Tenant attempts to terminate Canary Wharf lease on grounds of Brexit

05 Feb 2019

The UK’s departure from the EU continues to monopolise both media headlines and parliament time, and yet the implications of Brexit remain notoriously unpredictable. In the meantime, a trial has been making its way through the English courts which has the potential to upset the apple cart even further.

Frustration in English law
Frustration is a little used facet of English law.  It permits a contract’s termination in situations where an event occurs which changes the circumstances surrounding an agreement so fundamentally that the contract cannot continue to be performed.

There are several limbs to the test for frustration. In summary, the event that frustrates the contract must:

1. happen after the contract has been formed;

2. be so fundamental that it “strikes at the root of the contract”;

3. not be the fault of either party; and

4. render the continuing performance of the contract either radically different than that contemplated at the time that it was formed, impossible or illegal.

Jersey Law
Jersey has so far not adopted the doctrine of frustration, although recent years have seen a continuing tendency to weave English legal principles into the Jersey system. Nevertheless, the Royal Court does have the option to declare a contract voidable where its validity is called into question as a result of a “subsequent event” as referred to in the judgement of Deacon v Bower (1978 JLR 39). There is little supporting case law to confirm this position but it does leave the Jersey courts clear to develop a framework similar to that of frustration.

EMA v Canary Wharf
European Medicines Agency (EMA) is the tenant of a lease in Canary Wharf with a £13million a year rent. The lease is specified to run until 2039 and does not contain a break clause in EMA’s favour.

EMA purported to terminate the lease on the basis that Brexit has “frustrated” the agreement. In response, Canary Wharf sought a declaration from the court that the lease has not been frustrated and remains in force.

Canary Wharf has estimated its losses would be £264 million should the courts rule in EMA’s favour. Perhaps understandably, given the sums involved and the wide ranging implications, the case looks set to be referred to the Supreme Court.

The arguments made by the parties focus on whether or not they could have predicted Brexit and whether Brexit now precludes EMA from operating its business. There is no denying that the results of the referendum were surprising to many, but the question the court must answer is whether Brexit was a significant enough possibility in 2014 (when the parties entered into the lease) that EMA cannot deem the contract frustrated. The court will also be considering what the impact of Brexit will be on EMA’s ongoing business, which is no small task given that the terms (or even existence) of a deal with the EU remains unsettled.

Implications
If the court rules that the lease had been frustrated, purely as a result of Brexit, a number of UK tenants could follow suit. Such a decision would adversely affect the financial performance of landlords but of more concern is perhaps that the confidence landlords (and their lenders) have in their investment yields may start to wane.

The investment market has been built around the corner stones of certainty and security. Property investment (particularly in prime office and retail locations) survived the recession remarkably well as banks remained happy to lend against interests subject to occupational, market rent leases with lenders accepting tenant’s break clause at intervals as frequently as every three years. However, a ruling that tenants could terminate their leases purely on the back of Brexit is likely to mean that lenders would become much more cautious when lending against investment properties.

The forecasts presently indicate that Jersey’s local property market will remain generally buoyant in spite of Brexit, although we have seen a small contraction in the market as some wait for the results of Brexit before progressing property deals. The lack of modern case law to support a frustration-like option for tenants means that we are very unlikely to see a replication of the EMA v Canary Wharf dispute in Jersey. It is therefore likely that the effect of the court’s decision will be much reduced in Jersey by comparison to the UK. Nevertheless, the Jersey-based investment schemes which hold UK portfolios are likely to keep a weather eye on the results of the case.

It remains highly unlikely that the courts will rule in EMA’s favour. Judges have long been reluctant to allow parties to shirk their contractual obligations just because they entered into a commercially questionable deal. However, in such unusual times another source of doubt is not welcome news.

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