Options for businesses when temporary COVID-19 restrictions make it illegal to perform a contract

Introduction

Recent public health orders and government directions introduced to limit the spread of COVID-19 (coronavirus) in Australia may make the performance of some contractual obligations illegal, at least temporarily. This article considers circumstances in which these changes in law may either result in the temporary suspension of a party’s obligations under a contract (due to illegality), or have the effect of discharging the contract for frustration.

We have previously written about the effect of the COVID-19 pandemic on contractual arrangements, with a particular focus on force majeure clauses. Since then, State and Territory governments have introduced restrictions on the public to enforce lockdowns using public health orders such as those now in force in Victoria and New South Wales. We discuss below how these changes in the law may affect your business’s contractual obligations, irrespective of whether the contracts contain a force majeure clause.

Key takeaways

• These are unprecedented times in which sweeping new laws are being made on an almost daily basis. These laws are not necessarily consistent between States and Territories.
• Before continuing to perform any existing contracts, or entering into any new ones, consider whether performance of your obligations could lead you or your employees to breach the law and expose the company, its employees and agents to penalties.
• If it is illegal to perform your obligations, it may be that those obligations are suspended for the period of the illegality, even if the contract does not contain a force majeure clause. There is also the possibility that the illegality may frustrate the contract.
• Parties entering into new contracts should consider implementing mechanisms to reduce the risk that further changes in law may make it illegal to perform those contracts during the COVID-19 pandemic.

Factors to consider if it becomes illegal to perform a contract

How contracting parties might handle a sudden change in law that makes it illegal to perform some or all of the contract will depend on several factors, including:

• What specific obligations are now illegal to perform, and why? Can any of those obligations still be legally performed in any other way in accordance with the contract?
• How long will the illegality continue? Is it possible or commercially viable to wait until that period has passed?
• Does the contract provide for circumstances like this? Is there a force majeure clause which might temporarily excuse the affected party from its obligations?
• Will the contract still provide some benefit to the parties, or none at all, if the illegal obligations are not performed?

These questions are relevant when considering whether performance of an obligation that is now illegal has been suspended for the period in which the laws responding to the COVID-19 pandemic are in force, or whether the change in law has frustrated the contract altogether.

Temporary suspension of performance due to supervening illegality

If the contract contemplates the occurrence of a change in the law (for example, as a force majeure event, or under a provision which describes the parties’ rights and obligations if there is a material adverse change) or a substantial part of the contract can still be performed, it is not likely to be frustrated. This was the case in a 2013 Queensland decision, which found that a contract for mining operation services in Indonesia was not frustrated by a change of Indonesian law, because the agreement’s express provisions sufficiently provided that such an occurrence should be dealt with by way of contract variation.¹

Similarly, a contract is also not likely to be frustrated if it would be possible under the contract to delay performance for the period the laws responding to COVID-19 are in place, and that delayed performance would not be substantially different from what the contract envisaged.

However, even if the change in law is not enough to frustrate a particular contract, your business may still be excused from performing any illegal obligations, whilst the balance of the contract remains enforceable.²  If the illegality is only temporary, the suspension of performance will cease when the illegality ends.

For example, in the United Kingdom, temporary wartime regulations which prohibited building would have offered a good defence to a claim that an obligation to build shops at that time had been breached.³ In Australia, the High Court has held that a change in legislation excused a lessee from a covenant to operate a bakery in contravention of that legislation.⁴ In neither case did the change in law result in the frustration of the relevant contract.

When might a contract be frustrated for illegality?

A change in law which makes it illegal to perform a contract may have the effect of frustrating the contract rather than merely suspending the parties’ obligations to perform.

A contract may be frustrated if an event occurs that makes it impossible to fulfil the contract, or else transforms the obligation to perform into something radically different from that which the parties had intended.⁵  Once the event occurs, frustration operates to automatically discharge the parties from further performance – no positive act is required by any party to bring the contract to an end.

A frustrating event can include a change in law occurring after a contract has been made. The question arises as to whether the issue of the recent directions under biosecurity and public health legislation constitutes such an event in respect of those jurisdictions in which the directions have been made and performance of a contract is to occur. And the answer to this question is made more difficult by the current uncertainty as to the likely duration of these directions.

A short delay in performance might not result in a radical difference, but an ongoing, indefinite delay well might. But because businesses cannot be expected to wait indefinitely to see when the public health directions will be lifted and whether their contracts could then still be performed, they are entitled to assess now whether, on the basis of reasonable commercial probabilities, their contracts have been frustrated (and not merely suspended). Any such assessment requires very careful consideration; the risk for a party wrongly claiming that a contract is frustrated is, as noted in our previous update, that the claim may constitute a repudiation of the contract, exposing that party to substantial damages.

Whether a law introduced in response to COVID-19 has frustrated a particular contract depends on its effect both on the parties’ performance of their obligations and on the circumstances in which the contract was intended to be performed. The following examples indicate how fact-dependent this assessment can be:

• A firm contracted to build a reservoir in 1914. The reservoir was to be completed within six years, though an extension of time was possible if impediments arose. In 1915, wartime regulations required the contractors to cease work indefinitely. It was held that the contract was frustrated, despite the extension clause, because the extension clause was intended to cover temporary impediments, not an interruption which fundamentally altered the contract’s character and duration.⁶
• A business contracted to construct, install and maintain neon advertising signs. After the contracts were entered into, new wartime regulations came into force which prohibited the illumination of neon signs. Despite this, the contracts were not frustrated because the signs still served a purpose (for example, for daytime advertising) even though they could no longer be illuminated at night.⁷
• A supplier contracted to supply steel bars to an Australian customer. In previous dealings with this customer, the supplier had provided bars from a German metalworks, shipped from a German or Belgian port. This contract specified that the steel bars were required to be of a quality “similar to” previous orders. Despite the outbreak of World War 1, it was held that performance of the contract was still possible because it did not explicitly require the bars to be procured or shipped from an enemy country.⁸

Consequences of frustration

As noted in our previous update, the common law position is that a frustrated contract is terminated automatically, but accrued rights and obligations are not affected. This can produce complicated and potentially unfair outcomes when some obligations have been discharged before the frustrating event, but not others.

Legislation in Victoria,⁹  New South Wales¹⁰  and other States and Territories provide schemes by which the outcomes of a frustrated contract can be adjusted between the parties, so that neither is unfairly disadvantaged or advantaged. However, it is important to review your contract before assuming this legislation applies, because it may be expressly excluded.

Conclusion

If there is a risk that your business cannot comply with its obligations under an existing contract due to public health directions or other new laws relating to COVID-19, it is important to carefully consider the contract terms and your likely position if the contract is suspended or frustrated, as no two cases will be exactly alike.

If you are in the midst of negotiating a new contract and want to ensure that it can be lawfully performed in the present circumstances, you will need look very closely at the existing legislative restrictions and think about what future restrictions may be imposed by the Commonwealth, States and Territories. One way to ensure that the parties’ obligations are structured such that performance can be rendered in a manner that is lawful is to provide expressly what the parties must do if a law is made which impacts on that performance (for example, any alternative means of performance that would be acceptable if this occurred).

In this time of unprecedented regulatory uncertainty, it is important to act with caution when performing obligations under existing contracts and putting into place new contracts. Not only could performance result in fines, imprisonment or other penalties, but there may also be reputational consequences for being seen to be in breach of public health orders or other similar laws.

Norton Rose Fulbright Australia has developed tools to help clients navigate through these issues in respect of both existing contracts and new contracts, including to assist in reaching a conclusion whether a contract has been frustrated or a force majeure clause has been triggered. These tools are available to clients upon request, so please email Jack Pembroke-Birss, Lauren Holz, Peter Mulligan or Peter Cash if you would like to receive a copy.