IMPACT OF COVID-19 ON COMMERCIAL LEASES
Posted on: April 21, 2020
The COVID-19 outbreak, and the corresponding government shutdown orders, are wreaking havoc on our communities, the public health infrastructure, and the economy. One area of the economy that has been significantly impacted by the pandemic has been commercial leases. Large and small commercial tenants alike throughout the country, and our community, have been unable to pay their monthly rent due to the loss of income caused by the shutdown orders on all “non-essential” businesses. Beginning on April 1, many commercial tenants did not make their rent payments, or only made partial rent payments, invoking a variety of legal theories to justify their actions, including force majeure, governmental takings and co-tenancy provisions, as well as common law concepts such as impossibility and frustration of purpose, each of which is briefly discussed below.
A force majeure provision in a lease agreement serves to limit damages where a party’s performance under the contract has been frustrated by overwhelming forces beyond its control. Many lease agreements contain a force majeure clause that excuses a party’s performance due to events such as strikes, government directives and, occasionally, pandemics or unnamed events beyond that party’s reasonable control that could be interpreted to include the current COVID-19 pandemic. However, because New York courts require that force majeure provisions be narrowly construed, the specific language of such a provision must be carefully reviewed for its potential application in these circumstances. It should also be noted that the scope of force majeure provisions in lease agreements frequently excludes the prompt payment of rent and other sums due under the lease.
Some leases may contain provisions excusing the payment of rent in the event of a governmental taking for a public purpose. The governmental shutdown orders that have been imposed to combat the COVID-19 outbreak could be construed as a temporary taking, since the government is preventing use of commercial leaseholds for a public-health purpose, i.e., to slowdown the spread of the Coronavirus. However, many governmental taking provisions in lease agreements may be interpreted to apply only to permanent physical takings of all or a part of a leased space. Alternatively, tenants who pay their rent but are not able to use their leased space because of the government shutdown orders may have claims for “just compensation” from the State for the temporary regulatory taking of their leaseholds. Such claims are not expressly contemplated or permitted by the governmental shutdown orders that have been imposed and will need to be resolved through litigation against the State.
Additionally, some commercial leases contain co-tenancy provisions that predicate a tenant’s performance of its lease obligations, including the payment of rent, on the continued operation of a separate anchor tenant in the common shopping center or retail space. An awareness of the specific applicability of such a provision in a lease agreement could provide significant guidance in any negotiations between a landlord and a tenant at this time.
Outside of these contractual principles, tenants may seek relief under the common law principles of impossibility and frustration of purpose. These two concepts, generally, provide that a party is excused from performing under a contract if an extrinsic, unforeseen event has occurred which effectively makes it impossible for that party to receive the benefits of the contract. The applicability of these concepts to the financial strains arising from the COVID-19 outbreak has not been tested in New York Courts and may not be finally settled for some time.
If commercial tenants have business interruption coverage in their insurance policies, they may be able to obtain some relief from their policy providers. But business interruption coverage is, typically, triggered by direct physical loss or damage to an insured’s place of business, or, at least, within a defined vicinity of the place of business. As a result, insurers are summarily denying business interruption claims on the grounds that the Coronavirus does not cause direct physical loss to insured property. In addition, many insurers have invoked pollution exclusions to deny coverage. Numerous lawsuits have already been commenced by businesses against their insurers for wrongful denials of coverage, and they will take years to wind their way through the judicial system. As a result of the uncertainty over whether such claims are covered under business-interruption policies, we are encouraging all of our commercial tenant clients and business clients who have lost income due to the pandemic and governmental shutdown orders to promptly file notices of claims with their insurers to preserve their rights under their policies, especially since a late notice of a claim may be grounds for an insurer to deny coverage.
Unilateral decisions by tenants not to pay rent are causing many landlords to insist on strict compliance with the provisions in the lease agreement. However, landlords should keep in mind that there are significant practical issues and hardships associated with enforcing their leases against tenants unable to pay their monthly rent. Due to the pandemic, court operations are significantly limited, and eviction proceedings have been halted. Additionally, even if a landlord is ultimately successful in removing a delinquent tenant, it is unlikely that a landlord will be able to find a suitable replacement tenant in the immediate aftermath of the pandemic.
Thus, in our view, landlords and tenants should be motivated to negotiate and reach a mutual agreement on how to deal with the financial losses resulting from the COVID-19 pandemic. Some potential remedies for the parties to explore may be, among others, (i) rent deferment in whole or part; (ii) payment of additional rent only; (iii) adding missed rent to the end of the lease or evenly spread out over an agreed upon period; (iv) passing on a landlord’s savings on services, such as cleaning and maintenance costs, in the form of reduced rent; and (v) reduced rent in an amount sufficient for the landlord to meet its mortgage obligations.
We encourage commercial landlords and tenants that have been impacted by the COVID-19 pandemic to contact the Firm’s commercial leasing and real estate experts for further guidance on navigating their way through these complex issues.