Earlier this month, the Superior Court in Suffolk County, Massachusetts, held that a tenant need not pay rent if the agreed upon purpose for its lease has been banned. It is no doubt a ruling for our times that applies old law and common sense to doing business during the current COVID-19 pandemic.
The Judgment:
Briefly, in UMNV 205-207 Newbury LLC v. Caffé Nero, the court entered summary judgment in favor of the commercial tenant, Caffé Nero, and against the landlord, UMNV, and held that the doctrine of frustration of purpose entitled the tenant to withhold rent during periods when the government banned the contractually required use of the space. More precisely, Caffé Nero was entitled to withhold rent during the months it was barred by government order concerning the COVID-19 pandemic not to allow any consumption of food on the leased premises.
The Lease:
The lease in this case provided that Caffé Nero could use the leased premises “solely” for “[t]he operation of a Caffé Nero themed café under Tenant’s Trade Name and for no other purpose.” It also says that Caffé Nero was required to operate this café “in a manner consistent with other Caffé Nero locations in the Greater Boston area,” to serve food and beverages “of first-class quality,” and could only offer take-out sales “from its regular sit-down restaurant menu.”
The contractual use provision was key to the court’s analysis. As the court explained, “It would have made no business sense for the parties to enter into a lease providing that Caffé Nero may only use the leased premises for one narrow purpose, but must keep paying rent even if the only permissible use is no longer allowed or possible.” In short, the tenant should get what it pays for or not have to pay at all.
The Basis:
The court grounded its opinion upon the Massachusetts law regarding frustration of purpose. Under that legal doctrine, the court explained, a party to a lease or other contract is excused from performing its contractual obligations “when an event neither anticipated nor caused by either party, the risk of which was not allocated by the contract, destroys the object or purpose of the contract, thus destroying the value of performance.” Chase Precast Corp. v. John J. Paonessa Co., Inc., 409 Mass. 371, 374 (1991). That was precisely the case with Caffé Nero.
To apply the doctrine of frustration of purpose, one must first know the contractual purpose of the parties. It not the purpose of only one party for entering into the transaction, it is the agreed upon purpose of the parties that controls. So, for example, in the old case of Krell v. Henry, the hotel guest who rented a room with a balcony only for the purpose to see the coronation parade for King Edward VII could get his money back from the hotel when the parade was canceled the day he rented the room, but only because the evidence showed the parties expressly understood that was the expressed reason for renting the room. It was not a privately held purpose but the expressed reason for the transaction. Thus, the contractual definition of purpose is key to application of the doctrine, as the hotel could not simply collect room fees when the mutual purpose for the transaction to rent the room had been frustrated.
Use provisions in lease contracts are therefore key. Some leases allow for the tenant to use the premises “for any lawful purpose”. Had Caffé Nero had such a use provision in its lease, the outcome would have been entirely different. For Caffé Nero, however, the lease provided for a very limited purpose, i.e., to operate a sit-down café serving food and drink, with a take-out option derived from its dine-in menu. The use provision of the lease made the contractual purpose painfully clear.
Next, one must determine whether the parties’ contractual purpose has been frustrated. Frustration does not mean an event that renders the deal “less profitable” or “less valuable” than hoped, but rather a circumstance rendering the transaction utterly pointless given the contractual purpose of the parties. There is no doubt that government prohibition of the transaction at issue renders the object of the contract completely fruitless, thereby frustrating the contractual purpose of the parties. In the Caffé Nero case, the limited contractual purpose under the lease was banned by the Governor. Clearly Once banned, the mutual, contractual purpose had been frustrated.
Obviously, a party to a contract cannot render himself or herself incapable of performance and then claim to be free from their contractual obligations under the doctrine of frustration of purpose. The intervening circumstance causing the frustration must be beyond either party’s control. Obviously, Café Nero had no control over a global pandemic or the actions of the Governor of Massachusetts.
The “Force Majeure” Clause:
Finally, one must determine whether the risk causing the frustration of contractual purpose was somehow assigned to one of the parties to bear the cost in the event such risk might arise. In short, was the risk foreseeable and did the parties assign the risk to one or the other party? It is still a free country and people can agree to assign and accept risk in a multitude of ways. Rational business people can order their affairs that suit their competing needs and their risk tolerances. For example, a tenant could agree to a long-term lease that would not allow for any excuse from the rental obligation for any reason, including natural disaster, war, insurrection, or any sort of Act of God, in exchange for a rental rate that may otherwise be very favorable. We all make our bets and the law allows for those arrangements, but when contractual language is silent the courts apply doctrines to enforce the likely intent of the parties.
In the Café Nero case, the parties had not assigned to either the tenant or the landlord who should bear the burden in the event a global pandemic would result in government orders banning restaurant operations. Had the parties assigned that risk, then failure to perform notwithstanding the pandemic would constitute breach and result in a certain remedy to the non-breaching party. As they had not assigned the risk, the doctrine of frustration of purpose allows either party to terminate the contract, with neither party holding any further contractual obligation to the other whatsoever. In the end, that is what happened with Caffé Nero, as the court ordered Caffé Nero had no further rent obligation under the lease on account of the Governors’ bans against indoor restaurant operations.
The landlord argued that the Force Majeure provision served to assign the risk of pandemic to the tenant, but the court disagreed. The court noted that the Force Majeure provision only addressed the circumstance when performance was rendered “impossible” by some Act of God and that the payment of rent could never be excused due to the impossibility of performance. The doctrine of frustration of purpose, however, concerns the object of performance, i.e., the value or purpose of the contract itself. While the court acknowledged that it was not impossible for the landlord to rent the space and the tenant to pay for it, the court noted that the entire contractual purpose for that transaction had been frustrated by the government ban prohibiting the agreed upon use of the space under the lease.
The Fine Point:
This may also be a case where timing is everything. The landlord terminated the lease for non-payment of rent during the time the Governor’s ban was still in effect. As a result, here is exactly what the court ordered:
When final judgment enters, it shall include the following declarations: (i) Defendant’s obligation to pay rent under the parties’ Lease was discharged under the doctrine of frustration of purpose from March 24 to June 22, 2020, and during any other period when Defendant was barred by government order concerning the COVID-19 pandemic not to allow any consumption of food or beverage within the lease premises; (ii) Defendant was not in default under the Lease as of May 19, 2020; and (iii) the written notice of termination issued by Plaintiff on May 19, 2020, was therefore not effective.
Bottom line, the court said here that there was no rent owed during the 3-month closure period. The landlord defaulted Caffé Nero immediately, during that closure period when the contractual purpose was entirely frustrated.
What is most notable about the court’s decision was that it did not rule that the doctrine of frustration of purposes necessarily required termination of the entire lease contract. Rather, the court ruled that “performance under the contract was excused for frustration of purpose, at least for a period of time.”
So, what would have happened if the landlord had just waited? In the Caffé Nero case, the landlord defaulted the tenant and terminated the lease before the reopening order. The landlord argued the tenant was in default for non-payment when the lease and the doctrine of frustration of purpose said otherwise. So, the landlord took an overly strident position at the wrong time. What would have happened had the landlord demanded full rent when the partial re-opening order entered on June 22, 2020? Perhaps, at that point, as the purpose of the parties might not have been entirely frustrated, full rent might have come due. Or partial rent, but we cannot tell from the opinion whether and to what extent partial reopening would change the analysis.
The Take Away:
Draft your lease carefully, and read it closely. Perhaps a less restrictive use provision leads to a different result than what happened with Caffé Nero. Or, perhaps a more patient landlord might have improved his bargaining power had it been more patient during the time of complete shut down and waited to demand rent upon partial re-opening. Finally, Force Majeure does not answer all questions. Ultimately, courts interpret contracts to enforce the parties’ intent, whether they like it or not.