Frustration and force majeure clauses – what are the impacts of a pandemic on a commercial lease?

The COVID-19 outbreak rocked the Australian economy, disrupting business both domestically and internationally.  During this time, many tenants found it difficult to meet their obligations under commercial lease agreements, including the payment of rent.  While some commercial lease agreements dealt with the situation of a pandemic, many did not.  During the COVID-19 pandemic, it was claimed by some tenants that the pandemic entitled them to terminate commercial lease agreements under the doctrine of frustration.  Recently, it was made clear by the Supreme Court of New South Wales that frustration is not easy to establish.

Firstly, what is frustration?

The doctrine of frustration provides that a contract will be automatically terminated if an unforeseen event makes performance of the contract impossible, or radically different from that originally contemplated by the parties.  The doctrine of frustration is applied narrowly and includes situations where there is:

• a natural disaster;
• a terrorist attack; or
• war.

However, a contract will not be frustrated where the event impacting a party (or both the parties) could have been reasonably foreseen at the time of entering into the contract.  To overcome the narrow scope of the doctrine of frustration, some commercial lease agreements include force majeure clauses.

What is a force majeure clause?

Generally, a force majeure clause deals with events that create commercial impracticability, rather than just the situation where performance is impossible.  Under this clause, certain events may suspend a party’s obligations under the agreement.  Depending on the wording of the clause, this may include the situation of a pandemic or epidemic.

If your lease agreement contains a force majeure clause, this should be your point of call to determine whether a pandemic relieves you from your obligations under the agreement.  If a force majeure clause is not included in the commercial lease agreement, you may have to rely on the doctrine of frustration.  To do so, you will need to prove that your leasehold interest in the property is unusable and unsaleable, as confirmed recently in the case of ISPT Pty Ltd and AWPF Management No 2 Pty Ltd v Cao and Zhao [2023] NSWSC 1115 (ISPT case).

What happened in that case?

By way of brief background of the facts in the ISPT case:

• ISPT Pty Ltd and AWPF Management No 2 Pty Ltd (the Plaintiffs) were the proprietors of World Square Shopping Centre.
• In early 2020, the Plaintiffs leased two shops in the World Square Shopping Centre (the Premises) to Beijing Roast Duck Sydney Pty Ltd (the Tenant) for a term of three years, with a commencement date of 1 October 2019 (the Lease). Each of Howard Cao and Yuan Zhao (the Defendants) provided a guarantee and indemnity in respect of the Tenant’s obligations under the Lease.
• At the commencement of the Lease, the Tenant carried on an up-market licenced Chinese restaurant at the Premises.
• Due to the NSW lockdowns in response to the COVID-19 outbreak, the Tenant shut the restaurant on 23 March 2020. The Tenant did not reopen the restaurant when restrictions were eased from 15 May 2020 onwards and defaulted on the Lease.
• The Plaintiff owners claimed the outstanding rent and other amounts due under the Lease from the Defendants, pursuant to their guarantee and indemnity.
• In response, the Defendants contended that the Lease was frustrated because from 23 March 2020 the Tenant was not able to operate the licensed restaurant due to the public health orders.

Ultimately, the Court rejected the Defendants’ argument, concluding that the “the Tenant is not excused from performance simply because the Lease did not work out in the manner expected”. The Court determined that the Lease was not frustrated as:

• the Premises could always be used for at least one of the purposes expressly permitted, being either a licensed a la carte restaurant or take-away provider;
• in the context of a three-year lease, a period of just over two months in which dining at the Premises was banned or severely restricted was not of significance;
• there was no evidence that the Tenant explored the possibility of assigning the Lease and accordingly, the Defendants did not establish that the leasehold interest in the Premises was unsaleable; and
• the terms of the Lease recognised that there may be restrictions imposed on the Tenant’s ability to use the Premises as intended.

How does this apply to me?

The ISPT case confirmed that the question of whether a commercial lease has been frustrated is to be approached on a case-by-case basis and there is no blanket rule.  This will include consideration of:

• whether the premises is able to be used for the purpose(s) under the lease;
• if the premises are unable to be used for the permitted purpose(s), how long the state of affairs lasted or is expected to last, and the length of time left to run on the lease; and
• whether the lease can be sold/assigned to a third party.

The ISPT case highlights the difficulty of demonstrating that a commercial lease agreement has become frustrated.  In this case, the Court took the approach that the Tenant’s ability to access the Premises and to use them for the intended purpose was at the Tenant’s risk.

When seeking to end your commercial lease because of circumstances outside of your control, you might first consider whether the lease contains a force majeure clause.   If it does, you should consider whether your circumstances are addressed under the force majeure clause, and how the clause impacts your obligations under the lease.

Require assistance?

If you require advice regarding options for or implications of ending your commercial lease, contact the Litigation and Dispute Resolution team at Coulter Legal today.