Legal briefing | Real Estate | 11 Mar 2019

4 steps for landlords to guard against lease frustration

Overview

The judge in the recent case of Canary Wharf v EMA has found in favour of the landlord, Canary Wharf. Brexit will not frustrate the EMA's lease on either of the grounds argued: supervening illegality or frustration of common purpose. Can landlords do anything to minimise a tenant's chance of success in arguing its lease has been frustrated? Here are four ideas for landlords to consider when negotiating new leases, based on the judgment in Canary Wharf v EMA

4 tips for landlords

1. Permit assignment and subletting, unless the landlord has reasonable grounds to object.

The judge noted that alienation is a valuable right in itself. Provided that alienation has not become illegal,
the ability to assign or sublet, even where the tenant itself is no longer legally able to occupy, can be sufficient to defeat frustration. The fact that it may be very difficult for EMA to alienate was not decisive in this. 

2. Do not permit overly specific fit-out or initial construction of a leasehold premises.

Is the proposed construction and/or fit out so specific to a tenant or so irremovable once installed that alienation and/or subletting is likely to become impossible or extremely difficult as a result? EMA tried to argue that the construction and fit out was not suitable for any other tenant's occupation for the duration of the term.

The EMA had a large say in the initial fit-out of the premises, and had made a substantial contribution towards it. However, it was clear to the judge on the evidence that Canary Wharf had negotiated to ensure that the bespoke elements of the building did not materially prejudice the continued user of the property by potential future tenants, and so the EMA's argument on this ground ultimately failed.

3. Allow for a wide permitted use.

To take an example, if the permitted use for a power station is to produce energy from only one fuel, then any subsequent change in legislation banning use of this fuel might prevent the power station from operating and could support the tenant's argument for frustration. Provision for the use of alternative fuels, or an alternative class of fuels, would weaken a tenant's argument on this ground. 

4. Keep records of divergent purposes.

An argument for frustration of common purpose relies on there being a common purpose! Good record keeping of negotiations may be helpful to show the terms of a lease resulted from a compromise of two different negotiating positions rather than a common purpose. In this claim there was evidence of no common purpose – e.g. requests for break rights denied by the landlord and discussions of rent inducements being traded for length of term. Anything that shows a divergence between the landlord's desire for long term cash flow and the tenant's desire for flexibility will be helpful evidence that there is no common intention on which to found a frustration claim.

The EMA's arguments for frustration

1. Supervening Illegality

In simple terms, the EMA argued that the UK's withdrawal from the EU would render it illegal for the EU to retain its headquarters in the UK. The judge held that, although it is relevant to consider foreign law for the purposes of an entity entering into a contract, it is domestic UK law that is relevant when
looking at supervening illegality and there was no illegality under UK law.

2. Frustration of common purpose

The EMA argued that there was a common purpose for the EMA to use the premises as their headquarters for the whole of the 25 year term.

The judge applied the "Panalpina test" to see whether:

"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." (National Carriers Ltd v. Panalpina (Northern) Ltd [1981] 1 AC 675)]:

Looking at many factors, including the provision for alienation and subletting, the negotiations relating to fit-out, and the discussions on break-rights and rent inducements, it was held that the test was not
met. There was no wider common purpose outside of the terms of the lease, and no frustration of common purpose.

Conclusion

The facts of the Canary Wharf v EMA case are very specific and the changes in EU and UK law resulting from and relating to Brexit are unlikely to be applicable to many other leases. However, given the cost to the EMA of paying 'double rent' for the rest of its 25 year term (i.e. on its Canary Wharf premises and also its new premises in Amsterdam). This is a first instance ruling and one can imagine that EMA may appeal the decision.

Although the doctrine of frustration will remain difficult to use in determining a lease, the court did not reject the possibility of this. It provides some recent guidance on the grounds on which courts might entertain such an argument. As a result, landlords can take some simple steps as outlined above to attempt to minimise the risk of a tenant successfully claiming their lease is frustrated, by Brexit or otherwise.

For our previous briefing on the topic click here.

For our briefing on the wider relevance of this case to commercial contracts, click here.

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