destroyed in a flash flood a week before delivery is due, and the fabric is discontinued or impossible to source in time.
Circumstances that could lead to impossibility include:
• A party to the contract dies or becomes incapacitated
• The method of performance of the contract is no longer possible
• Non-occurrence of a particular event renders the agreement pointless
• Legislative changes render the performance illegal
Besides making performance impossible, a contract could also be frustrated if the event transforms the contractual obligation into a fundamentally different obligation. As the court said, the performance must radically differ from what was promised.
When is performance radically different?
In National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675, the court indicated that the contract must be so completely or extremely changed that it is no longer the same and has significantly altered the nature of the agreement.
How do we evaluate if frustration occurred?
• We will have to look at the contract itself to decide what was promised - what did the parties mean, and what were the circumstances when the agreement was entered into?
• Then we must look at the frustrating event to evaluate if performance was radically changed or is now impossible. Did the consequences of the event render the contract completely or radically changed? Did it significantly change the nature of the contract?
What happens if the contract is found to be frustrated?
The contract is terminated at the time of the frustrating event, and the parties are discharged from their future obligations under the contract. They are still liable for performance until the frustrating event occurred.
Since frustration is not regarded as a breach of contract, there is no right to claim damages or seek restitution.
In NSW, the Frustrated Contracts Act 1978 deals with the consequences of a frustrated contract in NSW.
Does the doctrine of frustration apply to lease agreements?
The short answer is, yes, frustration applies to a lease agreement, BUT it is very difficult to terminate a lease based on frustration.
There has, for many years, been a reluctance to apply the frustration doctrine to leases. Arguments often revolved around whether the frustrating event was just temporary in nature and, therefore, frustration didn't occur. Parties would examine whether the event made performance completely impossible or whether performance was merely delayed. The remainder of the lease terms was often a factor the courts considered.
The Panalpina case gave interesting insight into the application of the doctrine of frustration in lease agreements. The court found that frustration did not occur on those sets of facts but considered the question, "whether or not there is anything in the nature of an executed lease which prevents the doctrine of frustration, however formulated, applying to the subsisting relationship between the parties."
In Panalpina's case, the tenants of a commercial warehouse argued that their lease agreements became frustrated, and they, therefore, no longer had to pay rent. In short, access to the road to the leased premises was closed by the local council for 20 months (due to dangerous and derelict buildings on the street). The lease period was ten years, with four and a half years remaining.
The court held the closure to be a temporary event and not a "cataclysmic event" that gave rise to frustration of the lease by rendering the parties unable to perform their obligations for the remainder of the lease.
The court noted that whether a supervening event is a frustrating event or not is, in a wide variety of cases, a question of degree and, therefore, to some extent at least, a question of fact.
However, even though the court found against frustration on the facts, on the question of whether the doctrine of frustration applies to lease agreements, Lord Hailsham said,
"Is there anything in principle which ought to prevent a lease from ever being frustrated? I think there is not." No doubt the circumstances in which the doctrine can apply to leases are, to quote Viscount Simon in Cricklewood at p.231,"exceedingly rare".
In principle, then, a lease can be frustrated. The subject matter of the lease will determine the circumstances in which it might be frustrated. Factors such as the lease's remaining length and commercial character will be determining factors.
Each case will be determined on its own merits and whether the event fundamentally or radically changed the performance of the contract. It is not an easy case to win, but it can be done.
In Willmott Growers Group Inc v Willmott Forests Limited (Receivers and Managers Appointed) (In Liquidation) [2013] HCA 51, the High Court of Australia confirmed that the doctrine of frustration applies to contractual leases, although it reiterated that it must be considered on a case to case basis.
It also warns that "it may be difficult to envisage circumstances in which conduct of the tenant, short of actual abandonment, would properly be held to constitute repudiation or fundamental breach or in which anything less than a cataclysmic event such as the 'vast convulsion' referred to by Viscount Simon LC in Cricklewood Property and Investment Trust Ltd v Leighton's Investment Trust Ltd, would warrant a finding of frustration."
Where does this leave us?
If you want to argue the doctrine of frustration, the onus of proof is on you. You must prove that an unforeseen event, which makes it impossible to perform or radically changes the nature of the contractual obligations, occurred through no fault of your own.
From case law, we know the doctrine of frustration may apply to lease agreements, although we don't have many precedents, and the bar is high.
An experienced lawyer will assess the terms of your contract, analyse the event in the context of your contractual obligations and be able to advise you on your chances of a successful frustration claim. We will also advise on the appropriate legislation governing frustrated contracts.