Asset Finance: Frustration of contracts and COVID-19

One of the effects of the pandemic has been to slow down (some might say even further!) the litigation process in the UK courts, and despite one or two high-profile decisions relating primarily to business interruption insurance there have been few reported cases dealing with the effects of the pandemic relevant to asset financiers.

One likely vehicle of attack by customers arises from the doctrine of frustration of contracts, which may discharge the parties from performance of a contract that has become legally or physically impossible through no fault of the parties. In general terms this doctrine is very difficult to establish, and for example the European Medicine Agency failed in its attempt to use frustration to extract itself from a long lease on its central London premises as a result of the fact that it had to move to Amsterdam following Brexit.

There have now been 2 cases on aircraft finance which may be relevant generally to asset financiers.

Salam Air v Latam Airlines

In Salam Air SAOC v Latam Airlines Groups SA [2020] EWHC 2414 (Comm) Salam Air, an aircraft operator, was seeking an injunction to restrain Latam Airlines from making demands under three standby letters of credit in relation to the underlying leases of three aircraft. Salam Air argued that the aircraft leases had been frustrated by the impact of the COVID-19 pandemic and so no rent was due under them. The frustrating events being regulations issued by the Public Authority for Civil Aviation in Oman restricting air travel and substantially decreased demand for flying due to the pandemic.

The Court disagreed and Mr Justice Foxton noted that it would be “challenging” for any lessee under leases drafted on what is sometimes referred to as a “hell or highwater” payment basis to establish frustration.

The aircraft leases were drafted to make it clear that Salam Air’s obligation to pay rent continued in almost any conceivable circumstances, expressed to be “absolute and unconditional irrespective of any contingency whatsoever”, including “the ineligibility of the aircraft for particular use or trade.”  The terms of the leases clearly showed an agreed risk allocation between the parties and in taking on the leases, Salam Air had taken on the obligation to pay rent irrespective of whether its operating circumstances changed, even if that change was a dramatic and long-lasting fall in demand for aircraft, or a change in the regulatory framework which prevented flying. Where a lease made it clear that a lessee had taken on the risks inherent in the commercial operation of the aircraft, such as agreeing to pay rent even if there if there was a total destruction of the aircraft, it was “highly improbable” that a lessee would be relieved of the obligation to pay rent where that commercial operation was impacted, even by the effects of a pandemic. Salam Air’s circumstances under the leases did not therefore meet the test of frustration, and there was nothing unjust in holding it as lessee to the terms of its commercial bargain.

Wilmington Trust SP Services (Dublin) Ltd v Spicejet Ltd

In the Wilmington case the court granted the claimants summary judgment for amounts allegedly outstanding under three Aircraft Lease Agreements (ALA). The defendant argued that Indian government restrictions imposed due to the pandemic made it illegal to operate the aircraft, and that the ALA, on its true construction, provided for a suspension of payment for the duration of the illegality. The judge rejected this argument, particularly as the aircraft had in fact been used during the pandemic:

“I have no hesitation in rejecting this ground of defence, not least because MSN 41397 has in fact been used during the pandemic, albeit to a much more limited extent than previously. Indeed, this was not disputed. But in any event, I find it impossible – even on the most expansive approach to construction – to spell out any agreement that payment of rent falling due should be suspended for the duration of any restrictions such as those which have in fact been imposed. As argued by Mr Shah, this was a dry lease where possession of the aircraft was transferred by the First Claimant to the Defendant for a term of ten years, such that the Defendant had exclusive possession and undertook all the risks of operation and maintenance in return for a warranty of quiet enjoyment and an assignment of manufacturers’ warranties. This is made abundantly clear by numerous provisions in the Lease Agreement..”

Comment

Whether the effects of the pandemic could be successfully argued to constitute a frustrating event in relation to different forms of contract remains to be seen. The pandemic is likely to bring a wave of disputes as to which party bears the risks of non-performance under a contract and, despite frustration of purpose and illegality rarely being found by the English courts, we may well see it argued in more of them.