Lease rental must be paid come hell or high water – Airline operator fails in bid to restrain call on standby letters of credit

The case of Salam Air SAOC v Latam Airlines Group SA [2020] EWHC 2414 (Comm) examines the airline operator’s argument that its aircraft leases had been frustrated because of the COVID-19 pandemic so as to make it appropriate to injunct the lessor from issuing demands under standby letters of credit issued to secure the monthly rentals on the aircraft. Mr. Justice Foxton determined that the airline’s case that its lease had been frustrated was highly improbable and far too weak in light of the existence of a “hell or high-water” clause. 
Background facts
Salam Air SAOC (“Salam Air”) leased three aircraft from Latam Airlines Group SA (“Latam”) (“Aircraft Leases”) to operate a regional low-cost airline from Muscat International Airport in Oman. The aircraft were delivered to Salam Air in the first quarter of 2017.  
As security for performance of Salam Air’s obligations under the Aircraft Leases, it provided three standby letters (“Letters of Credit”), which Latam was entitled without notice to withdraw all or part of the amount thereof in the event default under the Aircraft Leases. Thereafter in May 2020, Latam filed for Chapter 11 bankruptcy protection and provided notice of termination of the Aircraft Leases. Salam Air redelivered the aircraft in June 2020 by which time it was three months in arrears in lease rental payments.
In September 2020, Salam applied to the English Commercial Court for an injunction to prevent Latam from making a demand under the Letters of Credit contending that the Aircraft Leases were frustrated due to the regulations issued by the Public Authority for Civil Aviation in Oman (“PACA”) in response to the COVID-19 pandemic, which prohibited nearly all flight to and from Oman airports. Salam Air contends that it had been relieved of its contractual obligations under the Aircraft Leases, in particular, its obligation to pay rent.
Salam Air’s application to interfere with the operation of the Letters of Credit
Justice Foxton, in determining whether the court should grant an injunction which would interfere with the operation of the Letters of Credit, examined the law on injunctions against the credit-provider and the beneficiary. 
The Judge restated the trite English law principle 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. Irrevocable letters of credit are intended to be equivalent of cash and to allow payment to be restrained would threaten the future use of such instrument which is considered as the lifeblood of many commercial transactions. The credit-provider also has made a contractual promise that it would honour such arrangement failing which it may damage its reputation for contractual and commercial probity.  As such, the criteria for which an applicant can obtain an injunction to restrain the credit-provider from paying out the instrument is where the validity of the instrument is impeached and where the credit-provider knows that any demand for payment already made or which may be made will clearly be fraudulent.1 In respect of the latter, for an injunction to be granted based on the fraud exception, clear evidence of both the fraud and the credit-provider’s knowledge is required and the balance of convenience test expounded in American Cyanamid Co v Ethicon [1975] AC 396 is not applicable.2
In the present case, Salam Air argued that it is not challenging the validity of the Letters of Credit or suggesting that Latam’s demand thereunder was fraudulent, but it is relying on the decision of the Court of Appeal in Themehelp v West [1996] QB 84, which held that the enhanced test for an injunction to restrain a credit-provider does not apply to an injunction restraining a beneficiary.
Justice Foxton, however, observed that the majority decision in Themehelp was heavily criticised by subsequent authorities3 and commentators4 and sought to limit Themehelp’s application in the following manner. First, it is only an authority that an injunction may be obtained against the beneficiary when the applicant has a claim in fraud against the beneficiary and the court in Themehelp did not consider whether the principle will extend beyond fraud. Second, Themehelp was distinguished on the basis that the injunction was sought before the right to claim under the performance guarantee had accrued whilst in the present case, the injunction was sought after Latam’s right to call on the Letters of Credit had arisen. Third, the court in Themehelp did not decide whether the application of the enhanced test was correct because that issue was not challenged on appeal. On the other hand, there is a strong policy consideration that an anti-beneficiary injunction must meet the same enhanced test as an injunction against a credit-provider. The learned Judge was satisfied that the first two conclusions were sufficient to determine that Salam Air was not entitled to the injunction.
Salam Air’s frustration case
Justice Foxton found that a six-year dry lease is a challenging context in which to establish frustration. This is because the lessor assumes very limited obligations under a lease agreement, which is only ensuring quiet possession of the aircraft in return for rental income with the lessee assuming commercial risks of operating the aircraft. In the present case, Latam could provide Salam Air with quiet possession of the aircraft and Salam Air had to pay rent.
Salam Air argued that there was an arguable case of frustration of purpose, which is a state of things assumed by both contracting parties as the foundation of the contract.5 To prove this, Salam Air contended that it shared its business plan with Latam and that the aircraft’s base of operations could not be changed from Muscat International Airport without Latam’s permission.
The judge however found that there was nothing in any of the Aircraft Leases to suggest that Salam Air’s use of a leased aircraft was a shared purpose but instead, the terms make it clear that Salam Air’s obligation to pay rent continued in almost every way i.e. on a hell or highwater basis.6 The obligation to pay rent was expressed to be absolute and unconditional irrespective of any contingency whatsoever including the ineligibility of the aircraft for particular use or trade or if the aircraft became a total constructive loss or requisitioned. The Aircraft Leases even placed on Salam Air the full risk of any occurrence of whatever kind which shall deprive [Salam Air] of the use, possession and enjoyment thereof during the lease period. The Judge found that these clauses are inconsistent with any suggestion that the regulations issued by PATA, which prevented Salam Air from using the aircraft to earn revenue had the effect of terminating the Aircraft Leases and freeing Salam Air from its obligation to pay rent. The Judge held that based on the Aircraft Leases, Salam Air had undertaken the risks inherent in the commercial operation of the aircraft and the regulations issued by PATA were insufficient to frustrate the same.
The Malaysian law perspective
In Malaysia, there is a distinction between the test that applies for an injunction to restrain a beneficiary from making a demand on and receiving the proceeds of the performance bond, and to restrain a credit-provider from paying upon a demand.7 Regarding the former, the Federal Court had confirmed fraud and unconscionability as exceptions to the rule that the court will not intervene to prevent a call on a performance bond,8 whilst the latter, the courts found that to justify an injunction to restrain payment under a performance bond, there must be clear evidence of fraud, which came to the knowledge of the credit-provider.9 The applicability of the enhanced test for an anti-beneficiary injunction is not a relevant factor in Malaysia because of the introduction of unconscionability as a separate and distinct ground to restrain the beneficiary.  
On the issue of frustration occasioned by the COVID-19 pandemic, Malaysia had introduced the Temporary Measures for Reducing the Impact of Coronavirus Disease (COVID-19) Act 2020 (“COVID-19 Act”), which came into force on 23 October 2020.10 However, the statutory relief provided under section 7 of the COVID-19 Act only extends to performance bond or equivalent that is granted pursuant to a construction contract or supply contract and lease or tenancy of non-residential immovable property and does not expressly cover the security instrument operating in an aircraft leasing agreement such as the Salam Air’s case. In such a circumstance, the High Court’s analysis and findings in Salam Air’s case will be persuasive in Malaysia when determining whether the COVID-19 pandemic would amount to an event of frustration pursuant to section 57(2) of the Contracts Act 1950, the effect of which would nullify an aircraft leasing agreement entered into on terms identical to Salam’s Aircraft Leases.  
Commentary by Shannon Rajan (Partner) of the Aviation Practice of Skrine.

1 Bolivinter Oil SA v Chase Manhattan Bank [1984] 1 WLR 392.  
2 Alternative Power Solution Ltd v Central Electricity Board [2015] 1 WLR 697.
3 Group Josi Reassurance SA v Walbrook Insurance Co. Ltd [1996] 1 WLR 1152, per Staughton LJ at pp.1161-1162, Czarnikow-Rionda Sugar Trading Inc v Standard Bank London Ltd [1992] 2 Lloyd’s Rep 187, per Rix J at p.202, Sirius Insurance v FAI [2003] 1 WLR 2214, per May LJ at para [31].
4 Gee, para 15-03, Benjamin’s Sale of Goods (10th), para 24-035 and Andrew and Millet, The Law of Guarantees (7th), para 16-031.
5 Krell v Henry [1903] 2 KB 740.
6 Bitumen Invest AS v Richmond Mercantile Ltd FZC [2016] EWHC 2957 (Comm).
7 Kejuruteraan Bintai Kindenko Sdn. Bhd. v Nam Fatt Construction Sdn. Bhd. & Anor [2011] 7 CLJ 442.
8 Since 2012, the Malaysian Federal Court in Sumatec Engineering and Construction Sdn Bhd v Malaysian Refining Company Sdn Bhd [2012] 4 MLJ 1 confirmed that Malaysian law joins the ranks of Australia and Singapore in allowing unconscionability as an exception to allowing calls on performance bonds. See related article on Restraining a Call on Performance Bonds, Legal Insights, June 2015.
9 LEC Contractors (M) Sdn Bhd v Castle Inn Sdn Bhd & Anor [2000] 3 MLJ 339.
10 Part II of the COVID-19 Act has been extended from 18 March 2021 until 30 June 2021 pursuant to the Temporary Measures for Reducing the Impact of Coronavirus Disease 2019 (Covid-19)(Extension of Operation) Order 2021.