In the recent judgment of The Center (76) Limited V Victory Serviced Office (HK) Limited HCA 1020/2020; [2020] HKCFI 2881, the Hong Kong Court of First Instance rejected a tenant’s argument that the tenancy agreement was frustrated due to the COVID-19 pandemic and social disruption.

This case is a useful reminder that the doctrine of frustration cannot be invoked lightly and that a lease will not be frustrated unless the parties’ obligations under it have been fundamentally or radically changed, rendering them physically or commercially impossible to fulfil.

Background

In June 2019, the parties entered into a tenancy agreement (Tenancy Agreement) in respect of office premises in Central, whereby the tenant operated its flexible workspace business. Since February 2020, the tenant had failed to fully settle the rent and other charges in respect of the premises. In June 2020, the landlord commenced proceedings to recover outstanding rent and other charges, amounting to over HK$28 million.

On 19 November 2020, the Court ruled in the landlord’s favour, granting it summary judgment for repossession of the premises and the outstanding rent /mesne profits and other charges, subject to the relief against forfeiture. One of the defences raised by the tenant was that the Tenancy Agreement had been frustrated by social disruption and the COVID-19 pandemic. Alternatively the tenant tried to invoke the rent suspension clause by saying that its obligation to pay rent had been suspended by reason of the social disruption, which caused the premises to become inaccessible.

Doctrine of Frustration

The leading authority for the application of the doctrine of frustration in the context of a lease is the House of Lords decision in National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675, where Lord Simon of Glaisdale held that “frustration of a contract takes place when there supervenes an event which so significantly changed 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”. His Lordship added that a contract would not be frustrated simply because the tenants “were undoubtedly put to considerable expense and inconvenience”. Accordingly, the ultimate question is “in the light of the quantitative computation and of all other relative factors, would outstanding performance in accordance with the literal terms of the contract differ so significantly from what the parties reasonably contemplated with those literal terms?”

The doctrine of frustration has limited application to the tenancy relationship in Hong Kong. It was previously considered by the Hong Kong District Court over a decade ago in respect of the Severe Acute Respiratory Syndrome (SARS) outbreak. In the judgment of Li Ching Wing v Xuan Yi Xiong [2004] 1 HKC, the District Court rejected a tenant’s claim that a two-year tenancy was frustrated following the evacuation of residents of the premises pursuant to a 10-day isolation order by the Department of Health in light of the outbreak of SARS. While the court acknowledged that the SARS outbreak was an unforeseen event, it held that it did not significantly change the nature of the parties’ outstanding contractual rights or obligations from what the parties could reasonably have contemplated at the time of the execution of the tenancy agreement. On the facts, the court found that the 10-day isolation order was quite insignificant a period in terms of the overall use of the premises for a term of two years.

Court’s reasoning

In the present case, as mentioned above, the tenant sought to invoke the doctrine of frustration and alternatively the rent suspension clause.  

While the court acknowledged that the COVID-19 pandemic and social disruption may have been unforeseen at the time of execution of the Tenancy Agreement and that such events must have rendered the tenant’s business operations more onerous and not profitable, it was held that none of this had “fundamentally or radically changed the nature of the parties’ obligations” so as to render it “physically or commercially impossible” to fulfil the Tenancy Agreement. In coming to this conclusion, the court commented that by holding onto the premises instead of surrendering them, the tenant was acting inconsistently with its claim of frustration and that the tenant’s refusal to deliver up the premises was evidence of “lack of good faith” in its defence of frustration. Most notably, the court also recognised that the tenant was in fact trying to hold onto the premises and generate income without paying rent. 

Further, the court held that there was no evidence that the premises had been destroyed, damaged or become unfit for occupation or inaccessible, other than a general assertion by the tenant of social disruption, poor economy and the COVID-19 pandemic, and thus the tenant’s alternative defence based on the rent suspension clause was also rejected. 

Takeaway

This case once again demonstrates the high hurdle one has to satisfy in order to invoke the doctrine of frustration in Hong Kong. It is not a defence to be lightly invoked, even in view of the current global pandemic crisis. Unless there is striking evidence indicating that the parties’ obligations have been fundamentally or radically changed in light of unforeseeable events, or that the leased premises have been rendered inaccessible for a significant period as compared with the duration of the tenancy, the parties are still expected to fulfil their legal obligations under the lease.