In Salam Air SAOC v Latam Airlines Group SA,¹ the English Commercial Court (i) dismissed the application of Salam Air SAOC (Salam Air) for an injunction against Latam Airlines Group SA (Latam) seeking to restrain Latam from making a demand for payment under three letters of credit issued in its favour and (ii) rejected Salam Air’s argument that the underlying aircraft leases had been frustrated as a result of the COVID-19 pandemic.

Facts of case

In 2017, Salam Air accepted delivery of three aircraft from Latam which were leased to it pursuant to English law governed operating lease agreements and which Salam Air intended to operate from Muscat International Airport in Oman. The aircraft lease agreements each had a term of six years and contained customary dry lease provisions, most relevant in the present context a “hell or high water” obligation to pay rent.

As security for performance of its obligations pursuant to the aircraft lease agreements, Salam Air provided Latam with three letters of credit (instead of cash security deposits) which Latam was entitled to draw under without notice following the occurrence of an event of default. Shortly after Latam filed for Chapter 11 bankruptcy protection in May 2020, Latam gave notice of termination of the aircraft lease agreements and Salam Air redelivered the aircraft in June 2020. At the time of redelivery, Salam Air was three months in arrears with lease rental payments.

In September 2020, Salam Air applied to the High Court seeking an injunction to prevent Latam from making a demand under the letters of credit and applying the proceeds against the outstanding rent payments, arguing that the aircraft leases had been frustrated following the issuance of regulations by the Public Authority for Civil Aviation in Oman (PACA) which prohibited nearly all flights to and from Oman airports as a consequence of the COVID-19 pandemic, and that Salam Air had therefore been relieved of its contractual obligations under the aircraft lease agreements, including its obligation to make rent payments.

Injunction

The judge first considered whether it would be appropriate to interfere with the operation of the letters of credit by injuncting beneficiary Latam from making a demand for payment under the letters of credit. Reminding the court of the “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,”² the judge held that Salam Air was not entitled to the injunction.

As far as injunctions against credit providers – those issuing letters of credit or similar instruments – are concerned, it is well-established in case law that such injunctions can only be granted where (i) the validity of the letter of credit is impeached or (ii) a demand under the letter of credit would be fraudulent.³ This is known as the “enhanced merits test.” Salam Air contended that this test did not apply to the present circumstances given it was seeking an injunction restraining the beneficiary from making a demand for payment rather than an injunction restraining the credit provider from making payment.

The judge dismissed Salam Air’s argument and noted that in his view there was “a very powerful case that an anti-beneficiary injunction should have to meet the same enhanced merits test as an injunction against the credit-provider.”⁴ The enhanced merits test had been established as a consequence of the decision to treat letter of credits and similar instruments as equivalent to cash – “a consideration which weighs as much in favour of its application to injunctions against the beneficiary which (if granted) would make the instrument very inferior to cash, as to injunctions against the credit provider preventing payment.”⁵

Frustration

Secondly, the judge considered Salam Air’s contention that the aircraft leases had been frustrated as a result of the COVID-19 pandemic, relieving Salam Air of its obligation to make rent payments pursuant to the aircraft lease agreements. The judge noted that this would require Salam Air to establish “a strong case rather than merely an arguable case” [emphasis added].⁶

The English law doctrine of frustration applies where, as a result of external circumstances, performance of the contract in accordance with its literal terms would be so “radically different”⁷ from what the parties contemplated when entering into the contract that it would be “unjust to insist on compliance with those literal terms,”⁸ taking into account factors such as the terms of the contract, its context, the parties’ knowledge, expectations, assumptions and contemplations as at the time the contract was concluded and the nature of the supervening event.

Salam Air argued that the test for frustration was met given it was unable to operate the aircraft from Oman due to the regulations issued by PACA. Salam Air also claimed that it would not have any use for the aircraft in the foreseeable future given the collapse in air passenger demand as a consequence of the COVID-19 pandemic and the expected slow recovery even once PACA’s regulations had been lifted.

The judge disagreed and described a six-year “hell or high water” lease agreement as a “challenging context in which to establish frustration.”⁹ The terms of the aircraft lease agreements demonstrated a clear allocation of risk between the lessor and the lessee: while the lessor took on very limited obligations beyond its covenant of quiet enjoyment, the lessee assumed all of the commercial risks and rewards of operating the aircraft, agreeing for instance that its obligation to pay rent was “absolute and unconditional irrespective of any contingency whatsoever” including, without limitation, “the ineligibility of the aircraft for particular use or trade” and would continue even if an aircraft became a total loss or was requisitioned and that it would “bear the full risk of any … occurrence of whatever kind which shall deprive … the operator of the Aircraft for the time being, of the use, possession or enjoyment thereof.”

In the view of the court, these provisions were “fundamentally inconsistent”¹⁰ with the suggestion that the aircraft lease agreements had been frustrated on the basis of Salam Air’s inability to operate the aircraft from Oman – this was a risk that was inherent in the commercial operation of the aircraft and had been assumed by Salam Air when it entered into the aircraft lease agreements.

The court also rejected Salam Air’s argument that there was frustration of purpose – even if Salam Air had communicated the specific purpose for which it intended to lease the aircraft (i.e., operation from, in and to Oman) to Latam, this was not sufficient to cause Salam Air’s purpose to become a purpose that Latam shared and, accordingly, the foundation of the aircraft lease agreements.

The court concluded that Salam Air’s frustration case was “far too weak to justify the step of interfering with the operation of the [standby letters of credit] which Salam Air agreed to provide as an alternative to paying a cash deposit, and which were commercially and legally intended to be equivalent to cash.”¹¹

Conclusion

This case demonstrates the reluctance of the English courts to interfere with the performance of letters of credit and similar instruments which are intended to be equivalent to cash and emphasises the importance which is attached to those instruments in facilitating commercial transactions.

The court’s decision that the effects of the COVID-19 pandemic – regardless of the severity by which a lessee’s business is impacted – are not sufficient to frustrate an aircraft lease agreement and relieve the lessee of its contractual obligations pursuant to the aircraft lease agreement will give much-welcomed comfort to aircraft lessors and financiers.

However, in coming to its decision the court placed strong emphasis on (i) the nature of the lease agreement (a dry rather than a wet lease), (ii) the duration of the lease term and (iii) the lessee’s “hell or high water” agreement to pay rent. These emphases leave some room for speculation as to whether the court would have reached the same judgment in the context of a short wet lease agreement pursuant to which the lessee only assumes very limited obligations.