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Frustration of Leases as a Result of COVID-19

Does a Pandemic in the form of COVID-19 give rise to a frustrating event? Andrew Maguire explains where commercial leaseholders stand now the country is in ‘lockdown’

What is frustration of a lease?

What constitutes the frustration of a lease? Lord Simon of Glaisdale, in the case of National Carriers v Panalpina (Northern) [1981] AC 675, famously declared that:

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”.

Consequently, the theoretical basis of frustration has been variously described by Judges as:

  • an implied term or condition;
  • a total failure of consideration;
  • a device by which absolute obligations are reconciled with justice;
  • the frustration of the adventure on which the contract is founded; and
  • a question of construction of the contract.

How have courts viewed frustration in the past?

The English courts have historically been generally hostile to frustration as a remedy and, in particular, in respect of leases. In Panalpina, the House of Lords held that the doctrine can apply to leases; dependent on the particular facts, and dismissed the appeal. The facts were that 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. In an action for unpaid rent, the defendants claimed that the lease had been frustrated. The judge held that a lease could not be frustrated. This decision was upheld by the House of Lords who considered that, on the facts, having regard in particular to the likely length of continuance of the lease after the interruption of user, in relation to the term originally granted, the defendants had failed to raise a triable issue as to its applicability.

More recently, Mr Justice Marcus Smith held that a lease was not frustrated, in a case where the tenant contended that a consequence of the decision of the United Kingdom to leave the European Union was that the tenant felt the need to relocate away from the United Kingdom: see Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch); [2019] EGLR 17. The brief facts being that the tenant, an agency of the European Union, held a lease granted in 2014 of part of premises in Canary Wharf, London, for a term of 25 years. When the UK gave its Article 50 notice of its intention to withdraw from the EU, the tenant took proceedings contending that the UK’s withdrawal would frustrate its lease on the ground, among others, that it would no longer be able lawfully to exercise the rights conferred on it by the lease, including the rights to occupy the premises or to assign. Marcus Smith J. was not persuaded, on the facts, and held that the changes brought about by Brexit did not render the tenant’s occupation of the premises impossible and did not render the tenant’s performance under the lease something “radically different”.

Can COVID-19 cause a lease to be frustrated?

The question arises whether a Pandemic in the form of COVID-19 – of which nobody presently knows how long it will last and, in consequence of which the UK Government has made certain types of user to be illegal (such as hotels, licensed premises and restaurants and other retail outlets) – can give rise to a frustrating event?

Consideration ought to given as to the purpose of the lease and the effect of the supervening event on its performance and the reason for the particular contract. If the entire purpose of the transaction has been taken away by lawful restrictions currently in place, or such user is deemed to be illegal, the doctrine of illegality may be relied on by a tenant. However, much depends on the particular relevant length of closures as compared to the relevant length of the term of the lease. It was for this very reason that the House of Lords in Panalpina held that the remaining 3 years or so of the lease still provided some benefit to the tenant. But what if a long lease has nearly expired? The same argument applies to short term lets. A different decision may then be arrived at by the court.

In Canary Wharf, consideration was given to whether a party may assign, sub-let or provide a licence to another of its leasehold interest. If it can, the result is that the lease is unlikely to be frustrated. However, if the prohibition on user affects, for example, all other hoteliers or restaurateurs or publicans, then this argument does not run so as to diminish the chances of a frustration argument succeeding. This is expressly noted in the judgment.

Moreover, in Panalpina, their Lordships were keen not to criticise USA cases which had held that liquor saloons, which were forced by law to close during Prohibition, were subject to the doctrine of frustration in relation to leases which had been previously granted, given that “the determination of a demise is an extraordinary thing”.

In Hong Kong, after the Severe Acute Respiratory Syndrome (“SARS”) outbreak in 2003, a first instance decision held that a 10 days’ isolation order, which closed the entire apartment block, was insufficient to give rise to a frustrating event to the tenant’s 2 years’ lease. The judge held that “fear alone did not provide the tenants with a legal justification to terminate their tenancy agreements” and that a 10 day period was insignificant in view of the 2 years’ duration of the lease, and although SARS may arguably be an unforeseeable event, it did not “significantly change the nature of the outstanding contractual rights or obligations” of the parties in this case (Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754).

In contrast, at the present time, one does not know how long COVID-19 may last nor for how long the Government’s restrictions affecting retail businesses may continue. Commercial decisions need to be undertaken now as opposed to waiting months for clarity as to what, if any, user is permitted. However, it is arguable that if a tenant has a relatively short-term tenancy, and if as a result of a closure order the tenant could not, or is likely to not be able to, access the premises for a substantial part of the term of its tenancy, it could successfully claim frustration of the tenancy. It all depends on the particular facts.

Can tenants ask for a rent review?

The lockdown of businesses whereupon the single user permitted by a lease for a tenant becomes illegal may prove to be a very powerful weapon in a tenant’s armoury. This problem is underscored when there is a “keep open” covenant in the lease, which demonstrates a common purpose between landlord and tenant.

It is against this backdrop that tenants may be seeking rent suspensions, or terminating their leases, and it remains to be seen whether landlords are able to successfully argue that as far as they are concerned, frustration has been such a rarely granted remedy that they may effectively ignore it?

In addition, it would be prudent to check whether the lease contains a rent cesser provision allowing the obligation to pay rent to be suspended during periods where premises are unoccupied, owing to the happening of a force majeure or other insurable event. Read more on force majeure and MAC clauses here. This in turn may give rise to specific arguments as to whether COVID-19 is included as an insurable event. Again, the specific terms of the lease will need to be carefully construed.

Tenants should also check their business disruption policies. These may cover compulsory closure where there is a notifiable disease. Whether COVID-19 applies is a question to be determined in each case.

More information

This article was written by Andrew Maguire of OTC’s Commercial & Chancery Team. Andrew specialises in disputes over the interpretation or breach of contracts and is recognised by Chambers & Partners and Legal 500. Andrew would be happy to inspect individual leases and discuss frustration and force majeure in more detail in light of the evolving government advice.

Please contact David Smith on +44 (0)20 7427 4905 or Colin Bunyan on +44 (0)20 7427 4866 for further information and details of future events on this area of law.

Covid-19, Commercial during Covid-19, Commercial, News 10 Apr, 2020

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