Frustrated? What does the EMA decision mean for contracts affected by Brexit?

Since the UK voted to leave the EU in June 2016, businesses have been considering what that might mean for their contracts. In many cases, the effect will depend on the circumstances of how Brexit happens in a legal or regulatory sense and there may be contractual or practical ways of mitigating any potential harm. But for the European Medicines Agency, the inevitability of its relocation from the UK to another Member State, coupled with the rigid terms of its 25 year lease, amounted to a more fundamental contractual problem.

According to the EMA, the lack of foreseeability and legal effect of Brexit meant that this was a case where the entire contract (the lease) would be 'frustrated', discharging it from the obligation to continue paying rent for the remainder of the 25 years. Inevitably, the landlord disagreed, and sought a declaration from the High Court that the lease would not be frustrated by Brexit.

What did the Court decide, and why?

The Court found in favour of the landlord, that the lease would not be frustrated by Brexit. Smith J, giving judgment, addressed the two principal arguments put forward by the EMA:

• that performance of the lease post-Brexit would effectively be 'illegal'; and
• that there had been a "frustration of common purpose".

The EMA's 'illegality' argument was on the basis that it would lack relevant capacity post-Brexit.

The EMA's capacity

The EMA's argument was, in essence, that:

• As a matter of law, an EU agency was obliged to have its headquarters in a Member State, so it could not continue to make use of the lease post-Brexit; and
• It would also be outside the EMA's legal capacity (ultra vires) for it to either continue to pay rent, or to deal with the property by sub-letting or assigning the lease.

The judge found that although there were strong political reasons for an agency of the EU to have its headquarters in a Member State, there was no rule of law (either EU law or international law) that required this. The location of an agency was an inter-governmental matter between the Member States and there was no limitation in the treaties of the EU on the Member States' decision-making in this regard.

Somewhat ironically, the judge found that the EMA's argument on this point was undermined by the draft EU-UK Withdrawal Agreement, which envisaged the EMA (as well as the European Banking Authority and the Galileo Monitoring Centre) staying in the UK, at least temporarily, until their relocation was completed.

There was also no relevant rule under international law. The judge referred to the existence of the UN's offices in Geneva, which date back to 1946, even though Switzerland did not become a member of the UN until 2002, as an example of an organisation situated outside its "territory".

Likewise, the EMA did not lack capacity either to pay rent or otherwise deal with a property outside the EU. The EMA's capacity to act extra-territorially could be tested by the example of a cross-border contract, for example for the provision of software or a piece of equipment. The judge found that it would be "remarkable" if the EMA could not commence litigation in a foreign jurisdiction in relation to a contract that had a relevant exclusive jurisdiction clause. There was no reason to differentiate this position in relation to immovable property.

Nevertheless, the judge went on to consider whether, if he was wrong on the preceding points, the lease would be frustrated by supervening illegality.

Frustration by supervening illegality

In English law, a contract may be frustrated where the contract is required to be performed in another country and that performance is rendered illegal under the law of the place where it is to be performed. But since the lease in this case was to be performed in England, the question was whether this principle should be extended - to consider whether the performance might be rendered illegal with regard to the law of incorporation, as far as that affects the party's capacity.

The judge found that the law could not be extended in this way. It may have been right to consider the capacity of the party to enter into the lease, but where it had the capacity at that time, the subsequent loss of capacity under the law of incorporation would not amount to subsequent illegality for the purpose of frustration.

But in any event – even if there was a lack of capacity, and even if that could amount to supervening illegality – the judge found that this would have been a case of self-frustration. The legal requirement to move premises came through a 2018 EU Regulation, so was in effect an act of the EU. Moreover, that Regulation could have made provision (as with the Withdrawal Agreement) for how the property was to be dealt with after Brexit, which could have included giving the EMA the power to pay rent and to sub-let or assign the lease. The fact that it did not do so could not be a basis on which the EMA could avoid its prior contractual obligations.

Frustration of common purpose: "It was not this that I promised to do"

The EMA relied in this respect on the principle that where a contract is formed on the basis of a fundamental common understanding or purpose, supervening events may destroy that common understanding or make that purpose impossible. As the judge put it "[o]nly if the supervening event renders the performance of the bargain "radically different", when compared to the considerations in play at the conclusion of the contract, will the contract be frustrated."

In this case, the parties had considered at the outset the possibility that the EMA may relocate. The EMA had sought a break clause to give it an option to do so, but the landlord had (successfully) resisted the inclusion of such a clause. The provisions dealing with assignment or sub-letting were "onerous", but this was precisely because the landlord was seeking to protect its interests should the EMA relocate. It was also relevant that the EMA had secured an inducement package on rent, which it would not have done had it not entered into such a long lease, with such strong protections for the landlord.

It could not, therefore, be said that the parties had a 'common purpose' that went beyond the terms of the lease. The EMA's departure was not only envisaged but was expressly provided for in the lease. It mattered not why the EMA was relocating.

The principle of frustration requires regard to be given to relative justice, but in this case, holding the lease to be frustrated would cause considerable damage to the landlord, which would be unexpected for the very reason that the lease made provision for the allocation of this risk.

What does this mean for Brexit-affected contracts?

As we have previously explained, Brexit has the potential to affect contracts in many ways. Some, such as territorial extent or who bears the cost of customs duties, may be fairly obvious, but practical or second order effects such as regulatory risks, currency swings or delays / failures of performance further down the supply chain, may be more hidden, but just as impactful.

The EMA case highlights that where Brexit does have an impact, potentially making contracts uneconomic, parties will rarely be able to rely on principles such as frustration – or, for that matter, force majeure – to relieve themselves of contractual obligations.

Now may be the time to engage with contract counterparties to discuss the risks and any mitigation measures that could preserve the commercial relationship and avoid costly disputes later down the line.

UPDATE: the EMA has been given permission to appeal the High Court judgment.