COVID-19: Impact on Contractual obligations – Force Majeure and Frustration

COVID-19 and the Movement Control Order (MCO)

Further to the announcement by the Prime Minister of Malaysia on 25th March 2020 that the Movement Control Order (“MCO”) which came into effect on 18th March 2020 will be extended to 14th April 2020 (“MCO Period”), with the exception of those businesses and premises which relate to ‘Essential Services’ (which include banking and finance, electricity, water, transport, telecommunication, food supply (i.e. restaurants operating take-away and/or delivery services only, or supermarkets), e-commerce, immigration and customs), there has been a complete halt to all other businesses across Malaysia that do not fall within such ‘Essential Services’.  

Apart from the immediate financial impact/constraints and other economic burdens felt by these businesses, there is a growing concern as to the impact of the MCO (fuelled by the suggestion that the MCO Period may be extended beyond 14th April 2020) and the ability of businesses to fulfil their contractual obligations struck prior to the MCO or the legal right to be released or excused from the performance of such obligations. 

Two legal concepts have often been quoted in this relation, namely (i) the doctrine of frustration and (ii) force majeure – both of which will be discussed below. 

Doctrine of Frustration

Under Malaysian law, the doctrine of ‘frustration’ is 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.”

While the term “unlawful” is self-explanatory, the word “impossible” is not defined in the Contracts Act but is generally not considered to be used only in the sense of physical or literal impossibility but includes a situation where there is a “frustration of purpose” or a radical change to what the parties bargained for in the contract.  In this respect, Malaysian courts have mostly applied the test formulated by the House of Lords in Davis Contractors Ltd v Fareham UDC [1956] AC 696 where it is stated that:

“Frustration occurs whenever the law recognizes that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract.”

The Malaysian position on the doctrine of frustration in relation to non-performance due to an act becoming impossible was summarised by the Court of Appeal in the case of Guan Aik Moh (KL) Sdn Bhd & Anor v Selangor Properties Bhd [2007] 3 CLJ 695 whereby a party must show the three elements of the event purportedly causing the frustration:

  1. the event must have been one for which no provision has been made in the contract;
  1. the event must be one for which the party was not responsible (i.e. it cannot be self-induced); and 
  1. the event which is said to discharge the contractual obligation must be such that 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.

However, it should also be noted that a contract is not frustrated by reason of it having become too difficult to perform or difficult to interpret (Pacific Forest Industries Sdn Bhd v Lin Wen-Chih [2009] 6 MLJ 293).

Would COVID-19 or the MCO give rise to frustration?

On the assumption that the contract in question does not provide for an event such as the MCO, the first element above would be satisfied.  It would also be reasonable to say that the second element of frustration is satisfied (i.e. no party to the contract was responsible for the MCO).  However, under the third element, a party to the contract would have to prove that the MCO has resulted in the contractual obligation being made radically different from what was undertaken, and that it would now not be just to enforce it.  

This third element is not easily satisfied and would ultimately turn on the facts surrounding each contract. To illustrate, reference is made to the Hong Kong case of Li Ching Wing v Xuan Yi Xiong [2004] 1 HKC 353, where the Hong Kong Court held that a contract for a fixed term tenancy of 2 years with 15 months left to run was not frustrated on the basis that the tenant was ordered by the Hong Kong Department of Health to evacuate the premises pursuant to a 10 days isolation order due to the SARS outbreak. The Hong Kong Court emphasised that the evacuation pursuant to the isolation order of 10 days was quite insignificant a period in terms of the overall 2 years fixed term period of the tenancy and that whilst the outbreak of SARS was an unforeseen event, such a supervening event did not significantly change the nature of the outstanding contractual rights or obligations from what was reasonably contemplated by the parties. It is to be noted that the Court made a finding of non-frustration despite the fact that the order for evacuation meant that the contractual right to occupy the premises in question had been taken away due to the isolation order.  It seems clear therefore that the degree of effect of the supervening event was taken into account, in this case the relatively very short period of deprivation being compared to the whole period of tenancy.

The Hong Kong case above may be contrasted with the English case of Krell v Henry [1903] 2 KB 740 where it was held that an agreement for the rental of a flat at Pall Mall for two days for the purpose of watching the coronation procession of Edward VII was frustrated in purpose due to the subsequent cancellation of the coronation. 

Looking at the above cases, whether the MCO will be a frustrating event will depend on the facts of the relevant tenancy. Since the MCO has caused business premises to be closed, if a particular business premises is affected it can be argued that the purpose of the tenancy has potentially been “suspended” by the lockdown. However, since the period of the MCO is relatively short (assuming it is between one to two months) compared to the usual term of tenancy of two to three years, it is likely for that reason that the HK case will be followed and it would not be regarded as an event of  frustration.  

Another scenario that may currently be faced by businesses is that the MCO has caused disruptions in supply chains, possibly leading to a delay in delivery and shipment of goods. Customers may then refuse to accept delivery on the ground of the failure to deliver at the contracted time.

On the assumption that the contract between the parties does not contain a “force majeure” clause (as discussed below) or has not provided for the consequences of an event such as the MCO, the issue here, again, would be whether the MCO has made it impossible for delivery or performance to be made on time.  Further, another issue would be whether time is of the essence of the contract – in other words, whether the contract is such that it only allows for delivery to be on one date and no other. If so, it can be said that the contract has been frustrated, which means that both parties are discharged from performance of the contract.

It can be seen that the issue of whether a contract has been frustrated is principally one of interpretation of the terms of the contract and the facts of each case.

What is the effect if the contract is frustrated?

If there is frustration, then parties shall be discharged from the performance of the contract as the contract would be void pursuant to Section 57(2) of the CA 1950. The party that had “failed to perform” is not in breach, hence the other party cannot claim damages for the “failure”.  It also means that the party that had “failed” cannot force the other party to accept performance on a later date.

Further, pursuant to Section 15 of the Civil Law Act 1956 (“CLA”), the parties would be able to recover any sums of money paid or valuable benefit given for the purposes of the performance of the contract. But take note that this Section is not applicable to certain contracts such as contracts for the carriage of goods by sea, insurance contracts and contracts for the sale of perishable goods. In respect of a partly performed contract, the remaining part of the contract which is yet to be performed will be treated in the same manner without affecting the part of the contract which has been performed (Section 16 of the CLA). 

Force Majeure Clause 

A force majeure clause is “normally used to describe a contractual term by which one (or both) of the parties is entitled to… [be] excused from performance of the contract, in whole or in part, or is entitled to suspend performance or to claim an extension of time for performance, upon the happening of a specified event or events beyond his control […]”(Chitty on Contracts 32nd Edition).

The concept of force majeure has its origins in the French Civil Code,  where there are express provisions which excuse/release parties from their contractual obligations where events have happened outside the parties’ control which could not have been foreseen at the time of contracting and which could not have been avoided by appropriate measures. However, unlike France, the concept is not a statutory right in Malaysia. On the contrary, force majeure is a contractual right which is to be negotiated and agreed to by the parties before they enter into the contract. Hence, if your contract does not contain such a clause, then you will only be able to rely on the doctrine of frustration as discussed above. 

Although the force majeure clause is widely used, it is not a standard clause for all types of contracts. A force majeure clause is usually found in long term contracts where there may be events beyond the control of the parties to the contract arising, resulting in one or both parties not being able to perform the contract. Contracts which typically contain such a clause are contracts in respect of the sale and purchase of goods, land and/or company shares, delivery of goods, supply of services, leases/tenancies, dealership/distributorship/agency and construction. 

Would COVID-19 or the MCO be sufficient to trigger force majeure?

Assuming that your contract does contain such a clause, how then will it be applicable in the current situation? In this regard, note that Malaysian Courts would construe or interpret the force majeure clause in the contract to see if the circumstance giving rise to a force majeure event is truly within the ambit of the force majeure clause in the contract. The burden of proof is on the party that seeks to rely on the clause to be excused or released from the obligations of the contract (Intan Payong Sdn Bhd V. Goh Saw Chan Sdn Bhd [2004] 1 LNS 537). 

Accordingly, whether a party can invoke the force majeure clause due to COVID-19 and/or the MCO would depend on the wording of the force majeure clause and the facts of each case. Matters pertinent to be considered by the party seeking to invoke the clause are as follows: 

  1. Is COVID-19 or the relevant restriction under the MCO specifically within the force majeure events covered by the clause (e.g. does it specifically set out pandemic/epidemic, business/travel restrictions or government actions as force majeure events)?
  1. If not, can it be argued to fall within the general wording (e.g. an event beyond control of the parties)?
  1. Are there any conditions to invoking the clause (e.g. notice requirement) and if yes, have these conditions been satisfied?
  1. Is the consequence of such a force majeure event occurring provided for in the clause (e.g. suspension for a period of time followed by termination after the expiry of the period or termination immediately) and if yes, is the MCO Period within or in excess of the said period? 
  1. Does the clause require a party to mitigate the effects of the force majeure event (e.g. by making alternative arrangements to perform the contract)? 
  1. Is the performance of the obligation totally prevented or is it merely made more difficult or delayed (e.g. a contract for the supply of fresh flowers may be totally prevented during the MCO Period as fresh flowers are perishable goods and will not be capable of being delivered after the MCO Period– contrast this against a contract for the supply of cars which arguably is only delayed and not completely prevented)? 
  1. Is the contract capable of being performed albeit in a different manner?
  1. Is the contract capable of being performed in part?

What is the effect if the force majeure clause is validly triggered?

The effect would usually be provided in the force majeure clause itself, and a typical effect would include the complete release or excuse of the parties from performing their obligations under the contract. In a more advanced form of the clause, there may be a period of suspension whereby parties are required to take mitigating steps during the continued occurrence of the force majeure event and only if the force majeure event exists beyond the said period will the parties be released or excused from the performance of their respective obligations under the contract. 

Conclusion

Whilst the doctrine of frustration and force majeure clause are accepted and generally given effect to by the Malaysian Courts,  the facts or circumstance surrounding each contract may not necessarily yield the same conclusion and it is advisable to seek legal advice before attempting to rely on the doctrine of frustration or invoke the force majeure clause, as a misinterpretation or misapplication of the same by a party may amount to a breach or anticipatory breach of the contract by the said party.  

Contributed by:

Chong Kok Seng (Partner)
(T) +603 – 2632 9889
(E) [email protected]

Semantha Lim Hui (Senior Associate)
(T) +603 – 2632 9934  
(E) [email protected]

Chua Jo Ann (Associate)
(T) +603 – 2632 9932 
(E) [email protected]

Abigail Yew Xi Yan (Associate)
(T) +603 – 2632 9949
(E) [email protected]  

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