Change of Circumstances and the Frustration of Contracts

As the COVID-19 crisis starkly illustrates, there is no guarantee that the circumstances under which a contract has been concluded will persist into the future. One potential way to deal with subsequent challenges is through variation of contracts between the parties, which was the topic of the previous AKT blog post https://www.akt.rs/en/publication/variation-of-contracts—the-problems-of-consideration. But in situations where renegotiation is not possible, or performance becomes impossible, English contract law needs to provide default answers. This blog post thus addresses the change of circumstances and the doctrine of frustration that might come into play in some situations.

To start with the general rule – the mere fact that performance of the contract has become more onerous for one or both of the parties either physically or financially (sometimes referred to as ‘hardship’) does not by itself produce any legal consequences. Unlike in some continental jurisdictions, including Serbia, there is no rule requiring renegotiation of the contract, allowing termination by one party, nor can the English courts readjust the contractual performance between the parties. The principles of party autonomy and sanctity of contracts are the starting points in dealing with these situations.

There are two general exceptions to this presumption. One is if the parties, expressly or impliedly, make provisions in their contract as to what happens in case of changed circumstances. Most famously, such clauses are known by their French name force majeure (higher force) clauses, and English courts have a long tradition of carefully interpreting and giving effect to them. These often prescribe suspension of performance, right to terminate the contract, and allocation of monies paid or due at the moment of a force majeure event. Such events usually include natural disasters, acts of state, epidemics or armed conflicts. Careful drafting by the parties and a reasonable attempt to foresee potential issues can thus provide the required level of certainty, and this will be upheld in English law.

If the parties have not provided for changed circumstances in their contract, the other possibility provided by English law is the operation of the doctrine of frustration. This doctrine covers rather narrow grounds, laid out by Lord Radcliffe in the still leading case of Davis Contractors Ltd v Fareham Urban DC ([1956] AC 696, 729, HL), as to when ‘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’.

In practice, this usually covers situations of physical impossibility (a thing of key importance for the performance of the contract has perished); legal impossibility (performance of the contract subsequently becomes illegal); or a wider category where the purpose has been frustrated by extraneous events. The most famous examples of the last category are so-called ‘coronation cases’ where the cancellation of the planned coronation of Edward VII in 1902 meant that contracts concluded with specific purpose related to the event became frustrated (such as renting a room to observe the parade, as in Krell v Henry [1903] 2 KB 740). The doctrine does not operate if the party alleging frustration has itself caused the frustrating event, or chose not to perform in situations where performance still remained possible.

In terms of legal consequences, the contract is automatically terminated at the moment of frustration, and both parties are released from any future performance – but not automatically from obligations due before that moment. Monetary and pecuniary consequences of frustration are for the most part further dealt with through the Law Reform (Frustrated Contracts) Act 1943. Without going into details, this Act generally confers on the courts the discretion to determine, as they see just, what sums of money should be paid or retained for benefits provided to the other party or expenses incurred before the contract became frustrated.

After looking at the situations of changes subsequent to the formation of the contract, the next AKT blog post will examine a related but distinct issue of mistakes during formation that can have serious consequences of the validity of a contract.

Velimir Zivkovic