Frustration of purpose: when performance is possible but pointless

Beverly Hills, the fourth of August nineteen forty one. A landlord leases a corner of Wilshire Boulevard to a car dealer for five years, for the sole purpose of conducting thereon the business of displaying and selling new automobiles, with a service station, and for no other purpose whatsoever without the written consent of the lessor. No subletting without consent. The lease starts in September. In December the United States enters the war.
On the first of January nineteen forty two the federal government orders that the sale of new automobiles be discontinued. A week later it allows sales to the military, and later that month sets up a priority system. Only buyers with a high enough rating may buy a new car. In March the dealer explains to the landlord what this has done to his business.
The landlord waives the restrictions on use and subletting, and offers to reduce the rent if the dealer cannot operate profitably. The dealer moves out anyway and repudiates the lease.
The landlord relets to mitigate and sues for the shortfall. At trial the dealer admits he still sells new cars at two other locations in the county. Asked whether he knew many dealers were continuing in business, he says, sure. It is just the location that I couldn't make a go, though, of automobiles. So here is the question. Nothing stopped the dealer from paying rent. Nothing stopped him from using the building.
What stopped him was that the reason he wanted it had mostly gone. Is that a defense? Think about it before I go on.
And now the question I keep asking. What exactly did these people promise each other? A building for rent, for a purpose both parties knew. Last lecture the promisor's performance became impracticable. Today the promisor can perform perfectly well. It is the other side's performance that has become worthless to him. The doctrine is frustration of purpose, and it began in England with the coronation of Edward the Seventh.
Judge Posner told the story in the coal case. Krell rented Henry a suite of rooms for watching the coronation of Edward the Seventh, but Edward came down with appendicitis and the coronation had to be postponed. Henry refused to pay the balance of the rent and the court held that he was excused from doing so because his purpose in renting had been frustrated by the postponement, a contingency outside the knowledge, or power to influence, of either party. The rooms were still there.
The reason for renting them was not.
Here is the first line for the board, from the Restatement, section two sixty five. Where, after a contract is made, a party's principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary.
Second line. Frustration is not impossibility. Performance remains possible but the expected value of performance to the party seeking to be excused has been destroyed by a fortuitous event. The test is the same as impracticability's. Was the event unanticipated, was its risk allocated to the promisor, and has it made performance vitally different from what was reasonably to be expected.
Third line, the limits. The promisor must prove that the risk of the frustrating event was not reasonably foreseeable and that the value of counterperformance is totally or nearly totally destroyed. Laws that make a business less profitable or more difficult do not excuse. Frustration is no defense if the event was foreseeable or controllable by the promisor, or if counterperformance remains valuable.
Now the case. Lloyd against Murphy, Supreme Court of California, nineteen forty four, Justice Traynor. First he accepted the doctrine, even for leases, where English courts had refused it. The modern cases have recognized that the defense may be available in a proper case, even in a lease. Then the question.
Whether the equities of the case, considered in the light of sound public policy, require placing the risk of a disruption or complete destruction of the contract equilibrium on defendant or plaintiff under the circumstances of a given case.
And the answer depends on whether an unanticipated circumstance, the risk of which should not be fairly thrown on the promisor, has made performance vitally different from what was reasonably to be expected. The purpose of a contract is to place the risks of performance upon the promisor. If a risk was foreseeable there should have been provision for it in the contract, and the absence of such a provision gives rise to the inference that the risk was assumed.
Was war foreseeable in August nineteen forty one? Traynor looked at the calendar. The National Defense Act had been law for more than a year. The automotive industry was in the process of conversion to supply the needs of our growing mechanized army. Automobile sales were soaring because the public anticipated that production would soon be restricted.
It cannot be said that the risk of war and its consequences necessitating restriction of the production and sale of automobiles was so remote a contingency that its risk could not be foreseen by defendant, an experienced automobile dealer.
And was the value destroyed? The sale of automobiles was not made impossible or illegal but merely restricted. If governmental regulation does not entirely prohibit the business to be carried on in the leased premises but only limits or restricts it, thereby making it less profitable and more difficult to continue, the lease is not terminated or the lessee excused from further performance. He was still selling new cars down the road. The landlord had waived the use restriction and offered to cut the rent.
The premises were rented soon after defendants vacated them. The dealer paid.
Traynor gave a reason of policy that explains the narrowness. The doctrine of frustration has been limited to cases of extreme hardship so that businessmen, who must make their arrangements in advance, can rely with certainty on their contracts. Litigation would be encouraged by the repudiation of leases when lessees found their businesses less profitable because of the regulations attendant upon a national emergency. Many leases were hurt by the war. If frustration excused them all, no lease would be worth the paper.
Now a case where the defense worked. Massachusetts, nineteen eighty two. The state hires a contractor to resurface two stretches of Route one twenty eight and replace the grass median with concrete barriers. The contractor orders twenty five thousand eight hundred linear feet of precast barriers from a supplier. In the spring of nineteen eighty three residents protest. A hundred citizens sue. The contractor tells the supplier to stop producing.
The state settles with the citizens, no more barriers, and deletes the item from the contract. The supplier has made about half the barriers, has been paid for all of them at the contract price, and sues for its lost profit on the rest.
The Supreme Judicial Court, in Chase Precast against John J. Paonessa Company, nineteen ninety one, Justice Lynch, adopted frustration of purpose for Massachusetts and applied it. It quoted the Restatement definition, and observed that it is nearly identical to the defense of commercial impracticability in the Code. Then the allocation question, in the court's own test. Was the contingency which developed one which the parties could reasonably be thought to have foreseen as a real possibility which could affect performance?
Was it one of that variety of risks which the parties were tacitly assigning to the promisor by their failure to provide for it explicitly? If it was, performance will be required. If it could not be so considered, performance is excused.
The state's contract with the contractor let the state delete items. The supplier's contract with the contractor had no such clause. But the supplier knew the barriers were for state projects, had supplied the state before, and knew the standard clause and the unit price philosophy in the construction industry, whereby contract items are paid for at the contract unit price for the quantity of work actually accepted.
Even so, the judge could reasonably have concluded that they did not contemplate the cancellation for a major portion of the project of such a widely used item as concrete median barriers, and did not allocate the risk of such cancellation. The supplier had suffered no out-of-pocket expense. Its lost profit was denied.
Put Lloyd and Chase side by side. The car dealer's purpose was restricted, not destroyed, the risk was foreseeable, and he was in fact still selling cars. Frustration failed. The contractor's purpose for the remaining barriers, to install them on a state road, was destroyed by a settlement neither party caused or foresaw, the risk had not been allocated, and the supplier had lost only a profit it knew the state never paid for. Frustration succeeded. Same test, opposite facts.
One more voice, Judge Posner in the coal case, on what frustration is really about. Rarely is it impracticable or impossible for the payor to pay. But if something has happened to make the performance for which he would be paying worthless to him, an excuse for not paying, analogous to impracticability or impossibility, may be proper. And on Krell.
Surely Henry had not intended to insure Krell against the possibility of the coronation's being postponed, since Krell could always relet the room, at the premium rental, for the coronation's new date. So Henry was excused. The question is always the same. Who was insuring whom?
Now let's change one fact. In January nineteen forty two the government had banned the sale of new automobiles entirely for the duration of the war, and the landlord had refused to waive the sole purpose clause. Choose an answer before I go on.
Now the dealer has Traynor's own hardest case. The court said the cases excusing tenants involved government orders that totally destroyed the possibility of selling the products for which the premises were leased, and it distinguished the prohibition case, where a saloon lease was excused because the purpose was totally destroyed. A total ban, plus a lease that allows no other use, comes close to total destruction of value. Foreseeability still cuts against him.
But most courts would now excuse, or at least discharge the lease going forward.
Change one fact again. The barrier supplier had spent two hundred thousand dollars on special forms and materials for the second half of the order before the stop notice came. Choose.
Frustration still discharges the contractor's duty to take the rest, but the remedy changes. Discharge is not a licence to leave the other party with the loss. The Massachusetts court leaned on the fact that the supplier had suffered no out-of-pocket expense as a result of cancellation. Where reliance costs have been incurred, courts allow restitution or reliance recovery to adjust the loss between two innocent parties. The supplier does not get its profit. It may well get its forms and materials.
Change one fact a third time. The coronation rooms had been let to Henry for a week at an ordinary rent with no mention of the procession, and the coronation happened to fall in that week. Choose.
No frustration. The Restatement requires that the non-occurrence of the event was a basic assumption on which the contract was made, and both parties must share it. A landlord who lets rooms at an ordinary rent has not built the coronation into the bargain. Henry's private purpose is his own risk. That is the hidden fact of Krell against Henry. The rooms were let at a premium, for the day, with the procession in view.
Take that away and it is an ordinary lease with a disappointed tenant.
Here is what people get wrong here, and why it is tempting. The first mistake is treating lost profit as frustration. Less profitable is not frustrated. Traynor said it, and the coal case said it. The second mistake is forgetting that the purpose must be shared. A purpose the other side never knew about cannot be a basic assumption of the contract.
The third mistake is assuming discharge ends the matter. It ends the duties going forward. What has already been paid or spent is sorted out by restitution, so that neither innocent party carries the whole loss.
Here is the rule, in one breath. Where an event the non-occurrence of which was a basic assumption of the contract substantially frustrates a party's principal purpose without his fault, his remaining duties are discharged, unless the risk was foreseeable and so tacitly assumed, or allocated to him by the contract, or the value of the other side's performance is only reduced rather than destroyed. Discharge ends future duties, and restitution adjusts what has already passed. Now, five questions.