Frustration of Purpose: A Frustrating Doctrine

Next Gen Capital, LLC v. Consumer Lending Associates, LLC illustrates the difficulty a tenant faces when trying to avoid liability for breaching a lease based on the “frustration of purpose” defense. No. 1 CA-CV 12-0624 (Ariz. Ct. App. Dec. 19, 2013).  In 2007, Consumer Lending Associates (“CLA”) signed a five-year lease, which limited CLA’s primary use of the premises to operating its “payday loan” business.  CLA was operating pursuant to an Arizona statute, which, by its terms, expired on July 1, 2010.  When the authorizing statute expired, CLA vacated the premises and refused to pay rent due through the end of the term, claiming that the lease terminated “by operation of Arizona law.”  The landlord sued for breach of contract, and the superior court granted a motion for summary judgment, holding that CLA had to pay unpaid rent and relates charges through the end of the lease term.  The Arizona Court of Appeals affirmed.

CLA argued that its breach was excused by the frustration of purpose doctrine, which is an equitable doctrine that relieves a party of its contractual obligations if an event occurs that frustrates the purpose of the contract and was not reasonably foreseeable.  This is a narrow doctrine limited to circumstances of extreme hardship.

A breaching party may be excused from a contract based on the frustration of purpose doctrine if he shows: (1) both parties understood that the frustrated purpose was a principal purpose for the breaching party; (2) the frustration is so severe that it was not within the risks assumed under the contract; (3) the contract was made with a basic assumption that the frustrating event would not occur; and (4) the contract language and circumstances do not infer that the party seeking relief should bear the risk or the loss caused by the frustrating event.

The lower and appellate court found that CLA could not establish the third element because it knew or should have known that the authorizing statute would expire on July 1, 2010 – in the middle of the lease term.

While a tenant will certainly be frustrated if it has to pay rent for an entire lease term even though it has no further use for the lease, the frustration of purpose doctrine will rarely be available as a safety net.  This case serves as a reminder that a party whose business depends on authorization by statute or ordinance to operate (or any other contingency that could alone destroy the purpose of the lease) should consider including lease provisions clarifying who will bear the risk of loss if the tenant or landlord is unable to continue their current operations.