As the world faces up to the challenges posed by the spread of COVID-19, clients have started asking what effect it could have on real estate.

The virus has the potential to disrupt the market. For example, there is a clear and direct effect on the travel sector as countries try to contain any outbreaks. The wider leisure sector also looks vulnerable as the likelihood of restrictions on public gatherings grow. Even within the office sector there is potential for disruption as firms advise their employees to stay at home. All of this will have an effect on the market just at a time when it was hoped we would see a "Brexit bounce".

The question is whether or not COVID-19 also has the potential to alter legal agreements relating to real estate. This note considers two particular types of agreement: leases and construction agreements.

Leases

Some clients have queried what effect the virus could have on lease arrangements. For example, if you have a letting to a travel agent, the tenant is likely to feel the negative economic effects of COVID-19 – could the tenant refuse to pay the rent or even bring the lease to an end prematurely?

The starting point in every case is to check the lease to see if there are any relevant provisions. For example:

  • a tenant break clause giving the tenant the option of bringing the lease to an early end (irrespective of the circumstances);
  • turnover rent provisions that are dependent on the income generated from the premises; or
  • a force majeure clause (though this would be highly unusual for leases).

In the absence of any specific provisions in the lease, it is highly unlikely that the tenant would be able to withhold rental payments because of a downturn in the market.

Equally, a tenant will have an uphill struggle if it tries to argue that the lease should be brought to an early end because of the change in the market (frustration). The threshold test for proving frustration is set very high. This was illustrated most recently in Canary Wharf Limited v. European Medicines Agency [2019] EWHC 335 (Ch). In that case, the European Medicines Agency argued that Brexit would frustrate its lease. The High Court did not agree. The fact that the lease contained alienation provisions that would allow the tenant to dispose of the lease if it could no longer continue its operations in the UK mitigated against a finding of frustration.

To argue frustration you have to show that there is some form of intervening illegality or failure of common purpose that renders performance of the lease impossible or so radically different from the parties' expectations that frustration is justified. Arguably, the outbreak of disease is not such an event – in recent years we have had to deal with SARS and swine fever. As such, public health issues should be within the contemplation of the parties at the time of grant, leaving it open to them to have negotiated provisions allocating the risk.

In addition, at the moment there is no actual ban on booking hotel rooms or attending leisure venues in the UK – instead, what we have is a situation where people are being more cautious and perhaps choosing not to do certain things. Should the government decide to ban certain activities, then perhaps tenants will have a stronger argument for frustration based on the illegality point, but it would not be clear-cut. Much would depend on the nature of the ban (including its duration compared to the duration of the underlying letting) and the actual terms of the lease involved.

Putting aside the legal framework, landlords generally want their tenants to be successful. As such, if COVID-19 becomes a chronic problem, it may be that both parties will be forced to negotiate practical compromises to help them navigate through difficult times.

However, it is not just existing leases that are going to be affected. We are already seeing clients re-evaluating their approach to new leases. It remains to be seen what sort of clauses may or may not come out of this, although we expect all sides will be looking at this forensically.

Construction documents

For developments that are in the process of being constructed, you will need to look to the terms of the building contract to determine what rights the contractor may have to claim time or money, should the works be delayed or disrupted as a consequence of COVID-19.

The JCT suite of contracts is commonly used for domestic English commercial developments (with the equivalent SBCC suite being used in Scotland). The standard JCT/SBCC forms are usually amended by a schedule of amendments (which should, of course, be reviewed) but it is fair to say that the provisions which give rise to the recovery of loss and expense usually remain more or less as per the standard wording. On that basis, our comments which follow focus on the standard JCT wording (and the SBCC wording is, to all intents and purposes, identical in this respect).

In an unamended JCT contract, a contractor is entitled to claim an extension of time (but not loss and expense) should an event of force majeure occur. Although the term "force majeure" is not defined by the JCT, it will generally apply when a party has been unable to perform its contractual obligations because an unforeseeable and unavoidable event has occurred which has not been caused by either of the parties. The fact that the contractor finds the works more expensive or time consuming to complete as a result of COVID-19 will not, of itself, trigger an ability to reply on force majeure. The contractor will need to show that it was impossible for it to perform its obligations under the contract directly as a result of COVID-19.

For JCT contracts which have yet to be entered into (or those which have only been entered into after COVID-19 was known), force majeure or its equivalent will arguably not be applicable (because the fact that the parties already knew about the existence of COVID-19 means it is not "unforseeable"). In such circumstances, the parties either need to include a bespoke amendment in the contract to allocate the risk of any delays caused by COVID-19 or, if the circumstances allow, rely on the extension of time provision which allows the contractor extra time to complete the works if the government or a local authority exercises any statutory power which directly affects the execution of the works. This may apply, for instance, if statutory measures are put in place to restrict freedom of movement. This would not apply, however, to the cessation of work following government advice or the adoption of best practice.

It should also be noted that an event of force majeure may entitle either party to terminate a JCT contract. The force majeure event must have prevented the carrying out of the whole or any part of the works for the period of time specified in the contract (the default position is two months) and the relevant notice requirements set out in the contract must be complied with for the termination to be effective.

Conclusion

We all hope that COVID-19 can be contained. The key to success will be keeping calm and behaving responsibly. That advice applies equally to legal arrangements. Irrespective of whether you are landlord or tenant, contractor or employer, the starting point is calmly to understand your legal commitments and not to assume that you will be automatically relieved from responsibility for performing them just because there is a public health crisis.