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07 April 2021
In Salam Air SAOC v Latam Airlines Group SA ( EWHC 2414 (Comm)), the Commercial Court:
In 2017 Salam Air accepted a delivery of three aircraft from Latam, which were leased to it pursuant to operating lease agreements governed by English law and which it intended to operate from Muscat International Airport, Oman. Each aircraft lease agreement had a six-year term and contained customary dry lease provisions – significantly, a 'hell or high water' obligation to pay rent.
As security for the performance of its obligations pursuant to the aircraft lease agreements, Salam Air provided Latam with three letters of credit (instead of cash security deposits), under which Latam was entitled to draw without notice. Shortly after Latam filed for Chapter 11 bankruptcy protection in May 2020, it gave notice of termination of the aircraft lease agreements. In June 2020 Salam Air redelivered the aircraft. At the time of redelivery, Salam Air was three months in arrears with its lease rental payments.
In September 2020 Salam Air applied to the High Court, seeking an injunction to prevent Latam from making a demand under the letters of credit and applying the proceeds against the outstanding rent payments. It argued that:
The judge first considered whether it would be appropriate to interfere with the operation of the letters of credit by injuncting beneficiary Latam from making a demand for payment thereunder. The judge held that Salam Air was not entitled to the injunction, reminding the court of:
[the] 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 (such as performance bonds) in exceptional circumstances.(1)
Concerning injunctions against credit providers (ie, those issuing letters of credit or similar instruments), case law establishes that such injunctions can be granted only where:
This is known as the 'enhanced merits test'. Salam Air contended that this test did not apply, given that it was seeking an injunction to restrain the beneficiary from making a demand for payment rather than an injunction to restrain a credit provider from making a payment.
The judge dismissed Salam Air's argument and noted that, in his view, there was "a very powerful case that an anti-beneficiary injunction should have to meet the same enhanced merits test as an injunction against the credit-provider".(3) The enhanced merits test resulted from a decision to treat letters of credit and similar instruments as equivalent to cash, a decision which the judge described as:
a consideration which weighs as much in favour of its application to injunctions against the beneficiary which (if granted) would make the instrument very inferior to cash, as to injunctions against the credit provider preventing payment.(4)
Second, the judge considered Salam Air's contention that the COVID-19 pandemic had frustrated the aircraft leases, relieving it of its obligation to make rent payments pursuant to the aircraft lease agreements. The judge noted that Salam Air would be required to establish "a strong case rather than merely an arguable case"(5) to be able to claim such relief.
The doctrine of frustration applies where external circumstances result in the performance of the contract in accordance with its literal terms being so "radically different"(6) from what the parties had contemplated when entering into the contract that it would be "unjust to insist on compliance with those literal terms",(7) considering factors including:
Salam Air argued that the test for frustration had been met, given that it was unable to operate the aircraft from Oman due to the regulations issued by PACA. It also claimed that it would not have any use for the aircraft in the foreseeable future because of the collapse in air passenger demand resulting from the COVID-19 pandemic and the expected slow recovery even once PACA's regulations had been lifted.
The judge disagreed and described a six-year 'hell or high water' lease agreement as a "challenging context in which to establish frustration".(8) The terms of the aircraft lease agreements demonstrated a clear allocation of risk between the lessor and the lessee. While the lessor had taken on limited obligations beyond its covenant of quiet enjoyment, the lessee had assumed all of the commercial risks and rewards of operating the aircraft. The lessee had agreed that its obligation to pay rent:
The lessee had also agreed to "bear the full risk of any… occurrence of whatever kind which shall deprive… the operator of the Aircraft for the time being, of the use, possession or enjoyment thereof".
According to the court, these provisions were "fundamentally inconsistent"(9) with the suggestion that the aircraft lease agreements had been frustrated on the basis of Salam Air's inability to operate the aircraft from Oman – this was a risk that was inherent in the commercial operation of the aircraft and had been assumed by Salam Air when it entered into the aircraft lease agreements.
The court also rejected Salam Air's frustration of purpose argument. Even if Salam Air had communicated the specific purpose for which it had intended to lease the aircraft (ie, operation from, in and to Oman) to Latam, this was insufficient to cause Salam Air's purpose to become a purpose that Latam shared and, accordingly, the foundation of the aircraft lease agreements.
The court concluded that Salam Air's frustration case was:
far too weak to justify the step of interfering with the operation of the SBLCs which Salam Air agreed to provide as an alternative to paying a cash deposit, and which were commercially and legally intended to be equivalent to cash.(10)
This case demonstrates the courts' reluctance to interfere with the performance of letters of credit and similar instruments which are intended to be equivalent to cash. It emphasises the importance which is attached to such instruments in facilitating commercial transactions.
The court's decision that the effects of the COVID-19 pandemic – regardless of the severity by which a lessee's business is affected – are insufficient to frustrate an aircraft lease agreement and relieve the lessee of its contractual obligations will be welcomed by aircraft lessors and financiers.
However, in coming to its decision, the court strongly emphasised:
This leaves some room for speculation as to whether the court would have reached the same judgment in the context of a short wet-lease agreement pursuant to which the lessee assumes only limited obligations.
For further information on this topic please contact John Pearson or Martina Glaser at Vedder Price LLP by telephone (+44 20 3667 2900 ) or email (firstname.lastname@example.org or email@example.com). The Vedder Price LLP website can be accessed at www.vedderprice.com.
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