Private Equity

As a general rule, courts enforce contracts in accordance with their terms, no matter how subsequent events may have impacted the original expectations of the parties. The COVID-19 pandemic gave rise to much litigation asserting old common law exceptions to that general rule; namely, the doctrines of “impossibility” and “frustration of purpose.” Most, but not all, of those claims have been unsuccessful. But one issue that has arisen in many of the commercial lease cases asserting these defenses to the payment of rent was the question of whether a “force majeure” clause had the effect of supplanting the common law doctrines in determining whether the COVID-19 pandemic or the governmental shutdowns in response to that pandemic excused a party’s rental obligations. A recent Delaware Superior Court decision, Simon Property Group, L.P. v. Regal Entertainment Group, 2022 WL 2304048 (Del. Supr. June 27, 2022), provides Delaware’s take on that issue and suggests that more attention to these clauses may be warranted.

Despite the tendency to lump the two doctrines together, “impossibility” and “frustration of purpose,” are distinct doctrines addressing completely different things. As Professor Andrew Schwartz has so clearly articulated in a recent article:

The Impossibility doctrine excuses a party from her contract when events or changed circumstances make performance impossible (or effectively so). And the Frustration doctrine excuses a party from her contract when events or changed circumstances render the other party’s counterperformance worthless (or effectively so). In other words, Frustration applies when an unexpected event, beyond the party’s control, completely undermines the party’s primary purpose in making the contract.

In general, the twin doctrines excuse the performance of opposite parties bound by a contract. While the Impossibility doctrine “operates to the advantage of parties that are bound to furnish goods, land, services, or some similar performance,” the Frustration doctrine “operates to the advantage of parties that are to pay money in return for those performances.” Furthermore, unlike Impossibility, the Frustration doctrine excuses a party from a contract even though it is perfectly possible to perform as promised.^[1]

It is the Frustration doctrine that has been most commonly invoked in tenants’ efforts to avoid paying rent for restaurant, shopping center retail space and movie theaters, which were prohibited by governmental edict from allowing customers on the premises. After all, paying rent is almost never actually impossible (or even impracticable). Historically, parties have only occasionally avoided payment of rent based upon the Frustration doctrine. Most famously, in an English case, a party renting a room for the specific purpose of being able to observe the King’s coronation, which was later cancelled due to the King’s illness, was excused from paying for that room.^[2] And in a U.S. case, a party renting a neon sign to illuminate his drive-in restaurant within the months preceding the U.S. declaration of war against Japan in 1941, and the enactment of a ban on the use of such neon signs, was excused from paying the rent for that sign he was prohibited from illuminating by governmental edict.^[3]

But note that in each of these cases, the entire purpose for entering into each of these leases had been frustrated by the subsequent event that was beyond the parties’ control. In most cases, there are broader purposes for which a party entered into a particular lease, and it is not enough to invoke the Frustration doctrine that a party is prevented from using the rented premises for only one purpose when it can be utilized for others, even when those other purposes are less profitable than the one that has been frustrated. For example, if only dine-in eating is restricted by a governmental shut down order, but take-out remains an option, the Frustration doctrine is unlikely to apply to a restaurant lease, regardless of the negative impact of the restriction on dine-in eating.^[4]

Apparently there is only one published case in the U.S. where frustration of purpose based on COVID-19-era governmental shut down orders has been successfully invoked. That case is UMNV 205-207 Newbury, LLC v. Caffé Nero Americas Incorporated, 2021 WL 956069 (Mass. Super. Ct. Feb. 8, 2021). In that case, however, the lease specifically limited the tenant to serving customers on-premises; and there was apparently no broader purpose that would have permitted take-out dining. Accordingly, the court concluded that the state’s prohibition of on-premises dining effectively frustrated the purpose of the lease and excused the tenant’s non-payment of rent during the period that order was in effect. But it was the court’s determination that the lease’s “force majeure” clause did not override the Frustration doctrine that is the most interesting aspect of the case; and where Delaware has apparently taken a different view.

The “force majeure” clause in the Caffé Nero lease provided:

Neither the Landlord nor the Tenant shall be liable for failure to perform any obligation under this Lease, except for the payment of money, in the event it is prevented from so performing by … order or regulation of or by any governmental authority … or for any other cause beyond its reasonable control, but financial inability shall never be deemed to be a cause beyond a party’s reasonable control …, and in no event shall either party be excused or delayed in the payment of any money due under this Lease by reason of any of the foregoing.

According to the Caffé Nero court, this clause only addressed events that made performance of the lease impossible; it did not address events that frustrated the purpose for which the lease was made. Thus, the court concluded that the force majeure clause did not in any way override the Frustration doctrine, despite the language in the force majeure clause indicating that payment of money was excepted from being excused by virtue of the named force majeure events. The reason was explained by the court as follows:

This force majeure provision says that generally neither UMNV nor Caffé Nero is liable for breach of contract if they are prevented from performing by any cause beyond its reasonable control, but it includes two important exceptions. First, financial inability shall never be considered a cause beyond a party’s control. Second, failure to pay rent or other money due under the Lease will never be excused on the ground that a party was prevented from making the payment by some cause beyond its control. The phrase “by reason of any of the foregoing” at the end of the provision refers to a party being “prevented from … performing by” any of the listed risks or any other “cause beyond its reasonable control.”

Thus, the force majeure provision addresses the risk that performance may become impossible, but does not address the distinct risk that the performance could still be possible even while main purpose of the Lease is frustrated by events not in the parties’ control.

Other courts across the country have apparently broadly read force majeure clauses as not being limited to just an override of the Impossibility doctrine, but as a broader allocation of all risk from force majeure events, and therefore an override of the Frustration doctrine as well. Professor Andrew Swartz is of the view that this is wrong, and Caffé Nero is the correct reading of the standard force majeure clause—i.e., that it only addresses the Impossibility defense not the Frustration defense.^[5]

And it is absolutely true that vast majority of force majeure clauses speak in terms of allocating the risk of force majeure events that “prevent, hinder or delay a party’s performance,” which are terms that seem to speak only to the Impossibility defense, not the Frustration defense. Nonetheless the trend appears to be to gloss over that distinction and lump Frustration arguments together with Impossibility arguments and treat the force majeure clause as trumping any of those common law defenses and supplanting them with the specific language of the force majeure clause. And that appears to have been the approach of the Delaware Superior Court in Simon Property Group.

In Simon Property Group, the Delaware Superior Court granted the landlord’s motion for summary judgement on its claims for unpaid rent arising from four separate commercial lease agreements for movie theaters, all of which had been subject to COVID-19 closure orders. While the tenants apparently argued that they should be excused from paying rent based upon a variety of theories, including impossibility, impracticability and frustration of purpose, the court appeared to blend all the theories together and focus exclusively on what the judge viewed as the clear allocation of risk to the tenant of all force majeure events (including the governmental shut down orders arising from the COVID-19 pandemic) pursuant to the various force majeure clauses in the leases. Like most other force majeure clauses, these clauses also spoke in terms of the clause allocating risk when “either party shall be delayed or hindered or prevented from performance,” which is language invoking Impossibility, not Frustration. But the court focused instead on the not uncommon fact that the force majeure clause excepted payment of rent from being excused by reason of any of those events that caused such delay, hindrance or prevention of performance and did not distinguish between impossibility, impracticability or frustration of purpose in terms of which of these common law defense were actually being overridden by the clause. And the court did so based on the weight of authority across the country that has similarly addressed the effect of the force majeure clause on the Frustration doctrine.

The Simon Property Group court made an effort to distinguish Caffé Nero on the basis that the Caffé Nero lease contained other clauses that allocated the risk of traditional frustration of purpose events (like a casualty to the leased building) and therefore could more readily assign the force majeure clause to only covering Impossibility based events. But while the parties may not have argued this point, it is hard to imagine that any commercial lease (including those at issue in Simon Property Group) would not have a similar casualty loss risk allocation provision. Moreover, unlike the restaurants involved in many of the other cases across the country where the Frustration defense was defeated because the closure orders did not completely frustrate the lease because take-out orders were still permitted, theaters don’t really have a take-out alternative. If you can’t show the movies to people sitting in seats in the theater, the very purpose for the theater lease would have arguably been frustrated. But here the tenant was denied an opportunity to make that argument because the force majeure clause was deemed to have overridden the Frustration defense despite wording appearing to only limit it to the Impossibility defense.

Indeed, the court did not clearly distinguish between the Frustration doctrine and the Impossibility doctrine. In describing the effect of the force majeure clause, the court appears to lump the Frustration doctrine in with the variations of the Impossibility doctrine: “The Leases unambiguously and clearly allocate risk of impossibility and impracticability to Tenants.” But isn’t “impracticability” simply a more liberal version of Impossibility, not another word for Frustration?

So what do you do with all of this? Well, because there is at least one case (and there may be more) interpreting a standard force majeure clause as only addressing the Impossibility defense, not the Frustration defense, landlords may want to consider adding language that clearly states that the payment of rent is required notwithstanding any purported frustration of purpose (in addition to the traditional language about prevention, hindrance or delay of performance). And tenants may well want to negotiate for an express carve-out of certain frustrating events. Indeed, should the clauses dealing with rent abatement in the event of a casualty be cross referenced as exceptions to the force majeure clauses statements about the absoluteness of the obligation to pay rent in all circumstances? And there may be more issues to consider—really read and think about the potential impact of your force majeure clause regardless of the nature of the agreement in which it appears.