UK: Contract Frustration – Seeing Into The Future?

Last Updated: 15 December 2016
Article by Nadine Wilkinson

What is "frustration"? Contractual frustration is the legal termination of a contract in circumstances where an event occurs, which is so fundamental and entirely beyond the contemplation of the parties at the time of contracting and which renders performance impossible, illegal or which makes the obligations of the parties radically different. If a contract is deemed to have been frustrated, it is automatically discharged and the parties are released from their future obligations.

There is a high threshold to reach in order to claim frustration. One of the most important criteria and one which is often overlooked, is the need for the frustrating event to be one that is beyond what the parties contemplated at the time of contracting. Therefore, if you appreciate the likelihood of an event occurring, even if such a likelihood is very slim, it is unlikely that you would be successful in claiming contractual frustration.

For this reason, when negotiating commercial agreements, it is important to reach a deal which holds as much certainty as can reasonably be achieved and which as far as possible, accounts for the foreseeable. Having a well drafted and certain contract which provides a mechanism for the parties to work with in the event that something goes wrong will help to avoid disputes.

The recent case of Armchair Answercall Limited v People in Mind Limited [2016] EWCA Civ 1039 is an example of parties to an agreement appreciating the likelihood of issues arising, but not setting out in their agreement how these should be dealt with.

In this case Kendlebell Ltd (Kendlebell) ran a franchise business which offered telephone answering services. It had 10 franchises which were based in the UK and Ireland. Each franchise recruited its own customers and provided them with premises, equipment and call handlers, which it then invoiced them for.

As the franchisor, Kendlebell provided its franchisees the necessary know-how, hardware and software, operational manual, training, brand name and other services in return for commission which was based on the turnover of the franchise. The business model was ineffective as it only allowed for the realisation of few economies of scale amongst the franchisees.

Kendlebell therefore, entered a "Services Agreement" with Armchair Answercall (AA) under which AA would take over the management of Kendlebell's business and operate it under a "New Method" which was to improve productivity. Under this New Method, AA was to take over and centralise the call centres which would effectively make the franchisees sales branches for the centralised call centre. AA would then invoice the customers directly and the franchisees would receive 25% of payments. The Services Agreement appreciated the likelihood of franchisees and existing customers raising issues with this New Method, but contained no provision dealing with this.

AA entered a separate agreement which was to last a year with Stephen Beasley who was the ex-managing director of Kendlebell (Contractor Agreement), for assistance with the transition of Kendlebell's business to the New Method. Mr. Beasley operated the agreement through People In Mind Ltd (PIM).

AA began negotiations with the franchisees outlining the changes to Kendlebell's business method. The franchisees rejected the New Method because of their loss of the call handling function and control over invoicing. In an email dated 5 October 2011, the franchisees asserted that the agreements were null and void because they prohibited the franchisees from having independent websites and further that the Services Agreement amounted to a repudiatory breach of the franchise agreements.

An impasse was reached between Kendlebell and the franchisees which was resolved by deeds of termination and releases executed between December 2011 and January 2012.

On the 17 December 2011 AA served a notice of termination to PIM in respect of the Contractor Agreement. In further correspondence between AA and PIM, AA alleged that the Contractor Agreement had become frustrated because the franchisees had left Kendlebell which meant that PIM's assistance was no longer required to transition the franchisees to the New Method. PIM did not accept that the contract had been frustrated and brought proceedings against AA for the balance of the contract up to the expiry date. The Court of Appeal held that the contract had not been frustrated. In reaching its decision the Court of Appeal considered amongst other factors, the foreseeability of the event occurring and the conduct of AA in terms of the time it took to treat the contract as having been frustrated.

As mentioned above, for frustration to occur an event must take place which could not have been reasonably contemplated at the time of the execution of the contract, is without default of either party, and significantly changes the rights and obligations of the parties. The rejection by the franchisees of the New Method, was not a supervening outside event that the parties could not have reasonably foreseen as being a real possibility. After all, the New Method had features which would have been undesirable to the franchisees and there was no means of compelling the franchisees to accept the New Method.

Whilst foreseeability does not immediately alter the position of whether a contract is frustrated or not, it is an indication as to whether an event is truly qualifies as frustration.

The lesson to be learnt here, is that if you foresee the possibility of an event occurring, you should not ignore it, instead you should assess any potential impact on your commercial arrangement and reduce your risks by having appropriate contractual provisions.

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.

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