As we previously discussed in our article on Force Majeure, the COVID-19 pandemic (“Pandemic”) is disrupting economies across the world and having deleterious effects on contractual relationships across industries. Many contracting parties are currently and will continue to be unable to perform their contractual obligations as a result of the Pandemic. In these instances, the issues of (i) liability for the non-performance of contractual obligations, and (ii) the ultimate validity of such contracts come into question.

COURTS DO NOT IMPLY FORCE MAJEURE INTO CONTRACTS

Where contracting parties have included a well-drafted force majeure (“FM”) clause in their contract, that FM provision will govern the relationship between the contracting parties. FM as a legal principle only exists in the law of contracts. Where contracting parties have not expresslyincluded a FM provision in their contract, the courts in Canada (other than Quebec) are generally unwilling to imply a FM clause into a contract. In such instances, parties must rely on the common law doctrine of frustration of contract. Typically, a contract with a FM provision will preclude the application of the doctrine of frustration.

WHAT IS THE DOCTRINE OF FRUSTRATION OF CONTRACT?

According to the Supreme Court of Canada in the leading case of Naylor Group Inc. v. Ellis-Don Construction Ltd.¹Naylor Group Inc. v. Ellis-Don Construction Ltd., 2001 SCC 58 (CanLII) [Naylor]., frustration of contract occurs “when a situation has arisen for which the parties made no provision in the contract and performance of the contract becomes “a thing radically different from that which was undertaken by the contract””.²Naylor at para 53.

The courts usually set a high threshold for finding frustration of contract (higher than for establishing FM), and the onus of establishing the necessary elements for frustration of contract must be proved in court by the party claiming that the contract has been frustrated.³Gerstel v. Kelman, 2015 ONSC 978 [Gerstel]. The three constituent elements for frustration of contract are:

1. No express contractual provision (i.e., no FM clause in the contract).

2. A supervening event that occurs without the fault of either party.⁴Naylor at para 55.
   • The supervening event must not have been either foreseeable and/or contemplated by the parties at the time of contracting, and must not have been deliberately chosen to not be provided for in the contract by the parties.⁵Capital Quality Homes Ltd. v. Colwyn Construction Ltd., 1975 CanLII 726 (ON CA) at p 626 [Capital]; Gerstel.

3. The supervening event must cause a “radical difference” or “radical change” in the performance of the party’s obligation under the contract.⁶Naylor at para 55.

• This “radical change” would be something that makes performance of the party’s contractual obligations under the current circumstances impossible, frustrated, or impractical.
• The “radical change” can be described as a situation “which renders the performance of the contract substantively different than the parties had bargained for”.⁷Bang v. Sebastian, 2018 ONSC 6226, aff’d Bang v. Sebastian, 2019 ONCA 501.

WOULD THE PANDEMIC BE CONSIDERED A “RADICAL CHANGE” IN THE PERFORMANCE OF CONTRACTUAL OBLIGATIONS?

The “radical change” criteria is the most important element in establishing frustration of contract: the “radical change” must make performance of the original contractual obligations impossible or incapable of being performed, or change the very foundation of the agreement.⁸Capital at para 29.

In considering whether there has been a “radical change”, a court will:

• interpret the contract’s terms in light of the nature of the contract and the relevant surrounding circumstances; and
• inquire whether those terms are wide enough to meet the new situation.⁹Troika Land Development Corp. v. West Jasper Properties Inc., 2009 ABQB 590 at para 31.

There is very little jurisprudence with respect to whether a public health outbreak, pandemic, or medical emergency would be considered a “radical change” by the courts such that contractual obligations are rendered impossible to perform.¹⁰We are aware of one SARs-related case in Hong Kong, Li Ching Wing v. Xuan Yi Xiong, [2004] 1 HKLRD 754. However, and especially with regard to the drastic and potentially catastrophic impact the Pandemic is having on contracts everywhere, we expect to see further judicial consideration of this legal doctrine when courts are re-opened and operating at full capacity.

Nonetheless, it remains to be seen whether the Pandemic would be considered by the courts sufficient to frustrate certain contracts. Even situations such as dramatic price changes due to changing markets, and market downturns/recessions, have previously been considered by the courts to be foreseeable and therefore not a suitable basis for a frustration claim in past cases.¹¹Paterson Veterinary Professional Corporation v. Stilton Corp. Ltd., 2019 ONCA 746 at para 18

Businesses that are mandated to close during the Pandemic by virtue of a government order or ban will likely have a stronger legal argument for frustration of contract.

Ultimately, the determination of whether there is frustration of contract remains a fact-specific exercise that will vary on a case-by-case basis, and we encourage anyone with questions regarding the performance of their contractual obligations or the validity of their contracts to contact an experienced commercial lawyer for assistance.

WHAT REMEDIES ARE AVAILABLE IF A CONTRACT IS FRUSTRATED?

If a contract is deemed to be frustrated by the courts, all contractual parties’ obligations under the contract are discharged (and non-performance of such obligations is excused), effective as of the occurrence of the supervening event.

Contracting parties must also be mindful that the doctrine of mitigation still applies in the case of frustration of contract: contractual parties have a duty to mitigate their losses or damages where possible.

CARSCALLEN LLP’S CORPORATE AND COMMERCIAL TRANSACTIONS EXPERTISE

We understand that the rapid emergence of COVID-19 means that many businesses are dealing with a myriad of legal issues. Please contact us if you have any legal questions about your contractual obligations in connection with COVID-19, or any other business or contract law matters. Our lawyers routinely work remotely and will continue to do so during this time. We remain available to provide legal advice and guidance to clients for all issues that may arise during the Outbreak

For more updates related to COVID-19, please visit our resources page and follow us on LinkedIn.

As this is an ongoing situation of a global nature, the information provided herein is current as of the publishing date of this blog.

• 1
  Naylor Group Inc. v. Ellis-Don Construction Ltd., 2001 SCC 58 (CanLII) [Naylor].
• 2
  Naylor at para 53.
• 3
  Gerstel v. Kelman, 2015 ONSC 978 [Gerstel].
• 4
  Naylor at para 55.
• 5
  Capital Quality Homes Ltd. v. Colwyn Construction Ltd., 1975 CanLII 726 (ON CA) at p 626 [Capital]; Gerstel.
• 6
  Naylor at para 55.
• 7
  Bang v. Sebastian, 2018 ONSC 6226, aff’d Bang v. Sebastian, 2019 ONCA 501.
• 8
  Capital at para 29.
• 9
  Troika Land Development Corp. v. West Jasper Properties Inc., 2009 ABQB 590 at para 31.
• 10
  We are aware of one SARs-related case in Hong Kong, Li Ching Wing v. Xuan Yi Xiong, [2004] 1 HKLRD 754.
• 11
  Paterson Veterinary Professional Corporation v. Stilton Corp. Ltd., 2019 ONCA 746 at para 18