2014 was a simpler time. England crashed out of the World Cup in the group stages, a robot made the first ever landing on a comet, and the European Medicines Agency (EMA) signed a 25-year underlease (the lease) with the Canary Wharf Group for its headquarters in London.
Three years later, the Prime Minister formally invoked Article 50. This began the legal process of British withdrawal from the European Union. Citing Regulation 2018/1718, EMA relocated its London office to Amsterdam and wrote to Canary Wharf, informing them that it would treat Brexit as a frustration of the lease. Aggrieved by this decision, Canary Wharf sought a High Court declaration that the lease would not be frustrated by Brexit.
Why does this case matter to the construction industry? Because it concerns a decision on the rarely used doctrine of frustration, and the judgment contains a very useful summary of the principles of frustration that are equally applicable to construction contracts.
What is frustration?
As Keating on Construction Contracts states at paragraph 6-052:
“Very rarely after the contract has been lawfully entered into and is in course of operation there may arise some intervening event or change of circumstances of so catastrophic or fundamental a nature as to determine the contract prematurely by the operation of the doctrine of frustration.”
The formulation in Davis Contractors Ltd v Fareham UDC is now usually regarded as the classic statement of the doctrine, where it was said by Lord Radcliffe that:
“… [frustration] occurs wherever the law recognises that without default of either party a contractual obligation has become incapable of being performed because the circumstances in which performance is called for would render it a thing radically different from that which was undertaken by the contract. Non haec in foedera veni. It was not this that I promised to do.”
In that case, the contractors entered into a contract to build 78 houses for a fixed price within a contract period of eight months. Attached to their tender was a letter stating that their tender was subject to adequate supplies of labour being available as and when required, although it was held that this letter did not form part of the contract. It followed that there was an unanticipated shortage of labour and materials and, while the work was never actually interrupted, the shortages meant that the contract took 22 months to complete and cost the contractors approximately £17,000 more than the contract price.
The House of Lords determined that the contract was not frustrated as the cause of the delay was not “any new state of things” that the parties could not reasonably be thought to have foreseen. Although timely completion was no doubt important to both parties, it was “useless to pretend that the contractor is not at risk if delay does occur, even serious delay” and it was a “misuse of legal terms to call in frustration to get him out of his unfortunate predicament”. The court was clear to emphasise that while it may be said that the footing of the contract (the adequate supply of labour and materials) had gone, “it by no means follows that disappointed expectations lead to frustrated contracts”, and the risk of loss to the contractors caused through the delay that occurred was on the contractors.
Canary Wharf v European Medicines Agency
In Canary Wharf v European Medicines Agency, EMA contended that following Brexit, the lease would be frustrated:
- On the grounds of “supervening illegality”, on the basis that EMA’s performance of the lease would become illegal in the sense of it being ultra vires.
- Because the “common purpose” of the contract would be frustrated on the basis that the lease was no longer any use for the contractually contemplated purpose, which EMA contended was to provide its permanent headquarters for the next 25 years.
Marcus Smith J granted the declaration in favour of Canary Wharf and found that the lease would not be frustrated by Brexit, either because of supervening illegality or frustration of a common purpose. In doing so, the judge gave important guidance as to what he referred to as the “central propositions” of the modern law of frustration, which can be summarised as follows:
- The doctrine of frustration operates to bring a contract prospectively to an end because of the effect of a supervening event. In making this statement, the judge referred to Lord Radcliffe’s general test for frustration in Davis Contractors Ltd v Fareham UDC, which he stated had “stood the test of time”.
- The judge went on to state that another formulation of the doctrine of frustration that had also stood the test of time was set out in National Carriers Ltd v Panalpina (Northern) Ltd, where Lord Simon had stated:
“Frustration of a contract takes place where there supervenes an event (without default of either party and for which the contract makes no sufficient provision) which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations from what the parties could reasonably have contemplated at the time of its execution that it would be unjust to hold them to the literal sense of its stipulations in the new circumstances: in such case, the law declares both parties to be discharged from further performance.”
- The judge then referred to the five propositions identified by Bingham LJ in J Lauritzen AS v Wijsmuller BV (The Super Servant Two), which were regarded as being established by the highest authority, and which Bingham LJ considered were not open to question:
(a) The doctrine of frustration was evolved to mitigate the rigour of the common law’s insistence on literal performance of absolute promises. The object of the doctrine was to give effect to the demands of justice, to achieve a just and equitable result, to do what is reasonable and fair, as an expedient to escape from injustice where such would result from enforcement of a contract in its literal terms after a significant change in circumstances.
(b) Since the effect of frustration is to kill the contract and discharge the parties from further liability under it, the doctrine must not be lightly invoked and must be kept within very narrow limits.
(c) Frustration brings the contract to an end forthwith, without more and automatically. It does not require an act by the parties to the contract.
(d) The essence of frustration is that it should not be due to the act or election of the party seeking to rely on it.
(e) A frustrating event must take place without blame or fault on the side of the party seeking to rely on it.
Smith J then went on to consider each of the grounds of frustration EMA relied on.
EMA’s argument that the lease was frustrated on the grounds of supervening illegality was advanced on the basis that it would not be legally possible for it to continue with its headquarters in London as it did not have legal capacity to hold or deal with immovable property outside the EU. The court rejected that submission on the basis that following Brexit, EMA would still retain capacity to deal with immovable property in the UK even if the UK no longer remained an EU member state, and that the EU itself had the capacity to maintain the headquarters of its agencies in a non-EU country.
While that part of the judgment was fact specific, of wider application was the judge’s finding that even if EMA did not have capacity, English contract law did not take into account supervening illegality arising under a foreign law (in this case EU law) when determining whether a contract had been frustrated. This was on the basis that while EU law may be relevant to the capacity of EMA to enter into the lease, it was not relevant to the question of whether subsequent illegality had caused the lease to be frustrated (Goldman Sachs International v Novo Banco SA followed). Put another way, when considering the capacity to enter into a transaction, English law would have regard to the foreign law of incorporation. However, when considering supervening events affecting contractual liabilities already assumed, foreign law was irrelevant. It followed from this that even if EMA lacked the capacity to continue performance of the lease by reason of supervening illegality under EU law, this would be irrelevant for the purposes of the English law of frustration.
The court then went on to consider whether, if it was wrong on the above points, the supervening illegality relied on by EMA would amount to circumstances capable of frustrating the lease. This resulted in the judge finding that for supervening illegality to frustrate a contract, it must remove all or substantially all of the benefit that one party receives from the contract. This meant that here, if EMA was correct in its contentions regarding its capacity under EU law, and if this were relevant to frustration under English law, it would follow that the lease would be frustrated, as EMA would be unable to use the premises at all post-Brexit.
However, the judge considered that even if that was the position, EMA’s case would fail because the frustrating event was self-induced as it found that the EU could have done more than simply ordering it to relocate to Amsterdam, for example by legislating for the winding-down of the EMA’s position in the UK.
In determining whether Brexit would result in the “common purpose” of the contract being frustrated, Smith J took as his starting point the approach recommended by Rix LJ in The Sea Angel:
“The application of the doctrine of frustration requires a multi-factorial approach. Among the factors which have to be considered are the terms of the contract itself, its matrix or context, the parties’ knowledge, expectations, assumptions and contemplations, in particular as to risk, as at the time of the contract, at any rate so far as these can be ascribed mutually and objectively.”
He accepted that withdrawal from the EU was not foreseeable when the agreements precluding the lease were entered into in August 2011, which the parties agreed was the relevant date for the purposes of EMA’s argument. However, he held that there were several factors which militated against a finding of frustration:
- The lease’s alienation provisions showed that the parties had not contemplated that there was to be permanent headquarters for EMA. Indeed, EMA had proposed a break clause, which Canary Wharf had successfully resisted.
- Both parties approached the lease from their own commercial standpoint such that there was no common purpose. EMA was focused on a bespoke premises with the lowest rent, whereas Canary Wharf was focused on long term cash flow. It was also foreseeable that over the term of the lease, there might be some development that would require EMA involuntarily to have to leave the headquarters due to circumstances beyond its control.
This decision no doubt gives some comfort to property owners. Prior to this judgment, it was suggested that a no deal Brexit may constitute the kind of unexpected and serious event that would be classified as a frustrating event. That said, since the judgment was handed down, the High Court has granted EMA permission to appeal. It remains to be seen whether the Court of Appeal upholds Smith J’s analysis.
As to parties to a construction contract, the case gives a useful summary of the principles of frustration and reinforces the fact that the doctrine is rarely invoked successfully because of the high threshold of demonstrating that the event has rendered performance “radically different” from that which was undertaken. If a party wants to have some comfort that, on the occurrence of a specified event beyond either party’s reasonable control, they will not be liable for a resulting failure to perform their contractual obligations, they would be wise to draft a carefully considered force majeure clause.