COVID-19 and the Frustration of Leases on Grounds of Illegality
2020-04-15

[This blog is an extract of a much fuller article on Frustration available online from the University of Aberdeen  Centre for Scots Law]

 

Contract Law and Frustration

Certainty of performance is at the heart of contract law, as Lord Hope remarked

 “…the maxim pacta sunt servanda [‘agreements must be kept]… lies at the root of the whole of the law of contract.”[1]

However, in certain circumstances, the obligation perform a contractual obligation is excused by the invocation of the doctrine of frustration. The key criteria for the successful invocation of the doctrine of frustration is that an unforeseen radical change in the circumstances in which a contract is to be performed makes it impossible that the contract be performed as agreed by the parties.  The classic definition of the modern law of frustration is to be found in Davis Contractors Ltd v Fareham Urban District Council [1956] AC 696 in the definition given there by Lord Radcliffe:

“So perhaps it would be simpler to say at the outset that frustration occurs whenever the law recognizes 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.”[2]

This approach was reinforced by Lord Simon in National Carriers Ltd v. Panalpina (Northern) Ltd  [1981] A.C.675 at 701 were he said:

”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.”

The four requirements for frustration of contract are that the supervening event must be unexpected, have occurred without the fault of the parties and have a catastrophic effect on the performance of the contract.

 The legal effect of frustration is that the contract is declared void from the moment of the occurrence of the frustrating event releasing the parties from any future obligation to perform, eg by payment or provision of goods or services, but not from any past obligations.

“What happens is that the contract is held on its true construction not to apply at all from the time when the frustrating circumstances supervene. From that moment there is no longer any obligation as to future performance, though up to that moment obligations which have accrued remain in force. “ Denny, Mott & Dickson Ltd. v. James B. Fraser & Co. Ltd., 1944  S.C. (HL) 35,  per Lord Wright.

There is no doubt that the Covid-19 pandemic was unexpected and beyond the control of anyone and that it is having a catastrophic effect on very many but not all contracts.  This blog will look at one important aspect of Covid 19 frustration: the frustration of leases for illegality.

 

Illegality

Under The Health Protection (Coronavirus) (Restrictions) (Scotland) Regulations 2020 and The Health Protection (Coronavirus, Business Closure) (England) Regulations 2020 the conduct of many normally lawful businesses has been made illegal, for example cafes, pubs, cinemas and hairdressers. Supervening  Illegality is a ground for frustration of a contract under the fundamental principle that the courts will not enforce an illegal contract.

“It is plain that a contract to do what it has become illegal to do cannot be legally enforceable. There cannot be default in not doing what the law forbids to be done.” Denny Mott & Dickson Ltd. v. James B. Fraser & Co. Ltd. 1944 SC (HL) 35; [1944] A.C.265 per Lord MacMillan.

 

Differing Approaches of English and Scots Law on Frustration of Leases

Payment of rent on a lease is often one of the most expensive obligations occurred by a commercial business like a pub or hairdresser.

Properties are usually rented out for significant periods of time ranging from months to centuries but if a rented property suddenly cannot be used for the purpose it  was leased for, eg as a pub or café, because that purpose is now illegal then the tenant faces the fundamental problem that they have no income but at same time faces the continuing to pay rent under the lease. This is precisely a situation where a lease may well be held to be frustrated. 

Frustration of leases is an area where Scots and English Law differ radically: Scots law allows frustration of a lease for good cause on much the same basis as any other kind of contract (eg of sale or services) but, at least in the past, English law makes it almost impossible and still sets the bar for frustration higher than Scots law. It will therefore be crucial if the contract is governed by Scots or English law.

 

English leases

English law is very reluctant to find a lease to be frustrated, indeed there is no reported case where this has occurred. In Cricklewood Property and Investment Trust Ltd v Leightons Investment Trust Ltd [1945] AC 221 the House of Lords decided unanimously that on the facts there had been no frustration of a long-term building lease by the imposition of building restrictions following the outbreak of war. On the question of principle, the House of Lords was evenly divided with Viscount Simon and Lord Wright willing to consider the possibility  that on very rare occasions a lease may be frustrated, as, for instance, if some vast convulsion of nature swallowed up the property altogether, or buried it in the depths of the sea. By contrast, Lord Russell and Lord Goddard thought that on principle it is simply impossible for lease to be frustrated. They reached this conclusion because they held that a lease is more than a mere contract in that it creates an estate in the land vested in the lessee, and that this estate in the land could never be frustrated, even though some contractual obligations under the lease might be suspended by wartime regulations. This precedent in Cricklewood points strongly to the non frustration of leases on account of the Coronavirus emergency legislation but English law has moved since then. In National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675 the majority in the House of Lords agreed with the reasoning of Viscount Simon and Lord Wright in the Cricklewood case, and thus held that the doctrine of frustration is, in principle, applicable to leases although several of their Lordships considered that the doctrine would “hardly ever” be applied to a lease. It will be interesting to see if the English courts are more sympathetic to frustration of leases in the current context, perhaps now is the occasion for the “hardly ever” to actually occur!

Two further points can be derived  from National Carriers one making it easer to find frustration, the other harder. The following passage in Corbin, Contracts was cited with approval in the House of Lords in National Carriers: “If there was one principal use contemplated by the lessee, known to the lessor, and one that played a large part in fixing rental value, a governmental prohibition or prevention of that use has been held to discharge the lessee from his duty to pay the rent. It is otherwise if other substantial uses, permitted by the lease and in the contemplation of the parties, remain possible to the lessee.” This would seem to make it easier to hold a commercial lease for a shop or a pub frustrated where the lease specifies that a pub or shop is the principal use of the premises contemplated in the lease. 

On the other hand, the English authorities, to a far greater degree than the Scots authorities, take the duration of the unexpired term of the lease set against the likely duration of the frustrating event into account. The English authorities tend to the view that a potentially frustrating event which causes an interruption in the enjoyment of expected use of the premises by the lessee, will nevertheless not frustrate the lease unless the interruption is expected to last for the whole of the unexpired term of the lease, or, at least, for a significant portion of that unexpired term. We might call this the “double duration” test: the court considers both the certain fact of the lease’s future length in the context of the uncertain fact of the likely duration of the lease. This is a test which is favorable to upholding the lease and to denying the application of the doctrine of frustration. This result can be seen in the two leading cases of Cricklewood and National Carriers

In Cricklewood, the lessee under a 99-year building lease claimed that wartime building restrictions had frustrated the lease. The House of Lords held that there had been no frustration, since the lease had over 90 years to run when the war broke out, and that it was unlikely that the war would last for more than a small fraction of the whole term.  Likewise,  in  National Carriers Ltd v Panalpina (Northern) Ltd the tenant held a 10-year lease of a warehouse and the frustrating event was that a temporary order made by the City Council closed the street which gave the only access to the warehouse, so making it impossible to use as a warehouse. However, the House of Lords held that on the facts the lease was not frustrated because the closure was expected to last only for a year or a little longer, which would still allow the lease to run for three more years after the street re-opened. As Lord Simon of Glaisdale remarked that for a court when deciding if frustration applies: “In a lease, as in a licence or a demise charter, the length of the unexpired term will be a potent factor.” On the facts of this cases however his lordship concluded that the lease was not frustrated  as “ The interruption would be only one sixth of the total term.”

Significantly,  however in the recent case of  Canary Wharf Management Limited v European Medicines Agency [2019] EWHC 335 (Ch) Smith J made comments  which  indicate that the English courts may now be more willing to allow leases to be frustrated:

“194. It may be doubted whether Lush J’s second point – namely, that the defendant had acquired a property interest, in the form of a lease, which was unaffected by the supervening illegality – remains good or reliable law in light of Panalpina, where the House of Lords held that, at least in theory, a lease that continued to subsist as a property interest could nevertheless be frustrated.”

More generally, the concept of the estate, which prior to National Carriers which provided such a conceptual obstacle to the extension of the doctrine to leases, is no longer viewed as the foundation of that relationship but merely one of its incidents. Indeed, the judicial trend in English law appears to be  towards a general assimilation of leases with other contracts. It is interesting, for example, to observe that the doctrine of disclaimer of a landlord’s title has been held to be analogous to the doctrine of repudiation of contract.[3]

  

Scots Leases

Scots Law, by stark contrast with English Law, has no inherent difficulty with recognizing that leases may be frustrated like any other kind of contract, not least because it has no doctrine of separate estates in land to confuse the issue.  In Tay Salmon Fisheries Co Ltd v Speedie 1929 SC 593 a 19 year lease of salmon fishings was held frustrated when the RAF took using statutory powers  over the land for target practice thus making the fishings incapable of possession for the purpose of the lease even although target practice was only occasional. In a similar vein in Denny, Mott & Dickson (supra) a long lease on a timber yard was held frustrated by a 1939 emergency order arising out of the war.  Lord Macmillan at 1944 (HL) 35, 41 made remarks which are very relevant to the  current prohibition on pubs, cafes and other businesses trading:

“…many of the recent cases have arisen from the supervention of emergency legislation rendering the implement of the contract illegal. It is plain that a contract to do what it has become illegal to do cannot be legally enforceable. There cannot be default in not doing what the law forbids to be done.”

The present case belongs to the latter category. It seems to me a very clear one for the application of the principle I have just enunciated. Here is an agreement between two parties for carrying on dealings in imported timber. By emergency legislation the importation of timber has been rendered illegal. Neither party can be said to be in default. The further fulfilment of their mutual obligations has been brought to an abrupt stop by an irresistible extraneous cause for which neither party is responsible. ….The operation of the agreement having been compulsorily terminated, neither party can thereafter terminate it voluntarily. You cannot slay the slain.”

The duration of the current Covid 19 emergency regulation prohibitions is inevitably uncertain and unknowable and on this situation of uncertainty Lord Wright made the following very useful remarks in Denny, Mott & Dickson:

“It is true that the agreement [the lease] was for an indefinite time, and that the war might end within a comparatively short period. The position must be determined as at the date when the parties came to know of the cause of the prevention and the probabilities of its length as they appeared at the date of the Order, but subsequent events ascertained at or before the trial may assist in showing what the probabilities really were (as Lord Sumner said in Bank Line, Ltd. v. Arthur Capel & Co.). In addition, there is to be remembered the principle stated by Lush, J., in Geipel v. Smith, that “a state of war must be presumed to be likely to continue long, and so to disturb the commerce of merchants, as to defeat and destroy the object of a commercial adventure.” It is true that Lush, J., was there referring to a single definite adventure, not to a continuous trading, but the real principle which applies in cases of commercial responsibility is that business men must not be left in indefinite suspense. If there is a reasonable probability from the nature of the interruption that it will be of indefinite duration, they ought to be free to turn their assets, their plant and equipment and their business operations into activities which are open to them, and to be free from commitments which are struck with sterility for an uncertain future period. Lord Shaw emphasised this principle in the Bank Line case, and so did Lord Sumner.  This, I think, is the true basis of the rule. It does not depend simply on the consideration that, when the interruption ceases, conditions of performance may be different, though that may also be worth dwelling on in certain cases, as in Metropolitan Water Board v. Dick, Kerr & Co., Ltd., where it was said that the interruption destroyed the identity of the performance contracted for.” 1944 (HL) 35 at 42.

The Scots approach in Denny which  we might call for convenience the ‘sterility from uncertainty’ test is in complete contrast with ‘double duration’ test approach applied by the English Courts in  Cricklewood and National Carriers  discussed above, although duration is obviously a factor considered by the Scots Courts it is not decisive,  see Duff v Fleming [1870] SLR 7 480 and especially Allan v Markland (1882) 10 R 383. It is submitted that the  Scots approach is fairer to the parties and fits better with the general operation of the doctrine of frustration within contract law.

 If we consider the impact of The Health Protection (Coronavirus) (Restrictions) (Scotland) Regulations 2020 and The Health Protection (Coronavirus, Business Closure) (England) Regulations 2020 respectively  on prohibited businesses we can see the likely difference in the approach to be taken by the two different jurisdictions.

In Scotland it is submitted that, as of April 2020, there is “a reasonable probability from the nature of the interruption” viz the continued prohibition by the regulations of services to the public such as running pubs, cafes,  restaurants  and many shops and other businesses in order to inhibit the spread of Covid-19. This prohibition is such that in the words of Lord Wright in  Denny, Mott & Dickson  “that it will be of indefinite duration,” and accordingly for both tenants and landlords that “they ought to be free to turn their assets, their plant and equipment and their business operations into activities which are open to them, and to be free from commitments which are struck with sterility for an uncertain future period.” Accordingly, if a Scots lease for premises is let for the express purpose of conducting a prohibited business such as a pub or café then there is a strong argument that such leases were ended when The Health Protection (Coronavirus) (Restrictions) (Scotland) Regulations 2020 came into force at 7.15 p.m. on 26th March 2020. The effect of frustration is that the tenant of frustrated lease would have no obligation to pay for future occupation of the premises, but can claim back any sums paid in advance under the principle of unjust enrichment. With leases there is always an issue of how much of a delay constitutes frustration, but it is submitted that the ‘sterility through uncertainty’ principle discussed above would apply in current circumstances  thus creating a rebuttable presumption in favour of frustration of the lease.

By contrast, if a lease is governed  English law then, even if the property cannot be used for its contractual purpose as a pub, café etc then frustration is relatively unlikely to be available to the tenant and they will continue to be obliged to pay the rent because of the ‘double duration’ test so far favored by the English courts in Cricklewood and National Carriers.  On the other hand, given the cataclysmic economic impact of the frustrating event that is Covid-19 and its associated legislation on thousands of businesses by making trading as a pub, café etc illegal it is possible that the English courts might finally adopt a less strict approach to the frustration of leases by escaping from the focus on estates in land and rather focusing on the purpose of the doctrine of frustration which is to provide justice in unforeseen circumstances which have a catastrophic  effect on the performance of a contract.

“The doctrine of frustration has been developed as a judicial device to relieve a contracting party in certain limited circumstances where it would be harsh to hold him to the apparent terms of the contract. It applies when circumstances have so radically altered from the state of things when the contract was made that the court can say that the parties cannot have intended their contractual obligations to apply in such altered circumstances.

In all the cases to which the doctrine has been applied it is possible to point to some supervening event which has had a catastrophic effect on the contract and has occurred without the fault of the parties…. Reference is also made to extraordinary delay sufficiently long to frustrate the commercial adventure of the parties. But in every case the delay has been due to some unexpected external cause beyond the control of the parties.”

The Hannah Blumenthal [1983] 1 A.C. 854 at 881 per Griffiths LJ

 In practice if the English courts will not allow frustration of leases then, in the face of the harsh economic reality situation of high rents and no income, it is likely many owners of prohibited businesses will simply put their business into administration or declare themselves bankrupt to escape their liability for rent on premises which they can no longer trade from. It is to be hoped that the English Courts will follow their Scots judicial brethern in setting aside their historical obsession with the abstract idea of estates in land and their general reluctance to allow leases to be frustrated and instead recognise that The Health Protection (Coronavirus, Business Closure) (England) Regulations 2020 by making the trading of pubs, cafes etc illegal for an uncertain indefinite period is a frustrating event even for leases.

 


[1] Lloyds TSB Foundation for Scotland v Lloyds Banking Group Plc [2013] UKSC 3 per Lord Hope JSC at para. 47.

[2] This definition has been repeatedly approved by subsequent courts see e.g.  National Carriers Ltd v. Panalpina (Northern) Ltd  [1981] A.C.675 at 701; Lauritzen AS v Wijsmuller BV (The Super Servant Two) [1989] 10 WLUK 146; [1990] 1 Lloyd's Rep. 1 and most recently in Canary Wharf Management Limited v European Medicines Agency [2019] EWHC 335 (Ch).

[3]  WG Clark (Properties) Ltd v Dupre Properties Ltd [1991] 3 WLR 579.

 

Published by School of Law, University of Aberdeen

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