Brexit: Frustration All Round?

According to Mr Justice Marcus Smith, Brexit is ‘not a frustrating event’. Before anyone feels compelled to write to Mr Justice Marcus Smith expressing their views to the contrary, we should emphasise that this is very much in the context of leases, and it will allow landlords to breathe a sigh of relief.

Today Mr Justice Marcus Smith handed down the keenly anticipated judgment in the High Court case of Canary Wharf (BP4) T1 Limited and ors v. European Medicines Agency [2019] EWHC 335 (Ch). The importance of the issue to all sides and, more broadly, to landlords and tenants alike has long been recognised.

The European Medicines Agency (EMA) is required to move to Amsterdam once (well, if) the UK leaves the EU, but it is tied into a 25-year lease with its landlord, the Canary Wharf Group (CWG). EMA argued that it should be able to terminate its lease on the grounds that the lease would be 'frustrated' by Brexit. CWG applied to the court for a declaration that Brexit is not a frustrating event for the purpose of a lease and that the tenant covenants of the lease would continue to bind EMA until such time as it is lawfully terminated or assigned.

Mr Justice Marcus Smith considered a variety of arguments, many of which will provide some food for thought for the lawyers out there, but ultimately, he concluded that Brexit is not a frustrating event which would discharge the parties from their obligations under the lease.

What is frustration?

Frustration brings a contract to an end such that the parties are no longer bound to perform any future obligations under it. Technically, any contract can be frustrated after it has been formed. However, the circumstances in which this can arise are limited. While there is no strict test, long established general principles provide that frustration can occur after an unforeseen event happens which is none of the parties' fault; goes to the root of the contract; and makes performance of the contract impossible, illegal or fundamentally different from what was envisaged at the outset.

The courts have previously held that ‘the doctrine [of frustration] must not be lightly invoked’ so the suggestion that Brexit, always a legal possibility, could give rise to frustration raised concerns throughout the market. If the court had found in the tenant’s favour, then this would undoubtedly have opened the floodgates to a host of situations where tenants could argue for frustration as a result of market changes. While the court did not find that EMA should have foreseen Brexit, it did suggest that tenants must have consideration, particularly when entering into a long lease, to the factual matrix in which they operate and that there might be developments which cause their commercial position to change over the course of the term of the lease.

What does this mean for the lease?

Since frustration did not apply in the EMA case, this means that the lease continues, and both parties must comply with their obligations for the duration of its 25-year term. For the tenant, that means complying with the obligations around rent, service charge and insurance payments, and to repair the premises. If the EMA breaches these terms the landlord will be entitled to take enforcement action for example, to sue for any debt (or damages), seek specific performance, or forfeit the lease, depending on the breach.

What next?

This decision is undoubtedly good news for landlords. Brexit may be a fundamental change for the UK constitution, but it does not have such a profound effect on an individual lease; and the court has made it clear that it will not intervene to correct what ultimately may be a bad commercial decision by a tenant. It should be noted, however, that the judgment did not exclude the possibility that (where the circumstances are right) leases can be frustrated.

Stepping back from the detail of the judgment, this is another reminder of the commercial reality of the current landscape in which there are many reasons why the circumstances of tenants may change, requiring them to relocate or putting them in financial difficulties. Both parties need to be alive to this at the point of lease negotiation and not enter into a lease lightly.

Read on for some top tips on future proofing leases.

Top Tips: What can the parties do?

1. Capacity

Mr Justice Marcus Smith spent a considerable amount of his judgment on the capacity of EMA to continue to meet the lease obligations, and he made it clear that he did not accept that a lease could override the laws of the place of incorporation of the tenant. In other words, if there was something within the laws of incorporation of EMA that precluded its ability to comply with the terms of the lease then that would override the lease. This emphasises the need for opinion letters on foreign or unusual tenants to establish that they have the capacity to enter into the terms of the lease. What these letters cannot always cover is that the tenant will continue to have that capacity throughout the term of the lease – this is perhaps a matter that will see closer scrutiny in coming years.

2. Brexit clauses

Increasingly the market is seeing scenario-specific break clauses, including those that explicitly deal with Brexit. The clause may take various forms, for example it could provide for a specific outcome if a certain event happens (such as a reduction in rent if the tenant has to pay certain tariffs on other supplies) or alternatively, it could allow for the lease to be renegotiated if there is a ‘trigger event', and then, if the landlord and tenant cannot agree, either party could terminate the agreement.

These clauses will be extremely difficult to draft and agree. For example, how should 'Brexit' be defined? What happens if an event occurs which is not provided for in the clause? Would a landlord agree to a renegotiation clause at all given the risk of termination and the notorious difficulty of obliging parties to 'cooperate' in negotiations? Great effort will be required to think through the possibilities, while bearing in mind that no clause will be able to deal with every possible eventuality.

In deciding whether to insert such a clause, the parties will have to consider whether the risk of the clause going wrong, or not being effective, is worse than the risk of not including one. This will depend on the circumstances, and the commercial bargaining power of the parties.

3. Assignment

Most commercial leases for 25 years would allow the lease to be assigned to a new tenant, with the consent of the landlord. If that is the case, the landlord's consent must not be unreasonably withheld. Often the landlord will have stated in the lease that it can require the original tenant to guarantee the performance of the assignee, so the tenant might still retain some liability. However, this would only last until the assignee further assigns the lease onto another tenant.

Mr Justice Marcus Smith suggested that the assignment provisions in the EMA lease were restrictive. While we find ourselves respectfully disagreeing, the underlying point remains the same – in entering into the lease, the tenant must consider the likely scenarios in which they will need to assign the lease to a new tenant and should try and cater for these in the lease.

4. Underletting

Many leases also allow for the tenant to underlet the lease. This is not ideal for the tenant because it would still be liable to the landlord for the performance of the lease obligations. It would also have the administrative burden of enforcing the terms of the lease against the undertenant. However, the undertenant's rent payments would at least offset the cost of being tied into the lease.

Again, the landlord's consent is likely to be required and it must not be unreasonably withheld. The lease is also likely to contain a number of stipulations about the underlease itself.

5. Rights of re-entry for insolvency events

Standard provisions in leases provide for the landlord to re-enter in an event of insolvency. It may be that landlords would look to expand these provisions to cover events where the tenant is lawfully prevented from operating from the premises. While many landlords would choose not to exercise such provisions they may like to have the option to try and futureproof against dealing with struggling tenants and to allow them to re-let and maintain an income stream.

If you require further information about anything covered in this briefing note, please contact Barbara Webb or Shona Ray Ferguson, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, February 2019