Last year, as the COVID-19 crisis set in, we took a look at the contract defenses of frustration of purpose and impossibility, two defenses our firm expected to see invoked in contract litigation related to COVID-19. We were not wrong, and it is interesting to see how the two defenses have played out one year later.
Frustration of Purpose
Frustration of purpose refers to situations in which performance of a contract becomes worthless to a contracting party. The classic law school example of this is a British case, Krell v. Henry, in which an individual purchased the right to use another individual’s apartment to view a parade. The parade was canceled, and the purchaser refused to pay for use of the apartment, as the purpose of using the apartment was frustrated. The court agreed and refused to uphold the contract.
The frustration of purpose defense has three required elements: (1) “the purpose that is frustrated must have been a principal purpose of that party in making the contract”; (2) “the frustration must be substantial”; and (3) “the non-occurrence of the frustrating event must have been a basic assumption on which the contract was made.”
Parties have been invoking the frustration of purpose defense and they have been seeing success with it, especially in the context of unpaid lease payments. For example, in Massachusetts, which relies on the same definition of frustration of purpose as New Jersey, there was a recent decision holding that a café was not liable for unpaid rent during the period in which the café was unable to operate due to the Commonwealth’s COVID-19 restrictions. The court noted that the lease at issue only permitted the premises to be operated for one purpose, on-site dining, and that once that purpose had been frustrated it was nonsensical to require lease payments. The court held that “it would have made no business sense for the parties to enter into a lease providing that Caffe Nero may only use the leased premises for one narrow purpose, but must keep paying rent even if the only permissible use in no longer allowed or possible.”
Similarly, a federal court in the Eastern District of Michigan also held that frustration of purpose was an adequate defense in the face of an action to collect lease payments. The business at issue in that matter, Bay City Realty, LLC v. Mattress Firm, Inc., was a mattress store. Again, state regulations essentially forced the closing of the store for a period of time. The court held that this general shutdown frustrated the purpose of the contract for that period of time and that rents for that time period were not due. However, the court also held that the contract itself was not voided by the shutdown order and that rents for the periods after the shutdown order ended were owed.
Frustration of purpose defenses have not always been successful, though. CAI Rail, Inc. v. Badger Mining Corp. a decision from the Southern District of New York this past February illustrates the shortcomings of this defense. The defendant here was a company leasing rail cars for transporting sand for hydraulic fracking. The drop in energy prices that occurred at the outset of the pandemic made the leases financially unfeasible. Too bad, held the court, “it is . . . not enough that the transaction has become less profitable for the affected party or even that the affected party will sustain a loss.” Frustration of purpose is a narrowly applicable doctrine, and the real test is whether the purpose of the contract has been totally frustrated. We expect courts to continue to take this narrow view of the doctrine’s applicability.
Impossibility—or impracticability—is essentially the inverse of frustration of purpose; instead of the purpose of the contract being made impossible, it is the actual performance of the contract that is impossible. Much like frustration of purpose, there are strict requirements that must be met to invoke this defense, namely the occurrence of a supervening event, the non-occurrence of which was a basic assumption on which both parties made the contract. Interestingly enough, the first example of impossibility or impracticability found in the Restatement involves the closing of a port due to a quarantine. Clearly the Restatement contemplates the use of the defense of impossibility where delivery of goods has been made impossible by quarantine restrictions.
Impossibility, however, does not seem to have fared as well as a defense during the past year. In the Cai Rail decision cited above the impossibility defense was rejected for essentially the same reason the frustration of purpose doctrine was rejected; mere unprofitability was not enough to render performance impossible. Similar decisions have been reached in other courts. While it is possible to imagine a fact pattern where impossibility comes into play (perhaps a banquet hall that failed to hold an event) the cases we have reviewed have not shown it to be a successful defense in the context of COVID-era litigation.
These are indeed difficult times for individuals and businesses, and we are already seeing business disagreements on the rise with regard to frustration of purpose and impossibility. If you anticipate litigation related to business dealings or are faced with contracting parties who are refusing to pay on their contracts, please contact us for a free consultation at 848.202.9323 or email us at firstname.lastname@example.org. Please note that any legal question requires consideration of individual facts and this article is not intended as legal advice to any particular individual or business and should not be relied upon as such.