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16 June 2020

196: COVID-19 and Brexit in the property world: frustrating or just very inconvenient?

In the last two months we have received an influx of enquiries arising from the impact of COVID-19 and the subsequent lockdown. In some cases, tenants are left with offices they cannot occupy or want to downsize. In others, property purchasers have found that finance has dried up, leaving them in an undesirable position of borrowing at greater cost or risking a breach of contract.

The overarching issue in all cases has been that an unforeseen event beyond anyone’s control has put a party to a contract at risk of breaching it. Putting aside the recent government interventions in the realms of rent payments, forfeiture and business rates, what does the common law say on frustration of contracts in such situations?

Expecting the unexpected

The test for frustration is four-fold:

  1. Has the event happened after the contract was formed?
  2. Is the event so fundamental as to strike at the root of the contract and is it entirely beyond what was contemplated when the contract was formed?
  3. Is the event due to the fault of either party?
  4. Does the event render further performance of the contract impossible, illegal or does it make it radically different from what was contemplated when the contract was formed?

It is difficult to establish that an event is a frustrating event and historically the Courts have set the bar very high. In particular, where an event has led to changes in economic conditions or if there is an alternative method of performing a contract(even if it makes it more expensive to perform), the Courts have refused to say that such an event amounts to frustration.

Could Brexit be a frustrating event for the purpose of a lease?

A recent example of this is the Canary Wharf case which was decided last year (Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch)). In this case, the European Medicines Agency (EMA) entered into an agreement for lease in 2011 for a 25 year lease of space at Canary Wharf.

The lease was completed in 2014, two years before the EU referendum. Following the outcome of the referendum, the EU passed a regulation providing that EMA, being an agency of the EU, must move its headquarters to Amsterdam. EMA subsequently tried to argue that its lease of space in Canary Wharf was frustrated by the result of the EU referendum.

The High Court held that in this case, the effect of the EU referendum was not a frustrating event. In particular, although EMA could not occupy the space as its headquarters, it was still possible for EMA to hold property in non-EU countries. The fact that the lease contained a right for EMA to assign or underlet their lease meant that the lease itself governed the situation in which EMA no longer wished to occupy the space itself.

Might COVID-19 amount to a frustrating event?

The difficulty with arguing that COVID-19 (or lockdown as a result of COVID-19) is a frustrating event is that the current lockdown is anticipated to only be a temporary measure. In previous cases, a 10 year lease of a warehouse, accessible only by one road, was found by the Court not to be frustrated when that access road was shut for 20 months due to a neighbouring property being in a dangerous condition.

In the current circumstances, could a retail lease for 5 or 10 years be frustrated because the government ordered shut down of retail space for three months? If the previous case (decided in the House of Lords) was followed, then probably not. The argument is even weaker in the case of office space, where it has not been illegal to occupy such space, but the use of the space has been diluted.

Has ‘further performance’ of the contract been rendered illegal, impossible or radically different than what was anticipated? This is an incredibly high bar and it is difficult to see how this could be applied now.

In fact, post-lockdown it may not be so much a matter that occupiers will need less space for business premises, but rather the same space for fewer people, which arguably creates a lower return on investment per square foot.

It will be for the valuers to decide whether this creates a negative effect on rents in the future but as far as frustration is concerned, it is likely to be limited to specific and unusual circumstances. Of course every case is judged on its own merits, and anyone concerned about their current contractual obligations should take advice at an early stage to establish their options.

 

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