Commercial Leasees – should tenants and landlords be adjusting expectations? Frustration of contracts

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Written by Kalev Crossland and Jesvin Boparoy, www.shieffangland.co.nz
Republished with permission.
Guidance only – not intended as a substitute for specific legal advice.

Overview

Here’s our scenario: The government locks down a community, city, region, state or the country. Customers can no longer come to the tenanted physical retail store to view or purchase products or participate in some tourist related activity. Even if the tenant’s business is an online business with a leased warehouse, it may now prevented from having others deliver the goods. No customers, no sales, no income – the tenant can’t pay my lease. What can or should the landlord and tenant do?

The above scenario is what we are being asked about a lot over the last few days. The question arises: Are things so bad that the tenant can tell the landlord or lessor that as I can’t retail or trade any longer our lease or contract for my retail premises is at an end?

The answer is: Maybe. In our opinion, we are getting to the stage where a legal argument could be credibly mounted that a judge or appeal court might take seriously.  

The commonly used Auckland District Law Society form provides for a lease to terminate if the premises become ‘untenantable’. But, it does not address the situation where the premises are ‘tenantable’ but access is prevented or restricted. This is where the Doctrine of Frustration at common law may assist you.                                                                      

Don’t get us wrong – and we must emphasise – the law takes contracts very seriously. They are the lifeblood of commerce, of our economy and integral to society’s functioning.   It is therefore very hard to get out of contracts. Commercial tenants cannot walk away from leases due to events making it harder or more expensive to perform. 

If you wrongly treat your contract or lease at an end, then you likely face a claim for breach of contract and a monetary judgment against you. But perhaps the tenant could argue that the contract has been frustrated by reason of it being impossible to perform, thus you are discharged. Landlords need to be alive to this possibility and factor it into their decision making process at least for the next few months.

What is Frustration of Contract? 

Frustration of contract is the common law’s way of allowing parties to be relieved of their legal obligations. It only applies to contracts which have become impossible to perform. This legal doctrine also applies to commercial leases.[1] An example might be where a building is struck by lightning and is burnt down. As such, there is no longer a building to purchase or lease. It is no-one’s fault, but the future performance of the lease is now impossible.

The legal test for frustration of contract is this:

…frustration occurs whenever the law recognises 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. … It was not this that I promised to do.[2]

The key to this test is – “radically different”. Are events so significantly changed to completely overtake the agreement? The test is simple on its face. This is for these reasons: 

(a) Each case is assessed on its own merits. Therefore, particular earlier case decisions dealing with frustration are only general guides. The Covid 19 pandemic is new in living memory. Only the Spanish Flu of 1918-20 has broad parallels. 

(b) Do understand that frustration of contract is not an escape hatch for those who had made bad or foolish deals for other unrelated reasons. A frustrating event also cannot be something that was ‘reasonably foreseeable’ by the parties. It needs to relate to a particular event outside of your control.

(c) Some leases or contracts may actually provide for frustration of contract. They might put the risk on the tenant. As such, you will still be bound to keep paying your rent or if you are a company placing it into voluntary liquidation. 

Dealing with the here and now 

Presently, the situation is very fluid. As at the date of writing, the New Zealand Government had not placed any community in level 4 lock down. But if it does or it passes emergency legislation or regulations banning certain retail or trade activities or preventing the movement of persons the grounds for arguing the contract or commercial lease is frustrated strengthens considerably.  

Commercial landlords and tenants also be able to take advantage of the situation by looking at whether your commercial leases have a negotiated ‘break out clause’ which may assist a tenant to terminate the lease or stop paying rent if the tenant cannot get access. Clauses like these are unusual and will need to be specifically contracted for. For example under the standard ADLS lease there can be no abatement of rent and the tenant will normally need to rely on business interruption insurance (if one is available).

Practically speaking, as court lawyers, we would suggest that commercial lessees (and their guarantors) facing this situation might have enough to at least to run a legal defence. It may or may not be successful. We do not know – but it is arguable. Landlords need to be conscious of this possibility.

The practical consideration here is that once a legal claim is defended resolution of the case goes into a queue at the Court. That queue is around 18 – 24 months long. It is also costly. This should incentivise most reasonable commercial lessors and lessees to enter into an off the record (without prejudice) discussion. 

Within that period, parties may negotiate an out of court settlement to avoid, the delays, uncertainty and costs of litigation. This could take the shape of  a rent holiday or a new rental calculated based on turnover or profit for a agreed period or postponed of payment obligations. A more creative solution is the lessor taking shares in the tenant company that can be converted to debt later on given conditions. 

We would encourage commercial tenants and lessors talking to one another and being realistic and dealing with the possible. A court judgment is not worth anything if the defendant has no means to pay.

Need help?

Need legal or strategic advice from a lawyer who has worked as a litigator continuously since the aftermath of the 1987 share market crash? For no obligation, no cost chat – please call Kalev Crossland 0274 740 835.

Or feel free to also call one of Kalev’s colleagues: Shan Langston 021 876 176  Jesvin Boparoy 021 035 1540 Alice Alipour 021 0294 4692.

[1] Maori Trustee v Prentice [1992] 3 NZLR 344.

[2] Davis Contractors Ltd v Fareham Urban District Council [1956] AC 696.