As the government restrictions on business operation and social interaction get renewed for a further period of at least three weeks, with many experts warning it may last significantly longer, we consider whether COVID-19 is likely to engage the legal concepts of ‘frustration’ and ‘supervening illegality’ in the context of property contracts in England and Wales.
Importantly, these principles will only arise if the property contract in question lacks a valid ‘force majeure’ clause that caters for pandemics (which many do not). A force majeure clause specifies what is to happen to the contractual obligations if an extraordinary event outside of the parties’ control prevents performance, for example, delaying performance, terminating the contract and/or specifying that neither party will be in breach as a result. The rest of this article focusses on remedies available if there is no force majeure clause, or if the COVID-19 pandemic is beyond its scope. For further information of force majeure clauses, please click here to read our earlier article entitled: Managing the Effects of COVID-19 – Force Majeure and Frustration, by Simon Brew (27 March 2020).
Frustration and supervening illegality
Frustration is a legal concept which originates from case law in the late nineteenth century (and it is noteworthy that there haven’t been many pandemics on a similar scale to COVID-19 since then). Frustration will discharge / cancel a contract when a contractual obligation becomes impossible to perform or drastically different from what the parties intended because of the supervening circumstances, without being the fault of either party. ‘Supervening illegality’ is a separate concept – but often features alongside frustration – and means that if the actions required under the contract have become illegal (and not merely more difficult), the contract will be discharged.
Leases and property
So how may this potentially affect property contracts? In applying these concepts to leases, the first point to note is that, while the House of Lords confirmed in 1980 that frustration could apply to a lease, there has not been a single reported English law case where it has actually happened. A recent spotlight was cast on this question in a well-known case where the European Medicines Agency (“EMA”) sought to argue that Brexit will frustrate, or render illegal, the lease of their headquarters’ building in Canary Wharf. That lease commenced in 2014 with a term of 25 years and no early termination provision. The EMA argued ‘supervening illegality’ and frustration.
The High Court decided that EMA failed on both arguments. In relation to ‘supervening illegality’, their argument failed because it was the EU itself that passed the law rendering continued occupation illegal after the Brexit referendum (and, therefore, it was a self-inflicted problem). In addition, the EMA could still do something useful with the lease, e.g. assign or sublet it. On frustration, their argument was again rejected. EMA had sought to argue that the parties had a common purpose when entering into the lease which was frustrated; the Court disagreed on the basis that, amongst other things, the landlord wanted to secure a good and reliable rent, and the tenant wanted high-quality premises (which were clearly different purposes). Finally, the Court noted that the parties (by incorporating a right for EMA to assign or sublet) actually anticipated the fact that a situation like this may arise by including back-up options for the tenant.
The case confirms that frustration is a very difficult concept to argue, and it remains the case that no party has successfully challenged a lease on this basis in a reported case. The decision was due to go to appeal, which would have offered further clarity on the law, but (unfortunately for the rest of us) the parties settled the case.
Guidance – leases
From the EMA case, it seems that almost anything in a lease that enables the tenant to utilise or deal with it in a substantive way (whether rights of subletting, assignment, or a wide or changeable permitted use) is likely to mean that a frustration argument will fail. There was an element of permanency about EMA’s ‘inability’ to occupy the premises, whereas that is unlikely to be the case for most typical tenants as the effect of COVID-19 is likely to be temporary. That said, timing may be important to increasing tenant’s prospects. Certainly, there has been case law showing that a proportionately small disturbance to the remainder of the term (e.g. a one year disturbance to a ten year term) would not be sufficient to lead to frustration, so it’s only likely to be short-term leases that are entirely immobilised by COVID-19 (both in terms of occupation and dealings) that may warrant a more detailed review, and only if proportionate to do so.
Guidance – sale contracts
With regards to contracts for the sale of land, it is likely that only those contracts which were entered into before COVID-19 became a known threat, but have not yet completed, that could justify a frustration analysis. The more significant problem with contracts for sale is that the buyer takes the land ‘on risk’ from exchange of contracts – the seller merely plays the role of trustee of the legal ownership of the property for the buyer, pending completion.
That said, there have been a limited number of cases in which the Court has recognised that frustration can apply to property contracts. Two examples are, firstly, a property destroyed by landslip, and, secondly, a property which was subject to an overage payment that could not be triggered following collective enfranchisement. On the other hand, frustration did not occur where the following things happened between exchange and completion in two separate cases; firstly, a process was started for the compulsory purchase of the property, and, secondly, a property was historically listed.
What seems to come out of those cases is that an extreme and permanent impact on the subject matter of the contract is likely required in order for the contract to be frustrated. A quote from Lord Denning, which features frequently in frustration cases, encapsulates the terrain of frustration: “It must be more than merely more onerous or expensive. It must be positively unjust to hold the parties’ bound”. It is therefore difficult to see how the COVID-19 pandemic, or its effects, are capable of creating such an impact on a property sale contract, where it would be necessary for the only rational solution in the eyes of the Court for the whole contract to be discharged, particularly in this modern era where transactions occur electronically without any face-to-face requirements. It is more likely that non-performance will simply amount to breach, but in the absence of any other argument frustration may, in the right circumstances, provide the necessary leverage to lead the parties into negotiations, and hopefully settlement.
With COVID-19 affecting so many leases and property contracts, it seems inevitable that a frustration case is likely to be run and reported in the coming period. Judges will be acutely aware of the impact that a finding of frustration may have for parties to property contracts up and down the country. Until then, frustration might help you but it is untested, unknown and difficult. Please contact us if you think you might have an issue affected by this article, whether you are a landlord, tenant, buyer or seller.