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Frustration of contracts and COVID-19

In our spring 2020 Briefing just as the global pandemic was taking hold we analysed some high-level issues likely to affect contractual relationships on the one hand between invoice financiers and their clients, and on the other hand between invoice financiers and debtors.

One of the effects of the pandemic has been to slow down (some might say even further!) the litigation process in the UK courts, and despite one or two high-profile decisions relating primarily to business interruption insurance there have been few reported cases dealing with the effects of the pandemic relevant to invoice financiers.

In the spring 2020 Briefing we sketched out the parameters of the doctrine of frustration of contracts, which may discharge the parties from performance of a contract that has become legally or physically impossible through no fault of the parties. We pointed out that this doctrine is very difficult to establish and gave as an example the failure of the European Medicine Agency to extract itself from a long lease on its central London premises as a result of the fact that it had to move to Amsterdam following Brexit.

There has now been a case on aircraft finance which may be relevant. In Salam Air SAOC v Latam Airlines Groups SA [2020] EWHC 2414 (Comm) Salam Air, an aircraft operator, was seeking an injunction to restrain Latam Airlines from making demands under three standby letters of credit in relation to the underlying leases of three aircraft. Salam Air argued that the aircraft leases had been frustrated by the impact of the COVID-19 pandemic and so no rent was due under them. The frustrating events being regulations issued by the Public Authority for Civil Aviation in Oman restricting air travel and substantially decreased demand for flying due to the pandemic.

The Court disagreed and Mr Justice Foxton noted that it would be “challenging” for any lessee under leases drafted on what is sometimes referred to as a “hell or highwater” payment basis to establish frustration.

The aircraft leases were drafted to make it clear that Salam Air’s obligation to pay rent continued in almost any conceivable circumstances, expressed to be “absolute and unconditional irrespective of any contingency whatsoever”, including “the ineligibility of the aircraft for particular use or trade.”  The terms of the leases clearly showed an agreed risk allocation between the parties and in taking on the leases, Salam Air had taken on the obligation to pay rent irrespective of whether its operating circumstances changed, even if that change was a dramatic and long-lasting fall in demand for aircraft, or a change in the regulatory framework which prevented flying. Where a lease made it clear that a lessee had taken on the risks inherent in the commercial operation of the aircraft, such as agreeing to pay rent even if there if there was a total destruction of the aircraft, it was “highly improbable” that a lessee would be relieved of the obligation to pay rent where that commercial operation was impacted, even by the effects of a pandemic. Salam Air’s circumstances under the leases did not therefore meet the test of frustration, and there was nothing unjust in holding it as lessee to the terms of its commercial bargain.

Whether the effects of the pandemic could be successfully argued to constitute a frustrating event in relation to different forms of contract remains to be seen. The pandemic is likely to bring a wave of disputes as to which party bears the risks of non-performance under a contract and, despite frustration of purpose rarely being found by the English courts, we may well see it argued in more of them.