26.11.2021

Can Covid-19 frustrate a contract?

Introduction 

Covid-19 has had a significant impact on the transport sector, in particular the aviation industry.

It has been common for parties affected by Covid-19 to assert that it amounts to a force majeure event excusing performance of the contract, or, that the contract has been legally frustrated. 

Salam Air SAOC v Latam Airlines Group SA [2020] EWHC 2414 is a recent case that highlights:

  • The difficulty in succeeding on a frustration argument; and  
  • The Court’s reluctance to intervene in commercial contracts.

Background 

Salam Air SACO (Salam) is an Omani airline established in 2016.    

In 2017, Salam entered into an agreement with Latam Airlines Group SA (Latam) to lease three aircraft for six years.  The leases were dry leases, meaning Salam had operational control of the aircraft and provided their own crew. 

The aircraft leases were on identical terms.  The key terms included:

  • Salam’s obligations to pay rent and make other payments were absolute and unconditional, irrespective of any contingency.
  • As an alternative to paying a deposit of three month’s rent, Salam provided stand-by letters of credit (SBLC).
  • Throughout the lease period, Salam was to bear the full risk of any occurrence of whatever kind that deprived them of their use, possession, or enjoyment of the aircraft.

On 26 March 2020, as a result of the Covid-19 pandemic, the Omani Government prohibited all flights to or from Oman with the exception of cargo. 

On 26 May 2020, Latam filed for bankruptcy and soon afterwards, in mid-June, Salam redelivered the aircraft.  Salam had last paid its monthly installment of rent in March 2020.  It was three months in arrears for its lease payments when the aircraft were redelivered.

In September 2020, Salam applied to the High Court for an injunction to restrain Latam making a demand for payment under the SBLC and applying the proceeds to the outstanding rent.  They argued that the leases had been frustrated, and it was relieved of its obligation to pay rent following the Government announcement on 26 March which prohibited almost all flying in Oman.

Decision 

Injunction 

The Judge outlined that an injunction preventing a credit provider paying out under an instrument such as a SBLC will only be successful where:

  • The validity of the instrument, as opposed to the commercial transaction, is called into question; or
  • The demand for payment under the instrument is fraudulent.

Salam argued these two circumstances were not necessary in the current situation, given they were seeking injunctive relief against the beneficiary (Latam), as opposed to the credit provider.  

This argument was rejected. 

There was nothing to suggest that the standard for obtaining interim relief against the credit provider should not also apply to the beneficiary.  Instruments such as a SBLC are to be treated as equivalent to cash.  If there is no express obligation on the beneficiary not to make a demand for payment, an obligation of this kind will not be lightly implied. 

Salam had not alleged fraud on Latam’s behalf, nor was it a term of the contract that Latam could not demand payment under these circumstances.  On this basis, Salam was not entitled to an injunction.

It is likely that the New Zealand Courts would come to the same conclusion. 

Frustration

Salam argued that the Government announcement, preventing its use of the aircraft to earn revenue for the foreseeable future, frustrated its agreements with Latam. 

This argument was also rejected. 

The leases were drafted to make it clear that it was Salam’s obligation to pay rent in almost all conceivable circumstance (on ‘hell or high water’ terms).  Salam had taken on all commercial risk (and reward) of operating the aircraft.  Its obligation to pay rent was absolute and unconditional and it had agreed to bear the full risk of any occurrence which deprived it of the use, possession or enjoyment of the aircraft.

Given the contract allocated the risk between the parties, it would have been fundamentally inconsistent to allow the contract to be frustrated on the basis of the Government banning passenger flights to and from Oman.

Comment 

The case highlights two features common in the commercial leasing and chartering of assets. 

First, courts will be reluctant to interfere with security arrangements such as a SBLC.  The court will only intervene in exceptional circumstances.  Generally, this will be where the validity of the instrument itself is called into question, or the demand for payment under them is fraudulent. 

Secondly, where the terms of the contract clearly allocate risk to one party – as is common in dry leasing and bareboat chartering arrangements – this will provide the context for considering claims for force majeure and frustration.

If you have any questions about this decision, please get in touch with our Transport Team or your usual contact at Hesketh Henry.

 

Disclaimer:  The information contained in this article is current at the date of publishing and is of a general nature.  It should be used as a guide only and not as a substitute for obtaining legal advice.  Specific legal advice should be sought where required.

 

 

 

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Kerry
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