In the current COVID-19 crisis, attorneys are receiving numerous questions from landlords and tenants, as to their respective contractual obligations under their commercial leases. Tenants are carefully analyzing the provisions of the lease to determine if any provisions therein could excuse or delay performance, particularly as it relates to the obligation to pay rent. This article is Part 1 of a 2-article series and summarizes the impact of COVID-19 on commercial leases and parties’ respective responsibilities thereunder. Part 2 of this series will explore the approaches parties are utilizing to negotiate lease workouts in this unique environment.
Many tenants wonder if government intervention will excuse or delay their obligations to pay rent, considering decreased cash flow. Leases are generally a contractual obligation to pay rent, and there is a reluctance of government entities to interfere with private contracts. Subject to any cure periods, in most cases, the landlord can lawfully terminate the lease for the tenant’s failure to perform. Even a bankruptcy filing may not be able to revive a lease if the landlord has already terminated the lease. However, if a bankruptcy petition is filed before the lease is terminated, the automatic stay could prevent the landlord from terminating the lease.
In general, the express language of the lease should drive the lease workout discussions. Accordingly, the parties should first study the language of the lease to better understand their respective obligations under the lease. “Force Majeure” is a term with which many real estate professionals have rapidly become familiar in the last several months. Many tenants have been hopeful that such provisions will excuse or delay their obligations to pay under the lease, due to certain extreme and unforeseen circumstances. However, under Virginia law, the applicability of force majeure clauses depends on the specific facts and circumstances, as more particularly described within the express language of the lease.
Many tenants do not realize that force majeure provisions are narrowly construed in scope and invoking the protection of such provisions is a higher bar than one might expect. Courts are generally reluctant to infer too much meaning into force majeure provisions. If such events are not to specifically contemplated, courts will often not assume certain events should be implicitly included therein. Virginia courts will examine whether (i) language in the lease specifically addresses the event in question and (ii) such event prevents fulfillment of the specific contractual obligation.
If the words pandemic or epidemic are not specifically referenced in a force majeure clause, courts are unlikely to infer that COVID-19 is a force majeure event that will excuse or delay performance, particularly as it relates to the payment of rent. Notwithstanding the foregoing, some tenants have been asserting that “governmental restrictions” or “emergency government action”, when referenced in such clause, can excuse or delay performance. However, it is important to note that many commercial leases specifically provide that payment is not excused by a force majeure event. It is anticipated that, in the future, force majeure provisions will no longer be viewed as trivial boilerplate to be marginalized in the negotiation phase. Going forward, most clauses will probably include pandemic, epidemic, and/or contagion among the list of force majeure events, and more tenants will seek to negotiate that payment should be among the list of excused performance obligations in such an event.
Force majeure clauses are not the only provisions being argued to excuse or delay performance under leases. Tenants have also asserted that frustration of purpose or impossibility of performance may excuse or delay obligations under the lease. This argument asserts that the fundamental purpose of the lease cannot be achieved due to unforeseen events beyond the parties’ control. However, courts will still examine whether some of the purposes of the underlying lease can still be fulfilled. If so, it is less likely that the tenants can avoid payment obligations under the lease or terminate the lease. One such example would be restaurants, which have been heavily impacted by governmental restrictions related to in-house dining. However, the ability to provide take-out orders still allows restaurants to fulfill other purposes of their lease, precluding them from necessarily terminating their lease or an abatement of rent.
Retail leases often contain some unique provisions to possibly excuse or delay performance. Some tenants have raised certain co-tenancy clauses, whereby, if a tenant terminates their lease or vacates the premises, other tenants may have the right to reduce rent and/or terminate their lease. The co-tenancy clause presents an objective basis under which tenants can reduce rent or terminate their lease, based on a clear, triggering event.
Failure of the landlord to perform its duties are another basis being asserted by tenants, as grounds for rent abatement or lease termination. Some tenants have asserted that interruption of service or denial of access, as a landlord obligation, should excuse or delay performance. However, such failures generally must be due to the fault of the landlord, which is generally not the case in the COVID-19 environment.
Some tenants have been asserting provisions related to casualty or condemnation to excuse or delay performance. One challenge in arguing casualty is that it typically pertains to physical destruction rather than contagion. However, condemnation has been a more viable basis, due to forced closures as a temporary taking, if the lease language so provides.
In general, it is recommended that tenants continue to affirmatively satisfy their obligations under the lease, rather than rely on one of these provisions to excuse their obligation to perform. If needed, eligible tenants should apply for small business loan assistance, under which rental payments for a specified period may be an eligible expense. Part 2 of this series will review the practical approaches being taken by the parties to address and work through the issues in the leases presented by COVID-19.