Frustration of leases due to Covid-19 has finally come before the courts. The judgment is regrettably unfocussed but here’s some value extracted from it.
Estimated reading time: 11 minutes
Throughout the last 18 months, F&B and nightlife businesses have wondered whether pandemic restrictions frustrate their leases. The impossibility of performing lease obligations continues to be very real. Every time a small door cracks open towards recovery, that door slams shut before the “re” in anything occurs. Recover, rebuild, refresh, rejuvenate, reignite, resurrect? Nope, sorry, return to restrictions.
In principle, we know that frustration may apply to commercial leases affected by Covid-19. I argue this case in my article titled “Frustration, not Fortitude: the case for applying the doctrine of frustration to leases affected by Covid-19” here. For ease of reading, the Business Times published my op-ed on the same topic here. The government’s Re-Align Framework was also in play early this year to bring to end certain leases.
Short of judicial precedent, however, the exact circumstances to support a claim for pandemic frustration remained uncertain. Tenants lack the resources to mount a test case before the courts. So the industry waited for the first-mover to present itself. But now that it has, the judgment is sorely disappointing. It offers little discussion, and quite frankly, squandered the precious opportunity to define pandemic frustration.
Nonetheless, let’s crane our necks to extract some precedent value from the judgment, so that it does not go to waste.
DATHENA v JUSTCO
Dathena Science Pte Ltd v Justco (Singapore) Pte Ltd [2021] SGHC 219 (“Dathena v Justco“) is the first case that raises the issue of contractual frustration in relation to Covid-19.
The parties and agreement
Dathena is a cybersecurity outfit. Justco is a well-known co-working space provider. On 16 January 2020, the parties signed a membership agreement commencing 1 May 2020 for a co-working space at OCBC, Chulia Street (“Premise“), for a term of 2 years (“Membership Agreement“). The Membership Agreement provided Dathena with allocated office space and server storage space based on Dathena’s IT requirements. Dathena paid a security deposit and membership fee for May 2020 to Justco.
The delay and claim
Due to Covid-19 restrictions on construction, Justco failed to deliver the Premise to Dathena by 1 May 2020. Indeed, by 1 September 2020, it was still not ready for Dathena to move in. On 29 May 2020, Dathena sent to Justco a notice of termination, stating that it considered the Membership Agreement to be terminated or frustrated (“Notice“). It claimed frustration based on Justco’s inability to deliver the Premise. Dathena also said the purpose of the Premise was frustrated by government regulations on social distancing and telecommuting.
Dathena then explored alternative locations with JustCo. A clause in the Membership Agreement entitled Justco to offer an alternative location to the Premise. However, Justco did not invoke that clause at the time. In any case, none of the options were suitable for Dathena due to its space and IT requirements.
On 27 July 2020, JustCo responded to the Notice. It insisted that the Membership Agreement was not frustrated because (a) the delay in handing over the Premise was not significant, (b) the delay was caused by mandatory government regulations, (c) Dathena had not indicated that it had to move in by 1 May 2020, and (d) Dathena likely wanted to terminate the agreement for its own commercial reasons.
Dathena commenced a claim for a refund of its security deposit and one month’s membership fees. Justco counterclaimed membership fees for the entire duration of the lease.
*The reported judgment contains numerous typographical errors in relation to dates. Many references to “2021” clearly mean to say “2020”.
Findings on termination
The High Court found Dathena justified in terminating the Membership Agreement. Justco had failed to deliver the Premise on 1 May 2020 and the Membership Agreement did not provide for a flexible date of hand-over. The court observed that Justco’s delay of 4 months amounted to “1/6 or 17% of the duration of the lease”, and the continuing uncertainty as to hand-over date prompted Dathena’s Notice.
On the evidence, the court determined that (a) Justco knew that Dathena’s IT requirements were integral to its office operations, (b) Justco knew Dathena needed to move in its servers before 1 May 2020 and Justco had suggested by its actions that that was possible, (c) IT installation delays caused by pandemic restrictions were Justco’s responsibility to resolve as master tenant of the Premise, (d) alternative locations offered to Dathena were not comparable to the Premise, and (e) Dathena did not waive its right to terminate the Membership Agreement by exploring the alternative locations.
See paragraphs 157 to 168, and 180 to 182, Dathena v Justco.
The decision on frustration
Dathena claimed frustration as an alternative ground for exiting the Membership Agreement. The High Court identified the question as whether Justco’s 4 month delay and inability to provide a comparable alternative amounted to frustration. The court recalled the doctrine of frustration: “[o]nce a supervening event occurs after the formation of the contract without the default of either party which renders the contractual obligation radically fundamentally different from what was agreed or, a contract becomes impossible to perform, a contract is frustrated.”
The court also reminded the parties that “the doctrine of frustration of contracts and the operation of the FCA [i.e. Frustrated Contracts Act] is not dependant on parties’ agreement”, and it is “the law that determines that a contract is frustrated if it is, regardless of the parties’ views.”
However, the court relied on Justco’s views to determine that the Membership Agreement was frustrated. It held that on the facts, “[n]othing could be more telling” that the Membership Agreement was frustrated than Justco’s own conduct which “indicated that at the material time, it was aware that it could not perform its contractual obligations”.
That was pretty much all the analysis that the court offered. There was no discussion about the specific circumstances that triggered the doctrine of frustration. In fact, it appears that the High Court found the Membership Agreement frustrated because Justco said it was so. This is an awkward position, especially since Justco’s position is that there was no frustration.
See paragraphs 183 to 188, Dathena v Justco.
Test for frustration
Oddly, the judgment refers to “the test of frustration under s2(2) of the FCA” (this is a typographical error, meant to refer to s2(1) of the FCA), and “as set out under s2(1) of the FCA”. The FCA refers to the Frustrated Contracts Act.
But the FCA merely regulates the consequences of frustrated contracts. The test for frustration exists in the common law. Frustration must first be established at common law before the FCA becomes operative.
Perhaps the High Court did not discuss the common law elements of frustration because of this confusion about the FCA. Whatever the reason, the absence of legal dicta surrounding what constitutes pandemic frustration is a real shame.
See paragraphs 122 and 184, Dathena v Justco.
PRECEDENT VALUE
At face value, Dathena v Justco offers little precedent value on pandemic frustration. There is nothing insightful, much less quotable, in the judgment on this topic. But this case is too important to commercial tenants to let it slide by like this, quietly failing to contribute to legal jurisprudence. So let’s try to make Dathena v Justco worthwhile.
Application to leases
Co-working membership agreements do not typically grant leasehold interests in the property. These agreements instead confer the right to use a collective space, hence the concept of co-working. It is a personal right, and not a property right, that we usually see in co-working space agreements.
However, the judgment refers to both a “membership agreement” and a “lease” contained within it. Although unlikely that a co-working agreement is also a sub-lease, the High Court seems to have regarded itself as dealing with a lease. We can thus cite Dathena v Justco as judicial confirmation that pandemic frustration applies to leases. That is good news for commercial tenants.
The supervening event
Frustration occurs when an unforeseen, supervening event radically affects either or both parties’ ability to perform a contract as originally agreed.
The High Court in Dathena v Justco never identified the supervening event relevant to establishing frustration. Was it the pandemic itself? Or a particular regulation mandated by the government in response to Covid-19? Was it a series of events making up a giant supervening event? The court, alarmingly, did not discuss this at all.
Instead, the court simply said that it reached its conclusion by “looking at the facts.” Besides that one sweeping tribute to “the facts”, the court offered nothing more. So let’s look at the facts to join the dots.
Pandemic regulations restricting construction, including installation of IT specifications, caused Justco’s delay in handing over the Premise. It is fair to say therefore that Dathena v Justco contains the High Court’s affirmation that a pandemic regulation limiting performance of lease obligations is an unforeseen, supervening event.
The contingency clause
For a supervening event to be unforeseen, the parties must not have provided for its eventuality in the contract.
Importantly, there was a clause in the Membership Agreement that allowed Justco to offer an alternative location. It is arguable that such a clause indicated that the parties provided for the possibility that the Premise would not be available.
The pandemic and its regulations were unforeseeable, yes. But the parties appear to have foreseen needing to substitute the Premise, for whatever unexpected reason. Yet, the court did not consider the effect of the contingency clause. We can conclude then that the court believed it to be irrelevant to the almighty unforeseeable nature of the pandemic and its regulations.
The unusable lease
A contractual obligation is radically different if it is impossible to perform or if it no longer serves its purpose. When did Justco’s obligation become impossible to perform? Did Justco’s delay frustrate the purpose of the Membership Agreement? The High Court did not examine these fundamental elements of frustration.
In other parts of the judgment, the court found Justco’s delay comprised 1/6 or 17% of the 2 year term. Presumably, frustration of the Membership Agreement turned on the Premise being unusable by Dathena for that fraction of the term. The court, however, did not explain whether Dathena was justified to call frustration on 29 May 2020, the date of the Notice, only 29 days instead of 4 months after the hand over date
For all that is lacking, Dathena v Justco provides us with this one crucial piece to the frustration matrix: when a lease is unusable for its purpose at least 1/6 or 17% of its term, it is frustrated.
The uncertainty
The High Court also observed that Justco’s ability to deliver the Premise continued to be uncertain. It is possible that such uncertainty will be a factor for the court’s consideration in future cases.
APPLICATION TO COMMERCIAL LEASES
The judgment in Dathena v Justco is lamentable for its lack of instruction on pandemic frustration. But it leaves us with a couple of basic take-aways.
In summary, (a) pandemic regulations limiting performance of lease obligations qualify unequivocally as unforeseen, supervening events, and (b) where pandemic regulations prevent a lease from being used for its purpose at least 1/6 or 17% of its term, the lease is frustrated.
F&B and nightlife leases
The points extracted from Dathena v Justco can be applied to most, if not all, F&B and nightlife leases:
(a) Pandemic regulations prohibiting or restricting dine-in and nightlife activities are certainly pandemic regulations limiting performance of lease obligations, and therefore unforeseen, supervening events.
(b) During the pandemic, F&B and nightlife leases have been (in varying degrees) unusable for their purposes. Given that a lease term is usually 3 years, the period these leases have been unusable has long crossed the 1/6 or 17% threshold.
However, F&B and nightlife tenants may have to explain that their leases are unusable although business is not at a complete standstill. Will the courts view dine-in prohibitions, restrictions on number of pax, vaccinated differentiated rules, banning of background music, change of approved use etc. as causing commercial leases to be unusable for their purpose? Will there be additional criteria, such as a percentage of revenue loss?
The High Court did not address Dathena’s suggestion in its Notice that social distancing and telecommuting regulations frustrated the purpose of the Premise. These regulations only restrict usage. They do not make offices entirely off-limits. So the issue remains wide open. Are leases only frustrated if they are 100% unusable? Hopefully, the courts can see that restaurants are meant to host groups, bars are meant to be crowded and play music, and nightclubs are meant to, well, be nightclubs. The rent paid by tenants reflect maximisation of such usage. Pandemic restrictions have not changed rents.
What’s ahead?
Dathena v Justco suggests that the courts may not be too concerned about opening the floodgates of pandemic frustration after all. The judicial caution expected when dealing with the subject was notably absent in Dathena v Justco. In fact, the High Court’s vague discussion gave the sense that frustration due to Covid-19 did not require much deliberation. It is almost to say “but of course”. If that case has set the tone for cases to come, we can be optimistic that pandemic frustration will offer a real way out for F&B and nightlife tenants.
Nonetheless, frustration even in a global pandemic is a factual inquiry. Each case will turn on its specific circumstances. The need for judicial signposts cannot be overstated. Tenants are at the edges of their seats trying to make sense of their options. While we wait for more meaningful judgments that could swing the law, unfortunately, Dathena v Justco is the little that we have to go on.
*The Dathena v Justco judgment deals with other legal points such as unfair contract terms that this blog does not comment on.
