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Is there any room for the doctrine of failure of basis in a leasehold context? 27 July 2022

Bank of New York Mellon v Cine-UK Limited & Picture House Cinemas Limited v London Trocadero (2015) LLP [2022] EWCA Civ 1021

Introduction

In two recent appeals, Bank of New York Mellon v Cine-UK Limited and Picture House Cinemas Limited v London Trocadero (2015) LLP [2022] EWCA Civ 1021, heard together by the Court of Appeal on 21 and 22 June 2022, the Chancellor, Sir Julian Flaux, Lord Justice Snowden and Sir Nicholas Patten had to consider (among other things) whether two tenants of commercial premises had any prospect of successfully establishing a claim in restitution based on unjust enrichment, on the ground that there had been a failure of basis of a severable obligation in their leases.  The tenants’ arguments did not prevail. The underlying reason for this is because a lease is more than just a mere contract giving a right to use premises.

The Contractual Nature of Leases

The question of the extent to which contractual doctrine can or should be imported into the law of landlord and tenant has been extensively debated over the years. Historically, although leases were originally regarded as mere personal contracts, outside the feudal landholding system, they came increasingly to be regarded as interests in land.  In more modern times, they came to be regarded as a mixture of contract and property. In Linden Garden Trusts Ltd v Lenesta Disposal Ltd [1994] 1 AC 85 at 108H, Lord Browne-Wilkinson described them as a legal hybrid - part contract part property. Increasingly they have come to be regarded as simply a species of contract, notwithstanding the fact that a lease also creates an estate in land.

In National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675, the House of Lords famously held, by majority, that it was possible for a lease to be frustrated, like any other contract, and that frustration would bring the leasehold estate to an end. In doing so they disagreed with the majority of the Court of Appeal and two members of the House of Lords in Cricklewood Property and Investment Trust Ltd v Leighton’s Investment Trust Ltd [1943] KB 493. Lord Wilberforce, at 696, Lord Simon of Glaisdale at 703 and Lord Roskill at 716 all cited Laskin J in the Canadian Supreme Court case Highway Properties Ltd v Kelly, Douglas & Co Ltd (1971) 17 DLR (3d) 710 who said:

"It is no longer sensible to pretend that a commercial lease, such as the one before this court, is simply a conveyance and not also a contract. It is equally untenable to persist in denying resort to the full armoury of remedies ordinarily available to redress repudiation of covenants, merely because the covenants may be associated with an estate in land."

Applying the “full armoury” of contractual remedies to a lease is not, however, without its difficulties. Two examples serve to illustrate this: the application of the doctrine of repudiation, and frustration itself.  

Repudiation

The County Court in Hussein v Mehlman [1992] 2 EGLR 87 reawakened debate as to whether a lease can be brought to an end by a tenant’s acceptance of a repudiatory breach by the landlord. Stephen Sedley QC, later Sedley LJ, said that it could, holding that the decision of the Court of Appeal to the contrary in Total Oil Great Britain Ltd v Thompson Garages (Biggin Hill) Ltd [1972] 1 QB 318 was no longer correct following Panalpina.  The Court of Appeal has since assumed on more than one occasion that a lease can be terminated by acceptance of a repudiatory breach. In Chartered Trust v Davies [1997] 2 EGLR 83, it was assumed, without argument, that a lease can end through repudiation and acceptance. In Reichman v Beveridge [2006] EWCA Civ 1659, the Court of Appeal left the point open, noting that there was much to be said either way on the point of principle. In Grange v Quinn [2013] EWCA Civ 24, Jackson LJ said, at [70], that it was now clear that a lease may be brought to an end by repudiation and acceptance but again, the point does not appear to have been argued.

Importing the doctrine of repudiation for breach into a leasehold context does not sit happily with the principle, which has been settled law for centuries, that lease covenants are independent. That is to say, non-performance of one covenant does not excuse performance of another (see eg Yorkbrook Investments Ltd v Batten (1986) 18 HLR 25). The very reason why a landlord reserves a right to forfeit for a tenant’s breach is because non-performance does not give either party a right to terminate the lease.

How does repudiation for breach fit with the landlord’s right of forfeiture and the statutory regime which goes with this?  Equity grants relief against forfeiture of property rights - can a landlord circumvent this by accepting a repudiatory breach? And what about a claim for damages?  Where an ‘ordinary contract’ is terminated for breach, the innocent party would be entitled to sue for loss of profit for the remainder of the contract, subject to mitigation. It is well established, however, that a landlord who forfeits cannot claim damages for future loss of rent.

Frustration

Difficulties may also arise with the doctrine of frustration. Ordinarily, frustration of a contract brings to an end the obligation on both parties to perform their future obligations. Its effect is prospective only. Frustration of a lease is different, however. It is not merely the contract which ceases to exist for the future; the property interest, which exists independently from the contract, also ceases to exist. In Panalpina there was a contractual relationship between the parties – they were the original landlord and tenant. It is unclear how frustration works where the parties are landlord and tenant by assignment and their relationship is not contractual but arises under privity of estate or the Landlord and Tenant (Covenants) Act 1995.

The tenants’ attempt to rely on a defence of unjust enrichment in the above appeals is a further illustration of why the modern approach, which emphasises the contractual nature of a lease, should not  be at the expense of ignoring the proprietary interest which is of paramount significance.  

The Appeals

The appeals in Bank of New York Mellon v Cine-UK Limited and Picture House Cinemas Limited v London Trocadero (2015) LLP both raised the issue whether tenants were liable to pay rent for periods of time in the Covid-19 pandemic when, due to the various Covid regulations enacted by the Government, they were precluded from lawfully operating their business as cinema operators from the premises demised to them.

The Appellants were tenants of the Respondent landlords and occupied property on commercial leases which were drafted on standard commercial terms, each for a term of 35 years. In each case the landlord had issued a debt claim for rent arrears which had accrued during the pandemic and had then proceeded to seek summary judgment on the basis that the tenants had no defence. At first instance Master Dagnall, in Bank of New York, and Robin Vos, sitting as a deputy judge of the High Court in Trocadero, rejected the tenants’ arguments and granted the landlord summary judgment.

In both appeals the tenants relied (among other things) on a defence of failure of basis, arguing that the Government restrictions imposed as a consequence of the pandemic caused a total failure of basis in relation to a severable part of the lease. The way in which the tenants put this claim was to say that it was fundamental to the basis of the lease that the premises would be capable of lawful use. There had accordingly been a failure of basis during the illegal periods, and the illegal periods could be severed from the rest of the term of the lease. The tenants would therefore have a claim in unjust enrichment in respect of any rent or other sums paid in respect of the illegal periods. The tenants accepted that failure of basis could not operate as a substantive defence to the claim for rent under the lease, so sought to rely on a defence of set-off. 

The Court of Appeal rejected the tenants’ arguments and dismissed the appeals. The defence of failure of basis fell at the first hurdle: the fundamental basis for the obligation to pay rent was not merely the right for the tenant to use the premises lawfully as a cinema, but was the demise of the premises and the grant of the right of exclusive possession for a term of years.

The underlying principle of failure of basis is that where C transfers a benefit to D in circumstances where the transaction is subject to a condition (ie a basis) which has not been satisfied, there will have been a failure of basis for the transfer of the benefit, such that C can bring a claim for restitution.  In Dargamo Holdings Limited v Avonwick Holdings Limited [2021] EWCA Civ 1149 (“Avonwick”), Carr LJ said, at [79]:

“The core concept of “failure of basis” is that a benefit has been conferred on a joint understanding that the recipient’s right to retain it is conditional. If the condition is not fulfilled, the recipient must return the benefit (see Goff & Jones at 12-01). Whilst failure of basis ranks alongside the unjust factors of mistake, duress and undue influence as a factor negativing consent, it differs in that it is concerned with qualification of consent, as opposed to impaired or vitiated consent (see Burrows, The Law of Restitution, 3rd ed, 2011).” 

As a general rule, there is no role for unjust enrichment where there is a subsisting contract: the continued existence of the contract will usually defeat the restitutionary claim. Where C provides a benefit pursuant to a valid contract, payment for the benefit is governed by the contract and not the law of unjust enrichment. A contract will generally constitute lawful basis (unless it is void or rescinded or discharged for breach or frustrated). In Avonwick, the Court of Appeal considered when a claim in unjust enrichment can succeed in the context of a subsisting contract. Having stated the limitations on the application of the law of unjust enrichment in the context of subsisting contracts, Carr LJ identified what she called the “Obligation Rule”,  at [67]:

“That is not to say that claims in unjust enrichment must not respect contractual regimes and the allocations of risk agreed between the parties. On the contrary, as explained by Professor Burrows in The Restatement (at 3(6)), an “often overlooked but crucial” element of the unjust factors scheme is:

‘...that an unjust factor does not normally override a legal obligation of the claimant to confer the benefit on the defendant. The existence of the legal obligation means that the unjust factor is nullified so that the enrichment at the claimant’s expense is not unjust...’”

The principal reason for this general rule is that the law should give effect to the parties’ own allocation of risk under the contract. Unjust enrichment has a role where the contract does not operate or has ceased to operate, or where there is a “gap” in the contract.

It was common ground in the two appeals that in order for a claim in unjust enrichment based on failure of basis to succeed, the tenants had to show that the failure was total.  The tenants had little prospect of establishing a total failure of basis in respect of whole of their leases: each lease was granted for a term of 35 years and the period of illegality arising by reason of the Covid legislation could be measured in weeks.  Neither tenant sought to argue that their leases had been frustrated (although such an argument by another tenant in Bank of New York had been put forward at first instance and dismissed[1]), and in light of the decision in Panalpina would have failed in any attempt to do so. The tenants thus sought to avoid the strict rigour of the total failure requirement by seeking to apportion the basis, ie by saying that the benefit to be provided under the lease, and the rent paid for this benefit, was divisible.  In Fibrosa Spolka Akcjna v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32  Lord Porter, at p.77, said:

“…money had and received to the plaintiff's use can undoubtedly be recovered in cases where the consideration has wholly failed, but unless the contract is divisible into separate parts it is the whole money, not part of it, which can be recovered. If a divisible part of the contract has wholly failed and part of the consideration can be attributed to that part, that portion of the money so paid can be recovered, but unless this be so there is no room for restitution under a claim in indebitatus assumpsit. A partial failure of consideration gives rise to no claim for recovery of part of what has been paid.” 

In Avonwick, at [103], Carr LJ said of the total failure requirement:

“In particular, its practical significance has been reduced by the doctrine of apportionment which allocates parts of the payment to distinct elements of the benefit in return for which the payment was made; if only part of that expected benefit has been conferred, it is said that there has been a total failure of basis in relation to the severable part of performance which has not been achieved. As Lord Toulson said in Barnes (at [114]) (referring by way of example to Roxborough and D O Ferguson & Associates v Sohl [1992] 62 BLR 95):

‘Modern authorities show that the courts are prepared, where it reflects commercial reality, to treat consideration as severable.’”

Traditionally, apportionment was only considered to be available where the contract expressly or impliedly provided for apportionment. Recent cases, however, have broadened this approach to the question of apportionment. For example, in Giedo Van der Garde BV v Force India Formula One Team Limited [2010] EWHC 237, Stadlen J said, at [297]:

“…in my view, … the question whether apportionment can be carried out turns not on whether apportionment is provided for either expressly or even by implication by the contract but rather on whether as a matter of practical common sense the court considers that it is able to apportion on objective analysis of the nature of the contract and the consideration.”

And in Barnes v Eastenders Cash & Carry plc [2014] UKSC 26 at [114] Lord Toulson JSC said:

“Modern authorities show that the courts are prepared, where it reflects commercial reality, to treat consideration as severable.”

The Decision

The Court of Appeal thus had to address these two questions in the appeals: (1) what was the relevant ‘basis’;  and (2) whether this could be apportioned. ‘Basis’ is the condition which constituted the ground for the transfer of the benefit to the claimant. In these appeals, it was said that the ‘basis’ was the reason for the tenants’ rental payment, in contrast to the reason for the grant of the lease. The tenants argued that their ability to use the premises lawfully as a cinema was fundamental to the basis of the lease and they cannot have intended to pay rent if they received no benefit; and the landlord cannot have expected to receive rent if the tenants could not use their premises in this way. The demise was of no value to the tenants if it could not be lawfully used at all. 

The tenants’ argument had echoes of what was said by the House of Lords in Panalpina, where Lord Simon, at p.705 said:

“Nor, finally, is it realistic to argue that on execution of the lease the lessee got all that he bargained for. The reality is that this lessee, for example, bargained, not for a term of years, but for the use of a warehouse owned by the lessor – just as a demise charterer bargains for the use of a ship.” 

Lord Wilberforce similarly said, at p. 694-5:

“In the second place, if the argument is to have any reality, it must be possible to say that frustration of leases cannot occur because in any event the tenant will have that which he bargained for, namely, the leasehold estate. Certainly this may be so in many cases—let us say most cases. Examples are London and Northern Estates Co. v Schlesinger [1916] 1 K.B. 20, where what was frustrated (viz. the right of personal occupation) was not at the root of the contract, and requisitioning cases, for example, Whitehall Court Ltd v Ettlinger [1920] 1 K.B. 680, where again the tenant was left with something he could use. But there may also be cases where this is not so. A man may desire possession and use of land or buildings for, and only for, some purpose in view and mutually contemplated. Why is it an answer, when he claims that this purpose is "frustrated", to say that he has an estate if that estate is unusable and unsaleable? In such a case the lease, or the conferring of an estate, is a subsidiary means to an end, not an aim or end of itself. This possible situation is figured, in fact, by Viscount Simon L.C. in the Cricklewood case [1945] A.C. 221, 229.” 

In Trocadero at first instance the deputy judge, having regard to Barnes at [115], concluded that the continued and uninterrupted lawful use of the premises as a cinema was not fundamental to the basis on which the tenant entered into the lease. He said, at [128]: “I use the expression “fundamental to the basis” because it should not be thought that mere failure of an expectation which motivated a party to enter into a contract may give rise to a restitutionary claim. Most contracts are entered into with intentions or expectations which may not be fulfilled, and the allocation of the risk of their non-fullment is a function of the contract.”

In the Court of Appeal in Bank of New York, the Chancellor said, at [149] to [150]:

“In the case of the leases in the present cases, it is clear that the consideration for the obligation to pay rent was the demise of the premises for, in each case, a 35 year term, giving the tenant exclusive possession. Mr Seitler QC accepted that that consideration or basis had not failed but submitted that there was more than one basis and that the common understanding or assumption that the premises could be used lawfully as a cinema was also a fundamental basis for the obligation to pay rent and that that basis had failed.

The difficulty with this argument was identified by Sir Nicholas Patten during the course of argument, which is that, whereas in cases like Barnes and Roxborough there was some wider arrangement which gave rise to an extraneous or extra-contractual understanding the operation of which did not subvert the contract, in the present case there was no wider context, but only the letting of the premises on the terms of the leases.” 

Identifying the basis of a contract requires an objective approach. In the Giedo case the judge said, at [286]:

“On balance in my view although the question is to be answered from the perspective of the payer in the sense of identifying the essential bargain for which he contracted or, to use the language of the majority in David Securities, the matter considered in forming the decision to do the act and the state of affairs contemplated as the basis or reason for the payment it is a question be answered objectively rather than by reference to evidence of his subjective motives.”

This posed a further difficulty for the tenants. The Chancellor continued, at [151]:

“Mr Seitler QC did not seek to rely upon some extraneous or extra-contractual common understanding or assumption outside the lease, but, even if he had, that case would be hopeless, essentially for the reasons given by Marcus Smith J in the Canary Wharf case cited at [120] above.[2] As that judge said, outside the terms of the lease, the parties’ interests and purposes are not common but divergent. Rather, Mr Seitler QC argued that that the common understanding or assumption is to be found within the lease, in the user covenant, but the problem with that argument, which leads into the contention that the permitted use is somehow the fundamental basis of the lease, is that it would have the effect of altering and thus subverting the terms of the contract and altering the allocation of risk for which the express terms of the lease provide.”

The failure of basis claim therefor failed at the outset. At [158] the Chancellor said:

“Since the basis of the obligation to pay rent under both the Hengrove lease and the Trocadero lease was the demise of the premises for a 35 year term and, on the true construction of both leases, the obligation to pay rent was only suspended where the cesser of rent clauses applied, namely where there was physical damage to or destruction of the premises by an insured risk rendering them unfit for occupation or use, there is simply no gap in the lease which requires filling by a claim in unjust enrichment. The contention that the fundamental basis for the obligation to pay rent is that the premises can be lawfully used as a cinema is inconsistent with the express terms of the leases and the allocation of risk between the parties…”

Although the Court of Appeal did not seek to emphasise the significance or importance of the fact that the leases created an estate in land, in deciding that the fundamental basis of the obligation to pay rent was the demise for a term of 35 years, they were recognising that a lease is far more than just a contract.

In Bank of New York the failure of basis argument had not been run at first instance. In Trocadero the deputy judge had rejected the argument but had said, obiter, that if he had concluded that there was a failure of basis he would have gone on to hold that the tenant had an arguable claim to say that the leases were severable on a time apportioned basis. The deputy judge did not decide that the leases were severable on a time apportioned basis and that the quarterly rent payments could be apportioned: he was dealing with an application for summary judgement and as such had only to conclude that the tenant had an arguable claim in this regard.

This issue was the subject of a Respondent’s notice in the Trocadero appeal, but their Lordships declined to deal with this point stating, at [161]:

“Given that those issues do not arise in circumstances where I have concluded that there was no failure of basis at all, it would seem advisable to say no more about them. The issue of apportionment of rent, in particular, is a potentially complex one which is better decided in a case where it is critical to the determination of the issues of appeal and not merely obiter.”

It is suggested, however, that a lease cannot be carved up nor rent apportioned in the way the tenants sought to argue it could be.

The obligation to pay rent

It is now no longer acceptable to say that rent issues out of the land, and thus has an extra-contractual character. In CH Bailey Ltd v Memorial Enterprises Ltd [1974] 1 WLR 728, at 732, Lord Denning described this notion as an “outdated relic of medieval law”.  In United Scientific Holdings Ltd v Burnley Borough Council [1978] AC 904, at 935, Lord Diplock said:

“the mediaeval concept of rent as a service rendered by the tenant to the landlord has been displaced by the modern concept of a payment which a tenant is bound by his contract to pay to the landlord for the use of his land.”

But is it right to regard rent as no more than a simple contractual obligation to pay a periodic sum of money and something which can be easily apportioned, reflecting commercial reality? 

A tenant is ordinarily under a contractual obligation to pay rent.  This obligation does not, however, detract from the fact that rent is something reserved by the landlord out of the grant of the lease.  A landlord who has reserved a rent has a right to receive rent from its tenant whether or not there is also a contractual obligation reinforcing this right. The tenant, while it remains the tenant, is liable to pay the rent even in the absence of a covenant to do so. This is the basis on which a subsequent tenant is liable on any of the lease covenants. Section 205(1)(ix) of the Law of Property Act 1925 recognises rent as an incorporeal hereditament. It is payable by the tenant from time to time and payable to the landlord from time to time.  The fact that rent is an incident of the reversion of the landlord was recognised by Neuberger LJ in Edlington Properties Ltd v J H Fenner & Co Ltd [2006] EWCA Civ 403 at [16]:

“In the first place, the notion that the right to recover the rent under a lease runs in law with the reversion, and that the common law courts would thus enforce the rights of a transferee of the reversion to recover rent under the lease, goes back to 1540 in statute, and at least 1583, when Spencer’s Case (1583) 5 Co Rep16a was decided, in common law. Secondly, while it is fair to say that the contractual character of a lease has tended to become more prominent over the past 50 years, it remains a fact that it is also an interest in land, and it is not hard to see that the right to recover the rent should be an incident of the reversion, and that accordingly it may have di­fferent features from the right to recover a debt unassociated with any interest in land.”  

Rent might be payable in instalments, but rent is consideration for the estate as a whole and is not, by its nature, apportionable. As Peter Smith J said in PCE Investors Limited v Cancer Research UK [2012] EWHC 884, at [49], and as followed by Morgan J in Marks & Spencer plc v BNP Paribas [2013] EWHC 1279 (Ch) at [42] to [45], it is not appropriate to divide up a single consideration.

“…It is not appropriate to separate out parts of the obligation in the Underlease and say that there is a total failure of consideration merely because the lease had been terminated in future as regards the rent that was payable in advance for that period. The Underlease contains a bundle of rights and obligations on both sides and as part of that in my view the Tenant agreed to pay the rent in advance as part of the overall consideration for obtaining the Underlease from the Landlord. Merely because the provisions obligate him to pay rent in advance even after the Termination Date does not mean that there is a failure of consideration as regards that payment merely because beneficial use of the premises is not taken. One looks at the overall package in the Underlease and the Tenant obtained consideration in the form of the entirety of the Underlease.”

Conclusion

A lease contains covenants which, in origin are contractual, and in many ways a lease can be regarded like any other contract. For example, the ordinary principles of contractual interpretation apply to leases and a breach can be enforced by specific performance or give rise to a claim in damages. But a lease also creates an estate in land and this fact is significant, not least because unlike mere contractual rights, property rights have the potential to affect third parties. There are rules which apply to leases which do not apply to other contracts, often reflecting the medieval origins of the law of landlord and tenant: thus a lease, unlike other contacts, must have a term certain. 

A lease is fundamentally more than a mere contract: it creates an estate in land.[3]  A lease can be created without any contract at all and with neither party promising to do anything.  The covenants are in addition to the creation of the estate. The contractual obligations go with the estate and are dependent on the continuation of the estate granted - this is why a landlord who forfeits cannot claim damages for future loss of rent.  The obligation to perform the lease covenants is dependent on the continuation of the estate: if the estate ends, the contractual liability to perform the covenants ends. But the estate doesn’t depend on the contract. The legal estate has an existence which is independent to the contract which created it - this is why an assignment of a lease, even in breach of contract, is effective to vest the lease in the assignee. The reason why contractual remedies such as termination for repudiation and remedies such as failure of basis and even frustration create difficulties is precisely because the covenants in a lease are associated with an estate in land.

It is now beyond question that the doctrine of frustration applies to leases, but it applies in such rare cases that there are still no decided cases where the court has decided that a lease has been frustrated.  The question whether a lease can be terminated for repudiatory breach remains to be authoritatively determined, albeit most practitioners now accept that the doctrine does apply to a lease and operates to determine both the contract and the estate in land.

Will there ever be any room for the doctrine of failure of basis to apply to a lease? It is difficult to envisage a situation where the demise itself, the grant of the term of years, will not be the fundamental basis of the lease. The basis for the grant of a lease must surely always be the grant of the estate: this is the essence of a lease. It is also difficult to envisage when there might be a total failure of basis which would not also be capable of constituting a frustrating event. The strict requirement that a failure of basis must be total would require a total failure of the estate, which would undoubtedly be a frustrating event. And because the estate is granted whole, at the start of the lease, it does not accrue from day to day: a lease is not a contract that is ‘apportionable’.

There is no reported case where a lease has been held to be frustrated. In Panalpina Lord Hailsham said “I hope this fact will act as a suitable deterrent to the litigious, eager to make legal history by being the first in this field.”  The Court of Appeals decision in these appeals will no doubt similarly serve to deter those seeking to make legal history.

Guy Fetherstonhaugh QC & Elizabeth Fitzgerald

Falcon Chambers

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