Commercial Leases in the Age of COVID-19 - A Menu of Options for Landlords and Tenants
Part One of Our Two Part Series
The interruption to business-as-usual in the commercial real estate industry brought about by the COVID-19 pandemic has been unprecedented and, while hopefully only temporary, the full extent of the impact may not be entirely understood for some time to come. One impact that is readily apparent, however, is that significant numbers of leased workspaces across the country and around the globe are suddenly empty. Government restrictions on gatherings, movement, and the operation of non-essential businesses have left many offices, laboratories, warehouses, manufacturing facilities, retail locations, and other workspaces shuttered in an extraordinary effort to control a global health emergency. As rent and mortgage payments come due, commercial landlords and tenants will have concerns about the effect of the pandemic on their rights and obligations under existing leases of those now empty spaces. Employees are working from home instead of from rented space, and landlords and tenants are asking what they can and should be doing to protect their businesses. Below, we explore just some of the options both landlords and tenants will want to consider when looking to answer that question.
At the most basic level, landlords right now are looking to protect their rental streams, and tenants are looking for ways to avoid or defer rent liability.
Events of Default / Performance Deadlines. In times like these, both landlords and tenants should review their existing leases carefully to determine which lease obligations they or the other party might be in jeopardy of breaching. Identifying the actions and events that might constitute a default under a lease and how much time might be available to cure such a breach (before damages might be incurred) will help avoid inadvertent defaults that might make a bad situation even worse. For example, tenants should confirm whether abandoning the premises or ceasing its operations could be considered an event of default, or whether they have notice and cure periods available to them for late payments, and how quickly a landlord can use a security deposit to address shortfalls. Similarly, landlords should confirm whether tenants might have the ability to withhold rent if services a landlord must provide under a lease or access to the premises are curtailed or eliminated.
On a related note, the COVID-19 pandemic is having a substantial effect on parties’ ability to meet construction and delivery deadlines and perform removal/restoration obligations under leases. Landlords and tenants will want to be aware of the effect of missing what might be fast-approaching deadlines which may be scheduled to occur during the middle of this crisis, such as those relating to the commencement or expiration dates of their leases. A lease may dictate, for example, what happens if a landlord fails to complete a build-out and deliver possession on time, or what happens if the tenant continues to occupy the premises beyond the end of the term without permission. In some leases, a tenant might have the right to terminate a lease if possession is not delivered by the landlord by a specified point in time, or the landlord might be subject to other penalties.
Before preparing a potential claim that a landlord or tenant should be relieved of certain lease obligations due to the COVID-19 pandemic, it is important that they know exactly what those obligations are and which they might be at risk of breaching because of COVID-19 interruptions. In other words, the first step for landlords and tenants to take right now in order to be prepared to protect themselves is to familiarize themselves with their leases in detail.
Force Majeure. Almost every commercial lease contains a force majeure clause—a provision excusing delays in performance of certain obligations caused by circumstances beyond that party’s control (i.e., “force majeure events”). Now is a good time to take a close look at force majeure clauses in leases to determine whether their scope might be broad enough to excuse delays in performance caused by COVID-19 interruptions. It should be noted that very few force majeure clauses will likely specifically refer to viral pandemics as force majeure events, but some clauses may include a reference to “government orders or regulations”, or define force majeure events more broadly as simply “unforeseen events” (either of which could be applied to the current situation). A force majeure clause of the proper scope might permit the delay of a party’s deadlines for performing certain of its obligations under a lease by the number of days that the party is unable to perform those obligations due to the force majeure event. This will be of particular interest, for example, to landlords whose leases have deadlines by which they must complete certain construction (much of which has been halted by governmental orders) and deliver possession, or to retail tenants who might have an outside date by which they are required to complete their own construction project and open for business to the public. It is important to note that monetary obligations of parties to a commercial lease are often specifically excluded from the list of obligations which may be excused as a result of force majeure events, so while force majeure may be helpful to parties looking to avoid non-monetary obligations under leases, it is unlikely to excuse tenants from having to pay their rent on time or to excuse landlords from having to fund tenant improvement allowances for work that might already have been completed. Even when force majeure clauses do not provide relief from payment or other obligations, a claim that non-performance should be excused under the common law doctrines of impossibility, impracticability, or frustration of purpose could be available. We will continue to explore this topic in future posts, so please be sure to continue referencing our COVID-19 Insights Page for updates. Force majeure, however, is not the only place to look for relief from monetary obligations.
Abatement for Loss of Use. Some leases will contain language providing for rent relief (i.e., abatement) in the event the tenant loses the ability to use some or all of its premises as a result of certain enumerated events or circumstances. Some of these abatement provisions will apply only to situations where the loss of use is caused by a landlord’s failure to satisfy some obligation, and usually only if the landlord fails to restore use within a number of days after receiving a written notice from the tenant. Service interruption rent abatement clauses like these typically only apply if the landlord fails to provide specified essential services (often limited to utilities, elevators, HVAC, etc.), but some are broad enough to cover any situation where the tenant loses the ability to access or use part of its premises due to some failure on the part of the landlord. Importantly, (a) most such service interruption rent abatement clauses are limited to circumstances where a landlord negligently or willfully fails to perform and/or has the ability to restore use, and (b) such interruption periods are also often extended by force majeure events, so a landlord’s mere compliance with governmental orders over which it had no control would not give rise to rent relief in most cases. Many landlords would argue that these rent abatement provisions are sparingly granted and limited in scope because tenants can in many instances rely on business interruption insurance to cover them for loss of use instead of resorting to a claim against their landlord for a breach of the lease; in fact, many landlords will require in the language of the lease that their tenants carry such insurance in order to backstop the payment of the landlord’s rental streams in the event of an interruption. However, this oversimplifies the issue, and the extent to which business interruption insurance can be the solution for landlords and tenants during the COVID-19 crisis will ultimately depend on the scope of the policy in question.
Insurance. Many tenants and landlords carry business interruption insurance policies, some of which require insurers to pay rent obligations of a tenant or fund lost rental income for a landlord where certain events have caused an interruption to the policy holder’s business. Unfortunately, many existing business interruption insurance policies specifically exclude viral pandemics or communicable diseases from their lists of covered events and also only provide coverage if physical damage to the premises occurs. That said, not all policies are alike, so parties should review their policies carefully to determine whether they might cover COVID-19 related interruptions. Even existing policies that do not provide the desired coverage may still prove to be helpful as recent legal developments in several states might provide the panacea landlords and tenants are looking for. State lawmakers in Massachusetts and other states have recently introduced legislation aimed at addressing this gap in coverage with bills that mandate insurers pay out on claims under existing business interruption insurance policies—even where such policies contain the typical exclusions for viral pandemic and communicable disease, and regardless of whether they contain the physical damage requirement. If successfully passed into law, these legislative efforts could be “game changers” for commercial landlords and tenants seeking relief for their business losses related to COVID-19. We will be monitoring these fast-moving legislative developments closely and will likely be updating this series with future blog posts on this topic.
Governmental Relief. Both landlords and tenants may be able to take advantage of relief in the form of government provided funds, loans, or grants made available to them through targeted stimulus programs like the federal CARES Act, other future phases of the federal stimulus effort, or state and local governmental relief efforts. Mintz attorneys have published a number of recent blog posts summarizing and explaining relief available under the CARES Act and will issue additional alerts as this and other similar legislative efforts develop, so please be sure to continue referencing our COVID-19 Insights Page for updates.
In many cases, landlords and tenants will not be able to obtain all desired relief by simply turning to their lease, their insurer, and/or the government. Stay tuned for part two of our two-part series, where we will discuss the practical challenges presented by the options discussed here and the alternative avenues that might be available to commercial landlords and tenants seeking relief from lease obligations in the wake of the COVID-19 pandemic.