Frustrating event? Hotel property and business assets fall $1 million in value due to COVID-19 pandemic

The case of Dyco Hotels Pty Ltd v Laundy Hotels (Quarry) Pty Ltd [2021] NSWSC 504 concerned a contract for the sale of a freehold hotel property in Pyrmont, Sydney (Quarrymans Hotel) together with associated hotel licence and business.

On 31 January 2020, a contract was entered into between the plaintiffs as purchasers and the defendant as vendor for a purchase price of $11,250,000. The deposit of $562,500 (5% of the price) was paid as required by the contract. Completion was due to occur approximately 8 weeks later on 30 March 2020.

Additional Clause 50 imposed various obligations upon the vendor in respect of the period from the date of the contract until completion, including an obligation to carry on the Business (as defined) "in the usual and ordinary course as regards its nature, scope and manner…"

In March 2020 the outbreak of the COVID-19 pandemic caused the NSW Government to make various orders under the Public Health Act 2010 (NSW). An order for the temporary shutdown of pubs and registered clubs, except for the limited sale of food and beverages to customers to consume off the premises, came into effect at midday on Monday, 23 March 2020 (about 8 days before completion of the contract was to occur).

The hotel closed its doors at midday on 23 March 2020 and re-opened for takeaway sales three days later. Trading figures for the hotel indicated that operating losses were incurred in March, April and May 2020.

The plaintiffs failed to complete the contract. On 21 May 2020, the defendant's solicitors served a notice of termination upon the plaintiff's solicitors.

The plaintiffs commenced proceedings claiming that the contract was discharged by frustration because from midday on Monday, 23 March 2020 the hotel business was not able to be operated in the usual and ordinary course as regards its nature, scope and manner, and indeed not able to trade as a going concern, and as a consequence the value of the assets the subject of the contract fell by about $1 million. The plaintiffs sought the return of the deposit of $562,500.

The defendant denied that the contract was discharged by frustration as alleged. It contended that by wrongfully refusing to complete the contract the plaintiff forfeited the deposit. The defendant also filed a cross-claim against the plaintiffs seeking "loss of bargain" damages.

Outcome

We have previously published an article on the doctrine of frustration. That article can be accessed here. We will not repeat the principles here.

In his reasons for judgment Justice Darke set out the test of whether a contract has been frustrated, with the consequence that the parties are excused from further performance under it, in the following terms at [100]:

"It is necessary to consider whether these unexpected events gave rise to a fundamental commercial difference between the actual and contemplated performance of the contract, or a fundamentally different situation for which the parties made no provision, such that it would not be just to hold the parties bound to the terms of the contract. Or, as Lord Reid put it, the question can be posed as whether the contract is on its true construction wide enough to apply to the new situation. "
Justice Darke sympathised with the predicament that faced the plaintiffs from about 21 March 2020, when the NSW Government commenced making public health orders in response to the COVID-19 pandemic which dramatically limited the ability of the hotel business to operate and earn revenue. However his Honour determined that the contract was not frustrated. The key factors in reaching this conclusion were as follows.

(a) The essential nature or purpose of the contract was a sale and transfer of particular assets for the agreed price. The defendant’s obligation under Additional Clause 50 to carry on the business until completion of the sale in the usual and ordinary manner was ancillary to that principal purpose, and "ought not to be regarded as of cardinal significance".

(b) The Additional Clauses of the contract stated that the defendant gave no warranties as to present or future financial performance, and the plaintiffs were not entitled to make any objection or claim or delay completion as a result of these matters. According to the Court these provisions indicate that insofar as the public health orders had an adverse effect upon the financial performance of the Business, "that is a risk of a type the plaintiffs were apparently prepared to take".

(c) The valuation evidence was that in April 2020 the value of the hotel had fallen by about $1 million. Notwithstanding that is a considerable amount, it is less than 9% of the purchase price.

Judgment was given against each of the plaintiffs for the sum of $900,000 (the difference between the contract price of $11.25 million and the value of the hotel assets as at 21 May 2020, being the date the defendant validly terminated the contract for the plaintiffs' breach).

Takeaway points

The key takeaway point from the above case is that the common law doctrine of frustration will not be easily or readily engaged. A $1 million fall in the value of assets that a party is shortly due to complete the purchase of, due to circumstances that were not foreseen by either purchaser or vendor at the time of the contract, was not sufficient to attract the operation of the doctrine here.

Furthermore, as regards a transaction involving the sale and transfer of an asset which has exchanged but not completed, a clause to the effect that vendor gives no warranties as to value / financial performance will likely be fatal to the purchaser seeking to rely on the doctrine of frustration as an escape route from the contract.

Finally, we recommend that all commercial parties review their contracts and assess who bears the risk of a significant unforeseen event such as a pandemic. For any prospective contracts yet to be entered into, consideration should be given as to whether to include a clause which expressly deals with such contingencies.

Contributors

Nathan Jones Special Counsel