The Coronavirus Pandemic and Frustration of ContractsNaylor Group Inc. v. Ellis-Don Construction Ltd., 2001 SCC 58,  2 SCR 943
It is early days yet in the spread of the 2020 coronavirus pandemic. It has already had a devastating impact on the economy. The current focus is on staying healthy and surviving bodily. Eventually the germs will settle, and the focus of the survivors will shift to the allocation of the immense financial losses. Lawsuits will inevitably occur.
The economy is built on contracts, written and oral, whether to buy goods and services or to pay rent or wages or interest. In an economic downturn where demand collapses, the risk of adverse impact is borne by those who are on the "buy side" of the contract, who have promised to pay.
Those on the buy side may be bankrupted or impoverished if they are required to pay up to fulfill their contracts. They no longer have a need for the things they agreed to buy, because their own income or sales have collapsed. They no longer have the revenue coming in that they depended on.
Force majeure versus frustration
More sophisticated parties sometimes write contracts with “force majeure” clauses that excuse performance in the event of specified extreme events. Most commonly, these are natural disasters or wars. That provides solid protection for a supplier that is unable to supply what it agreed to because of such an intervening disaster.
In some instances, contracting parties have attempted to put in force majeure terms for weak demand. It is hard to define these in a way that will be enforceable. In one of the leading cases on this subject, a paper company wanted to cancel a contract to buy waste paper for recycling because of poor market conditions. The Supreme Court of Canada rejected that as an excuse, holding that such a condition could only be used for an event over which the contracting party exercises no control.
An alternative concept in contract law is frustration of contract. It is potentially available for every contract. Unlike a force majeure clause, it operates by virtue of the common law and does not need to be explicitly included in the contract.
When can frustration be cited to avoid paying damages?
Historically, the condition for finding a frustration of contract has represented a high threshold, requiring not just hardship but something close to impossibility. The leading early Canadian decision on this emphasized such factors:
Frustration occurs whenever the law recognizes 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.
Such a standard would be difficult indeed to meet, and the mere hardship of business losses due to the coronavirus would be unlikely to meet that standard.
Frustration when government regulation bans an activity
Even under this high standard, some types of contracts could be seen as frustrated. One type of event that could account for it was a government regulation or embargo that prevented the contract from being carried out, such as where the government prohibited the export of a particular mineral.
That is relevant to the businesses whose operations have been forced to shut by government regulation due to the pandemic, such as under Ontario’s Emergency Management and Civil Protection Act. For example, a restaurant tenant who is unable to pay rent to its landlord may argue that the contract has been frustrated by a government regulation that makes it impossible for it to make use of the leased premises.
The issue is also important for the many employers who have laid off their employees. At common law, a layoff may be considered a breach of contract or even a constructive dismissal, and give rise to a claim for damages by the employees.
The Alberta Court of Appeal has endorsed the principle that this type of event creates the frustration of a contract:
Supervening illegality occurs when, after the making of a contract, a change in the law renders it illegal to perform the contract in accordance with its terms. The change in the law, to qualify as a frustrating event, must be one which was not foreseen by the parties and for which no express or implied provision is made in the contract. In addition, the illegality must not be temporary or trifling in nature when viewed in the context of the contract as a whole. If these conditions are met, the contract is automatically discharged by frustration the moment performance in accordance with its terms becomes illegal.
In the current pandemic, there are some businesses that have been shut down by government order. They should have an easier time in arguing that contracts have been frustrated. There are others that are in principle allowed to open, but they may be unable to. For example, their workers may sicken, or even if they are not sick they may refuse to report for work because of fears of contamination. There are many possible permutations, and the outcome will depend on the facts of each case. The duration and eventual extent of the pandemic are also likely to be considerations in deciding whether or not it frustrated a contract.
An event cannot frustrate a contract if it was foreseeable or contemplated
Foreseeability is also a factor in the question of frustration. The Supreme Court of Canada raised this issue in a case in which Ellis-Don Construction Ltd. sought to get out of a contract. Its excuse was that a Labour Board decision now required it to employ workers that belonged to a different union than the one provided for in the contract. The court ruled that this was not a pure “supervening event in the sense required by either approach to the doctrine of frustration and in fact the OLRB ruling against the appellant was a foreseeable outcome.” It was within the knowledge of Ellis-Don that such a decision by the OLRB was a possibility.
More recently, the Saskatchewan Court of Appeal has taken a broader view, finding frustration when there was a crop failure due to bad weather. It rejected the plaintiff’s argument:
[The Plaintiff submits that] the doctrine of frustration should engage only when the event preventing performance under a contract was not foreseeable. It says excessive rainfall is foreseeable in Saskatchewan and hence wet field conditions cannot frustrate a production contract.
I am not persuaded by this argument. There is a long and time-tested line of authority applying the doctrine of frustration to situations where crop failures have been caused by weather and other natural events.
The Saskatchewan court's decision was on solid ground with respect to precedent. It cited earlier cases, dealing with weather related crop failures, from England, Manitoba and Ontario, that all found that contracts had been frustrated in similar circumstances. However, even within this context, the particular facts matter. It is extreme weather events that radically alter the nature of the contract that give rise to frustration. If the contract contemplated a particular type of weather event and made provision for it, then its occurrence does not frustrate the contract (JGL Commodities Ltd. v Puddell Farms Ltd., 2018 SKQB 345).
The Ontario Court of Appeal has also emphasized the issue of whether the event was something that could be contemplated: “the law of frustration requires that there be a radical change in the nature of the parties’ contractual obligations, arising from a situation which the parties had not contemplated in the formation of the contract.” In that case, a non-competition agreement for a physician was found to have been frustrated by an unforeseen event, namely the dissolution of the relationship between two companies that had jointly operated the clinics where she worked.
It is noteworthy that, on the facts, there was nothing that made it impossible for the Defendant to comply with the Plaintiff's demand, as he was offering her employment in a new clinic. However, requiring her to do so would have broken the relationship with her established patients. The lower court's reasons in ACT Greenwood are worth reading as a good example of modern contractual interpretation, and specifically on how to infer what types of events were outside the contemplation of the contracting parties.
It will always be a question of fact (and a matter of opinion) whether something is so unforeseeable that it was not contemplated and therefore constitutes a supervening event that frustrates a contract.
The pandemic might possibly fit within the definition of an event that frustrates contracts
It is well accepted that a mere business downturn such as a recession would not be an event that frustrates a contract. The precise timing of recessions caused by economic cycles is difficult to predict, but there are always economists who are willing to predict that one will occur in the foreseeable future. They occur with some regularity, and in that sense it is foreseeable that a recession can occur.
One could draw a distinction between an economic downturn that might normally be contemplated, and a national emergency that creates an economic catastrophe.
The pandemic that is now raging across the world is an event of a type that has not been seen in at least a century. It is a “Black Swan” event.” The last comparable event was the Spanish Flu epidemic of 1918. With advances in science in the past 100 years, one might have thought that the probability of such an event ever happening again was remotely low.
Therefore, it can plausibly be argued that a pandemic of the type that is currently underway was not contemplated by any parties entering into contracts in the previous years. On that ground, it may happen that, when the post-recovery lawsuits take place, courts will adopt a lenient view and decide that contracts were indeed frustrated by the pandemic.
Time will tell. There is unlikely to be a blanket position outcome that applies to all, as the facts of each case will be different. Those defendants who can show that the pandemic made it effectively impossible for them to carry on their business are more likely to succeed. Until there are some post-pandemic decisions in this area, many people will wait anxiously for the outcome.
Peter Spiro is Counsel to Monkhouse Law P.C., www.monkhouselaw.com, and Principal of Spiro Law P.C., www.peterspiro.com. This article is intended as general information and not legal advice for the situation of any particular reader.