With the commencement of the third wave of India’s countrywide lockdown, the time has arrived for businesses to take a cold, hard look at their depleting resources and find ways to manage their losses. On account of the recent lockdown, even though the restrictions are gradually being lifted, ‘non-essential’ businesses are being compelled to cease operations and aren’t able to access their rented premises. Consequently, the need to terminate rental agreements to cut losses has gained importance. Rental agreements, whether they are lease deeds or license agreements, are part of the operational costs of any going concern. The terms ‘lease’ and ‘license’ often tend to be interchangeably used.
However, it is important to draw a distinction between these two concepts, to understand the nature of the parties’ obligations under their agreements, and to identify ways to terminate these obligations in light of the current pandemic.
In this note (“Note”), I examine the statutory provisions relating to leases and licenses under Indian laws, the concept of the doctrine of frustration, and its applicability to leases and licenses.
What is a lease?
Section 105 of the Transfer of Property Act, 1882 (“TPA”) defines ‘lease’ as a transfer of a right to enjoy an immovable property, made for a certain time, or in perpetuity, in consideration of a price (being anything of value) to be provided periodically or on specified occasions, to the transferor/lessor by the transferee/lessee.
The concept of a lease is the outcome of separation between ownership and possession of a property. Prior to making the lease, the owner had the right to sell the property or create any interest on it (e.g. mortgage it) and to enjoy possession of such property. Once the owner creates the lease, not only does the lessor grant the lessee the right to enjoy the property to the exclusion of third parties, but also to the exclusion of the lessor himself, during the term of the lease. Exclusive possession can often be a determinant of a lease though it is not a litmus test to identify a lease. In some factual scenarios, exclusive possession could be passed on without the transfer being indicative of a lease. For instance, where an agreement to rent out an accommodation contains an exclusive possession clause, if the purported lessor himself has no power to grant the lease, a transfer made by him cannot be a lease, and will be considered to be a mere transfer of right to use the property.
Therefore:
(Ownership) – (Right of Exclusive Possession) = Lease
The primary ingredient one has to look for in a lease is that the parties had the intent to create a lease, which can be gauged from the terms of the agreement underlying the transfer.
Illustration A:
A let out his property to B for a period of 3 years, and B paid A Rs. 70,000 as rent for the accommodation every month. The rent agreement did not contain any clause that specified the purpose for which B could occupy the premises, except for stating that it could only be used for commercial purposes. There were no restrictive clauses in the agreement to indicate that A retained control over the property. All utilities and maintenance of the property was to be paid for and facilitated by B. This conveys the intent to create a lease, and since that is the primary determinant, it will be considered to be a creation of lease.
Another ingredient often confused to be a determinant of a lease is a long term/duration. As evident in Section 105, the term of a lease can be for a specified period or even in perpetuity. So, a long term need not necessarily imply the creation of a lease; it may however contribute towards cementing a finding of a lease.
What is a license?
As per Section 52 of the Indian Easements Act, 1882, “where one person grants to another, a right to do, or continue to do, in or upon the immovable property of the grantor, something which would, in the absence of such right, be unlawful, the right is called a license.” Therefore, a license is the grant of a right to do something in relation to an immovable property.
Illustration B:
A was hired by B Pvt. Ltd. as a manager and was provided a housing accommodation. In lieu of payment for the accommodation, B deducted a certain sum of money from A’s salary every month. A was entitled to stay in that accommodation till such time he/she remained in the employment of B. Given that the right to occupy the premises was conditional on A’s continued employment with B, it will be considered to be a grant of license.
Lease vs License
Often license agreements are cloaked as lease agreements, by naming them so and by using the terms ‘lessor’ and ‘lessee’. However, as the courts have observed, whether the transaction is a lease or a license will depend on the operative intention of the parties involved. The creation of an interest in the property is essential to a transfer being considered a lease. However, whether a particular case results in the actual transfer of interest or the mere grant of a privilege to use the property is not always easy to identify and depends on the terms of the agreement in question.
In C.M Beena and Anr. v. P.N Ramachandra Rao , the Supreme Court of India observed that the real intention of the parties in an agreement can be deciphered from a complete reading of the agreement itself. If the agreement seems to only grant the occupant the right to use the property in a particular way or subject to certain terms, while the owner continues to retain control or possession over the premises, a license has been created. Here, though physical possession is in the hands of the occupant, possession in the legal sense continues to reside in the grantor of rights, since he/she retains control of the property.
Illustration C:
A, a mall owner, and B, a person taking a mall shop on rent, enter into a rental agreement for the shop for a period of 3 years. A is responsible to ensure that all the utilities promised to B are provided uninterrupted, and there is a profit-sharing arrangement between A and B. A certain percentage of B’s sales will be payable to A. Here, though B is physically in possession of the mall shop, it is A who has control over it. Hence, this is a grant of license.
The main difference between a lease and a license is that the former grants the lessee the right to possess and control the property, while the latter merely grants the licensee the right to use the property for a specified purpose in a specified manner.
What remedies are available to a tenant seeking to terminate a lease agreement due to the current pandemic?
In Raja Dhruv Dev Chand vs Harmohinder Singh & Anr. the Supreme Court observed that if a lease requires either party to do an act, which act subsequently becomes impossible or unlawful, due to the occurrence of an event that such party could not prevent, any other covenant/obligation under such lease will also become void. However, just because the covenant has become void, it does not render the lease itself void. Thus, we can infer here that if one of the obligations under the lease has been rendered impossible or unlawful, that obligation can be avoided, though the lease itself will not fall through.
The TPA specifies circumstances in which a lease can be avoided by a lessee. Section 108(B)(e) of the TPA states that a lease can be avoided if the following two prerequisites are fulfilled:
- A fire, tempest, flood, violence of an army or a mob, or other irresistible force has occurred; and
- As a consequence of the above, a material part of the leased property has been destroyed or rendered substantially and permanently unfit for the purpose for which it was leased.
Illustration D:
X lets out a house she owns on lease to Y, and due to a fire in a nearby field, the house is burnt down. Y can no longer reside in the house due to its condition. Here, Y can terminate the lease under Section 108(B)(e) of the TPA on account of destruction of the property.
However, if the leased property is not destroyed or rendered substantially and permanently unfit on account of the above-mentioned forces, the lessee cannot avoid the lease merely because he does not or is unable to use the property for purposes for which it was originally let to him.
Considering this in the context of the current pandemic, it is highly unlikely that rented premises will be rendered ‘substantially and permanently unfit or be destroyed’ on account of the lockdown. Reasons one may have as a tenant, to terminate the rental agreement could range from the inability to open the premises for business, to substantial losses due to the lockdown, rendering the tenant unable to meet the rent. More importantly, the only reasons for impossibility of performance that can be entertained in a lease agreement are those specifically listed in Section 108(B)(e) of the TPA, and the current pandemic is not among those specifically listed. The Ministry of Finance (“MoF”), in its office memorandum dated February 19, 2020, interpreted the ‘force majeure clause’ in the Manual for Procurement of Goods (“Manual”) issued by the MoF and observed that the term “natural calamity” in para 9.7.7 of the Manual can be interpreted to include the disruption of the supply chain due to the spread of Coronavirus. However, there has been no similar clarification by any Government authority interpreting “other irresistible force” under Section 108 of the TPA. As such, we may have to look at the rules on statutory interpretation for any support in interpreting this provision of the TPA.
Interpreting “or other irresistible force” under Section 108(B)(e)
As per the ejudem generis rule of interpretation of statutes, when a general word follows specific words of a distinct category, the general word may be given a restricted meaning of the same category. Section 108(B)(e) lists certain causes that can result in destruction of the leased property, followed by the words “or other irresistible force”. Applying the rule of ejusdem generis would mean that any other force similar to fire, tempest, flood, violence of an army or a mob, would fall within the ambit of this provision. Hence, an earthquake or an avalanche could fall within this provision. However, it is highly unlikely that the spread of an infectious disease leading to a countrywide lockdown can be read into this provision. As such, the benefit of Section 108 cannot be availed by a lessee seeking to terminate his lease due to the pandemic. In this situation, the logical alternative available to the lessee would be the claim of ‘frustration of contract’ codified in Section 56 of the ICA.
What is the doctrine of frustration under Section 56 of the ICA?
Section 56 of the ICA envisages two forms of impossibility of performance of contractual obligations – (a) an agreement to do an impossible act is void from the very outset; (b) an agreement to do an act, where the act becomes impossible after the agreement is entered into, due to the intervention of some event that the promisor could not prevent, becomes void at the stage of the occurrence of such event.
The implication of taking the defense of frustration is that the agreement is rendered void, which means that the agreement is terminated and the obligations of the parties come to an end. Impossibility of performance may entail physical impossibility, i.e. the subject-matter of the agreement has been destroyed or is no longer in existence, or the performance of the contract becomes impracticable or useless, having regard to the object and purpose the parties had in mind while entering into it. However, the supervening events should be such that they take away the very basis of the contract. (Satyabrata Ghose v. Mugneeram Bangur & Co.)
Applicability of Section 56 of ICA to leases
In Sushila Devi And Anr vs Hari Singh And Ors., the Supreme Court discussed the applicability of Section 56 of the ICA to lease agreements and observed that once a valid lease has come into existence, even if it is through an agreement, the agreement to lease disappears and its place is taken by the completed conveyance –the lease. Now, the lessee acquires an interest in the property beyond the contractual right that was granted by the agreement. Section 56 of the ICA only applies to contracts and the benefit of Section 56 cannot be availed in the case of a completed conveyance.
Let’s view this in the context of the current pandemic. An agreement under which a lease has already been granted for a consideration, whether it is a monthly rent payment or it is a one-time payment for a fixed period lease, a lessor cannot terminate the agreement, and escape payment obligations, or if it was a one-time payment, ask to reverse the lease and request a refund of the amount paid, on the basis of Section 56. As mentioned above, if it is an ongoing lease, it has transformed into a conveyance and ceases to be just a contract. As such, you cannot terminate the contract claiming that it has been frustrated (as per Section 56 of the ICA).
Will the doctrine of frustration be applicable in case of license agreements?
The rights granted by the licensor to the licensee are contractual in nature, and do not grant any estate or interest in the property. Further, no provision of the Indian Easements Act, 1882 or the ICA, prohibits these provisions from being read together. Hence, it is safe to conclude that the doctrine of frustration could apply to leave and license agreements. If the nature of rights granted in a license are contractual in nature, by implication, the provisions of the ICA would be applicable, and by extension, Section 56 of the ICA too would be applicable.
Viewing this in the context of the current COVID-19 pandemic, it is safe to assume that in license agreements where there are no contractual clauses akin to force majeure clauses, or if such clauses do not actually allow one to terminate the contract due to an unforeseeable event, the defense of frustration may be relied upon. Taking the example of the mall license agreement under Illustration C above, if one is able to establish that the lockdowns and consequent restrictions are here to stay, for an undeterminable future and that it completely frustrates the purpose for which the license agreement was entered into – for setting up shop to sell certain goods, one may succeed in the claim to terminate the agreement.
However, as we have also discussed in our write up here, taking the defense of frustration is not an easy battle to win. It comes with its own challenges and entails a very high threshold of proof – proving complete frustration of the contract may not be very easy considering how uncertain these times are. Restrictions are lifted and imposed every few days, making it difficult to gauge whether it is really impossible to perform one’s obligations under the contract. Therefore, it will depend on the specific terms of the contract and the manner in which the court interprets the prevailing conditions of lockdown and their permanence to establish impossibility of performance.
Author’s Take
The Ministry of Home Affairs vide its order dated March 29, 2020, directed the Governments of all State and Union Territories to take necessary actions to ensure waiver of rent for workers, including migrants, by landlords for a period of one month. However, possibly realizing the weight of the potential monetary burden (on landlords) and backlash from the real estate community such a move would result in, the Governments have not yet issued any order/notification providing for the same. Further, even if the Governments were to provide for the same, it would do nothing to alleviate the burden on businesses due to commercial lease and license arrangements. So unless the agreement itself includes wide enough force majeure clauses that would allow the lessee or licensee, as the case may be, to get a rent waiver, there is not much one can do, except terminate the agreement. If the agreement allows the lessor or licensor to terminate it with minimal notice period, it is a dream come true. However, a common problem faced by tenants in commercial arrangements is that of terminating the agreement during a lock in period. Such an action can bring with it, its own consequences, including payment of rent for the remaining lock-in period, which may also be recovered by the landlord from any deposits that the tenant has placed with him, particularly in a license agreement. In light of these problems, the importance of terminating these agreements is much greater now, since businesses are struggling with abysmal revenues, and continuing to be saddled with their rent obligations.
In conclusion, if an agreement indeed grants a lease, the tenant cannot terminate the agreement citing the pandemic as the cause. On the other hand, if the agreement grants a license, which will only depend on how the agreement is worded, the tenant has two options routes available to him/her to terminate the agreement – a widely worded force majeure clause (which may include “acts of a Government Authority” or “epidemic” as defined force majeure events), or if the tenant can demonstrate a complete frustration of the contract due to the apparently endless lockdown.
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Disclaimer: This post has been prepared for informational purposes only. The information/or observations contained in this post does not constitute legal advice and should not be acted upon in any specific situation without seeking proper legal advice from a practicing attorney.