Initial relief from Property Sector by EMA Ruling

Judgment means that Brexit will not be a ‘get out of jail free’ pass for tenants trying to get out of their leases.

The recent judgment on 20 February 2019 in the high-interest case of Canary Wharf (BP4) T1 Ltd v European Medicines Agency found that EMA’s 25-year lease of Canary Wharf premises will not be frustrated by Brexit.

It remains to be seen (and is also of high interest) as to whether EMA will appeal this decision as an overturn of the judgment will have far-reaching consequences across the property sector.

What is ‘Frustration’?

Frustration is an English contract law doctrine which acts as a device to set aside a contract where an unforeseen event occurs after the contract has been entered into which either makes the contractual obligations impossible to perform or radically changes the party’s principal purpose for entering into the contract. The event must be unexpected and have such a profound effect that it would be unjust to require the contract to be performed. It came about as a result of the 1863 case Taylor v Caldwell, but it has very narrow application in law today – and whilst past decisions have indicated that frustration can indeed apply to Leases, historically there has not been a single recorded case whereby a tenant has successfully argued that its lease should be frustrated.

Background

In 2014 EMA completed on its 25-year Lease for its European headquarters in Canary Wharf, with the Landlord spending more than £40million to secure the deal, doing a huge fit-out as part of the inducement. Despite a £13million annual rent, a break clause was contemplated and pushed for by EMA in the negotiations but eventually was dropped, and so the 25-year lease had no break. At that time Brexit was not a serious possibility in people’s minds and so there were no clauses in the Lease which covered any such scenario.

When Article 50 was invoked in 2016, the EU passed a Regulation requiring the EMA to open new headquarters in Amsterdam (currently under construction). With remaining lease liabilities in London estimated at over £500 million (and the building very likely to be unoccupied once the HQ relocation occurs), the EMA told their Landlord that they deemed that Brexit would frustrate their Lease – and so Canary Wharf applied to the High Court for a declaration that it would not.

EMA’s argument

EMA contented that their Lease was frustrated by ‘supervening illegality’. It argued it was not responsible for the decision to relocate, was unable to dispose of its lease and – because European law prevents it from having headquarters outside the EU – performance of the contract was ‘ultra vires’ (without legal authority).

They also (separately) argued that the parties to the lease had a common purpose that the premises would be the EMA’s headquarters and that this purpose would be frustrated by Brexit.

Decision

The judge ruled that even though there were strong political and economic reasons for relocating EMA’s HQ to Amsterdam, there was no legal justification for arguing that the EMA lacked legal capacity to hold on to or divest itself of property outside of its territory. It would still legally be able to pay rent and perform its lease obligations.

Furthermore, even if it WAS deemed ultra vires (unlawful) for the EMA to pay rent and perform the lease, the lease would still not be frustrated. Under English law, changes to capacity brought about by foreign law will not frustrate contractual liabilities which have already been entered in to.

Going even further, the judge held that the doctrine of frustration can only be used where the parties themselves do not bring about the “frustrating event” and - in this case - the passing of the November 2018 Regulation requiring the EMA to relocate to Amsterdam is an example of self-induced frustration (which is a surprising finding as the Regulation was imposed by the European Parliament and Council, which is a separate and distinct legal entity from the EMA).

With regard to ‘common purpose,’ the judge found that the two parties had entirely conflicting purposes upon entering into the Lease – the Landlord would want to secure the maximum long-term cash flow at the highest rent whereas the EMA would want flexibility as to term and the lowest rent.

The judge held that - even though Brexit itself may not have been foreseeable at the time the Lease was completed in 2014 - the fact that it was a 25-year lease which included alienation provisions to benefit the tenant was an indication that the tenant could have reasonably foreseen that they may need to involuntarily depart from the lease at some stage (for whatever reason).

Conclusion

Currently, there is no conclusion to this case – the EMA has until 29 March to apply for permission to appeal. Given the importance of this case and the amount of money at stake we have to assume that it is likely to appeal, possibly even leapfrogging directly to the Supreme Court. It will be fascinating to see whether there are any limits to the grounds of appeal (i.e. just on ‘supervening illegality’) or if the reasoning on common purpose is challenged as well.

To avoid the possibility of tenants trying to use Brexit as an argument for frustration in the future, Landlords should allow assignment/subletting of the whole of the premises and should make sure the user covenant is not unduly prescriptive.

In the current climate of Brexit uncertainty, this case has importance for the whole property industry.