By Tim McCaffrey, Counsel, Eversheds Sutherland (US)
The coronavirus pandemic has impacted individual and corporate behavior on a global scale. Businesses across every sector are attempting to mitigate the economic impact of this crisis. Previously standard leasing terms are changing, both in light of the current environment and in anticipation of a second wave of infection. But even as parties negotiate carefully drafted provisions and carve-outs, it remains unclear when courts will be available to interpret these changes and how they will ultimately respond.
The most commonly discussed change to standard contract terms is the force majeure provision, which typically allows one or both parties to delay or excuse performance of contractual obligations when prevented by unforeseeable circumstances. Where pandemic-specific language is not already part of a force majeure clause, many parties are seeking to add it to the contract.
Tim McCaffrey, Eversheds Sutherland
In typical leases, this defense to performance is only available to landlords for obligations such as the timely delivery of the property or completion of certain landlord work. And in those instances where it does apply to benefit tenants, it typically expressly excludes payment obligations.
But in today’s climate, tenants have begun requesting the ability to invoke a force majeure clause, even to excuse or defer payment obligations. Depending on the timing of lease commencement, tenants may want force majeure provisions to apply to the rent commencement date, or to a failure to timely vacate the property so that the novel coronavirus would not cause a tenant to be deemed in holdover. These are significant departures from standard commercial and retail leasing terms, and if landlords are inclined to grant these requests, they would be wise to include language limiting these allowances to COVID-19-related events only.
Rent deferral requests
Another concession tenants are increasingly requesting is rent abatement or deferral, as payment of rent is currently the most critical issue facing landlords and tenants under commercial leases. Many tenants were able to pay April rent from pre-shutdown revenues, but those tenants then operated at reduced capacities in April. Thus, substantially more payment defaults were expected in May. Thus, landlords have been, and will continue to be, faced with requests for rent concessions.
Landlords facing these situations might consider various approaches. One option is to enforce existing lease terms and exercise all rights. This approach could potentially backfire, resulting in loss of good tenants and/or full non-payment of rent without access to courts to enforce remedies. Another approach involves accommodating requests from valued tenants that clearly arise from the pandemic. Many landlords will take a middle-of-the-road approach, sending notices and preserving rights, but electing not to seek to enforce drastic remedies in the short term. Ultimately, a landlord’s ability to grant such concessions will likely be subject to the landlord’s ability to pay its own mortgage in the face of such concessions.
Tenants are seeking these abatement/deferral alternatives not only under current leases, but also as provisions in new leases and in lease extensions anticipating a second wave of the virus. In some instances, landlords are agreeing to defer rent payments for several months, payable over the remainder of the lease term — sometimes with interest. Careful landlords are expressly conditioning these concessions on tenants remaining current with any agreed-upon payment schedules.
One provision landlords are also increasingly securing is written confirmation that costs of reopening (for cleaning, disinfecting, etc.) are reimbursable from tenants through Common Area Maintenance (CAM).
Unfortunately, however, even the most carefully crafted COVID-19 provisions face uncertainty regarding applicability and enforcement. Tenants who invoke force majeure provisions may be met with pushback from landlords regarding whether closure orders apply to the tenant.
For example, shelter-in-place orders often exempt essential businesses from closure, and so lease parties may dispute whether the tenant operates an essential business. And essential businesses whose employees are able to work from home, leaving offices functionally vacant, may face landlord claims that the tenant voluntarily stopped using its space.
Parties may also dispute whether business closures are the result of the novel coronavirus or the result of decreased demand for the product or service offered by the tenant. For example, a force majeure provision may not apply to a restaurant tenant that stays in operation for carry-out or delivery business, but may help a hair salon tenant that is closed by government order.
Court closures
Court closures have only added to the uncertainty surrounding even the most carefully crafted COVID-19 provisions. While some courts remain open, many courts are closed to non-emergency filings, and such courts are reported to be operating at 25 percent of their pre-closure capacity. While many such courts are currently establishing procedures for phased reopenings, issues like security checkpoints and elevator travel complicate litigants’ ability to return to courtrooms while adhering to social distancing guidelines.
Until courts find a way to resolve non-emergency disputes, parties will be unable to operate under lease documents with any certainty.
It is also unclear how strictly judges will enforce lease defaults in a post-COVID-19 environment. Where many courts in the past have strictly enforced lease provisions, particularly payment provisions, it is unclear whether courts will continue to do so. At least one judge has stated that she intends to consider whether the parties who come into her courtroom have acted reasonably during the pandemic.
For example, tenants that send “cookie-cutter” force majeure notices that are not tailored to the specific conditions at the property are less likely to find support from a court that is later asked to rule on the tenant’s claim.
Regardless of the approach landlords and tenants take with respect to lease documentation and enforcement of remedies during the current pandemic, open and forthright communication between tenants and landlords will serve all parties best. It may help bridge the gap and save a quality tenant.
Where that is not possible, and the parties move to litigation, documented communication and attempted cooperation may provide comfort to a judge in more predictably enforcing a lease during this crisis.
Tim McCaffrey works in the litigation practice group of Eversheds Sutherland (US) LLP and focuses his practice on commercial real estate disputes. Emily Robins, an attorney working with Eversheds Sutherland on litigation matters, assisted with this article, which was originally written for the June 2020 issue of Heartland Real Estate Business magazine.