How COVID-19 influenced a business sale dispute

In the recent District Court decision of Happy Lounge Pty Ltd v Choi & Lee Pty Ltd and Anor [2020] QDC 184, the applicant, Happy Lounge Pty Ltd (the seller) entered into a contract of sale on 26 February 2020 with the first respondent, Choi & Lee Pty Ltd (the buyers), to sell The Palace Lounge (the venue) for $550,000. The venue is a bar and lounge located in Fortitude Valley, Brisbane. The contract was not subject to finance, the buyers paid a deposit of $55,000 and the date of completion for the contract was stated to be 18 March 2020. This date was subsequently revised to 24 March 2020.

On 29 January 2020, the Queensland Health Minister declared a public health emergency in relation to COVID-19, which has been further extended to at least 2 October 2020. On 19 March 2020, the seller's liquor licence was approved to be transferred to the buyers - this was the same day that a Public Health Direction was issued, prohibiting gatherings of 100 persons or more at certain premises, including the venue.

On 23 March 2020, a further Public Health Direction (the direction) was issued, effectively prohibiting the venue from operating until at least the end of the declared public health emergency. On the same day, the buyers objected to settlement which was due to occur on 24 March 2020, due to the fact that the venue was no longer able to operate as a bar and lounge, and the seller did not provide a week of tuition in accordance with its obligations under the contract. On 24 March 2020, the seller confirmed that it was ready, willing, and able to settle the contract.

On 25 March 2020, the buyers wrote to the seller purporting to terminate the contract and requested a return of the deposit. On 3 April 2020, the seller wrote to the buyers treating its notice of termination as a repudiation of the contract, and advising that it intended to affirm the contract and sue for specific performance of its terms.

The buyers subsequently pleaded that the contract had been frustrated, and effectively terminated as a result of the frustration.

Was the contract frustrated?

A contract may be automatically terminated by frustration if events occur which renders the situation radically or fundamentally different from the circumstances in contemplation by the parties when the contract was made.[1] The existence of general hardship, inconvenience, or material loss due to an increased expense or delay is generally not sufficient to frustrate a contract.[2]

The relevant event in this instance was determined to be the direction that was issued on 23 March 2020, which prevented the venue from operating.

The seller pointed to special condition 9(b) of the contract as precluding the buyers from claiming frustration of the contract, which stated that "the buyer acknowledges and agrees that all the Assets are sold 'as is and where is' at the completion date". The seller asserted that this meant that the buyers agreed to purchase the business irrespective of any short term trading restrictions imposed upon it by the direction.

However, the Court found that the wording of special condition 9(b) was not specific enough to preclude the buyers from asserting that the contract had been frustrated.

The buyers also sought to rely on several other provisions of the contract in order to demonstrate that the contract had been frustrated. They asserted that as the seller was unable to comply with various conditions of the contract as a result of the direction, the subject of the contract had radically changed as the venue could no longer operate within its normal operating hours and performing its normal functions.

One particular provision was Standard Condition 7.1 which required the seller to give the buyers possession of the business and its assets on the settlement date. The business was defined as "a bar and lounge as specified in the contract". The Court found that while the direction clearly interfered with the buyers' ability to run the business as normal, the seller was still able to give the buyers possession of the business on the settlement date.

The Court also considered the fact that the COVID-19 pandemic was a widely known situation prior to the settlement date, and the possibility for restrictions to be placed on businesses was very likely. It was found that the risk of restrictions preventing businesses such as the venue from opening should have been foreseen by the buyers before entering into the contract.

Further, while a change in circumstances need not be permanent to amount to frustration, the expected length of time for the trading restrictions was significantly less than the remainder of the lease on the business, which was not due to expire until 2032.

The buyers also sought to rely on certain provisions in the contract that required the venue needed to continue to operate as a "going concern" until the sale was completed. The settlement date of the contract was 24 March 2020 - the venue continued operating until 23 March 2020, when the direction took place. Further, other obligations assumed by the seller remained performable, such as the transfer of the liquor licence and assignment of the lease.

Finally, there was a provision in the contract requiring the seller to use its best endeavours to attend the business for a week to perform an effective handover to the buyers, including by introducing them to various suppliers, customers and clients. While this was not able to take place in the way envisioned by the parties, the Court found that the parties could have still done a handover in other ways - by email or social media, so that the provision could have still been enforced.

In the circumstances, the Court concluded that the buyers had failed to demonstrate that the direction forcing the venue to cease trading had unexpectedly created a fundamentally different situation striking at the core of the contract so as to destroy its commercial purpose. The buyers' claim that its obligations under the contract ought to be discharged due to frustration were therefore dismissed.

Alleged breaches of contract

Alternatively, the buyers sought to rely upon purported breaches by the seller to show that the contract was lawfully terminated by the buyers on 25 March 2020. These alleged failures were that the seller failed to obtain the mortgagee's consent to assign the lease, provide evidence in proving the value of the business stock, and carry on and manage the business as a going concern.

The Court accepted that the seller had failed to obtain the mortgagee's consent to assign the lease to the buyers in accordance with Item R of the Schedule to the contract. It also accepted that the seller had not provided evidence of the value of the stock in breach of special condition 12 of the contract. These factors alone were sufficient to justify the buyers' termination of the contract.

It found, however, that going concern condition was unenforceable as a result of the direction.

Conclusion

Ultimately, the sellers were unsuccessful in their application for specific performance of the contract, with the Court finding that the buyers were entitled to terminate the contact on the basis of the seller's failure to obtain the mortgagee's consent to assign the lease and also the seller's failure to provide evidence of the value of the stock.

The Court therefore declared that the contract was lawfully terminated and that the buyer was entitled to a refund of its deposit and its costs of the proceedings.

[1] Codelfa Constructions Pty Ltd v State Rail Authority (NSW) (1982) 149 CLR 337.

[2] Tenants (Lancashire) Ltd v CS Wilson & Co Ltd [1917] AC 495.

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