COVID-19 and the Frustration of Leases: Lessons from Hong Kong

Introduction[1]

With many parts of England subject to severe COVID-19 restrictions that have mandated the closure of non-essential shops, it is likely that many tenants are being forced into financially untenable positions. Subletting and assignment are commercially impossible in the current climate, and the difficulty of finding new tenants means that it would be illogical for landlords to agree to early termination. It is therefore pertinent to consider the potential application of the doctrine of frustration to leases, which would have the effect of automatically discharging the parties’ obligations thenceforth.[2]

At the time of publication, I am not aware of any reported cases in England and Wales of frustration being pleaded in respect of a tenancy dispute relating to COVID-19 or the attendant restrictions. Among common law jurisdictions, the Hong Kong Court of First Instance has led the charge, and its November 2020 decision in The Center (76) Ltd v Victory Serviced Office (HK) Ltd[3] may well set the tone for any upcoming tenancy disputes relating to COVID-19.

This note will begin by summarising the current position in English law as regards the applicability of frustration to leases, before analysing how the law has been applied to the COVID-19 situation in the Center 76 case. I will then argue that while the outcome reached in the Center 76 case was just, English courts should not adopt its ratio when approaching similar cases that may arise in the near future, and should instead seize the opportunity to re-examine the law on frustration as applied to leases.

Frustration and Leases: Where the Law Stands

The starting point of any analysis must be the National Carriers case[4], in which a majority of the House of Lords[5] first accepted, in principle, the proposition that a lease was capable of being frustrated. However, because frustration was not actually made out on the facts, and because there has been no subsequent case where frustration has been successfully pleaded,[6] that proposition remains obiter even today.

At time of publication, the position currently stands as follows: while the proposition that leases are capable of being frustrated seems to now be universally recognised,[7] this is strictly speaking not binding as a matter of law, so it is still technically possible (albeit practically inconceivable) that a claim might fail on this preliminary basis. More significantly, when frustration is pleaded in respect of leases, the standard required for a successful claim is exceedingly high. An illustrative recent case is Canary Wharf (BP4) T1 Ltd v European Medicines Agency,[8]  in which the European Medicines Agency failed in its claim that a 25-year lease for its EU headquarters  which commenced in 2014 had been frustrated due to Brexit, because the lease was assignable and the property could be sublet.

The Center 76 Case

It is against this backdrop that we turn to the Center 76 case. The tenant, a flexible workspace provider, had a five-year lease of a 76^th-floor office in The Center, a skyscraper in the heart of Hong Kong’s Central district, which commenced in September 2019. Since February 2020, the tenant had failed to pay the rent and other charges, and in June 2020 the landlord commenced proceedings for possession and to recover the arrears. The action succeeded, and summary judgment was given in November 2020. Of present interest is the fact that the tenant’s submission that the lease had been frustrated by disruptions caused by social unrest and COVID-19 restrictions was rejected as ‘unmeritorious… moonshine’.[9]

DHCJ Ho’s reasoning for rejecting this submission[10] is twofold:

‘The Defendant has not adduced any evidence to show how long the disruptive events and/or COVID-19 pandemic were expected to last during the unexpired term of the tenancy or at least for a long period of that unexpired term.’

‘Furthermore, the Defendant’s conduct in holding onto the Premises instead of surrendering them is inconsistent with its claim of frustration. Its refusal to deliver up possession of the Premises is evidence of its lack of good faith in this defence.’

While the decision is unsurprising on the facts, both grounds of DHCJ Ho’s judgment raise interesting points of general applicability.

The First Ground: the Duration of Interruption

It is good law that the duration of the interruption of use (specifically, whether the duration is a significant proportion of the original lease) is a critical factor in determining whether a lease has been frustrated. On the facts of the National Carriers case,[11] access to a warehouse being blocked for 20 months in a 10-year lease that had 5 years left to run was held to be insufficient to make out frustration. This is sound, because it would have been disproportionate and unjustified to automatically terminate the entire contract on account of one-third of the remaining lease being disrupted.

Indeed, this proposition dates back at least as far as the Cricklewood case (heard in 1944),[12] wherein Viscount Simon LC held that retail disruption caused by WWII restrictions was not capable of making out frustration, because

‘the lease at the time had more than ninety years to run, and though we do not know how long the present war… [is] going to last, the length of the interruption so caused is presumably a small fraction of the whole term.’[13]

That the duration of the claimed interruption should be for a substantial period of the remaining lease in order to make out frustration seems to be wholly consistent with the doctrine of frustration itself. The general test for frustration as set out by Lord Radcliffe in Davis Contractors v Fareham Urban District Council[14] is whether a thing undertaken under the frustrating circumstances would be ‘a thing radically different from that which was undertaken by the contract.’ For a lease to be rendered ‘radically different’ by disruptions, it is common sense that the disruption suffered should last for a substantial period of the remaining lease.

As such, DHCJ Ho was surely correct for finding against the tenant due to its inability to demonstrate that the disruptions caused by social unrest and COVID-19 disruptions would remain extant for a ‘long period’ of the remaining tenancy.[15] It is of course trite law that the burden of proof is on the claimant, who was in this instance the tenant asserting that frustration had occurred.

Yet one cannot help but feel sympathy for the tenant (at least as far as this point is concerned), due to the practical impossibility of demonstrating the length of the disruptions caused by COVID-19 and social unrest. At the time of trial (before the results of several COVID-19 vaccine trials were announced), nobody, least of all an indebted tenant and its legal counsel, was in a position to even speculate how long the pandemic might last, or whether Hong Kong might again see mass political protests. The tenant can hardly be faulted for failing to adduce evidence that simply does not exist—the government monitors the pandemic and updates its policy on a day-to-day basis, so it is simply not possible to adduce evidence as to the duration (or even likely duration) of pandemic-related restrictions.

These observations raise an interesting general problem, which is perhaps the most germane aspect of the Center 76 judgment: any tenant trying to plead frustration under COVID-19 restrictions (or indeed, any restrictions of indeterminate duration) would face insuperable difficulty in fulfilling the burden of proof vis-à-vis the extent/duration of those restrictions. If the Center 76 case remains good law, it would be virtually impossible for any such claim to succeed.

The Second Ground: the Tenant’s Conduct

On the facts of the Center 76 case, the tenant failed to pay rent for several months, yet nonetheless refused to deliver possession of the premises when so demanded. In the subsequent action by the landlord, it then pleaded frustration, while still continuing to use and occupy the premises even as the case was being heard.[16] DHCJ Ho was understandably unimpressed by this conduct, and held that the tenant, to summarise with a colloquialism, could not have its cake and eat it too. There is nothing controversial about DHCJ Ho’s finding: surely, if the tenant believed that the lease had been frustrated, it would deliver possession and terminate the lease at the earliest opportunity; its failure to do this was evidence that the lease had not been frustrated, as the tenant still saw (and presumably in fact derived) value in retaining possession in an attempt to ‘generate income without paying rent to the prejudice of the [landlord]’.[17]

While the tenant’s conduct on the facts was certainly egregious, it is submitted that this finding should be confined to the facts of the present case. It may not be the case that every instance of a tenant refusing to deliver possession is evidence that the lease has not been frustrated, because there may be compelling reasons for not doing so. Take, for example, the lease of a showroom for the display of large chattels (e.g. furniture, or grand pianos, or luxury cars) that cannot practicably be moved in order to deliver up vacant possession, especially during a pandemic. The tenant in such a case may well still derive some value from the storage of the showpieces, but surely this value would be de minimis if the main purpose of the lease (to use the property as a showroom) is frustrated by the mandatory closure of non-essential shops. Therefore, the conduct of the tenant in failing to transfer possession when demanded should not be determinative in every case, although it is certainly conceded that a tenant that takes active steps to leave the premises would likely have the stronger factual claim for frustration compared to a tenant that does not do so.

The Way Forward

Despite the fact that the Center 76 case was heard in Hong Kong, both grounds of the judgment on frustration can easily apply to cases heard in English courts. If the judgment is indeed adopted, the implications for tenants seeking to frustrate their leases would be dire.

As regards the first ground, English tenants seeking to plead frustration would, logically, also find it impossible to fulfil the burden of proof as regards the expected duration of disruption while the pandemic is still ongoing. This would have the unjust effect of causing claims to fail that would have otherwise succeeded if the actual duration of disruption is known beforehand: suppose that the current COVID restrictions last until the end of 2021, but no longer. If the government announced this in January 2021, a retail tenant that entered into a one-year lease at the end of 2020 would certainly have a strong case for frustration; but if the government refuses to commit to a long-term strategy and instead intermittently reviews the restrictions (as it is now doing), the tenant would not be able to succeed in its claim until most of the lease is already elapsed—a financially ruinous outcome.

The second ground of DHCJ Ho’s judgment, while more confined to the facts of the Center 76 case, nonetheless suggest that tenants must be mindful of their conduct, as it could well form the evidential basis of the court’s finding on frustration. In particular, a retail tenant facing a demand to deliver up vacant possession may be in a difficult dilemma, since doing so might be financially ruinous (due to the added expense of transporting and storing stock), but not doing so may impede a subsequent claim of frustration.

If English courts decide to adopt the ratio of the Center 76 case, tenants intending to plead frustration in respect of COVID-19 restrictions would certainly face an uphill battle, with the broader implication that the doctrine of frustration as applied to leases would be robbed of a great part of its practical significance. Beyond implausible scenarios such as where ‘some vast convulsion of nature swallow[s] up the property altogether’,[18] the status quo under stringent COVID restrictions seems to be the quintessential situation where frustration should rescue a tenant from a lease that has been rendered commercially ruinous; however, most claimants would have little prospect of success if faced with an impossible burden of proof as regards the duration of disruption.

It is therefore submitted that English courts should decline to follow DHCJ Ho’s judgment in the Hong Kong Court of First Instance, and should instead take this opportunity to re-examine the law on frustration as applied to leases. It is accepted that frustration is an exceptional and residual doctrine designed to cure injustice where no other remedy can operate, and as such should not be applied liberally.[19] Notwithstanding, its extension to leases would be largely devoid of purpose if the bar remains insuperably high. Adopting a lower standard of proof as regards the duration of disruption than that applied in the Center 76 case would not only result in greater legal coherence insofar as it allows the doctrine to be successfully applied in practice, but may also provide a lifeline to countless tenants in dire financial straits. A careful balance must be struck, and time is of the essence.