Frustration of international construction and engineering contracts and COVID-19

Introduction

Frustration has garnered much attention following the outbreak of the COVID-19 pandemic, as a possible escape route for parties facing onerous liabilities under contracts entered into before the outbreak. In this article, we examine the common law principles governing frustration of contracts in England and Australia, and argue that major international and engineering contracts are unlikely to have been frustrated by COVID-19. We go on to examine, in light of that conclusion, the practical approaches seen by parties facing significant disruption to major construction projects.

Key points/how does it affect you?

• Major construction contracts are unlikely to have been frustrated by COVID-19.
• A party taking a position that their contract has been frustrated risks being found to be in repudia-tory breach.
• The stance of both English and Australian govern-ments in keeping construction sites open as much as possible throughout the pandemic has made it difficult to sustain an argument based upon frus-tration.
• In practice, parties are seeking to reach their own terms as to how to proceed and share the costs between employer and contractor.

Frustration defined

In broad terms, the doctrine of frustration under English and Australian law follows the same overall structure:

• The question of whether a contract will be frus-trated is governed by the common law.
• The consequences of frustration are dealt with via statute,1 giving the courts broad discretionary powers to make a monetary award that does justice between the parties.

The classic definition of when a contract will be frustrated was provided by Lord Radcliffe in Davis Contractors Ltd v Fareham Urban District Council:

. . . frustration occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circum- stances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. Non haec in foedera veni. It was not this that I promised to do.

This formulation was specifically adopted by the Australian courts in the case of Codelfa Construction Pty Ltd v State Rail Authority (NSW).3 In that case, Mason J asked himself “whether the situation. . . is fundamentally different from the situation contemplated by the contract on its true construction in the light of the surrounding circumstances”.

These formulations of the principle make clear that the bar for proving frustration is a high one, while at the same time linking frustration to the expectations of the parties when they contracted. If the event in question is covered by the contract then axiomatically the contract is not frustrated — the circumstance was contemplated  by the parties and the relevant provision governs the position.

The starting point when considering whether a con-tract is frustrated is therefore the terms of the contract itself. No contract entered into before 2020 is likely to have envisaged COVID-19 specifically and relatively few construction contracts contain provisions dealing explicitly with pandemics or similar health crises. That is not to say, however, that they contain no terms at all that are relevant — many standard form construction contracts contain broadly framed clauses that purport to deal with any unforeseen delaying events compendi-ously.

Some contracts refer simply to instances of “force majeure”, relying upon decided cases as to the meaning of those words. While a whole article could be written on the question of whether these words capture the effects of COVID-19 (and many have been), it is in our view likely that they do — in the case of Lebeaupin v Crispin and Co5 the court specifically approved the suggestion that an “epidemic” would be a case of force majeure (although the issue did not arise on the facts of the particular case).

An alternative approach is to define in general terms what kinds of events will discharge the parties from further performance. For example, the International Federation of Consulting Engineers (FIDIC) “Red Book” (2017 ed)6 defines generically “Exceptional Events” which, if they cause substantial delay to the relevant project (a single period of 84 days, or 140 days cumu-latively), entitle the parties to terminate the contract. “Exceptional Events” in the Red Book are defined as events beyond the control of the parties, not attributable to the fault of either, that could not reasonably have been foreseen at the outset of the contract. Again, these requirements appear likely to be satisfied in relation to COVID-19—unquestionably, the pandemic was neither foreseeable nor the fault of either party.

When will a contract be frustrated?

Assuming the relevant contract does not contain a contractual provision that governs the consequences of COVID-19, the question is whether the event has had a sufficiently fundamental impact to amount to frustration. In a construction and engineering context, there are a number of points that are of particular significance to the question of whether COVID-19 will or may qualify as a frustrating event:

• A contract is not frustrated if the relevant event impacts “merely the expense or onerousness” of performance; a fundamental change to the “nature” of the obligations is required (National Carriers Ltd v Panalpina (Northern) Ltd7). COVID-19 has doubtlessly caused significant delays and costs to almost every major construction project, rendering such projects substantially more onerous. That will not in itself amount to frustration.

• Even a radical change in background economic factors, rendering a construction project no longer commercially viable, is unlikely to amount to frustration. Although the possibility of a “frustra-tion of common purpose” has been recognised in some cases, it is notoriously difficult to deploy in practice. A recent English example is Canary Wharf (BP4) T1 Ltd v European Medicines Agency8—the European Medicines Agency (EMA) (a European Union institution) sought to argue that the lease of its headquarters in London was frustrated upon Britain leaving the European Union. The EMA’s arguments were dismissed on the basis that there simply was no common purpose — there were two parties with divergent interests, with a negotiated agreement representing the best available compromise between the two. It is hard to imagine how the employer and contractor in a major construction project could demonstrate a “common purpose” sufficient to found an assertion that their contract was frustrated.

• A contractor facing difficult choices over how to allocate scarce resources is unlikely to be able to avail themselves of a frustration argument where
they prefer one project over another. This derives from the well-known case of J Lauritzen AS v Wijsmuller BV (The Super Servant Two),9 in which one of two ships owned by the same company sank. The company had two contracts to fulfil; it had already allocated its remaining ship to one contract and claimed the other was frustrated. That argument was rejected — the frustration was self-inflicted, because the shipowner could have fulfilled either contract by allocating its remaining ship to it.

• In order for delay of performance to result in frustration, it must be shown that the delay is more than temporary or transient, particularly in the context of the contract’s length. For example, an order closing down a construction site for a month is unlikely to trigger frustration of a large-scale 2-year contract.

Supervening illegality

Of particular significance in the context of COVID-19 is frustration of contracts by supervening illegality —
where performance of the contract has become illegal due to a change in the law. Both the UK and Australian governments have, at various times and to varying extents, imposed legal limits on the activities of indi-viduals and businesses in an effort to slow the spread of the coronavirus. Where performance of a contract would necessarily involve the infringement of those limits, it is likely to have been frustrated — this has been of particular significance to the hospitality and events industries.

It is however unlikely that many construction con-tracts will have been frustrated in this manner. In the UK, even at the height of the pandemic, the government stopped short of ordering a blanket halt to work on construction sites; indeed, explicit advice was given that work on construction sites could continue. Instead, guidance was issued to employers and contractors advis-ing as to how work could safely carry on. The Australian government’s approach has, in large part, been similar — construction has mostly been treated as an essential service and been allowed to continue even while other businesses are forced to close. Even where construction work has been ordered to stop, this has mostly been for periods of just a few days — enough to cause enormous disruption to the project but unlikely to be sufficient to frustrate the relevant contract.

Drawing together the threads

While each case will turn on its own facts, we consider that it is unlikely that major international construction contracts will have been frustrated by
COVID-19. An assertion of frustration would need to clear a number of hurdles, none of which will be easily passed, and failure at any one will prevent the contract having been frustrated:

• The contract would have to contain no force majeure or similar provision which applies to COVID-19. Given the prevalence of such provi-sions in the standard forms, and the unforesee-ability of the COVID-19 pandemic, that is a somewhat unlikely scenario.

• COVID-19 would have had to render the contract not merely more difficult to perform but rather fundamentally different from that envisaged at the outset. In light of the restrictive approach taken to this test in the authorities, it is difficult to see how it will be passed in the context of a major construction project.

• If the parties seek to argue that the contract has been frustrated by supervening illegality, they will need to make good an assertion that performance was prevented by law. That is again unlikely, given the approach of governments in both the UK and Australia in endeavouring to keeping construc-tion sites open wherever possible.

Even attempting to argue frustration is an unattractive prospect for some employers and contractors. A contrac-tor or employer taking the position that their contract has been frustrated will likely find themselves in repudiatory breach of their contract if they are wrong in their analysis. That presents a significant risk to any party seeking to deploy the argument. In our experience, few, if any, contractors have gone as far as simply stopping work in reliance upon an argument that their contract has been frustrated.

Practical perspectives

Given that the doctrine of frustration is unlikely to provide an answer for those seeking to resolve the disruption caused by COVID-19, what approaches are parties adopting instead? We would identify the follow-ing three points as particularly significant.

First, there is broad recognition across the industry that practical “middle ground” solutions need to be found where possible. Frustration is something of a binary choice — either both parties are completely excused from all future performance or the contractor remains bound to complete the project irrespective of the cost.

In commercial terms, an intermediate position between these two extremes is likely to benefit both parties; the project continues but employer and contractor come to an accommodation as to how to distribute the additional costs between them. Experience to date would suggest that many employers and contractors are taking a straightforward approach and agreeing simply to split additional costs 50:50.

Second, where parties are entering into contracts now, many are taking the opportunity to include bespoke amendments dealing with either COVID-19 specifically or epidemics/pandemics more broadly. This is undoubt-edly preferable to relying upon broad wording of uncer-tain scope such as force majeure. It is important to note that some of the standard forms (including the FIDIC Red Book) define “Exceptional Events” or similar in terms that exclude those which could have been foreseen at the time the contract was entered into. Parties who use the standard forms now without negotiating bespoke COVID-19 clauses may find that there are no provisions which are engaged by COVID-19 at all; risks of further delays will be allocated according to the general con-tractual provisions (ie generally to the contractor).

Negotiations over bespoke terms present their own issues, however, not least in deciding the most appro-priate way to allocate the relevant risks. We have seen a range of approaches, although allowing contractors to extend time for COVID-19-related delays for a defined (but not allowing them to claim additional costs or expenses) is perhaps the most prevalent. More con-troversial are amendments which seek to expand the definition of force majeure so as to include events such as pandemics and permit additional costs and expenses. It is also possible that government contracts will provide for events such as epidemics/pandemics, as it makes sense for such risks to be borne nationally. Inevitably standard form contracts will follow suit, expressly allo-cating liability for these types of risk based in part upon a perception of how well the country is able to manage
such events.

Finally, many parties are facing difficulty in obtaining insurance cover to pass on risks relating to COVID-19. The Supreme Court’s decision in Financial Conduct Authority v Arch Insurance (UK) Ltd10 dealt a heavy blow to the insurance industry which now finds itself facing extensive liabilities for business interruptions caused by COVID-19. Negotiations over allocation of risk take place against the background that employers and contractors may be unable to pass on those risks to the insurance market as they might normally expect to. This raises the stakes of those negotiations for the parties concerned.

Conclusion

The repercussions of the COVID-19 pandemic are still being felt globally, and doubtless, will continue for many years to come. Litigation raising the issue of whether contracts have been frustrated by COVID-19 is a certainty. In a construction and engineering context, we are sceptical as to whether the high hurdle for frustration will be passed. All parties faced with COVID-19-related disruptions would be well advised to seek, where possible, negotiated alternatives to relying upon the doctrine of frustration. When COVID-19 is finally under control, at least in the majority of countries, there will be a dialogue as to how best to manage the threat posed to major domestic and international infrastructure projects. This will encompass not only the delivery of the projects but also supply chains, commissioning and operation.

This article was first published by LexisNexis Australia.