COVID-19:Financial Issues Facing Commercial Landlords and Tenants
Updated: May 21, 2020
This article focuses on some of the financial issues facing landlords and tenants in the commercial lease context related to COVID-19, as tenants begin seeking rent abatements and other concessions from landlords. As losses continue to mount for commercial tenants, there has been some governmental pressure on landlords to step in and offer financial assistance.
Landlords and tenants are rushing to reevaluate their respective obligations under their leases to assess risks and mitigate potential adverse consequences as a result of the COVID-19 crisis, in light of the specific circumstances leading to the complete or partial discontinuation of business operations and use of the demised space. While the ultimate adverse impact of COVID-19 on the U.S. real estate market remains to be seen, it is likely to be material and not only in the short term. Both parties should look to avoid lengthy and costly legal action by searching for creative alternative solutions that can benefit both in the long term. Given the current impact of the pandemic, and the uncertainty of when businesses across many cities will be able to resume normal operations, even if a landlord is successful in evicting its tenant for failure to pay rent, the costs and potential difficulty to procure a replacement tenant will likely prove challenging. In addition, the ability to collect from a tenant that has been forced to close or has been pushed into bankruptcy is practically null. Even obtaining a monetary judgment when there are no assets to execute against, or too many creditors, would prove too costly for the landlord.
FORCE MAJEURE CLAUSE
The most currently talked about contractual clause is the "force majeure", usually contained in every single commercial contract. Courts have historically interpreted force majeure provisions narrowly on a case-by case basis and are more open to excuse a party’s performance if the force majeure clause expressly lists the event that prevents a party’s performance. Since the World Health Organization declared COVID-19 a pandemic on March 11, 2020, force majeure clauses that expressly include “pandemics” or language regarding pandemics, infectious diseases, public health emergency or governmental prohibitions may trigger the clause. In some jurisdictions, Courts will only enforce a force majeure clause if it is actually impracticable or impossible for a party to fulfill its responsibilities and obligations under a contract. Leases should be reviewed to identify specific terms that would apply to the current pandemic. Even if a force majeure clause contemplates a pandemic or similar event, most force majeure clauses in commercial leases expressly exclude suspension or abatement of rent during a force majeure event, and may even require the tenant to have business interruption insurance to cover the rent. We will cover business interruption insurance in other article.
COMMON LAW "FRUSTRATION" DOCTRINE
Frustration occurs when an unforeseen event either renders contractual obligations impossible or substantially frustrates a party’s main purpose for entering into the contract. One of the requirements of this defense is that what created the frustration must have been unforeseeable, beyond the tenant’s control, and must have created an absolute impediment, rather than just an inconvenience. Courts broadly oppose invalidating contracts, including commercial leases, simply because performance is “profitless and expensive,” as opposed to impossible. This doctrine has been used in many cases involving zoning authorities but there is no settled legal precedent in connection with pandemic-related lease disputes. In addition to potential lengthy and costly legal action, it is uncertain whether the current pandemic outbreak and its impact on any given business would be enough to reach the threshold necessary for a successful frustration claim.
"GO DARK" PROVISIONS
Many leases contain a “go-dark” provision that may or may not permit a tenant to discontinue its business operations for as long as the tenant continues to pay rent under the lease. Some times, specially in malls where certain stores attract customers to the mall, and where a "dark" store looks as abandoned to customers, going dark is a default under the lease agreement even if the tenant continues to pay. In other leases, such as for medical office buildings, where the fact that an enclosed office is "dark" is not apparent to the public, payment of rent may maintain the lease current.
Compliance with Applicable Law Clause
Depending on the applicable provisions of a lease, new legislation, county ordinances, and even CDC recommendations as enforced by other government agencies could trigger either a tenant’s covenant to comply with additional laws or a landlord’s covenant to provide additional services to its tenants. The parties should consider the service charge provision or adjusting the definition of “Operating Expenses” to determine whether a landlord can pass costs incurred in connection with its compliance of COVID-19 legislation to the tenant.
It is important that landlords and tenants maintain an ongoing dialogue in good faith and that any amendments to current commercial leases be in writing and contain a provision of confidentiality, especially if the landlord is negotiating terms with other tenants on a case by case basis.
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