The Covid-19 outbreak has not only brought uncertainty but unprecedented hardship to businesses as well as the general population at large. The real estate sector, already reeling from a significant slowdown, has suffered yet another blow as demand has nose-dived both for commercial and residential properties.
With the forced lockdown and discontinuation of commercial activities across India, the sanctity of commercial leases has come to the fore. Acknowledging the crisis, countries such as Singapore and the United Kingdom have announced a waiver or deferment of rental payments to ease the hardship faced by businesses. In the absence of a similar nationwide policy in India, businesses are looking at ways to avoid or delay the payment of lease rentals to mitigate cash flow issues to survive the present crisis.
Possible legal avenues
The doctrine of “Force Majeure” has often been cited as a possible way out of executed commercial lease agreements. This term typically captures all acts which are generally beyond the control of contracting parties such as natural calamities like floods, cyclones, earthquakes, and may also include unforeseen man-made circumstances such as change of government policy that adversely affects the performance of contracts. However, we need to understand that such a clause needs to be expressly built into the lease agreement to reflect the commercial understanding agreed to between the parties. A force majeure provision is to be expressly agreed to and in the absence of such a clause, it cannot be read into a lease agreement by implication.
Further, such a clause will come into operation only in circumstances expressly mentioned in the clause. Therefore, unless the term “pandemic” or “epidemic” or “lockdown under government order” is specifically covered, such a clause cannot be invoked. Thus, parties need to look at their agreements, carefully assess the consequences envisaged (like suspension or termination of contract) and consult their legal advisors before invoking the “Force Majeure” clause.
It is worthwhile to mention that suspension of payments as a recourse rarely finds mention in the usual Force Majeure clauses.
The lessee also needs to follow the procedural requirements detailed in the clause stringently (like providing notice to the opposite party within the agreed time period) before invoking the clause to stand up to legal scrutiny in the court of law should it become contentious. The doctrine of frustration of contract cited by certain sections, is generally not applicable to commercial leases as leases are governed by a special statute, namely, the Transfer of Property Act, 1882. Section 108 of Transfer of Property Act states that a lessee can choose to make the lease void in case the property is “wholly destroyed or rendered substantially and permanently unfit for the purpose for which it was let.”
The question that arises for consideration is, can the coronavirus pandemic fit into these criteria? The answer is in the negative. Although the lockdown has forced businesses to shut shop, they are still in possession of the property along with their fixtures. The damage caused is neither “permanent” nor is the property “wholly destroyed”. Courts have in various cases held that mere economic hardship or increase in costs of running business will not allow parties to terminate contracts. The damage caused has to be so profound as to render the property “substantially and permanently unfit” for usage.
Thus, the temporary nature of the coronavirus outbreak will act as an impediment in this scenario. Separately, the doctrine of frustration of contract, governed by Section 56 of the Indian Contract Act, 1872, becomes relevant for leave and license agreements which has become a preferred instrument for governing shortterm license arrangements. The statute envisages a situation where, the performance of the contract becomes “impossible” or “unlawful” due to an event which was beyond the control of the parties.
In this case, the contract becomes void and parties can escape their liabilities under the contract. However, it may be difficult to argue that the hardships arising out of the coronavirus pandemic have made the performance of contract “impossible” and consequently, frustration of contract is unlikely to be allowed as a defence to lessees to terminate their contracts. In any event, the burden is always on the party invoking Section 56, and it is a very stiff burden to discharge.
Options available to the parties of a commercial lease
The question that arises therefore is, what is the recourse available to parties to a commercial lease? Keeping in mind this unprecedented situation, it would be prudent that the lessor and lessee, discuss and arrive at a mutually agreeable settlement rather than litigate on the issue or avoid payment of lease rentals unilaterally. Possible alternatives may include deferment or waiver of lease rentals during the lockdown period and/or entering into revenue sharing agreements with the lessor for the foreseeable future. Certain State Governments (example, Maharashtra) have started issuing advisories to lessors for deferment of payment of rents to address the issues highlighted above. Going forward, we expect more state governments to take steps to lower the liabilities of businesses.
What is the future?
In view of the Covid-19 experience parties while entering into agreements, should specifically look at including “epidemic”, “pandemic”, “cessation of business due to a governmental order” or build in appropriate causative provisions in the “Force Majeure” clause, with specific redressal mechanisms like suspension of payment or a waiver of rentals for the duration of the event. Businesses may also consider wider adoption of business continuity insurance which will specifically cover pandemics, lockdowns and its consequences. The authors expect that in light of this unprecedented pandemic and its fall out, a new jurisprudence is likely to evolve from judicial decisions by Indian courts which will aim to protect the interest of both lessors and lessees in similar situations that might arise again in the future.
The writers are, respectively, a Partner and an Associate at Khaitan & Co.