COVID19 and Contractual Performance: Lease Agreements

The Covid 19 outbreak has created difficulties in subsistence of livelihoods, health and safety of people including disruptions of global market, trade and commerce. More particularly, the effect of the pandemic has caused difficulties in contractual obligations of parties. As a result of supply chain disruptions, restriction in mobility, cash flow shortages, the maintenance of contract has become very difficult, and in some cases, impossible for the parties.

1. Legal Principles relevant to Covid 19 and Nepalese Context

A. Force majeure ‘Force majeure’ is a contractual concept used as a risk allocation tool which enables a party to claim for an excuse of performance of contract in occurrence of an exceptional event. Force majeure clause provides the exhaustive list of events such as earthquake, flood, wars, etc. considered as force majeure events. In context of COVID 19, wordings such as ‘disease’, ‘pandemic’, ‘epidemic,’ ‘governmental actions’ or even catchall phrases like ‘outbreak of illness’ or ‘health emergency’ could suffice for the purpose of force majeure. Generally for force majeure events to trigger, such event: (a) must be beyond the parties control, (b) should be unforeseeable at the time of contract, (c) even after occurrence, party could not reasonably have avoided such event and (d) such event should not be attributable to any of the party. The force majeure events may (a) suspend or delay the performance of contract (generally) or (b) terminate the contract itself (in case of frustration). Force majeure clause is dependent upon the wordings of the contract. In absence of such clause in contract, default legal provisions of Civil Code 2017 (Section 531) will apply. Generally, force majeure event entitles the parties to claim for (a) extension of time or (b) claim for reasonable costs incurred due to suspension or delay of performance. B. Doctrine of frustration Frustration is a legal principle in contract law which enables a party to terminate the contract due to occurrence of an extraordinary event which frustrates the purpose of the contract. In other words, it makes the performance of obligations under contract impossible for parties. C. Nepalese Context Section 531 of Civil Code 2017 (2074) (“Civil Code”) provides for the exemption of obligations in the event of fundamental change of circumstances. This provision is similar to doctrine of frustration. The events constituting change in circumstances include (a) illegality, (b) in occurrence of events beyond human control such earthquake, flood, landslides etc., (c) destruction of subject matter of contract (d) death or disability of person in relation to contract requiring personal performance. This rule does not apply in situations where contract performance becomes onerous to parties due to (a) performance becoming difficult, (b) it leads to less profit or loss (c) in occurrence of strike or lockout (d) and performance default by third parties. In a lease agreement, the primary obligation of house owner is to provide access to premises and for tenant it is to make payment of the rent amount. Therefore, until and unless there occurs a situation of destruction or inhabitability of premises, where the performance is impossible, lease agreement will not generally be protected by above mentioned legal provision.

2. Covid 19 and Lease Agreement in context of Nepal

Nepal implemented country-wide lockdown from March 24 to June 14, 2020 as a measure to avoid the spread of Covid 19. One of the worst hit sectors due to this lockdown is the commercial sector. There are a huge number of business houses, shops, hotels, etc. who have taken space on lease (Commercial Tenants/Tenants). Most of the tenants have full dependency over the earning from their commercial activity conducted in such spaces of owners (House Owners). Amidst this uncertainty, the parties to the lease agreement should carefully review their agreement clauses and if needed, seek legal advice to ascertain their rights and obligations.

3. Issues relating to lease agreements:

A. Payment of rent The difficulty in payment of rent amount by tenants could be resolved through quarterly rent payments, request to waive rent payment and others. On March 29, 2020, the government called for house owners of daily wage-based labourers to not charge one month’s house rent and committed to exempt house rent tax of the said month. But there is no any substantial decision taken in relation to the status of commercial lease agreements. Recently, upon the request of tenants, 70% of house owners around Thamel, Kathmandu have agreed to provide 50% rent exemption for a period of six months to commercial tenants. B. Payment of tax As per the decision of the Cabinet, notice of IRD and ensuing litigation at the Supreme Court, taxpayers are required to file for income tax and VAT filings within 30 days from the date of official lockdown lifting order from GoN. It is to be noted that tax deferral is provided as per Income Tax Act and it does not extend to be applicable for the payment of rental tax by natural persons whose rental income is governed by Local Finance Acts. In practice, there are instances where some municipalities in Kathmandu have provided exemption of rental income to house owners C. Obligation to remain open for business: Commercial lease agreements have a continuous operation requirement which require the tenant to remain open for business for a minimum number of hours on specific days during the term of lease. Given the outbreak of COVID 19 and the government orders for closure of businesses, tenants were found defaulting in payment and house-owners got frustrated about their lost earnings. The pertinent issue here is whether the government restrictions requiring the closure of business can take precedence over a tenant’s promise to remain open. Protection from eviction The GoN via notice in the Nepal Gazette on March 29, 2020 imposed a moratorium on eviction of tenants from their existing leased premises by house owners throughout the lock-down period. The notice does not provide clarity as to whether it was applicable for residential or commercial evictions, or both. The notice seems to be applicable for both kinds of lease agreements as the legal provisions do not distinguish between the two. In practice, police have arrested few house owners who have evicted medical staff however it shows that the threat of eviction is still pervasive and prevalent.

4. Recommended approach

The issue at hand has moved beyond contractual remedies to the matter of leniency and convenience of parties. Section 398 of Civil Code provides space to the house owners and tenants to reconsider or change the terms of agreement. Similarly, under Section 533 of Civil Code, parties are autonomous to revise the terms and conditions of the agreement. The revision of agreement could be done by way of amongst others, extension of time for rent payment, downsizing of rental premises, adjustment with future rental payments, etc. In the absence of clear directions from the government, it will depend on the relationship between the tenant and the house owner, the house owner’s commercial decision, tenant’s history in the performance of the terms of the lease, and other business considerations as a temporary solution to the crisis.