Risk allocation in commercial leases: the High Court considers rent suspension, insurance and frustration arguments
Whilst there is often no substitute for reading the full judgment in a case, the 100 pages delivered in Bank of New York Mellon (International) Limited v Cine-UK Limited [2021] EWHC 1013 (QB) (and the other cases heard with it) is more than a little off-putting. Having waded through it, I can reassure readers that the courts’ approach to arguments raised by tenants to challenge their COVID arrears can largely be gleaned from reading the rather more palatable 18 pages of the decision in Commerz Realinvestmentgesellschaft mbh v TFS Stores Limited [2021] EWHC 863 (Ch). (Master Dagnall confirmed in Bank of New York that he regards the two judgments as “fully consistent” in their analysis and conclusions.) Alternatively, take a look at my short summaries of that decision at Lockdown arrears: the High Court gives its view and Lockdown rent arrears: the High Court gives its (summary) view.
Nonetheless, if you are after detail – especially when it comes to the relevant Lease clauses and insurance provisions, not to mention frustration principles – then Bank of New York is the one for you! For those who do not have the time or inclination to digest the detail, the key points are summarised below.
What is the case about?
The case looks at whether tenants of commercial premises have remained responsible to pay their rents despite the enforced closure of, or inability to trade from, their units during COVID-19. It considers rent suspension clauses, the operation of insurance provisions within leases and principles of frustration.
Although the hearing preceded the judgment in FCA v Arch (UK) Ltd & Ors (see Financial Conduct Authority (Appellant) v Arch Insurance (UK) Ltd and others (Respondents) (supremecourt.uk)) – where the Supreme Court made findings on the interpretation of certain standard-form terms in business interruption insurance policies – the parties were given the opportunity to make submissions in light of that judgment.
What were the facts?
The Master heard applications for summary (i.e. early) judgment made by associated landlords in relation to arrears owed under three leases of commercial premises. The subject premises were a mutiplex cinema, a bingo hall and a retail shop in Blackpool (with Sports Direct being the tenant of the latter).
The leases were all protected by the Landlord and Tenant Act 1954, contained upwards-only rent reviews, permitted assignment/subletting with landlord’s consent and did not have “keep open provisions. Their durations were as follows:
Cinema - 35 years from May 1999, with a break clause in 2024 – i.e. a further 2.5/12.5 years remaining after the current planned release of pandemic restrictions
Bingo hall - 15 years from September 2017, i.e. a further 11 years remaining
Sports Direct - 15 years from October 2007, i.e. just over a further year remaining
All three tenants had been subject to government restrictions regarding the use of and access by the public to their premises and had been required to close for certain periods of time. For some of them, it had not been commercially feasible to reopen even when permitted to do so on a limited basis by the government.
The claims had originally covered the rent due on 25 March 2020. However, by the time of the hearing in November and December 2020, the court had given permission to enable rent for the other quarters also to be claimed.
Summary of the parties’ positions
The tenants argued that they had been overtaken by unforeseeable events which had rendered the commercial purpose of the leases temporarily (at least) impossible and unfulfillable. They submitted that this should result in the burden of rent being lifted from them on a number of legal grounds. They also contended that, since they had paid for insurance under the leases, the insurance should cover the rents.
The landlords argued that the allocation of risk in relation to these (at least partly foreseeable) events was a matter for negotiation between the parties and could have led to rent suspension if appropriate provisions had been included within the leases – which they were not. They also submitted that their insurance cover did not extend to reimbursing loss of rent where the rent cesser provisions were not engaged and the relevant tenants can pay.
Was early judgment appropriate?
The tenants asserted that they had a real prospect of defending the landlords’ claims and/or there were compelling reasons why the claims should be disposed of at a trial, e.g. the landlords’ refusal to negotiate.
On most points, the Master disagreed that a full trial was required. He felt that the parties had all had an adequate opportunity to address the relevant issues in argument and noted the public interest in having the issues determined (where this can fairly and justly be done) sooner rather than later, with appropriate savings of cost and resource. The Master commented that "this is not a matter where any evidence is going to be produced to better inform the court". He concluded that it was therefore appropriate for him to decide the issues of interpretation raised in this case and did not feel that the absence of negotiation by the landlord constituted a “compelling reason” for a trial.
Was the Code of Practice relevant to the arrears claims?
The Master noted the various restrictions on landlords' remedies which had been imposed by the government since the pandemic hit in March 2020, currently due to expire in summer 2021. He also commented on the Code of Practice published in June 2020, which strongly encourages communication and negotiation between landlords and tenants in arrears situations. (See Government code published for commercial property arrears during COVID-19)
The tenants submitted that it was highly inconsistent with the Code for the landlord to be insisting upon full payment of rents and to be pressing for summary judgment, particularly where the tenants' turnover had been destroyed by the pandemic and resulting government regulations. However, the Master did not consider that the existence of the voluntary Code – to which none of these landlords had signed up - should oblige a landlord to negotiate or obstruct it from obtaining summary judgment in a clear case, nor did he feel that the court should use its power to stay the claim to allow for negotiations. He noted that the government had put no limitation on a landlord's right to sue for rent and/or the resulting possibility of enforcement, including by seizing goods through a writ of control.
The Master also pointed out that the Code does not restrict landlords from requiring tenants who can pay their rents to do so and that the tenants in this case had made no suggestion that they could not pay the outstanding rents. It was not for landlords to have to demonstrate their tenants' financial positions. The Master commented:
"I regard the Code both as being outside the litigation process and not applicable to these Tenants who are not said to be unable to pay."
Did the rent cesser/suspension provisions apply?
The Master agreed with the landlords that the correct approach was to start by reviewing the interpretation of the rent cesser clauses without reference to the terms of the insurance, not least since the leases pre-dated the insurance policies by a number of years. (No evidence was produced regarding the insurance policies in place when the various leases were granted and it was noted that the various definitions within the leases of “Insured Risk” did not expressly provide for infectious diseases, which indicated that they were not within the parties' contemplation at the time.)
Although these clauses were designed to protect tenants (and indirectly landlords) against an Insured Risk Event preventing the use of the premises by the tenant, the relevant wording required the inability to use the premises to be as result of them being "damaged or destroyed" by the Insured Risk Event. The references to "damage" were clearly aimed at the physical, such as referring to remedial and reinstatement works. The Master therefore did not regard it as clear that the parties would have agreed for the rent cesser clause to operate in COVID circumstances, even if the landlords had decided to insure against such risks.
Referring to the general principles with regard to the construction of contracts, the Master made a number of observations in his approach to interpreting the clause including:
- that the relevant insurance is primarily for the protection of the landlord as owner of the "bricks and mortar" and is therefore concerned with that, rather than effects on trade
- even if a landlord insured against a risk which would only lead to non-physical damage/disadvantage - rendering it an “Insured Risk” - this would not automatically extend the interpretation of the rent cesser clause to apply to non-physical damage/disadvantage
- although the COVID restrictions are unprecedented in modern times, pandemics causing mandatory closures have previously been experienced with both the Spanish flu in 1918 and the 17th century Great Plague
- there has always been the option for tenants to insure themselves against the inability to use their premises. Since such insurance covers the relevant business (i.e. the trade) rather than the premises themselves, it would not fall foul of lease provisions against the tenant effecting insurance of the premises.
The Master noted that his conclusions were supported by the insurance provisions within the leases.
The Master also considered – and rejected - the tenants’ proposal for an implied term to apply the rent cesser provisions in COVID circumstances. (This is examined in further detail below.)
How did the lease insurance provisions work?
The tenants sought to rely upon the insurance provisions in two ways:
- they argued that the insurance covered the relevant rent owed and that they should enjoy the benefits of this; or
- if the insurance did not cover the relevant rent, then it should have done so and the tenants’ liability for rent should be adjusted accordingly.
The Master felt it was arguable that the tenants should be able to obtain the benefit of insurance to satisfy/reduce their rent liability where the relevant cover extended to the consequences of the closure of the premises in the event of an Insured Risk Event. However, although the landlords' insurance extended in principle to losses arising from the pandemic (and therefore fell within the definition of an “Insured Risk"), the Master agreed with the landlord that there was no relevant cover in the current circumstances, i.e. where the rent cesser clause does not apply to release the tenants from their payment obligations. Looking at the wording of the policy, the Master noted that it was aimed at the business of the landlord rather than the tenants and that it was the landlord (as the insured) who had to suffer some form of loss.
The Master also rejected the tenants’ argument that the landlords had acted in breach of the insurance provisions by insuring against COVID and the resulting regulations (therefore making them an Insured Risk), but without arranging for the cover to extend to the rent in circumstances of closure or inability to use the premises. He felt it was logical for the landlord only to insure against the consequence of the rent cesser (or possibly a tenant insolvency resulting from an Insured Risk) and that the tenants could protect themselves through business interruption policies. Again, the Master observed that this was a matter of "negotiated allocation of risk".
The Master considered whether the tenants would have any real prospect of establishing some estoppel or equivalent defence on the basis that the landlords had required the tenants to pay the insurance premium, but this argument was rejected given that the landlords had not in any way represented that the rent would be covered in the current COVID circumstances.
What about implied terms?
The tenants contended that there was a real prospect of successfully arguing for implied terms in the leases that:
- there should be a rent suspension in these circumstances, i.e. where unprecedented and unforeseen circumstances such as COVID and the resulting regulations force the closure of premises; and
- where the landlord arranges insurance for a relevant risk (paid for by the tenants), this should extend to covering the rent and service charge in the event of closure of the premises resulting from the relevant risk.
The Master agreed that the tenants' proposed implied terms would have been fair and reasonable and equitable, although they might have given insurers a liability which they had not contemplated. However, the tenants had the burden to show that the proposed implied terms were either (or both) obvious or necessary for business efficacy. In the Master’s view, they failed to do so. The implied terms were not so obvious that their proposed provisions went “without saying" and they were not required to give the leases business efficacy since the leases worked without them. The Master was also unconvinced that COVID and its related regulations were truly unforeseeable.
The leases were lengthy, standard-form, professionally drafted documents which appeared to have been prepared with care. They went into great detail regarding all sorts of circumstances, including when the rent cesser and insurance cover would apply. The Master noted that it had been open to the tenants to negotiate a term to remove liability for rent if any Insured Risk Event resulted in a closure, rather than just the physical deterioration of the premises. Whilst he appreciated some force in the tenants' argument that it would be inconvenient for them to obtain a "top-up" insurance to apply in certain specified circumstances, this did not make it unreasonable for them to do so. He also felt that the tenants’ payments towards the premium did not require the landlord to tailor the insurance cover to their benefit.
In the Master's view, the landlords’ interpretation of the leases and suggested allocation of risk was perfectly commercial and reasonable and should be preferred.
Other arguments
There were a number of other arguments put forward by the tenants in defence of their position, namely:
- “Temporary” frustration of the leases
- Temporary suspension of an obligation where it becomes impossible for it to be performed legally
- A partial failure of consideration, on the basis that the tenants were unable to operate from the premises in accordance with the permitted uses
These were all rejected by the court.
How did the court respond to the frustration argument?
The Master noted that frustration generally provides for the discharge of a contract where there is a wholly unexpected event not catered for by the parties’ agreement and which sufficiently affects the contract so as to in some way negate its purpose.
Although the doctrine of frustration applies to leases, such occasions are rare. The Master observed that the doctrine is one of justice but said that the demands of justice should not be overstated so as “to suggest that the court has a broad absolving power whenever a change of circumstances causes hardship to one of the contracting parties...”
The tenants here were not looking to suggest that any of the leases had been frustrated altogether – and the Master confirmed that he would not have been prepared such to make such a finding. Instead, they argued that there had been a “temporary frustration” during the periods of lockdown and enforced closures, meaning that rent should not be payable for such periods.
The Master accepted that an enforced closure of premises in such circumstances might be a supervening event capable in principle of leading to the frustration of commercial leases, especially where the permitted use has become impossible. However, he felt that such a consequence would only apply in a rare or very rare case. In his view, consideration was required as to whether the situation had become so "radically different" and outside what had been in the reasonable contemplation of the parties that it was unjust for the lease contract to continue. Relevant to this exercise was the original duration of each tenancy, the likely period of disruption (which the Master considered unlikely to be more than 18 months) and the remaining term of the lease once the disruption has ended, bearing in mind their protection under the 1954 Act (see under “What were the facts?” above).
Even with Sports Direct – which reopened in April 2021 and therefore had around 1.5 years of its lease term remaining at that time – the Master considered that there was a “significant period” left on the lease after the limited period of enforced closure. (He made it clear that this was not a case where the contractual lease term ended during a lockdown, which he noted might be argued to be “a different situation”.) He therefore saw no real prospect of the tenants successfully arguing that the COVID situation constituted such a “radical difference” so as to make it unjust for the leases to continue, bearing in mind their terms and allocations of risk (as outlined above).
The Master also rejected Sports Direct’s suggestion that there had been a "temporary frustration". Apart from the fact that this would also need sufficient “radical difference” (which had already been rejected), there is no such thing as a "temporary frustration" so as to suspend the contract for a period of time in law. Frustration has the effect of discharging a contract and ending it, rather than suspending it, and it is clear from case-law that any such flexible version frustration would require legislation.
Concluding remarks
The Master noted the difficulties caused by COVID and the resulting government regulations and said that it was "impossible not to feel sympathy" for the tenants who had been deprived of their turnover. He observed that there had been some suggestion for the common law to change its approach to contractual interpretation so as to transfer the burden of the present emergency to others who might be able to bear it better, such as insurance companies and major financial institutions. However, he pointed out that the landlords in this case would argue that they are trustees (either actual or in effect) for investors such as pensioners who may be reliant on returns from these funds and therefore the underlying properties. He therefore approved the following observations:
"In times of uncertainty the law must provide a solid practical and predictable foundation for the resolution of disputes and the confidence necessary for an eventual recovery... Contractual rights are to be evaluated by applying settled principles to the contract in question. Legal certainty remains paramount and gives the surest basis for the resolution."
The Master noted that anything else was a matter for Parliament rather than for the courts.
This article was written by Emma Humphreys. If you have any questions, please contact Emma or your usual Real Estate Disputes team member.
