COVID-19 Commercial Lease Issues
The COVID-19 pandemic is impacting commercial landlords and tenants under existing leases, causing them to examine certain lease provisions to help navigate the uncertainty and determine the extent of their respective obligations and rights. The challenges faced by landlords and tenants vary among different types of commercial leases. Many retail tenants are shut down by government order, while many office tenants are unable to fully use their space but continue to operate remotely. Industrial tenants who are still operating are likely suffering economically due to reduced demand for (or ability to produce and/or deliver) their products. Meanwhile, landlords remain obligated to pay taxes, insurance, debt service, personnel and maintenance expenses. As current circumstances are unprecedented, commercial landlords and tenants are taking different approaches to rent and other obligations under their leases. Some retail tenants have announced to their landlords that they do not intend to pay rent for the next few months, which is likely an event of default (and possibly an anticipatory breach) under their leases. Other tenants are wisely trying to work with landlords to reach some kind of agreement that reduces their short term obligations. As tenants and landlords struggle to meet their obligations during the economic downturn, various lease provisions, including, but not limited to, the provisions described below, should be examined to determine whether they offer any grounds for suspending rent and other lease obligations and, if so, to what extent. Below are some relevant lease provisions and common law doctrines, as well as descriptions of what parties are doing currently and what relief may be available to them.
Relevant Lease Provisions and Common Law Doctrines:
- Payment of Rent. In most leases, the payment of rent is an independent—“hell or high water”—covenant which is not excused under any circumstances other than in connection with a casualty or a condemnation. Accordingly, most tenants do not have an express right under their leases to unilaterally defer or abate rent payments due to the COVID-19 pandemic.
- Force Majeure. This provision may potentially be used as a basis to excuse delayed performance of certain obligations if the pandemic and/or government response are considered a force majeure event under a given lease and if other requirements are met. Typically, force majeure applies to an unforeseen event beyond the control of the parties which makes performance impossible or impractical. However, the language of these provisions varies widely and, depending on that language, force majeure may not excuse the parties of timely performance of their obligations, as courts have generally been unwilling to read these provisions liberally (though they may be more willing to do so in the wake of a pandemic). In many leases force majeure is limited to certain specifically enumerated events, which may or may not include a pandemic. In other leases force majeure is defined more broadly. Assuming that the current pandemic does meet a given lease’s force majeure standard and offers temporary relief from a party’s obligation to perform, most leases specifically exclude payment of rent and other monetary obligations from the obligations which may be excused by a force majeure event. In those cases, however, force majeure may temporarily relieve a party of non-monetary obligations, such as a tenant’s requirements to stay open or complete repairs, or a landlord’s obligations to timely deliver the premises, complete repairs or provide other services.
- Impossibility of Performance. Parties to a lease may try to invoke the common law doctrine of impossibility to excuse performance of their obligations on the basis that governmental prohibitions on business operations and other restrictions were unanticipated and have rendered such performance impossible. Even assuming that the governmental restrictions were unanticipated, since performance must be impossible (not merely impractical or unprofitable) this argument is unlikely to allow a tenant to abate rent, though it may excuse performance of other lease obligations such as a tenant's required hours of operation or a landlord's provision of certain services.
- Frustration of Purpose. Some tenants may argue that they have a common law right to terminate their leases or abate rent where performance is not impossible but, due to a significant change in circumstances, a basic assumption underlying the lease has not occurred or is temporarily not occurring, resulting in the frustration of the tenant's purpose in having entered into the lease. In the context of the COVID-19 pandemic the sole permitted purpose of a tenant’s operation under its lease would have to be so frustrated by the unforeseen governmental prohibition against business operations that the entire lease transaction would have not made sense if made with knowledge of the prohibition. However, in order for a court to excuse a tenant's performance based on a frustration of purpose argument the governmental prohibition would have to be found to render the lease valueless to the tenant, rather than performance merely causing financial hardship to the tenant. It is unclear whether the temporary governmental prohibitions will be found to have sufficiently frustrated a tenant's purpose to an extent permitting abatement. As a common law doctrine, any frustration of purpose inquiry will be fact driven and depend on factors such as the unpredictability of the government shut-down and the degree of frustration it has caused.
- Casualty; Condemnation. Commercial leases typically give tenants the right to terminate their leases if all or a material portion of their premises is physically damaged by a casualty and not timely restored (or able to be timely restored) or condemned by the government. Most casualty provisions also provide for rent abatement until the premises have restored. It is unclear, but seems unlikely, that a court would be willing to consider a temporary business or property closure due to infectious disease a casualty permitting lease termination, but a court could permit rent abatement if it finds that an infectious disease rises to the level of physical damage. Similarly, short of a governmental seizure of the premises for use as a makeshift hospital, laboratory or other pandemic response use, it is unlikely that a temporary shut-down by the government will be considered a taking.
- Operational Requirements. Many retail leases contain provisions obligating tenants to be open for business for certain hours, requiring them to remain fully staffed during such hours and/or continuously operate in order not to be deemed to have abandoned the premises. In order to comply with governmental shut-downs or permit their employees to follow public health guidelines on social distancing or suggestions to stay at home, many tenants have little to no control over their ability to comply with these provisions. At the same time, landlords (especially for indoor malls) may not be able to meet their lease obligations, such as keeping enough other tenants operating (see "Co-Tenancy" below) or keeping the food court open. If performance of these obligations is not temporarily excused by the force majeure clause, it may be temporarily excused on the basis that compliance with applicable law (a typical lease covenant) renders such performance impossible or impractical.
- Co-Tenancy. Many retail leases for malls and shopping centers contain co-tenancy provisions, which afford the tenant the right to pay reduced rent or terminate their leases if occupancy of the mall or shopping center falls below a certain percentage or if a specified anchor tenant (often a department or grocery store) goes dark. It is no secret that retail real estate was already in trouble before COVID-19 arrived (2019 saw a record number of store closures) and the current pandemic is all but certain to exacerbate the problem--some analysts are predicting that 100,000 stores will close between now and the end of 2025. Mall and shopping center tenants should look at their leases to see if they are eligible for reduced rent and/or have the right terminate their leases under their co-tenancy clauses. Landlords should do the same to make sure they understand what their exposure is and make efforts to keep their required anchor tenants, and enough tenants overall, operating to avoid a wave of vacancies.
Government Intervention. Through the CARES Act and related government programs, the federal government has sought to provide some relief to certain landlords and tenants, albeit not directly as rent reimbursement. For example, the Paycheck Protection Program and the Economic Injury Disaster Relief loan program provide SBA loans (which in certain circumstances may be forgiven) to those commercial landlords and tenants who qualify as small businesses and meet other criteria. Additionally, for residential tenants at properties financed by federally backed mortgage loans the CARES Act temporarily prohibits eviction actions, which is in addition to temporary freezes on eviction proceedings and moratoriums on eviction enforcement put in place by state and local governments. Notably, while Cook County has halted eviction proceedings it is still permitting landlords to file eviction complaints, which serves as a stark reminder that any eviction relief provided to tenants will be temporary.
Bilateral Landlord/Tenant Solutions. In order to alleviate tenants’ burden of paying rent during the quarantine, some landlords and tenants have agreed to permit the landlord to apply the tenant’s security deposit to current rent. In some of these cases, the expectation is that the security deposit will be replenished at some point, while in others the landlord is not requiring the security deposit to be restored. Other landlords have agreed to allow tenants to defer rent for a short period of time in exchange for that same period of time being added to the lease term (extending the lease term) or the deferred rent payments being amortized over some period of time, or paid at some later date. Some landlords, in exchange for agreeing to defer rent, are asking tenants to sign promissory notes for the amount of any deferred rent. Tenants should resist signing these deferment notes if they can avoid it, as they will potentially have fewer available defenses to enforcement of a note than enforcement of a lease. It is less clear, however, whether it makes sense for a landlord to accept a note in exchange for agreeing to defer rent. While outside of bankruptcy it may be advantageous for a landlord to do so (for the same reason that it may be detrimental for a tenant to provide a deferment note), if the tenant ends up in bankruptcy and assumes the lease, the landlord would likely be worse off (and certainly not better off) having the note in lieu of a claim for outstanding rent, as the outstanding pre-petition rent would need to be paid in full by the assuming tenant/debtor, whereas the outstanding amount due under the note would be general unsecured debt, which is rarely paid in full. However, if the tenant rejects the lease in bankruptcy, depending on which circuit the bankruptcy court is in and several other factors, it could be advantageous to a landlord to have a deferment note. A landlord considering accepting a note in exchange for deferring rent should carefully consider the risks and potential benefits of this approach. It is important to note that landlords are under no obligation to provide any of the relief described above to their tenants but many recognize that their tenants may simply lack the means to pay and that the alternative may be worse (e.g., a tenant going out of business). It is also important to note that mortgage lender consent may be required for any lease amendments as many loan documents (including SNDAs) require lender consent to lease modifications, so landlords should review their loan documents and tenants should review their SNDAs to make sure they obtain the any required consent before amending their leases. Some landlords, out of concern that certain tenants (e.g., office tenants whose employees are working remotely) asking for relief might simply be trying to take advantage of the situation, are requiring tenants to show evidence of actual hardship and efforts to mitigate such hardship. Accordingly, tenants trying to obtain relief of their lease obligations because of the COVID-19 pandemic should do what they can to operate their businesses and/or apply for any available government programs that might allow them to continue to operate and satisfy its rent obligations.
Unilateral Tenant Responses. As stated above, some retail tenants are simply telling their landlords that they are not making rent payments in the short term. Some residential tenants, meanwhile, have discussed and/or threatened, rent strikes. While tenants without the means to pay may have no other choice than to miss rent payments, and while collective action may make it seem safer or more acceptable to do so, it is important to note that unexcused non-payment of rent is almost certainly a default under any lease. Instead of non-payment of rent altogether some tenants have sent partial rent payments to their landlords. While many commercial leases contain provisions stating that a landlord’s acceptance of a partial rent payment is not an accord and satisfaction which relieves the tenant of the remainder of its payment obligation, landlords should review their leases before accepting any partial rent payments and, regardless of the lease language, any landlord in receipt of a partial rent payment should send a letter to its tenant stating that acceptance of partial payment is not an accord and satisfaction or a waiver of its rights under the applicable UCC provision.
Insurance. Tenants should read their insurance provisions carefully to see if any business interruption insurance they carry would apply to closures (or reductions in business) related to the pandemic. Many landlords carry rental loss insurance and such landlords should likewise review their insurance policies to determine if they can make a claim for lost rent do to COVID-19. Please note that many policies of business interruption and rental loss insurance contain exclusions for losses due to infectious disease, bacteria and/or viruses, which may preclude claims.
Lender Obligations. Just as many tenants are finding it difficult to pay rent, many landlords who are not collecting rent are finding it difficult to make their mortgage payments. Additionally, many landlords not receiving the full rent they are due under leases with tenants may not be able to satisfy the financial covenants (debt service coverage ratio, etc.) contained in their loan documents. Such landlords should reach out to their lenders as soon as possible to discuss their options, even before being faced with non-payment of rent. Many lenders are agreeing to temporarily defer loan payments, forbear from declaring a default and/or waive financial covenant testing for their borrowers despite not being under any obligation to do so.
Other Potential Relief
Utilities. Landlords facing hardships due to COVID-19 should reach out to their utility providers to request such relief.
Taxes. Many Illinois counties are considering delaying or have already delayed upcoming property tax due dates to provide temporary relief to taxpayers. Taxpayers should check to see if their properties are in counties that have done so and, if not, request extensions if needed.
If you questions related to commercial lease issues, please contact David Serritella, a Partner in Pedersen & Houpt's Real Estate Practice Group, at 312.261.2268 or email@example.com.
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