Covid-19 – Frustration of leases

April 28, 2020

By Bill Hanbury

Introduction and overview

Since the “lockdown” began more than a month ago on 23 March 2020 commercial parties are increasingly looking at whether Covid-19 is a supervening event justifying reliance on contractual provisions covering such things as force majeure, frustration and illegality. The late Prof Treitel‘s publication on Treitel, Frustration and Force Majeure (Sweet & Maxwell, 3rd ed, 2014) has become a sought after port of call for practitioners who never expected to have to actually advise on these topics!

For an overview of all three topics the reader is referred to the article Coronavirus: force majeure, frustration and illegality by my colleagues Joel Finnan, Duncan Hedar and Tom Longstaff that was published in the e-bulletin of 9 April.

However, all three concepts have different characteristics and should not be mixed up. Frustration justifies its own article, particularly as it applies to commercial leases.

The circumstances currently facing business are wholly unprecedented in that this is not an economic downturn or recession that could have been planned for. The government has deliberately imposed a lockdown where its object is to minimise the number of transactions in the economy with a view to maximising public health advantages from isolation and so forth. The lack of preparedness is at the heart of the discussion over the common law doctrine of frustration.

As well as contractual provisions which enable parties to deal with the unexpected, including force majeure clauses, Simon Whitfield’s article on the Interpretation of Contracts in last week’s edition of this e bulletin is relevant to this issue. Clauses which plan for the unexpected have in common with the common law doctrine of frustration that they deal with supervening events. But the point about force majeure or illegality clauses is that they deal with events that are contemplated.  There is then the interpretation question: whether they contemplated this event? Sometimes, the clause succeeds in its aim and sometimes it does not. Those arguments relating to frustration are different from clauses dealing with supervening events, such as force majeure, in that the parties have not contemplated them. Had they done so they would have dealt with the consequences of that event in their contract.  This is one of the reasons why frustration is difficult to advise on, or at least, advise on confidently.

Although establishing a contract has been frustrated is difficult and, for example, force majeure clauses will be more widely applicable than frustration as an argument. However, whereas in “normal times” frustration is rarely argued about, we do not live in normal times. Particularly in relation to commercial leases and other substantial long-term obligations, it is, likely to be argued about more frequently in the light of the aftermath of the current Covid-19 crisis.

Key principles

Frustration is a common law doctrine which applies in certain limited circumstances. It allows a party to escape from his contractual obligations as a result of the supervening event which goes to the core of the contract.

The test for frustration was set out by Lord Radcliffe in Davis Contractors v Fareham UDC [1956] A C 696. The question is whether the supervening event is one that renders the contracting party incapable of performing the obligation originally contracted for. Marcus Smith J affirmed that this had “stood the test of time” in Canary Wharf v European Medicines Agency [2019] EWHC 335 (The European Medicines Agency case).

It is only those cases where the supervening event is wholly unforeseen that frustration may be successfully argued. Whereas these circumstances do arise in the commercial contract world (see for example BP exploration v Hunt [1983] 2 AC 352) they arise less frequently in relation to commercial leases. The reason for this is likely to be that such leases are long term obligations with complex terms which are rarely susceptible to interruption by external events whereas international contracts, for example, to exploit oil reserves, are much more commonly so.

However, the argument has been successfully run that where the King Edward VII’s ill-health caused his coronation to be postponed or cancelled, in the case of Krell v Henry [1903] 2 K B 740 (Krell), a licence or licence  agreement entered into on the strength of that event taking place was  “frustrated”. More relevant to the topic under discussion is the European Medicine Agency case. In that case the European Medicines Agency attempted to argue frustration to escape a 25-year lease. It argued that the lease had been frustrated by Britain’s proposed departure from the EU following the 2016 referendum. The court held that the answer to the argument lay within the lease itself. When that was properly interpreted the parties had contemplated that the European Medicines Agency’s HQ may not remain in London – hence they have included an alienation clause. In the circumstances it had been contemplated the allegedly frustrating event and dealt with it in the lease.

Is Covid-19 a frustrating event?

What then of the first global pandemic for a hundred years – surely this is a very different character and scale than the European Medicine Agency case?  Surely nobody has contemplated such a pandemic? What happened in the last pandemic?

Unfortunately, no examples survive from 1918. However, other common law jurisdictions have had to grapple with this, for example:

• Montgomery v Board of Education 131 NE 497 (1921) (Supreme Court of Ohio), where an 8 ½ month contract to supply horse-drawn transport for children attending a local school was argued to be frustrated by an influenza epidemic causing the school to be shut, the frustration argument failed.
• More relevant to our times is a case arising out of the SARS outbreak. In Wing v Xiong (DCCJ 3832/2003, Hong Kong District Court however the District Court held that the 10-day period of closure was insufficient to give rise to a frustration of the contract. In that case the claimant sought to argue that a 10-day exclusion from his flat, which he had rented for two years, as a result of health enforcement by the Hong Kong authorities, amounted to a frustration of the lease. The District Court disagreed, possibly because of the shortness of the exclusion and the length of the term.

Conclusions

One of the reasons for the court’s reluctance to find frustration of a contract, particularly where long-term obligations are involved, as where there is a commercial lease typically spanning for many years, is that a consequence of the successful party arguing frustration is that he is discharged from all further obligations.  This is sometimes/often in the present circumstances, very convenient. To be clear, the lease, or other instrument, does not become void ab initio and there may be outstanding obligations which in certain circumstances may be dealt with by the Law Reform (Frustrated Contracts) Act 1943. But the consequences of discharge are not always thought to be fair.

When the 1943 Act was enacted, the wartime administration had to grapple with the frequent frustration of leases consequent on enemy activity and other events.  Parliament, but more probably, the courts may soon be called on to deal with the consequences of the first pandemic for 100 years.

It can easily be seen that the examples chosen above are not of the magnitude of the potential disruption consequent on coronavirus. How successful these arguments are will depend in large part on how long the “lockdown” is and the level of economic decline consequent thereon. Present indications are that it is likely to be severe and prolonged although, in economic terms, it is hoped “V shaped” rather than “U-shaped” dip. It is inconceivable, however, that important cases will not emerge from this crisis and those that are appealed may help to clarify the law. Landlord and tenant law is at the sharp end when it comes to frustration as commercial tenants take on long-term obligations- they do not perform a “project”, as is often the case in a commercial contract case such as BP Exploration (Libya) Ltd v Hunt .

It is likely that a landlord facing such difficult economic times will strongly argue against frustration and will if unsuccessful seek to take the argument to a higher court.