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The legal opinions in this article are the author’s own, not WorldCC’s, and this is not legal advice.

A recent decision of the English Commercial Court in Salam Air SAOC versus Latam Airlines Group SA1 involved an application by Salam Air (who had leased three aircrafts from Latam Air) to prevent Latam Air from making demands on three stand-by letters of credit (equivalent to cash in the eyes of English law) which Salam Air had provided in lieu of deposit for three-month rent, on the ground that the leases were frustrated by the Omani regulations (due to COVID-19 pandemic that restricted passenger flights and caused loss of business) and therefore Salam Air was relieved from their payment obligations.

Salam Air, having faced loss of business by the Omani regulations (due to the COVID-19 pandemic) that had been restricting passenger flights, argued that the leases were “frustrated” (which essentially means the contractual obligations are rendered impossible to perform or the principal purpose for entering into a contract has radically changed), and on the ground of “frustration” applied to the court to seek an injunctive relief from their payment obligations. The application was rejected by the Court. The Court clarified that the payment obligation was absolute and unconditional -- irrespective of any contingency whatsoever, the risks assumed by Salam Air were inherent in commercial aviation.

The civil aviation industry is perhaps one of the worst affected by the coronavirus (COVID-19) pandemic which halted the global aviation for months, affecting the full aviation eco-system. The crippling effect of the pandemic on carriers has been felt up and down the supply chain and particularly by lessors. While many lessees initially requested payment holidays, this subsequently escalated to major discounts, write-offs, re-purposing of aircraft and ultimately events of default.2  

It is important to be aware of the implications of a “hell or high water” payment clause and understand what it means in the context of commercial contracting. It is likely to obligate a contracting party to pay in almost any conceivable circumstance, even during a catastrophe like COVID-19 pandemic, and Salam Air’s obligation to pay under the three leases was a perfect example.

The English Commercial Court ruled that Salam Air's obligation to pay Latam Air for the three aircraft leases was absolute under the “hell or high water” payment clause, irrespective of any contingency whatsoever. The detrimental effects of COVID-19 notwithstanding, the promise to pay survived the effects and remained unaffected. The ruling clarified that the risks assumed by Salam Air are commonly inherent in commercial aviation.

If a contract you sign contains a “hell or high water” payment clause, your signature confirms your promise-to-pay in accordance with that clause. A court is unlikely to consider excuses not to pay unless the excuses are strong enough to pass all possible tests of law. You are obligated to the clause until the contract expires irrespective of any difficulties which you may encounter. The term “hell or high water” comes from a colloquial expression “come hell or high water” which means a task must be accomplished regardless of any difficulty.

During the court proceedings, Salam argued that the effects of the COVID-19 pandemic had compromised their ability to fulfill the lease obligations (i.e., the leases were frustrated) and consequently they had the right to apply for an injunction to prevent Latam Air from making demands under the three stand-by letters of credit that they had provided to secure the monthly lease rental.

But this argument was held “weak” by the English Commercial Court, especially where such leases contained “hell or high water” provisions and where they made it clear that the obligation to pay rent continued in almost any conceivable circumstances.

The Court also held that restrictions imposed on the operation of the aircrafts by the regulations implemented to control the spread of COVID-19 did not prevent either party from performing their contractual obligations.  Even if the lessee had informed the lessor of the specific purpose for leasing the aircrafts, that purpose did not become the joint purpose of the parties as, on the contrary, it was in Krell v Henry.3                                    

The Court’s comments appear to confirm the predominant industry view: that a lessee’s obligation to pay rent under an industry standard English law aviation lease is absolute, and the English law doctrine of frustration will not relieve a lessee from that obligation resulting from the COVID -19 pandemic. 4                

Facts of the case proven – back story is important!

  1. The lessee Salam Air, a low-cost passenger airline operating short-haul flights from Sultanate of Oman, had leased three aircrafts from the lessor in 2017 under six-year dry leases (governed by English law) and had provided three stand-by letters of credit (as an alternative to paying a deposit of three months’ rent) confirmed by Barclays Bank Plc to secure its payment of the rent to the lessor. The leases included a provision that the lessee's obligation to pay rent was "absolute and unconditional irrespective of any contingency whatever".
  2. The Public Authority for Civil Aviation in Oman issued three regulations (posing conditions to restrict entry to Oman) in response to the COVID-19 pandemic, the effects of which had been to frustrate the leases, as claimed by the lessee.

The third regulation issued on 26 March 2020 was perhaps the most significant. It prohibited all flights to or from Oman airports except for cargo flights and flights to and from the Omani exclave of Musandam. As the lessee submitted, the third regulation was likely to remain in effect for a long period given the rate of COVID-19 infection in surrounding countries. The lessee not only envisaged a heavy reduction of passenger demand even after the regulation was lifted, the lessee also believed that it would not have any use for the aircrafts for the foreseeable future.

  1. Negotiations held between the lessee and the lessor included compromise proposals for early re-delivery of the aircrafts, however, no final agreement was reached. The lessee discontinued paying the lease rents and returned the aircrafts to the lessor in June 2020. In the same month the lessor gave notice of termination of the leases.
  2. The lessee then applied to the Court for an injunction to restrain the lessor from making demand under the three stand-by letters of credit on ground of contract frustration that, as the lessee submitted, had relieved the lessee from their payment obligations.

ISSUES BEFORE THE COURT – in hindsight we see more clearly!

Interference with the operation of the letters of credit

The question before the Court was whether it was appropriate for them to interfere with the intent of the letters of credit by accepting the application for injunction and thereby restraining Latam Air from making demand under those.  The question engendered two deeper considerations:

  1. Letters of credit and on-demand bonds are intended to operate autonomously from the underlying commercial transactions. They generally involve an irrevocable promise by a bank or an insurance company to pay if certain conditions are met.
  2. It has long been a cardinal principle of English commercial law that the court will only intervene by injunctive relief in the operation of irrevocable letters of credit and similar instruments in exceptional circumstances, because both are intended to be “the equivalent of cash.”

For these reasons, the circumstances in which a credit-provider could be restrained by an application from paying out under an instrument are limited to determining if the instrument itself is invalid or if the bank knows the demand for payment is fraudulent. For the purpose of an injunction, the case that the applicant is required to establish must be sufficiently strong. In the case of Alternative Power Solution Ltd v Central Electricity Board 5 the Privy Council noted that, for an injunction to be granted based on fraud exception, the requirement is to provide clear evidence of both the fraud and the credit-provider’s knowledge about the fraud, and additionally the case must be supported by strong corroborative evidence.

Salam did not challenge the validity of the letters of credit, nor did it suggest that Latam’s claim on them would be fraudulent. Salam, in fact, relied on the majority decision in Themehelp Ltd v West & Others.6 and argued that the substantive and evidential obstacles which applied to an applicant seeking an injunction restraining a credit-provider from paying out under a letter of credit did not apply where the injunction sought was intended to restrain the beneficiary from making a demand thereunder.

The court acknowledged that though it was bound by the decision in Themehelp, in which the court found that in some circumstances an injunction to prevent the beneficiary from making a demand under an irrevocable letter of credit (and similar instruments) can be obtained even though the applicant is unable to satisfy the requirements of the fraud exception, given the criticism it earned in subsequent legal authorities, the court was not willing to give the decision any broader application than it strictly required. Themehelp was subject to the following limitations:

  • it was only authority for an injunction where the applicant had a claim in fraud against the beneficiary;
  • it was a case where the injunction was sought "well before" the right to claim under the instrument; and
  • there was nothing to hold that the enhanced merits standard did not apply. 

As the lessee did not contend that there had been any fraud by the lessor and an injunction was not sought "well before" the right to claim, the Court held that the lessee was not entitled to the injunction.

Frustration

The English courts have adopted various tests for frustration, and the factual matrix will always be important in determining whether it applies. Broadly, the doctrine can apply when, after a contract is formed, an unexpected event occurs that would render performance in accordance with the literal terms of the contract impossible, illegal, or so different from what the parties reasonably contemplated at the time of execution that it would be unjust to insist on compliance with those literal terms. The courts will consider the contractual terms, the factual matrix, and in particular, the parties’ knowledge and expectations as to risk allocation under the relevant contract.7

The court found that a six-year “dry aircraft lease8 is a challenging context in which to establish frustration, since the lessor’s obligation was limited to providing quiet possession of the aircrafts (which the lessor did) and the lessee assumed all the commercial risks and rewards of operating the aircrafts. From the perspective of the lessor, it did not matter whether the lessee used the aircrafts at all, how frequently and at what level of occupancy. Contrary to lessee’s argument, the Court also observed that there was nothing in the leases that suggested that lessee’s use of the aircrafts was a shared purpose of the parties, as opposed to a matter that was a concern for the lessee alone.

The Court also rejected lessee’s argument that “common foundation of contract” existed in the term that the aircrafts’ base of operations could not be changed from Muscat International Airport without lessor’s permission, clarifying that such provisions are usual in aircraft leases to secure lessor’s interest in the physical and legal safety of the aircrafts.

The Court further clarified that the leases had been drafted on a "hell or highwater"9 basis so that the lessee's obligation to pay rent was "absolute and unconditional irrespective of any contingency whatever", and that it was inconsistent with lessee’s suggestion that the Omani regulations, which prevented the lessee from operating the aircrafts to earn revenue and profit, had the effect of terminating the leases and freeing the lessee of its obligation to pay rent. The Court concluded that risk that the lessee might be unable to operate passenger flights from Muscat or elsewhere, or that there might be a drastic and long-lasting fall in the demand for air travel, were risks inherent in the commercial operation of the aircraft and assumed by the lessee under the leases.

What do we take away from this?

Letters of credit, intended to operate autonomously from the underlying commercial transaction in connection with which they are established, are treated as the equivalent of cash under English law. An application to prevent payment under a letter of credit will only be accepted under exceptional circumstances, either where the validity of the credit instrument is impeached or when it could be established that the credit bank knows that any demand for payment is fraudulent.

Lease obligations are likely to continue and survive almost all circumstances including any unforeseen or catastrophic circumstances especially if, so is made clear by the lease conditions and if a party intends to claim relief under the doctrine of frustration the party must be able to establish the purpose to have been shared by both contracting parties and that the purpose which is frustrated, is the very foundation of the contact.

ABOUT THE AUTHOR

Pallab Mukherjee, Head of Compliance & Corporate Governance at Bahrain National Gas Company (B.S.C), is a Chartered Mechanical Engineer having a master’s degree in Construction Law & Arbitration. He is a commercial management expert having more than 30 years of diverse experience across Middle East and India in various industry sectors including Oil & Gas and Petrochemicals; has played pivotal roles in commercial management transformation projects and assumed key commercial roles in brown and green field projects that have built some of the largest petrochemical assets in the GCC region. He actively promotes the profession of contract management, conducts contract management workshops and writes legal essays.

END NOTES

1. [2020] EWHC 2414 (Comm)

2. Aircraft leasing in the time of Covid-19 – case review (Trowers & Hamlins, 13 April 2021)

3. [1903] 2 KB 740; also read Trans-Lex report describing facts, appeal.

4. English Court rejects Covid-19 frustration argument in aircraft leasing case (Watson Farley and Williams, Enterprise, 3 Feb 2021)

5.  [2015] 1 WLR 697, also read the article High Court finds alleged frustration of contract due to COVID-19 pandemic is not sufficiently arguable to grant injunction restraining demand under letter of credit (Herbert Smith Freehills LLP, 24 March 2021)

  1. [1996] Q.B. 84; also read the article Confusion and difficulties surrounding the fraud rule in letters of credit: an English perspective (Dr. Hang Yen Low, Griffith Business School, Australia)
  2. Commercial Court Rejects Frustration Argument in Aviation Leasing Dispute (Tim Fox & Peter Morton, K&L Gates LLP, 10 February 2021)
  3. With a dry lease, an aircraft owner/lessor leases an aircraft to a lessee/operator without a crew, ……the lessee provides its own crew and exercises operational control of its flights.” in the article Aircraft Dry lease Checklist (Brennan Block, Brownwinick Law, 30 October 2019)
  4. Bitumen Invest AS v Richmond Mercantile Ltd FZC [2016] EWHC 2957 (Comm)

REFERENCES

1. Hell or High-Water Contract (Clay Halton, Investopedia, 7 March 2021); see also definition of “Hell or high water clause” at Wikipedia

2. Oman Air suspends domestic, international flight (Arab News, 25 March 2020)


Content reflects views and opinions of the author and do not necessarily reflect the views and opinions of World Commerce & Contracting.

Pallab Mukherjee, Head of Compliance & Corporate Governance, Bahrain National Gas Company (B.S.C)


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