COVID-19 Pandemic and Commercial Leases
Both landlords and tenants are suffering major losses due to the impact of COVID-19. Forced closures of businesses have put a strain on many tenants, preventing them from being able to satisfy their obligations under their leases.
FORCE MAJEURELandlords and tenants under commercial leases are now considering invoking the rarely-used concepts of Frustration of purpose, Impracticability of performance, and Force Majeure. Under these concepts, a tenant seeks to terminate the lease or obtain an abatement of rent, while a landlord could use such concepts to excuse unmet obligations such as maintenance and similar duties. Both landlords and tenants should be forewarned that raising such defenses may put them in the position of having committed an anticipatory breach of contract themselves.
Although not generally a matter of intense focus during lease negotiations, landlords and tenants must now read the precise language of the force majeure provisions in their leases to see if the current pandemic is covered. Force majeure provisions are drafted to take into account unanticipated events beyond the control of the contracting parties. The courts strictly construe the language of force majeure clauses, meaning that they will not allow the defense by relying on general concepts. If words similar to “disease,” “epidemic,” “pandemic,” “public health emergency,” “quarantine,” or “acts of government” are not specifically identified in the force majeure clause, it is most likely not to be allowed by the court to excuse a landlord’s or tenant’s failure to pay or perform its respective obligations under the lease as a result of COVID-19.
In considering enforcing the force majeure defense, courts will generally ask the following three questions:
• Is the performance that has been interrupted covered by the force majeure clause?
• Is the event that is causing the interruption included in the force majeure clause?
• Did the event causing the interruption actually prevent performance of the obligation?
In applying a force majeure defense to commercial leases, landlords or tenants may try to use it to excuse their failure to (1) complete various obligations under a lease (such as obligations within the timeframes provided under the lease); (2) provide quiet enjoyment, if landlords are required to close buildings to comply with governmental mandates; (3) provide services required under the lease; (4) pay base rent, additional rent, or reimbursements required under the lease; and/or (5) comply with continuous operation clauses (such as “go dark” clauses included in many retail leases).
While tenants can try to stop paying rent as a result of force majeure, landlords will likely resist or limit such payment to a very short duration, perhaps providing only a one-time exception to the rule. Tenants who attempt to terminate the lease altogether will likely not be successful because of the temporary nature of COVID-19 and its governmental restrictions.
FRUSTRATION OF PURPOSE/IMPRACTICABILITY OF PERFORMANCEIf the force majeure defense is not an option, another defense is to argue frustration of purpose and/or the impracticability or impossibility of performance principles. These concepts use similar arguments to reach a successful defense.
These doctrines are typically viewed by courts as narrow and restricted, and so rarely effective. For frustration of purpose or impracticability of performance, a court would generally consider the following:
• What was the intended use of the premises?
• Has there been a total or near total frustration of the intended use or is use of the premises not reasonably practicable?
• Was the event causing the frustration/impracticability foreseeable when the parties entered into the lease?
The frustration of purpose argument would most likely not be available to warehouse, certain industrial (such as those plants which are manufacturing devices required to fight the COVID-19 pandemic) or medical leases, which governmental regulations all or nearly all permit to remain open during the COVID-19 pandemic. The situation with office or retail leases more typically different (depending on the restrictions being placed on the specific businesses operated in the leased premises). For example, if a lease was intended for normal office use, COVID-19 and the government-mandated closures would have frustrated the use if the office building was closed (or if people were not allowed to go into the office due to quarantine rules).
There would be a strong argument that the current levels of closures were not foreseeable. It is unclear whether a court would favor abatement of rent or termination of a lease in the situation of a national crisis, as such a benefit to a tenant’s business would adversely affect a landlord’s business. In addition, the court might have to consider the public policy implications of allowing a termination of a lease or abatement of rent defense in one case, as that could be invoked by essentially all tenants within the jurisdiction.
OTHER LEASING CONSIDERATIONS: OPERATING EXPENSES AND RENT ABATEMENT NEGOTIATIONSOperating Expenses
A landlord whose building remains open during the pandemic may incur extra expenses relating to additional cleaning costs, such as extra disinfecting and additional cleaning staff required for higher frequency of cleaning in the building. Leases in multitenant buildings often include an operating expense provision containing a list of items that are expressly allowed to be passed through to the tenants and another list of items that are expressly excluded from being passed through to tenants.
In the case of COVID-19, expenses to clean on a much more thorough and frequent basis could be substantial. Depending on the language of the lease and leverage of the parties, who will ultimately bear these additional costs, it may vary, but typically this will be a pass-through cost to tenants. However, if not specifically listed, tenants may contest paying the additional cleaning costs if there is an audit of the operating expenses.
Rent Abatement Negotiations
As quarantines are lengthened, landlords may begin to experience an increasing number of tenants defaulting under their leases or requests from tenant to abate their rent. Rather than terminating the leases or suing for failure to pay rent, landlords may agree to negotiate with tenants instead (as this could also help landlords through the period in which they are unable to generate revenue from the building if tenants cease payment altogether). These rent abatement or rent forgiveness negotiations are likely expressly excluded from operating costs.
Notwithstanding, if a landlord is considering granting any type of rent abatement or rent forgiveness, landlords should carefully review their mortgages and debt instruments and obtain the consent of their lenders before entering into any agreement with a tenant to reduce, abate, or forgive rent. Most tenants are not a party to their landlord’s debt instruments (e.g., mortgage or deed of trust), other than occasionally signing a subordination non-disturbance and attornment agreement (SNDA).