Understanding Frustration & Force Majeure in Contracts: Illustrations & FIDIC Conditions, Lecture notes of Law

Download Understanding Frustration & Force Majeure in Contracts: Illustrations & FIDIC Conditions and more Lecture notes Law in PDF only on Docsity! Contracts Law Conference Allocating and managing the risk of the unexpected By Nathan Abbott This paper was presented at the LegalWise Contracts Law Conference in Melbourne in March 2013. 1. Introduction The purpose of this paper and presentation is to examine the operation of a force majeure regime in the context of a typical contractual risk allocation and against the backdrop of the common law doctrine of frustration, as varied by statute. Force majeure arises relatively rarely, however is topical, for example as a result of the impact of floods over the last couple of years on open-cut coal mining and rail transportation in Queensland, earthquakes in Christchurch and the Varanus Island explosion in 2008, which disrupted gas supplies in Western Australia to the extent of approximately 35% for two months. It will always be best practice to try to identify, assess and allocate the risks of any transaction to the maximum extent possible. However, it will never be possible to anticipate every eventuality. The extent to which it is possible to do so will be a product of a range of factors, including particularly: the type and nature of the transaction; the parties' familiarity and experience with such transactions; and the expertise and effort brought to bear by the parties' advisers in negotiating and drafting the contract. Contractual risk allocation can be conceived of for present purposes as a spectrum. At the far end of the spectrum is frustration, which operates to bring the contract to an end in the event of relatively extreme occurrences. Somewhere closer to the near end of the spectrum will be found a typical contractual risk allocation, with its precise location depending on the factors referred to above. In between the contractual risk allocation and frustration, is that part of the spectrum where a force majeure regime may operate to preserve the contract, despite some extreme occurrence, by suspending the obligations of the parties for the time being. The more thorough the contractual risk allocation, the closer it is to frustration on the spectrum and the less scope there is for the operation of a force majeure regime. We will consider the law of frustration and some examples of a typical contractual risk allocation and a force majeure regime. A force majeure regime should always take account 2 of a number of key parameters and attention must always be paid to the risk that it may undermine the contractual risk allocation to the advantage of one party over the other. 2. Risk Allocation As a construction lawyer, I would like to think that the standard form construction contracts are a useful basic template for good risk allocation practice. Construction projects, and the construction contracts which regulate them, are principally focussed on time, cost and quality, in particular which party will bear the risk of the unexpected with respect to the various factors which have been shown over the ages to have the potential to impact adversely on construction projects. Generally speaking, it will be the party best able to control or transfer the risk that should bear the risk, although risks beyond the control of either party will often also be allocated to one of them. Both construction projects and construction contracts range in sophistication from the generic to the unique and bespoke. Construction contracts are often based on standard forms, however they are often very substantially amended. Not all of the risks apprehended by a construction contract will be relevant to other types of projects or transactions, however many will be, or will at least be analogous to relevant risks, essentially because the need to manage time, cost and quality is likely to be at the heart of any project or transaction. By way of example, the AS 4300-1995 Australian Standard General conditions of contract for design and construct include at least the following clauses which allocate the risk of the unexpected: 2.1 Clause 12 – Latent Conditions The latent conditions regime in AS 4300-1995 essentially provides for time and money to be adjusted in the contractor's favour where the physical conditions on the site differ materially from what should reasonably have been anticipated by the contractor. 2.2 Clause 14 – Legislative Requirements Essentially, where a change in a legislative requirement could not reasonably have been anticipated and necessitates an impact on the contractor's cost, then the difference in cost is valued as a variation. 2.3 Clause 16 – Care of the Work and Reinstatement of Damage The contractor is essentially responsible to care for the site and to reinstate it at the contractor's cost if it is damaged, unless the damage is caused by or on behalf of the 5 No matter the extent to which the contractual risk allocation is developed and refined, there will be a point beyond which an extreme occurrence has the potential to make the performance of the contract pointless or impossible. 3.1 Common law doctrine of frustration The test for frustration was formulated in England by Lord Radcliffe in Davis Contractors,1 and adopted in Australia by the High Court in the case of Codelfa Construction,2 as follows: “…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.” Some illustrations of situations which the common law has recognised as constituting frustration are as follows: (a) destruction of subject matter – for example, the case of Taylor v Caldwell,3 where a contract for performances was frustrated by the burning down of the concert hall; (b) disappearance of the purpose of the contract – for example, the case of Herne Bay Steamboat Co,4 where a contract for boat hire to watch the coronation of the king was frustrated because the king had appendicitis and the coronation was cancelled; (c) disappearance of, or radical change in, a state of affairs essential to performance – for example, the case of Codelfa Construction5 mentioned above, where injunctions obtained by neighbours to stop railway construction works from being carried out at night, frustrated the construction contract; 1 Davis Contractors Ltd v Fareham Urban District Council [1956] AC 696; [1956] 2 All ER 145. 2 Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337 at 365; 41 ALR 367; per Mason J. 3 Taylor v Caldwell (1863) 3 B & S 826; 122 ER 309. 4 Herne Bay Steamboat Co v Hutton [1903] 2 KB 683. 5 Codelfa Construction Pty Ltd v State Rail Authority of New South Wales (1982) 149 CLR 337; 41 ALR 367. 6 (d) the contract becomes illegal – for example, the case of Denny Mott,6 where a contract for the supply of timber and lease of a timber yard was frustrated by new government regulations restricting such activities; and (e) delay, although there is a high threshold for frustration in this instance, and there is difficulty in assessing how long a delay needs to be to frustrate a contract – for example: (i) in the case of Bank Line,7 a 12 month vessel charter contract was frustrated when the government requisitioned the ship for WWI for an indeterminate period; and (ii) in the case of National Carriers,8 a warehouse lease was not frustrated in circumstances where a road closure prevented access to the warehouse for 20 months of a 10 year contract. The doctrine has also developed to recognise situations where frustration does not occur. For example: (f) a contract is not frustrated simply because it has become uneconomical for one party;9 (g) a contract is not frustrated where the relevant supervening event was foreseeable – for example, the case of oOH! Media Roadside,10 where a contract for use of a building to display outdoor promotional material was held not to be frustrated after the line of sight of approaching traffic was partially obstructed by a newly built office tower. In this case, it was acknowledged by the court that there is a difficulty in assessing the degree or extent to which an event must overturn expectations, or affect the foundation upon which the parties contracted, before the contract is taken to be frustrated;11 and 6 Denny, Mott & Dickson Ltd v James B Fraser & Co Ltd [1944] AC 265; [1944] 1 All ER 678. 7 Bank Line Ltd v Arthur Capel & Co [1919] AC 435. 8 National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675; [1981] ANZ ConvR 73; [1981] 1 All ER 161; [1981] 2 WLR 45. 9 Maori Trustee v Prentice [1992] 3 NZLR 344. 10 oOH! Media Roadside Pty Ltd v Diamond Wheels Pty Ltd (2011) 32 VR 255; [2011] VSCA 116. 11 Ibid at [66]. 7 (h) a contract is not frustrated where the reason for the impossibility of performance is: (i) a breach of the contract by one of the parties;12 or even (ii) self-induced – a state of affairs brought about by a party's own deliberate actions13 (and potentially also a party's negligent actions). It is evident from the above that to rely upon the common law to determine how and when a contract is frustrated would be to subject parties to a relatively opaque body of law, the consequences of which are likely to be difficult to predict in any given fact scenario. Its operation should ideally be the reserved for truly unexpected events, and to the extent that it is practical to do so, parties should specify in the contract how they intend to deal with those events which are able to be anticipated. The consequences of frustration at common law are that parties are automatically released from their obligations and the losses are deemed to lie where they fall,14 regardless of whether it is a reasonable outcome in the circumstances. This position has been modified by statute. 3.2 Statutory regime In Victoria, frustrated contracts are now dealt with under Part 3.2 of the Australian Consumer Law and Fair Trading Act 2012 (Vic) (Act). The predecessor of this part was Part 2C of the Fair Trading Act 1999 (Vic). This part of the Act is broad in its application. It applies to a contract if the parties to the contract are discharged from the further performance of the contract because — (a) performance of the contract becomes impossible; or (b) the contract is otherwise frustrated; or (c) the contract is avoided by the operation of section 12 of the Goods Act 1958 (Vic) (which states that where there is an agreement to sell specific goods, and subsequently the goods, without any fault on the part of the seller or buyer, perish before the risk passes to the buyer, the agreement is thereby avoided). 12 Heytesbury Properties Pty Ltd v City of Subiaco (2000) 108 LGERA 259; [2000] WASC 8. 13 Scanlan's New Neon Ltd v Tooheys Ltd (1943) 67 CLR 169; 43 SR (NSW) 153; [1943] VLR 72; (1943) 60 WN (NSW) 87. 14 Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32; [1942] 2 All ER 122. 10 However, it is sufficient for our purposes to identify that the basic chain of events central to an equitable estoppel claim – inducement, reliance and detriment – can easily arise where circumstances have taken an unexpected turn. Example case – Update Constructions By way of illustration, take the case of Update Constructions.23 A building contract for construction of child care premises was entered into for a fixed sum. With no apparent fault on the part of either party, it was discovered during the course of building that the proposed building was located on the site of an old well which had been built just under ground level. The result was the necessity to perform additional structural works, including to dig out new footings and to add further foundations, amongst other work. The builder notified the proprietor's architectural agent of the situation in a conversation on the building site, and the agent agreed that the extra works should be carried out. Neither written notice nor written approval was given. The contract was not crystal clear on how the situation was to be dealt with, but it did set out requirements: • that, if the builder discovered any unexpected sub-surface conditions, the builder must notify the proprietor and obtain the proprietor's instructions before proceeding; and • that the builder give written notice to the proprietor of any variation to the building works. However, the clauses both contained references to a part of the contract which had been deleted, complicating the interpretation of the contract. Leaving aside any questions of contractual interpretation, a key part of the case was that the NSW Supreme Court of Appeal found that the proprietor was estopped from later being allowed to rely upon a requirement for written notice as an answer to the builder's claim for reimbursement of costs incurred in carrying out the additional work. This was a result of the architectural agent's acquiescence to the builder's verbal proposal to carry out the works. The builder's action was a detriment to the builder, directly induced by the conduct of the architectural agent by representing (even if indirectly) that the requirement of written notice was not being insisted on. 23 Update Constructions Pty Ltd v Rozelle Child Care Centre Ltd (1990) 20 NSWLR 251. 11 4. Force Majeure A force majeure regime addresses the gap between the contractual risk allocation, which can never anticipate every eventuality, and the law of frustration. It operates to preserve the contract, despite some extreme occurrence, but it does so by suspending the obligations of the parties for the time being. It therefore has the potential to impact radically on the contractual risk allocation. An excellent and instructive example of a force majeure regime is to be found in the Fédération Internationale Des Ingénieurs-Conseils (FIDIC, French for the International Federation of Consulting Engineers) Conditions of Contract for Construction 1999 (Red Book) at Clause 19, which provides as follows: 19. Force Majeure 19.1 Definition of Force Majeure In this Clause, "Force Majeure" means an exceptional event or circumstance: (a) which is beyond a Party's control; (b) which such Party could not reasonably have provided against before entering into the Contract; (c) which, having arisen, such Party could not reasonably have avoided or overcome; and (d) which is not substantially attributable to the other Party. Force Majeure may include, but is not limited to, exceptional events or circumstances of the kind listed below, so long as conditions (a) to (d) above are satisfied: (i) war, hostilities (whether war be declared or not), invasion, act of foreign enemies; (ii) rebellion, terrorism, revolution, insurrection, military or usurped power, or civil war; (iii) riot, commotion, disorder, strike or lockout by persons other than the Contractor's Personnel and other employees of the Contractor and Sub- contractors; 12 (iv) munitions of war, explosive materials, ionising radiation or contamination by radio-activity, except as may be attributable to the Contractor's use of such munitions, explosives, radiation or radio- activity; and (v) natural catastrophes such as earthquake, hurricane, typhoon or volcanic activity. 19.2 Notice of Force Majeure If a Party is or will be prevented from performing any of its obligations under the Contract by Force Majeure, then it shall give notice to the other Party of the event or circumstances constituting the Force Majeure and shall specify the obligations, the performance of which is or will be prevented. The notice shall be given within 14 days after the Party became aware, (or should have become aware), of the relevant event or circumstance constituting Force Majeure. The Party shall having given notice, be excused performance of such obligations for so long as such Force Majeure prevents it from performing them. Notwithstanding any other provision of this Clause, Force Majeure shall not apply to obligations of either Party to make payments to the other Party under the Contract. 19.3 Duty to Minimise Delay Each Party shall at all times use all reasonable endeavours to minimise any delay in the performance of the Contract as a result of Force Majeure. A Party shall give notice to the other Party when it ceases to be affected by the Force Majeure. 19.4 Consequences of Force Majeure If the Contractor is prevented from performing any of his obligations under the Contract by Force Majeure of which notice has been given under Sub-Clause 19.2 [Notice of Force Majeure] and suffers delay and/or incurs Cost by reason of such Force Majeure, the Contractor shall be entitled subject to Sub-Clause 20.1 [Contractor's Claims] to: (a) an extension of time for any such delay, if completion is or will be delayed, under Sub-Clause 8.4 [Extension of Time for Completion]; and 15 4.3 Mitigation The requirement above is that the event could not have been provided against or reasonably avoided or overcome. There is also a duty in Clause 19.3 to use all reasonable endeavours to minimise any delay. 4.4 Exclusions The definition above excludes events substantially attributable to the party. Other examples of common exclusions are: negligence; malfeasance; fault; and failure to exercise due diligence. There is also an exclusion in Clause 19.5 for situations where a subcontractor may have a greater entitlement to relief. 4.5 Impact The requirement above is that performance be prevented. Other examples of common impacts include that performance be hindered or delayed, to some or any degree. 4.6 Qualification by degree Each of the above aspects is liable to be qualified by reference to some degree, for example including: reasonableness; materiality; and substantiality. 4.7 Examples The specific examples of events included above are typical, namely: war; rebellion; riot; radio-activity and natural disasters. 4.8 Notice Notice is a typical requirement and strict compliance with any notice requirement may be a condition of any entitlement to relief. 4.9 Operation The regime above operates in Clause 19.3 to excuse performance, except an obligation to pay, for so long as the event prevents performance. 4.10 Termination Clause 19.6 above provides either party with a termination option if substantially all the work is prevented for a sufficiently long continuous or aggregated period. It also sets forth a formula to calculate the final financial reconciliation of the contract if it is so terminated, consistently with the usual contractual or statutory entitlement on frustration. 16 4.11 Frustration Clause 19.7 above confirms that the force majeure termination payment entitlement will also apply if the contract becomes impossible or unlawful to perform or is otherwise frustrated under the law of the contract. 5. Conclusion And so we can see that the capacity of a contract to accommodate the unexpected is the product of a range of factors, including particularly: the type and nature of the transaction; the parties' familiarity and experience with such transactions; and the expertise and effort brought to bear by the parties' advisers in negotiating and drafting the contract. By thoroughly apprehending, assessing and allocating risks in the first place, reliance on a force majeure regime to guard against frustration, will be reduced. A thoroughly drafted force majeure regime will then better respond to the inevitable residual risk of those events which can never reasonably be anticipated, without relieving a party from a risk properly allocated to it.