Frustration Of Purpose Doctrine And Covid In North Carolina Commercial Leases

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My last blog post suggested that landlords and tenants should take a new look at their leases to see if there is language that specifically allocates the risk of a pandemic. What if your lease contains no force majeure clause? What happens if the lease does not otherwise address COVID-19, pandemics, Acts of God or other events like new governmental restrictions? Will the tenant be excused from paying rent if, say, the new Omicron variant forces businesses to shutter or limit services for a period of time? Under those circumstances, the parties will have to look to North Carolina common law to determine the rights and responsibilities of the parties. The tenant’s first argument will likely be that the frustration of purpose doctrine excuses rent payments. But is the tenant right? Maybe, but it’s a tough argument.

There is no case on point in North Carolina which addresses whether the frustration of purpose doctrine is a defense to nonpayment of rent due to business interruption caused by the COVID pandemic. Generally, however, “[c]hanged conditions supervening during the term of a contract sometimes operate as a defense excusing further performance on the ground that there was an implied condition in the contract that such a subsequent development should excuse performance or be a defense . . . .” Faulconer v. Wysong & Miles Co., 155 N.C. App. 598, 601, 574 S.E.2d 688, 691 (2002). The frustration of purpose doctrine excuses performance “whenever a fortuitous event supervenes to cause a failure of the consideration or a practically total destruction of the expected value of the performance.” WRI/Raleigh, L.P. v. Shaikh, 183 N.C. App. 249, 254, 644 S.E.2d 245, 248 (2007). “The doctrine of commercial frustration is based upon the fundamental premise of giving relief in a situation where the parties could not reasonably have protected themselves by the terms of the contract against contingencies which later arose.” Faulconer, 155 N.C. App. at 601, 574 S.E.2d at 691. “However, the doctrine of frustration cannot be used where the frustrating event was reasonably foreseeable.” WRI/Raleigh, L.P., 183 N.C. App. at 254, 644 S.E.2d at 248. “In addition, if the parties have contracted in reference to the allocation of the risk involved in the frustrating event, they may not invoke the doctrine of frustration to escape their obligations.” Brenner v. Little Red Sch. House, Ltd., 302 N.C. 207, 211, 274 S.E.2d 206, 209 (1981). “Essentially, there must be an implied condition to the contract that a changed condition would excuse performance; this changed condition causes a failure of consideration or the expected value of performance; and that the changed condition was not reasonably foreseeable.” Faulconer, 155 N.C. App. at 602, 574 S.E.2d at 691.

In Brenner, the plaintiff contracted with the defendant school to pay the tuition for the entire school year in advance of the first day of school. In consideration therefor, defendant promised to hold a place in the school for plaintiff’s child, to make all preparations necessary to educate the child for the school year, and to actually teach the child during that period. Both parties received valuable consideration under the terms of the contract. After receiving plaintiff’s tuition payment, defendant reserved a space for plaintiff’s child, made preparations to teach the child, and at all times during the school year kept a place open for the child. However, the plaintiff’s wife ultimately refused to send their child to defendant’s school.

The Court first looked at whether the value of the contract had been destroyed and noted that “[the] performance by defendant was sufficient consideration for plaintiff’s tuition payment.” Brenner, 302 N.C. at 210. The Court continued: “A school such as defendant must make arrangements for the education of its pupils on a yearly basis, prior to the commencement of the school year. Many of these arrangements are based upon the number of pupils enrolled, for example, the teaching materials to be ordered, the number of teachers to be hired, and the desks and other equipment which will be used by the children. In addition, private schools are often limited in the number of pupils that can be accommodated, so that the reservation of a space for one child may prevent another’s enrollment in the school. Had it been advised before the first day of school that plaintiff’s child would not be in attendance, defendant might have been able to fill the vacant position. After the start of the school year, the probability of filling the position decreased substantially, thus to allow plaintiff to recover the tuition paid might deprive defendant of income it would have received had the contract not been entered into. Therefore, although plaintiff did not receive the full consideration contemplated by the contract, he received consideration sufficient to avoid the application of the doctrine of frustration of purpose. There was no substantial destruction of the value of the contract.”

Next, the Court found the doctrine of frustration of purpose inapplicable based on foreseeability. The Court held that “[a]lthough the parties could not have been expected to foresee the exact actions of plaintiff’s former wife in refusing to send the child to defendant school, the possibility that the child might not attend was foreseeable and appears expressly provided for in the contract. The contract states that tuition is ‘payable in advance of the first day of school, no portion refundable.’ This provision allocates to plaintiff the risk that the child will not attend, and prevents the application of the doctrine of frustration of purpose.”

Since the doctrine of frustration of purpose did not apply and the terms of the contract were clear and unambiguous, the court was bound to enforce it as written. Crockett v. First Federal Savings and Loan Association of Charlotte, 289 N.C. 620, 224 S.E.2d 580 (1976); Weyerhaeuser Co. v. Carolina Power & Light Co., 257 N.C. 717, 127 S.E.2d 539 (1962).

In summary, in North Carolina, to establish frustration of purpose, the tenant must show three (3) things:

  1. There was an implied term in the contract that a changed condition would excuse performance;
  2. The changed condition results in a failure of consideration or the expected value of the performance; and
  3. The changed condition was not reasonably foreseeable.

This defense is rarely successful because many, if not most, commercial leases have a force majeure clause or other language which allocates the risk in the event of a business disruption for various reasons. Even if the tenant can establish the first two elements, above, the tenant must still establish the event was not foreseeable.

With respect to the COVID pandemic, the tenant’s argument is likely to fail. Until 2018, the National Security Council maintained a pandemic office. Various public health and national security experts have warned of pandemics for years. Some commercial lease policies already specifically include the term “pandemic” in their force majeure clauses because of the known and foreseeable risk. There is always a chance a savvy lawyer can convince a Court that this pandemic is a once in a lifetime event and, therefore, unforeseeable. However, it is more likely that courts would take a broader view and conclude that pandemics, generally, are foreseeable events. Moreover, even if a tenant can convince a court to excuse nonpayment of rent, the rent should only be excused for the period of time that the event impacted their business. For example, if a governmental restriction enacted because of COVID prohibited in person consumption at bars for two (2) months, then a bar may be excused for two months of nonpayment. It likely will not justify termination of the entire lease.

We are seeing more and more new commercial leases make specific reference to “pandemics” and “COVID.” It is a good idea to retain an experienced lawyer to assist with the drafting of the lease to make sure events like the COVID pandemic are properly considered and accounted for between the landlord and tenant.

By: Kevin J. Williams, Esq.

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Attorney Kevin J. Williams at his desk in his Greensboro North Carolina office.
Attorney Kevin J. Williams at his desk in his Greensboro North Carolina office.

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