The High Court has dismissed Salam Air SAOC (Salam)'s injunction application to restrain Latam Airlines Group SA (Latam) from making demands under three standby letters of credit (LoCs), finding that the effects of the coronavirus pandemic did not frustrate the underlying leases of three aircraft. 

Salam Air v Latam Airlines [2020] EWHC 2414 (Comm)

Mr Justice Foxton reminded the parties that ''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 (such as performance bonds) in exceptional circumstances''. 

Covid-19 restrictions imposed by the Omani aviation authorities did not prevent either party from performing their unequivocally drafted contractual obligations pursuant to the leases. Therefore, there was no frustration of purpose.

FACTUAL BACKGROUND

• The LoCs were an alternative to the deposit of three months' rent to Latam, an international airline company based out of Chile, payable under three aircraft leases entered into by Salam on identical terms in 2017 (the Aircraft Leases). 
• The Aircraft Leases were governed by English law and subject to the exclusive jurisdiction of the English courts.
• Salam was a low-cost airline operating out of Oman and, during negotiations, it became clear that the purpose of the Aircraft Leases was to allow Salam to operate short haul flights from Muscat. 
• Under the Aircraft Leases:
  • Salam’s obligation to pay rent and make other payments due under the agreements was ''absolute and unconditional irrespective of any contingency''; 
  • the LoCs could be called upon by Latam ''without notice'' in the event that Salam did not comply with the above obligation; 
  • Salam bore all the risks of ownership of the aircraft and, following delivery, the only continuing obligation upon Latam was that neither it nor anyone else would interfere with ''the use, possession and quiet enjoyment'' of the aircraft by Salam. 
• In response to the emerging Covid-19 pandemic, the Public Authority for Civil Aviation in Oman issued a series of regulations restricting air travel. This led to the prohibition of all commercial passenger flights to or from Omani airports in March 2020, following which Salam ceased its operations as well as rent payments due under the Aircraft Leases (later terminated in June 2020). 
• Latam sought to call upon the LoCs. However, Salam's case was that the effect of the aviation regulations had been to frustrate the Aircraft Leases resulting in no further rent being due. Salam therefore commenced proceedings before the English courts seeking an injunction to restrain any demand under the LoCs. 

KEY LEGAL POINTS

Salam's application raised two issues of law:

• whether it would be appropriate for the Court to interfere with the operation of the LoCs by injuncting Latam from making a demand under it ; and
• if so, whether Salam could demonstrate a sufficiently arguable case that the Aircraft Leases had been frustrated by the Omani restrictions on passenger flights imposed as a result of the Covid pandemic? 

On the first question, Foxton J restated the general English law principle that ''the court will not grant an injunction interfering with performance by [a] bank under [a] banking contract''. Letters of credit and similar instruments are intended to be equivalent to cash – significantly, the LoCs replaced a deposit of three months' rent – operating autonomously from the underlying commercial transactions. Banks, as credit-providers, make contractual promises to honour such arrangements.  To prohibit their function would not only risk a banker's reputation, but threaten the future use of letters of credit as a vital lifeblood for facilitating commercial transactions. 

Salam had not advanced any evidence of fraud, so its application failed. As a further general rule, Foxton J added that ''if payment would be in accordance with the contract, the buyer has no basis for an injunction.''

Nevertheless, Foxton J went on to consider Salam’s case on frustration characterising it as ''weak''. The terms of the lease were very clear – Salam's obligation to pay rent was ''absolute and unconditional irrespective of any contingency whatever''. While the Omani regulations prevented it from freely operating its aircraft, they did not prevent it from fulfilling its contractual obligations under the leases. Fundamentally, there was nothing in the Aircraft Leases to suggest Salam's use (let alone profitable use) of the aircraft was a shared purpose of the parties and consequently Salam's argument based upon frustration of purpose failed.

COMMENTARY

Since being established in the early 20th century, frustration of purpose has seldom been found by English courts. The purpose must be shown to be have been assumed by both contracting parties as the very foundation of the contract. Damage to a lessee's business by reason of a catastrophe, even if fatal, is unlikely to frustrate an underlying lease contract; even more so where ''quasi-cash'' credit instruments are concerned and the underlying contract's terms are abundantly clear.  The lease obligations will continue in almost any circumstances. 

Under English law, a letter of credit is treated as the equivalent of cash. In seeking to restrain the use of such instruments, a buyer is effectively ''seeking to prevent the bank from paying and debiting the buyer's account''. For this reason, an application to prevent payment will only be granted exceptionally; for example, where the validity of the credit instrument is challenged or it is shown that the credit bank knows that any demand for payment is clearly fraudulent. 

It is worth noting that the ''traditional'' merits test (an arguable case) for interim injunctions in American Cyanamid v Ethicon Ltd [1975] AC 396 has been held not to apply in these circumstances. Even if a limited exception applies, an applicant must provide clear evidence of both the fraud and the credit-provider's knowledge of it. 

A party who provides a letter of credit or similar should be aware that the courts are unlikely to interfere with its performance.  In general, the letter of credit is treated as though you have handed over cash to the beneficiary instead.

Tom Ash