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15 December 2022

Frustration Of Contract And Covid

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Covid has had a wide-ranging effect on contracts. The government introduced various schemes to mitigate the effects, for example in relation to the recoverability of rent and the ability...
UK Coronavirus (COVID-19)
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Covid has had a wide-ranging effect on contracts. The government introduced various schemes to mitigate the effects, for example in relation to the recoverability of rent and the ability to forfeit property for a certain time due to the pandemic. There has also been litigation relating to business interruption insurance policies, which went to the Supreme Court.

The Courts have also dealt with some cases in which it was alleged that contracts had been frustrated as a result of the pandemic.

The fundamentals of the law of frustration

According to the leading English textbook on the English law of contract, Chitty on Contracts (34th Edition, 2021),

" ...in J. Lauritzen AS v Wijsmuller BV (The Super Servant Two), Bingham LJ set out the following five propositions which describe the essence of the doctrine. These propositions, he stated, were "established by the highest authority" and were "not open to question". The first proposition was that the doctrine of frustration has evolved "to mitigate the rigour of the common law's insistence on literal performance of absolute promises" and that its object was:

"... to give effect to the demands of justice, to achieve a just and reasonable result, to do what is reasonable and fair, as an expedient to escape from injustice where such would result from enforcement of a contract in its literal terms after a significant change in circumstances."

Secondly, frustration operates to "kill the contract and discharge the parties from further liability under it" and that therefore it cannot be "lightly invoked" but must be kept within "very narrow limits and ought not to be extended". Thirdly, frustration brings a contract to an end "forthwith, without more and automatically". Fourthly, "the essence of frustration is that it should not be due to the act or election of the party seeking to rely on it" and it must be some "outside event or extraneous change of situation". Finally, a frustrating event must take place "without blame or fault on the side of the party seeking to rely on it". (my emphasis)

Each case must be looked at on its own merits, examining the contract in detail and bearing in mind that the doctrine of frustration cannot be lightly invoked, meaning that there is a high hurdle to be jumped before a court can find that a contract has been frustrated.

The importance of certainty in the law was set out in Bank of New York Mellon (International) Limited v Cine-UK Limited, Aew UK Reit Plc v Mecca Bingo Limited
Aew UK Reit Plc v Sportsdirect.com Retail Limited
[2021] EWHC 1013 (QB), 2021 WL 01600624. In that case the court granted summary judgment for rent arrears against three commercial tenants who had argued that the terms of their leases had been overtaken by wholly unforeseeable events when they were forced to close their premises during the COVID-19 pandemic. Rent cesser clauses in the leases were not operative because they required physical damage or destruction. In light of that, the tenants were not entitled to rely on the landlords' insurance for loss of rent because the landlords had not suffered any loss of rent. Nor had the leases been temporarily frustrated. Importantly, in relation to matters of legal principle and the approach which the courts should take, the judgment concluded as follows,

"248. However, I feel that I should end this judgment in somewhat similar terms to the end of the judgment in TKC v Allianz. The situation of COVID and the COVID Regulations has (at least in modern times and as a matter of degree) been unprecedented and in particular with regard to its effect upon the Entertainment (and Hospitality) Sector but also the Non-Essential Retail Sector who have been deprived of the turnover which is the life-blood of their businesses (and especially where there is no on-line equivalent). It is impossible not to feel sympathy for them.
249. As stated by Mr Salter QC as the section 9 Judge in the TKC v Allianz case (at paragraph 133) "Some may also argue that the common law should therefore change its approach... and should adapt its principles of contractual interpretation and implication to the present unprecedented circumstances, so that they assist in transferring the burden of the present emergency to those, such as insurance companies and other major financial Institutions. who may perhaps better be able to bear it."
250. On the other hand, the Landlords, BNY and AEW, will say that they are trustees (actual or in effect) for others (for example, pensioners) who have invested in their funds, and who may themselves be reliant upon their returns from such funds (and thus the underlying properties) for their own financial condition and well-being.
251. Mr Salter QC proceeded in his paragraph 134 to quote authors of a note as having "wisely observed":

"In times of uncertainty the law must provide a solid practical and predictable foundation for the resolution of disputes and the confidence necessary for an eventual recovery... Contractual rights are to be evaluated by applying settled principles to the contract in question. Legal certainty remains paramount and gives the surest basis for resolution."

252. That has been the basis of my analysis and this judgment. Anything else is a matter, in my view, for Parliament and not for the Courts."

The legal principles relating to frustration of contracts important whatever the basis of a claim that a contract has been frustrated, whether allegedly due to Covid or any other basis. The Covid pandemic has affected a large number of contracts, and there are a few English decided cases specifically about Covid.

Based on English common law, it is important to analyse each case based on its specific facts and to apply legal principles. Whilst the common law evolves, it does so slowly and does not change in relation to an individual case. The judges are conscious that their decision affects not just the case upon which they are adjudicating, but cases in the future.

If a court finds that a contract has been frustrated, the court has no discretion other than to "kill the contract and discharge the parties from further liability under it". As a result, the doctrine of frustration cannot be "lightly invoked", but must be kept within "very narrow limits and ought not to be extended". Thirdly, frustration brings a contract to an end "forthwith, without more and automatically".

Whilst the Covid pandemic was a significant event throughout the world, it did not effect major changes in English law.

Specific law on cases where frustration of contract has been claimed (or not)

In London Trocadero (2015) LLP v Picturehouse Cinemas Limited, Gallery Cinemas Limited, Cineworld Cinemas Limited [2021] EWHC 2591 (Ch), 2021 WL 04441740 the judge stated that,

"The Defendants say that they are not liable for rent and service charges which have arisen in relation to periods when the premises could not be used as a cinema. They put their case either on the basis that a term to this effect should be implied into the leases or, alternatively, on the basis that there has been a failure of consideration (or, as it is now more often referred to, a "failure of basis"). They maintain that this is the case notwithstanding their acceptance that the leases have not come to an end as a result of frustration and that the Landlord is not in breach of the terms of the leases. Mr Seitler, appearing on behalf of the Defendants, acknowledges that the court is being asked to develop existing principles but maintains that, given the unique circumstances presented by the Covid pandemic, it is appropriate to do so." (my emphasis).

It is noteworthy that in that case the parties seeking to avoid payment as a result of Covid accepted that the contracts were not frustrated. The tenant argued that the court should imply terms into the lease agreement alternatively that there had been total failure of consideration. The arguments which were put forward in defence of claims to rent were adjudged not to have any realistic prospect of success and summary judgment was given.

On appeal, the Court of Appeal found that

In Wilmington Trust SP Services (Dublin) Limited, Sabarmati Aviation Leasing Limited (formerly known as Sky Aircraft Cassia Two Limited), Falgu Aviation Leasing Limited (formerly known as Sky Aircraft Cassia One Limited) v Spicejet Limited [2021] EWHC 1117 (Comm), 2021 WL 01737541 claims were made for amounts allegedly outstanding under three separate Aircraft Lease Agreements, together with contractual interest and costs. The judge reviewed the wording of the lease agreements in detail and set out the relevant clauses in her judgment "as many of the arguments which arose in this case turn on the wording of the Lease Agreements". Amongst the terms to which the judge specifically referred were provisions relating to risk. I refer to paragraph 6 of the judgment. In paragraph 64, set out below the judge referred to the fact that,

"for example, the Defendant was not absolved from paying rent by the total loss of the aircraft, it is difficult to see how a temporary prohibition on use could put it in a better position."

The judge dealt with the argument about illegality arising out of Covid very concisely,

"20. This again is a point which arises only in connection with MSN 41397. The Defendant's argument was that the restrictions imposed by the Indian Government in the light of the Covid pandemic made it illegal to operate the aircraft and that the Lease Agreement, while not affecting the accrual of rental payments in these circumstances, nonetheless provided on its true construction for a suspension of physical payment for the duration of the illegality.

21. I have no hesitation in rejecting this ground of defence, not least because MSN 41397 has in fact been used during the pandemic, albeit to a much more limited extent that previously. Indeed, this was not disputed. But in any event, I find it impossible – even on the most expansive approach to construction – to spell out any agreement that payment of rent falling due should be suspended for the duration of any restrictions such as those which have in fact been imposed. As argued by Mr Shah, this was a dry lease where possession of the aircraft was transferred by the First Claimant to the Defendant for a term of ten years, such that the Defendant had exclusive possession and undertook all the risks of operation and maintenance in return for a warranty of quiet enjoyment and an assignment of manufacturers' warranties. This is made abundantly clear by numerous provisions in the Lease Agreement, but the terms of clauses 7.5(a) and (b) and 19.1 in particular seem to me to put the matter beyond doubt."

The judge indicated that the parties did not fundamentally disagree on the legal principles of frustration,

"58. There was no significant dispute between the parties as to the principles of law to be applied when considering whether a contract has been frustrated. The test commonly adopted is whether, through no fault of either party, performance of the contract has been rendered "radically different" from the obligation undertaken. In The Sea Angel, [2007] 2 Lloyd's Rep. 517 at [111], the Court of Appeal held that this required the application of 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 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. Since the subject matter of the doctrine of frustration is contract, and contracts are about the allocation of risk, and since the allocation and assumption of risk is not simply a matter of express or implied provision but may also depend on less easily defined matters such as "the contemplation of the parties", the application of the doctrine can often be a difficult one. In such circumstances, the test of "radically different" is important: it tells us that the doctrine is not to be lightly invoked; that mere incidence of expense or delay or onerousness is not sufficient; and that there has to be as it were a break in identity between the contract as provided for and contemplated and its performance in the new circumstance."

The judge went on to state that,

"64. That said, these were ten-year dry leases under which the Defendant assumed the entire commercial risk of operating the aircraft. This was made abundantly clear by the provisions of the Lease Agreements, and if, for example, the Defendant was not absolved from paying rent by the total loss of the aircraft, it is difficult to see how a temporary prohibition on use could put it in a better position. If the ban imposed by the DGCA were permanent, that might be a different matter but it has never been suggested that the ban is other than temporary even if it is currently indefinite with no sign of imminent removal. Indeed, MAX 8 aircraft were approved for return to use by the US FAA in November 2020 and also by other countries, although they have apparently been grounded again since then for a totally unrelated reason...

67. However, as I read those comments, the interests of justice only come into play if the court is otherwise minded to hold that a contract has been frustrated. In other words, it is required to pause before reversing the contractual allocation of risk. I do not understand him to be saying that the court effectively has a discretion to invoke the doctrine even if it is not satisfied that the threshold test of "radical difference" has been met. Since in my view that test has not presently been met, I do not consider that the interests of justice arise for separate consideration."

In a case arising out a seizure of a helicopter by the Italian Guardia di Finanza based on the alleged failure to pay any tax when the aircraft was imported from Switzerland into Italy, the claim in the English court was for lease payments – Iris Helicopter Leasing Limited v Elitaliana SRL, Point Holding SPA [2021] EWHC 2459 (Comm). The Defendant claimed that the contract had been frustrated.

"21. I have been referred to a number of authorities in the context of frustration. It is not necessary for me to set out large excerpts from those cases. It is sufficient to quote what might be regarded as the currently leading judgment of Rix LJ in Edwinton Commercial Corporation & Anor. v Tsavliris Russ (Worldwide Salvage & Towage) Limited (The Sea Angel) [2007] 1 CLC 876 at paras.111-112. What he said there, and which has been picked up in subsequent cases including a number of cases concerned with dry aircraft leases, is as follows:

"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 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. Since the subject matter of the doctrine of frustration is contract, and contracts are about the allocation of risk, and since the allocation and assumption of risk is not simply a matter of express or implied provision but may also depend on less easily defined matters such as 'the contemplation of the parties', the application of the doctrine can often be a difficult one. In such circumstances, the test of 'radically different' is important: it tells us that the doctrine is not to be lightly invoked; that mere incidence of expense or delay or onerousness is not sufficient; and that there has to be as it were a break in identity between the contract as provided for and contemplated and its performance in the new circumstances."

The court dealt with other import points in the extracts from the judgment set out below.

"24. ...That means that it is important – albeit not determinative – to look carefully at the terms of the relevant contract. If the terms of the relevant contract explain where the risk of events such as those which have taken place is to fall, then it is unlikely that the occurrence of those events will then give rise to a defence of frustration.

25. For reasons which I will explain when I identify the relevant contract provisions, the provisions in this case, in my view, place the risk of what has happened squarely upon the first defendant. It seems to me that to accept that the doctrine of frustration has any application in the present case would result in a reversal of the clear contractual allocation of that risk which is to be found in the dry lease. That is, to my mind, the very reverse of the proper approach to frustration and it produces the unjust result which, as Rix LJ says, is a result which the doctrine of frustration should not produce.

26. With that summary of where my judgment is leading, I turn to identify the relevant clauses which have led me to that conclusion. I should say that I have been referred to a number of cases involving dry leases, and in different ways they emphasise that the doctrine of frustration is one which is unlikely to have very much application in the context of contractual terms such as the one with which I am concerned. There is a very clear analysis of aircraft leases and frustration in the judgment of Foxton J in Salam Air SAOC v Latam Airlines Groups SA [2020] 9 WLUK 516 ("Salam Air"), and as he says, where one has a six-year aircraft lease it is a challenging context in which to establish frustration."

Salam Air Saoc v Latam Airlines Group Sa [2020] EWHC 2414 (Comm) was a case involving a "dry" aircraft lease. The Court examined the detailed provisions of the leases, and stated,

"47. While I accept that the terms of the contract in issue are not necessarily determinative of the issue of frustration, the nature of the contract and its terms are of obvious relevance when considering whether the contract has been frustrated by a particular event and how particular risks have been allocated.

48. A 6-year "dry" aircraft lease is a challenging context in which to establish frustration. The lessor assumes very limited obligations under such a contract – essentially only that of ensuring quiet possession of the Aircraft – in return for the income stream represented by the rent, with the lessee assuming the commercial risks and rewards of operating the aircraft. From the lessor's perspective, it matters not whether the lessee uses the aircraft at all, how frequently or with what level of occupancy. Latam was at the material times still able to perform its obligation to provide SalamAir with quiet possession of the Aircraft, and SalamAir to perform its obligation to pay the rent.

49. In ACH Acquisition XX LLC v Olympia Airlines SA [2012] EWHC 1070 (Comm) , Teare J considered an argument that an aircraft lease had been frustrated because the aircraft could no longer be operated due to the revocation of its airworthiness certificate (an argument not raised on the appeal at [2013] EWCA Civ 369 ). The terms of the aircraft lease there were similar to, but not identical, to those at issue here. One difference was that the examples of circumstances in which rent would continue to be payable included the following:

"any other cause which, but for this provision, would or might otherwise have had the effect of terminating or in any way affecting any obligation of Lessee under this Agreement".

53. Teare J had little difficulty in dismissing the argument that the lease was frustrated, holding at [181]:

"I have already set out the terms of the lease of most relevance when considering the possible application of the doctrine of frustration. They are found in the context of a 'dry' lease pursuant to which possession of the aircraft is transferred to the lessee who is the operator of the aircraft. In such a lease, particularly one where the lease is for a substantial period of 5 years, the parties would expect the lessee to assume the risks inherent in operating an aircraft. One such risk is that the aircraft authority might withdraw the certificate of airworthiness and impose certain conditions before it is reinstated. Whilst such events might occur only rarely it is an obvious risk of operating a passenger aircraft. Clause 5.14 emphasises the risk assumed by the lessee because it provides that the lessee's obligations are absolute and unconditional irrespective of any contingency whatever. The examples given of matters which are not to affect the lessee's obligations, and hence of which it is envisaged that the lessee will take the risk, are not obviously limited to 'a temporary period of unairworthiness which could be remedied by some relatively simple maintenance process'. Rather, the examples contain no words of limitation ('any unavailability of the Aircraft for any reason, including ... any prohibition or interruption of ... Lessee's use, operation or possession of the aircraft' and 'any lack ... of airworthiness'). Since the clause includes the words 'irrespective of any contingency whatever' it is not possible, in my judgment, to imply words of limitation. This is emphasised by the inclusion within the list of examples of 'any other cause which, but for this provision, would or might otherwise have the effect of terminating or in any way affecting any obligation of Lessee under this Agreement."

54. The present case – in which it is not any feature of the Aircraft leased which prevents their operation, but restrictions on the business in which SalamAir wishes to deploy the Aircraft, namely carrying passengers within and to and from Oman – is, if anything a clearer case. The risk that SalamAir might be unable to undertake passenger flights from Muscat or elsewhere in Oman for some significant period, or that there might be a dramatic and long-lasting fall in the demand for air travel more generally, were risks inherent in the commercial operation of the Aircraft and assumed by SalamAir under the Aircraft Leases. If total destruction of the Aircraft, or dispossession through requisition, do not relieve SalamAir of the obligation to pay rent, then it is highly improbable that the matters relied upon by SalamAir in this application have this effect.

55. Finally, as I have noted, these were six year leases with three years left to run at the time it is alleged that the inability to operate passenger flights to, from and within Oman frustrated them. While the Aircraft Leases gave SalamAir the option to terminate the leases after 4 years if it ceased to carry on the business of air transport at all, there is nothing to suggest that this contingency has materialised. It is SalamAir's case that it is retaining 6 aircraft leased from others, but that it does not expect to have sufficient business for three additional aircraft. In my view, the contention that the effects of the 26 March regulation were sufficient to frustrate aircraft leases with three years to run is a weak argument. However, in contrast to my conclusions in paragraphs [49] to [54], I accept that this issue is sufficiently arguable to satisfy the conventional American Cyanamid merits test had it applied.

Especially in the case of long-term contracts, as opposed to contracts for, say, a specific event, it will be very difficult to convince a court that the whole purpose of the contract has been frustrated.

The commercial rationale of the contract is key and the court will examine the assumption of risk at the time the contract was entered into.

In a nutshell, the cases have decided that in relation to events which may prevent the carrying out of contracts, the court needs to look at the terms of the contract, the duration, the parties' expectations at the time the contract was entered into, the assumption of risk by each party and bear in mind that the law needs to provide legal certainty for future cases.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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