Articles

Covid 19 and Frustration of Leases

25th March 2020

Introduction

At the time of writing the Coronavirus Bill is being considered in Parliament. The Bill includes a moratorium on forfeiture of commercial premises but this will not prevent rent liabilities accruing at a time when many commercial tenants cannot make any use of the premises demised to them. There will no doubt be many tenants who would, given the choice, walk away from their lease and any personal guarantee.

Since National Carriers Ltd v Panalpina (Northern) Ltd [1981] A.C. 675 prevailing wisdom has been that although the doctrine of frustration of contracts is in principle applicable to leases it will seldom ever apply. An argument based on frustration failed more recently in Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch) and many people have assumed that in the landlord and tenant context the coronavirus pandemic will not frustrate leases. This article examines that assumption.

What is frustration?

The doctrine of frustration operates to bring a contract prospectively to an end because of the effect of a supervening event. The effect of frustration is to release both parties from any further performance of the contract.

In Davis Contractors Ltd v. Fareham UDC, [1956] 1 AC 696 at 729 Lord Radcliffe set out in general terms the test for frustration:

“…frustration occurs whenever the law recognises 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. Non haec in foedera veni. It was not this that I promised to do.” 

Another formulation of the test is that of Lord Simon in National Carriers Ltd v. Panalpina (Northern) Ltd [1981] 1 AC 675 at 700:

“Frustration of a contract takes place where there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances: in such case, the law declares both parties to be discharged from further performance.”

When will a lease be frustrated?

Common purpose

In the European Medicines Agency case, Marcus Smith J termed “common purposes” cases those cases where the court had found contracts to be frustrated on the grounds that “it was not this that I promised to do”.

Marcus Smith J placed great reliance on a passage from the judgment of Rix LJ in Edwinton Commercial Corporation v. Tsavliris Russ (Worldwide Salvage and Towage) Ltd, The “Sea Angel” [2007] EWCA Civ 547. Rix LJ said this:

“In my judgment, the application of the doctrine of frustration requires a multi-factorial approach. Among the factors which have to be considered are the terms of the contract itself, its matrix or context, the parties’ knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed mutually and objectively, and then the nature of the supervening event, and the parties’ reasonable and objectively ascertainable calculations as to the possibilities of future performance in the new circumstances.”

One of the “coronation cases” (cases relating to when the coronation of King Edward VII was postponed because of the illness of the King), provide an illustration of when a common purpose would be frustrated. In Krell v. Henry [1903] 2 KB 740, the defendant agreed to hire the plaintiff’s flat in Pall Mall for 26 and 27 June (days, but not nights). These were the days it had been announced that the Coronation processions would take place and pass along Pall Mall. Marcus Smith J said:

“What the parties were buying and selling was, quite literally, a room with a view. Their common purpose was just that: whilst the parties surely would have been in opposition in bargaining on price, the thing that they were bargaining about was predicated on the procession taking place. Matters would have been very different had the room been a hotel room charging a higher rate because of the higher demand for rooms on that particular day due to the Coronation.”

Obvious candidates for frustration would be short lets where the premises have, to the knowledge and expectation of both landlord and tenant, been let for a particular event which will no longer happen e.g. the letting of a stand in a convention centre for an event which will no longer happen.

At the other end of the spectrum the longer a lease the more difficult it will be to successfully argue that it has been frustrated. An event which prevents premises being used for a short period in a 30 year lease is not, in the language of National Carriers an event “which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual . . . obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances”.

The facts of the National Carriers case were as follows. A warehouse was demised to the defendants for a 10-year period. The only access to the warehouse was by a street which the local authority closed, after five years of the term had elapsed, for a 20-month period. That was insufficient to warrant frustration.

The multi-factorial approach

The multi-factorial approach espoused by Rix LJ, however, means that it is not simply a case of looking at the length of the contract and the period during which the premises cannot be used. The court will look at all the circumstances and the terms of the lease. Circumstances might arise in which although premises cannot be used by the original tenant, they could be used by an assignee or a subtenant. In effect, that is why the EMA lost its case: it could not be headquartered outside the EU but the lease allowed the demised premises to be assigned or sublet.

The court would also consider whether the lease contemplates the events said to have caused frustration. The decision in the European Medicines Agency case pointed out that the provisions allowing assignment and subletting indicated that the parties had contemplated that the European Medicines Agency might not remain in occupation for the term of the lease.

Other terms that a court would look closely at would include any force majeure clause, any provision for suspension of rent, and any break clause.

If supervening circumstances mean that premises cannot be used for their original intended purpose it will be relevant to consider whether the lease permits them to be used for an alternative purpose. If the premises cannot be used for their intended purpose and the lease allows no alternative attention will focus on the length of the lease when granted and the period of expected interruption.

An example of an insufficient period arises from a previous pandemic in Hong Kong. In Li Ching Wing v Xuan Yi Xiong [2004] 1 HKC 353, a tenant in a 2-years fixed-term tenancy claimed that the lease agreement was frustrated because the Department of Health evacuated the tenant out of the infected block and imposed an isolation order for 10 days because of the SARS outbreak. The lease was not frustrated.

The difficulty for the bars, restaurants and now shops shut due to the coronavirus lockdown is that there is no clarity on the length of time that current conditions will ensue. The forfeiture moratorium introduced by Coronavirus Act lasts until 30th June 2020 but that will obviously be extended if necessary.

If the facts of the Hong Kong had been that there was a 6 month period when the premises were incapable of occupation would the result of have been different? One can only hope that we do not need to find out, but the possibility cannot be ruled out.

What about rent deposits?

Frustration releases both parties from any further performance of the contract.

Having set aside the contract, the initial response of the courts at common law was to let the loss lie where it fell. However, the Law Reform (Frustrated Contracts) Act 1943 allows the recovery of prepaid sums.

Section 1(2) of the Act provides that:

“All sums paid or payable to any party in pursuance of the contract before the time when the parties were so discharged (in this Act referred to as ‘the time of discharge’) shall, in the case of sums so paid, be recoverable from him as money received by him for the use of the party by whom the sums were paid, and, in the case of sums so payable, cease to be payable:

Provided that, if the party to whom the sums were so paid or payable incurred expenses before the time of discharge in, or for the purpose of, the performance of the contract, the court may, if it considers it just to do so having regard to all the circumstances of the case, allow him to retain or, as the case may be, recover the whole or any part of the sums so paid or payable, not being an amount in excess of the expenses so incurred.”

The effect of this subsection is to entitle a contracting party to recover money paid to the other contracting party prior to the frustrating event. The court has no discretion over the question whether a sum already paid is recoverable: the only discretion concerns the allowance for expenses.

In consequence of the fact that leases are seldom frustrated, there is a dearth of authority, but it would seem that this provision could form the basis for a claim for the return of a rent deposit.

Piers Harrison

Barrister

 

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