The outbreak of COVID-19—and associated practices of physical distancing and self-isolation—have changed many aspects of business and commerce in Ontario. Indeed, if these events make it impossible for business operations to continue uninterrupted, they may strike at these operations' very legal foundations by altering or, in the extreme case, cancelling the contractual arrangements upon which they rest. They may do so if they fit within what are known as "force majeure" provisions of a contract or if they "frustrate" the contract.

Accordingly, to help your business navigate the COVID-19, this blog post provides a general overview of the law relating to:

  • The interpretation of force majeure provisions in contracts; and
  • The common law doctrine of frustration in contract law.

Force Majeure

Introduction

Parties include force majeure provisions in their contracts to define a list of events or circumstances where the occurrence of which either relieves one party, or both parties, of all or part of their obligations under the contract or permits a party to delay performance of its obligations.

Their purpose is to allocate risk. If, according to the text of the clause, one party is relieved from having to perform a contractual obligation upon the occurrence of a specified event, the risk of that event preventing or delaying performance is allocated to the other party. If both parties are relieved of an obligation by a force majeure event, neither party has assumed the risk of the event occurring.

Whether a given event falls within a contract's force majeure provisions depends essentially on how the contract is best interpreted. In other words, force majeure events are not implied into contracts by the common law. They must be explicitly provided for in a contract and determining how they operate is a matter of contractual interpretation. Thus, if a contract contains no force majeure provisions, the only way for some event to relieve a party's contractual obligations is if the event frustrates the contract based on the distinct principle of contractual frustration at common law.

The Alberta Court of Appeal has suggested that the requisite contractual interpretation exercise should address three questions:

  • How broad is the definition of the triggering events?
  • What impact must those events have on the party who invokes the clause?
  • What effect does invocation have on the party's contractual obligation?

Further, the clause's purpose and context should be considered:

In my view, one is driven by the clause to inquire about a reasonable allocation of risk between the parties about the various events that might occur. That inquiry should be case and industry specific. The inquiry, as a result, would assess risk in terms of what, in commercial terms, were the mutual and reasonable expectations of the parties about risks that may arise.

It is important when interpreting a force majeure clause to avoid reallocating the contractual risks that the parties voluntarily assumed, as indicated by the terms of the clause.

Exhaustive Force Majeure Provisions

Some force majeure provisions are exhaustive. Their text enumerates a list of events that trigger the provision and, when properly interpreted, makes clear that the list is closed. Only listed events trigger the provisions and other events are excluded.

The interpretation of exhaustive force majeure provisions should still determine how broad the definitions of the listed events are and what range of circumstances they capture. It should also determine what effect on a contractual party the listed events must have in order for the event to relieve the party of its contractual obligations. It should bear in mind the commercial context and the need to avoid reallocating the contractual risks that the parties voluntarily assumed.

Non-Exhaustive Force Majeure Provisions

Some force majeure provisions are non-exhaustive. Their text may enumerate a list of defined events that trigger the provisions, but it also makes clear that if a given event not listed satisfies some condition, it too will trigger the provision. For example, the text may stipulate that the provision is triggered by a number of listed events, as well as any event that is "beyond the reasonable control of the parties."

The open texture of a non-exhaustive force majeure provision permits the use of general principles to interpret whether a given event triggers the provision. The Supreme Court of Canada has provided guidance, stating as follows:

[A force majeure clause] generally operates to discharge a contracting party when a supervening, sometimes supernatural, event, beyond control of either party, makes performance impossible. The common thread is that of the unexpected, something beyond reasonable human foresight and skill.

The question then is whether the candidate event that makes performance impossible is: (i) unforeseeable and (ii) uncontrollable. Again, it is important when analyzing this question to bear in mind the commercial context and risk allocation arrangements of the parties.

The British Columbia Supreme Court has held that force majeure provisions are not triggered in circumstances that simply affect the profitability of a contract or the ease with which a party's obligations can be performed.

Consequences of a Force Majeure Provision being Triggered

If a force majeure provision is triggered by an event or circumstance beyond the parties' control, the consequences are dictated by the relevant contract itself. Typically, contracts set out the following requirements for a party who invokes a force majeure provision:

  • The party must give notice that the triggering event has occurred as of a certain date, failing which the party may forfeit its ability to rely on force majeure.
  • The party must mitigate or otherwise attempt in good faith to remedy the effects of the triggering event on its contractual obligations.

Frustration

Introduction

Frustration of a contract has the effect of discharging each party's obligations where an unforeseen event for which no provision is made in the contract occurs without the fault of either party. The purpose of the doctrine of frustration is to recognize that where it is not reasonable to place the risk of a particular event on either party to a contract, that contract and the responsibilities thereunder should be discharged.

The fundamental requirement is that the unforeseen event must bring about such a change in the parties' obligations that to compel performance despite the new circumstances would be to order the parties to do something radically different from what they initially agreed to do. Determining whether a contract is frustrated does not involve asking whether a court should imply a term into the contract according to which the parties intended to treat the contract as discharged upon the occurrence of the unforeseen event. It involves interpreting the contract to ascertain whether new circumstances render the parties' contractual obligations radically different.

The Alberta Court of Queen's Bench has suggested that to undertake this interpretive exercise a court should:

  • Interpret the terms in light of the nature of the contract and relevant surrounding circumstances; and
  • Inquire whether those terms are wide enough to meet the new circumstances.

The Saskatchewan Court of Queen's Bench has suggested that the court should consider:

  • The facts existent at the time the contract was entered into;
  • The objectives the parties sought to achieve by way of the contract; and
  • The general commercial background against which the contract was negotiated.

Frustration may occur where the event makes the parties' contractual obligations physically or legally impossible to perform. A change in law can constitute an unforeseen event that radically changes the party's contractual obligations. For example, the Ontario Court of Appeal has held that a change in land use legislation after an agreement of purchase and sale of property was concluded but before closing frustrated the agreement by making compliance with the new legislation in time for closing impossible.

The Relationship between Frustration and Force Majeure

In some cases, a party may argue that a contract is discharged because it is frustrated by an unforeseen event even though the contract contains a force majeure provision. For example, the party may make this argument because the unforeseen event is not captured by these contractual provisions.

In these circumstances, a question arises as to whether a court will entertain the frustration argument or decline to consider it on the basis that the relevant force majeure provision explicitly sets out all the conditions under which a party would be relieved of its contractual obligations. The question poses the greatest difficulty where the force majeure provision at issue is exhaustive. If the provision is non-exhaustive, it is less likely that the unforeseen event on the basis of which frustration is advanced would not be captured by the provision.

For a frustration argument to succeed, it must be that no provision in the contract is made for the unforeseen event that makes performance of the contract impossible. This suggests that if there are provisions in the contract that delineate when a party's contractual obligations are relieved, but these provisions do not capture the unforeseen event, this will not preclude a frustration argument, since it is a condition precedent to advancing that argument in the first place that the unforeseen event is not captured in the relevant contractual provisions already.

However, GHL Fridman suggested that if a contract specifies the circumstances under which it is altered by an unforeseen event, a court will not entertain an argument based on frustration that the contract should be altered in other circumstances.

The clearest and least controversial position would appear to be that a frustration argument can be advanced in the context of a contract that contains a force majeure provision provided that the effect of discharging the contract due to frustration by the relevant unforeseen event would not contradict the language or purpose of the contract, in particular, the allocation of risks between the parties that the force majeure provision represents.

The Consequences of Frustration

The standard position at common law is that a frustrated contract is fully discharged and both parties are no longer obligated to perform any obligations under it. But in Ontario the consequences of frustration should be dictated by the Frustrated Contracts Act (the "Act") rather than the common law.

Section 2(1) of the Act provides: "This Act applies to any contract that is governed by the law of Ontario and that has become impossible of performance or been otherwise frustrated and to the parties which for that reason have been discharged." Pursuant to s 2(2), the Act does not apply to a charterparty or contract for carriage of goods by sea, an insurance contract, or a contract for the sale of goods that, without knowledge or fault of the seller, perished at the time the contract was made.

Sections 3(1)-(4) of the Act provide that the parties to a frustrated contract may apply to the court to receive restitution of any money paid under the contract before it was discharged, any expenses incurred in connection to performance of their contractual obligations, and any non-monetary benefits conferred under the contract. Section 3(5) prevents a party from being able to recover any sum that has become payable to it by a contract of insurance by reason of the circumstances giving rise to the frustration of the contract.

Section 3(6) states where a contract contains a provision that is intended to have effect in the circumstances that, but for the provision, would operate to frustrate the contract, a court must give effect to the provision and give effect to s 3 of the Act only to such extent as is consistent with the provision.

Finally, section 3(7) of the Act provides that if a part of a contract can be properly severed and able to be performed by the parties notwithstanding the frustrating circumstances, a court can treat that severable part as a separate contract that has not been frustrated.

Conclusion

One of the extraordinary features of COVID-19 and its social impact has been how difficult it was to forecast it, at least for those of us ordinary citizens who are not public health experts. Think about how you spent your New Year's Eve; did you think that by St. Patrick's Day no pubs would be open to the public because of the need to observe physical distancing initiatives?

A main point of making legal arrangements by means of a contractual agreement in the commercial context is to figure out whether you or the other party is going to take the risk of some unforeseen event like COVID-19 happening and interrupting your commercial relations. You might include in your contract a term that says that the other party will take that risk. Or you might accept the risk in exchange for a different term that is favourable to you.

Now that the COVID-19 emergency has taken place, its effect on contracts is determined by looking back at those contracts and checking whether any arrangements were made for events like this pandemic. Did any party take the risk that it would happen and interrupt their business? If not, then is it fair for the risk to fall on one party rather than the other by holding them to their obligations in radically changed circumstances? If not, then should the parties be relieved of their contractual arrangements altogether?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.