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In this article, Aisyah Muhammad discusses whether a party to a contract can rely on the doctrine of frustration in the event of the non-performance of its contractual obligations during the Covid-19 pandemic.

Introduction

The emergence of the highly contagious Covid-19 virus has without a doubt caused major disruptions across various industries including transportation, retail, tourism and oil and gas. The unprecedented movement control order (“MCO”) imposed in Malaysia has effectively caused the closure of all government and private premises except those involved in providing essential services. As a result, many business owners are struggling to keep their businesses afloat and are unable to perform their contractual obligations.

One of the common questions being asked during this pandemic is whether a party can be excused for the non-performance of its contractual obligations. To address this issue, we will have to look at the particular terms of the contract itself and the particular facts and circumstances surrounding the non-performance.

The parties to a contract may have specifically agreed on the appropriate measures to be taken when unexpected events like Covid-19 take place. Such provision is known as force majeure. Force majeure is not a statutory concept, it is generally negotiated and agreed by the parties prior to entering into a contract. As such, in the absence of a force majeure clause, the courts would not imply one into the contract.

The question then arises — how can a party be protected during a pandemic when no provision has been made in the contract to allocate the risk between the parties; or when a force majeure clause does not sufficiently provide for the same?

In the absence of any relief in the form of termination rights or force majeure provisions, a party to a contract may be able to rely on the doctrine of frustration. A contract becomes frustrated when an event occurs which has rendered it impossible or unlawful to perform the contractual obligations. The doctrine of frustration can be found in section 57(2) of the Contracts Act 1950 (“CA 1950”):

A contract to do an act which, after the contract is made, becomes impossible, or by reason of some event which the promisor could not prevent, unlawful, becomes void when the act becomes impossible or unlawful

The Court of Appeal in Guan Aik Moh (KL) Sdn Bhd v Selangor Properties Bhd¹ laid down three essential elements to be satisfied to give rise to frustration:

• the event must be one for which no provision has been made in the contract;
• the event must be one for which the promisor is not responsible; and
• the event renders it radically different from that which was undertaken by the contract. The Court must find it practically unjust to enforce the original promise or contractual obligation.
  
  

Can a contract be frustrated because of Covid-19 or the MCO?

Following the test laid in Guan Aik Moh, the first limb to satisfy is that there are no termination rights or force majeure clauses for a “pandemic”, “epidemic”, “government order” or any other similar events in the contract. The second limb is easily met as no party is responsible for the Covid-19 pandemic and/or the MCO. Lastly, the party seeking relief would have to prove that the Covid-19 pandemic and/or the MCO is radically different from what was undertaken by the contract and that it would be unjust to enforce the original promise or contractual obligation. This third limb is the hardest limb to satisfy and it generally depends on the circumstances of each case as described below.

1. A contract is not deemed frustrated merely because it is inconvenient or difficult to perform.

The Federal Court in Pacific Forests Industries Sdn Bhd v Lin Wen Chih² held that:

[22] A contract does not become frustrated merely because it becomes difficult to perform. If a party has no money to pay his debt, it cannot be considered impossible to perform as it is not frustration. Neither can he plead frustration because the terms of the contract make it difficult to interpret. If it cannot be performed or becomes unlawful to perform, then the party who is to perform his part of the bargain can plead frustration. The doctrine of frustration is only a special case to discharge a contract by an impossibility of performance after the contract was entered into. A contract is frustrated when subsequent to its formation, a change of circumstances renders the contract legally or physically impossible to be performed.

This illustrates that a party cannot suspend its contractual obligations just because the party’s obligation has become more onerous due to a change of circumstances.

2. A contract may become frustrated due to a government order or sanction.

In Yew Siew Hoo v Nikmat Naju Development Sdn Bhd³, the parties entered into an agreement for the construction of a central waste treatment plant to treat the waste water from a pig farm. Unfortunately, there was an outbreak of the Japanese Encephalitis disease subsequent to the execution of the agreement. This led to the State Government of Negeri Sembilan banning the rearing and sale of pigs in the affected area. It was held that this constitutes a frustrating event to discharge both parties from the agreement.

3. A contract is not frustrated if the frustrating event was only for a short duration.

In the Hong Kong case of Li Ching Wing v Xuan Yi Xiong⁴, a tenant claimed that his tenancy agreement was frustrated due to the isolation order imposed by the Government following the outbreak of the Severe Acute Respiratory Syndrome (“SARS”). On the facts, the 10-day isolation order, of which the defendant was not allowed to stay in the premises, was quite an insignificant period in terms of the overall use of the premises for a term of two years. The Hong Kong Court concluded that whilst the outbreak of SARS was an unforeseeable and supervening event, it did not significantly change the nature of the outstanding contractual rights or the obligations from what the parties could reasonably have contemplated at the time of the execution of the tenancy agreement. Further, in a contract of sale and delivery of goods or services whereby the parties have agreed that time is of the essence, the imposition of the MCO would render it impossible to deliver goods or services within the stipulated period in the contract. In this situation, it is possible to argue that the MCO constitutes a frustrating event. As a result, both parties may be discharged from the performance of the contract.

It should be noted that the frustrating event cannot be an event that was within the contemplation of the parties or an event which is reasonably foreseeable at the time the contract was entered into. Therefore, if parties were to enter into a contract now and the pandemic is within the contemplation of the parties, such an event cannot be considered as a frustrating event.

As illustrated by the cases above, whether the Court considers a contract frustrated depends on how the terms of the contract are interpreted and the circumstances of each case. The party seeking relief must prove that it is not able to perform its contractual obligations due to the Covid-19 pandemic and/or the MCO and that such event renders the contract legally or physically impossible to be performed.

What happens when a contract is frustrated?

By virtue of section 57(2) of CA 1950, if frustration is proved, the contract becomes void. Consequently, both parties would be discharged from further performance of the contract. When the contract is deemed frustrated, section 15(2) of the Civil Law Act 1956 (“CLA 1956”) provides the following remedies:

• All sums paid before the parties were discharged of its contractual obligations shall be returned whereas any sums payable will cease to be payable.

• If the party to whom the sums were paid or payable has incurred expenses before the parties were discharged of its contractual obligations, the Court may, if it considers just, allow that party to retain or recover the whole or any of the sums so paid or payable, provided that the sum does not exceed the expenses incurred.

Nonetheless, section 15(2) of CLA 1956 is not applicable to contracts for the carriage of goods by sea, insurance contracts and contracts for the sale of perishable goods.

Conclusion

Given that the outbreak is unprecedented and that there is no reported case law, it is recommended that parties commence negotiations to seek mutually and commercially viable solutions prior to seeking legal recourse. Failing which, we can expect that there will be more commercial disputes arising from the non-performance of contractual obligations in the near future. Ultimately, the question of whether Covid-19 and the MCO can be considered as grounds for frustration of contract depend on the facts and circumstances of each case, the terms of the contract and the determination by the Court.

1 [2007] 3 CLJ 695.

2 [2009] 6 MLJ 293.

3 [2014] 1 LNS 2.

4 [2004] 1 HKC 353.

 

Written By:

Aisyah Mohammad

Corporate/M&A

For further information regarding corporate/M&A matters, please contact our Corporate/M&A Practice Group.

 

 

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