Frustrated Contracts in the Time of a Pandemic: Takeaways for Financial Institutions – Commentary

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Introduction
Facts
Background
Decision
Comment

Introduction

The covid-19 pandemic has caused great uncertainty as to how legal doctrines, legislation and rarely invoked contractual provisions are interpreted by the courts. Of these, the 1990 Frustrated Contracts Act,(1) which has only been litigated a few dozen times, has become a common tool for litigants facing a breach of contract action.

For financial institutions, cases interpreting this legislation will be of great interest. Although the jury is still out, the first reported decision involving standard loan and guarantee agreements, Bank of Montreal c 2643612 Ontario Ltd,(2) seems to confirm that it will be difficult for a debtor to fall back on the Frustrated Contracts Act due to the pandemic.

Facts

In 2018, the Bank of Montreal (the bank) granted the defendant, a company operating a restaurant (the company), a small business loan. The co-accused and president of the company signed various security agreements, including a bond, in her personal capacity. The loan and guarantee instruments contained the standard obligations, including that in the event of default, the balance of the loan became due and payable at the discretion of the bank.

In April 2020, the company ran into financial difficulties and the bank agreed to defer payments for six months. In November 2020, approximately eight months later, the bank demanded repayment of the loan from the company and the guarantor, and eventually commenced proceedings when the debtors failed to repay the loan, and a motion for summary judgment was filed. presented by the bank.

To succeed, the bank had to show that there was no genuine issue in dispute as to the defendants’ obligation to repay the loan. The company and the guarantor invoked, among other arguments, the doctrine of frustrated contracts in support of their position.

Background

As noted in the decision, in Ontario, the Frustrated Contracts Act applies to “any contract governed by Ontario law which has become impossible to perform or has otherwise been frustrated and to parties who, for that reason, were released.(3)

The “law of frustration” applies “when a situation has arisen for which the parties had not foreseen anything in the contract and the execution of the contract becomes ‘a radically different thing from that which was undertaken by the contract'”. (4) When a party’s obligations are extinguished as a result of frustration, each party’s obligations under the contract are terminated.

It is important to note that the party seeking to invoke the doctrine of frustrated contracts must demonstrate that the disruption is permanent and that performance of the contractual obligations is impossible – not simply impractical, uneconomical or difficult.(5)

Decision

In Bank of Montreal c 2643612 Ontario Ltdthe Court determined that the loan and guarantee agreements had not been frustrated, since “the pandemic and subsequent blockages did not render the loan agreement and related agreements materially different from the agreements that the parties have signed”.(6) The company’s obligations to repay the loan were not contingent on the company operating its restaurant. That is, the agreements did not specify how (i.e. from what funds) the loan was to be repaid, just that they were to be paid in accordance with the specified terms of the agreement . The pandemic has not changed the nature of these obligations, nor has the pandemic been a permanent disruption.

Accordingly, summary judgment was granted in favor of the bank.

Comment

The Court’s decision reaffirms that debtors who want to rely on such doctrines to excuse non-performance of their obligations under standard loan and guarantee agreements will have a steep climb.

As a caveat, as always, it will be important to consider the specific provisions of any contract in order to assess the strengths and weaknesses of this argument in a given circumstance, and whether it is possible to invoke this legislation. Indeed, where the contract has anticipated the circumstances, for example by including a force majeure clause, the law on frustrated contracts cannot apply, as the Court confirmed in Braebury Development Corporation v Gap (Canada) Inc.2021 ONSC 6210.

For more information on this, please contact Geneviève Fauteux of Borden Ladner Gervais LLP by phone (+1 416 367 6000) or email ([email protected]). The Borden Ladner Gervais LLP website can be accessed at www.blg.com.

Endnotes

(1) LRO 1990, c F.34.

(2) 2021 ONSC 4401.

(3) RSO 1990, c F.34, s 2 (1); 1993, c 27, annex.

(4) 2021 ONSC 4401, citing Divisional Court in Cowie v Great Blue Heron Charity Casino, [2011] OJ No. 5573, citing Naylor Group Inc v Ellis-Don Construction Ltd2001 SCC 58 (CanLII), [2001] 2 SCRs. 943 at paragraph 5.

(5) 2021 ONSC 4401 citing Canadian contract lawfourth edition (Scarborough: Carswell, 1999) at pages 679-680.

(6) 2021 ONSC 4401, at paragraph 17.

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