Many of us in the real estate market have been waiting to feel the first effects of Brexit. With a buoyant property market and lots of foreign investment, we have been somewhat removed from it… until now. Canary Wharf’s recent application to the High Court for a declaration that Brexit will not frustrate the European Medicines Agency’s (EMA’s) underlease of 25–30 Churchill Place, is the first significant property-related Brexit case.
If the court finds in the EMA’s favour, it could have huge implications for the real estate sector and the economy as a whole.
Doctrine of frustration
When frustration occurs, it automatically kills the contract concerned and discharges the parties from future liability. Over the years, the courts have applied different tests for identifying frustration.
The traditional test, accepted by the House of Lords in Davis Contractors Ltd v Fareham Urban District Council [1956] 2 All ER 145, applies when a supervening event or circumstance makes performance of the contract radically different from the original obligation the parties contracted for.
However, there has been a move away from the traditional test in favour of a “multi-factorial” approach. This requires the courts to consider all the facts and circumstances of a case when deciding whether a contract is frustrated.
The court will consider the terms of the contract itself, the context, the parties’ knowledge and expectations at the time of the contract, the nature of the supervening event and the parties’ assessment of the possibility of future performance in the new circumstances.
The multi-factorial approach requires that each case be assessed on its own facts. However, it can generally be said that a frustrating event is one that:
1. occurs after the contract has been completed;
2. renders performance impossible, illegal or radically different from that originally contemplated by the parties.
3. is not due to the act or election of the party seeking to rely on it;
4. is not the fault of the contracting parties; and
5. is not envisaged by the contract.
The limits of the doctrine are narrow and the courts are consistent in their message that the doctrine should not be extended. It is not a mechanism to allow a party to escape a bad deal.
Frustration and leases – never or hardly ever?
When deciding that the doctrine of frustration could, in principle, apply to leases, Lord Hailsham said that his decision was the difference between “never” and “hardly ever” (National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675). It seems that Lord Hailsham was correct in this regard because, almost 38 years later, there is still no reported case in which an English court has held a lease to be frustrated.
Nevertheless, the authorities do consider scenarios in which a lease could be frustrated:
1. Where a lease is entered into for the purpose of viewing a particular event that is later cancelled. For example, in Krell v Henry [1903] 2 KB 740 a licence to use rooms for the purpose of watching King Edward VII’s coronation procession was frustrated when the procession was cancelled.
2. Where the lease provides for one principal use which subsequently becomes illegal. In National Carriers, Lord Simon referred to the American prohibition cases, in which leases of premises to sell liquor were held to be frustrated after prohibition was introduced.
3. Where the lease provides for one principal use which becomes difficult to carry out. For example, in the case of Tay v Speedie [1929] SC 593 in Scotland the tenants of a salmon fishery were allowed to abandon their lease after the establishment of a bombing range extending over the entire fishery.
4. Where “…some vast convulsion of nature swallowed up the property altogether, or buried it in the depths of the sea” (Cricklewood Property and Investment Trust Ltd v Leightons Investment Trust [1945] 145 EG 93).
Brexit – should they stay or can they go?
Many businesses that want to maintain access to the single market post-Brexit have asserted they intend to close or downscale their UK presence in favour of offices on the continent. In November last year, EU27 ministers announced that the EMA and the European Banking Authority will move from Canary Wharf to Amsterdam and Paris respectively. Focusing on the EMA case, what are the arguments for and against a finding that Brexit will frustrate long-term leases?
The EMA entered into a 25-year lease of more than 10 floors of 25–30 Churchill Place in July 2014. Put simply, the landlord demised the premises for a term at a rent. The premises were to be used as commercial offices. There is no break clause, but the EMA has the benefit of an alienation clause which allows for assignment and underletting in specific circumstances.
The lease
The terms of the lease, in particular the permitted user and alienation covenants, will be relevant to the question of frustration. In our view, if the lease permits alienation and the permitted user is broad, it is unlikely frustration arguments will succeed.
The permitted user clause in the EMA’s case is general. The case can be distinguished from Krell v Henry, when the court found the specific purpose of viewing the coronation processions was the foundation of the contract. The foundation of the EMA’s lease, and most standard form leases of office space, is the provision of office space, not the UK’s continued membership of the European Union nor the EMA’s access to the single market.
If the EMA no longer wants to occupy the premises, it could make use of the alienation provisions in the lease. Most standard form office leases will allow for some form of alienation.
In this regard, the case is comparable to London and Northern Estates Company v Schlesinger [1916] 1 KB 20, when an Austrian tenant was prevented from occupying residential premises as a result of the Aliens Restriction (Consolidation) Order 1914. The court found that, even though the tenant could not personally reside in the premises, he could still make use of the alienation covenants and, as a result, the contract was not frustrated. The EMA’s case is far less extreme since its continued occupation of the premises will not be illegal post-Brexit.
This raises the question of whether the EMA has been unable to find someone willing to take a lease of more than 10 floors with more than 20 years to run with no break option. As mentioned above, frustration should not be invoked simply to allow a party to escape a bad bargain.
The context
The parties’ knowledge at the date the lease was completed is a relevant consideration. The older the lease, the more likely it is that Brexit will frustrate it.
The EMA lease was granted pursuant to a 2011 agreement for lease. It is unlikely that the parties then would have foreseen Brexit. In fact, it could be said that the referendum result was unexpected, with opinion polls even the day before the vote suggesting that the UK would vote to remain.
On the other hand, it was in January 2013 that David Cameron announced his intention to hold a referendum on the UK’s membership of the EU. In May that year, the Conservatives published a draft EU referendum bill which said that a vote would be held no later than 31 December 2017 and, in May 2014, the United Kingdom Independence Party won the most seats in the European Parliament election.
One could argue that by July 2014, when the lease was completed, the parties should have been aware that Brexit was a real possibility and could have reflected this by including a break option.
The tenant’s status
The status of the tenant and the impact that Brexit will have on its operations is relevant to the question of frustration.
It could be argued that the parties in the EMA case envisaged that the demised premises were to be the EMA’s main headquarters and that Brexit frustrates this because it is implicit that an institution of the EU must be based within the EU. The EMA’s argument will be bolstered if it can point to a rule, regulation or constitution which requires it to be based in the EU. In this regard, we think the EMA will have a stronger argument for frustration than, for example, businesses with a European client base.
Uncertainty continues
While we await the court’s decision, there will be wide-ranging uncertainty caused by the EMA case, and the outcome will be far-reaching whatever the result. If Canary Wharf does not succeed in obtaining its declaration, we can expect to see more tenants trying their luck with arguments of frustration. Indeed, this could even extend to contracts outside the real estate sector, with significant risks to the UK economy as a whole if contracts across the board are challenged on the basis of a frustrating Brexit.
Chloe Meredith is an associate and Alison Hardy is a partner at Ashurst
