Covid and Commercial Lease Disputes
This week the Wall Street Journal reported about the first lawsuits to be filed during the Covid crisis. Landlords and tenants are understandably concerned about what litigation may come from the current crisis. Landlords and investors wonder what options they have to limit losses from unpaid rent. Commercial tenants wonder whether their businesses are doomed to fail for the inability to pay rent, at a time when many cannot legally operate. In this post I will analyze sections from commercial leases that most directly apply to the current crisis. Spoiler alert: at the end of this analysis I give reasons why landlords and tenants should consider cooperating with each other instead of filing lawsuits.
[Please keep in mind that this should not be considered or relied on as legal advice. Every commercial lease, property, landlord, and tenant is unique. You should consult an attorney that can review your specific lease agreement and situation.]
A scenario like the Covid crisis could theoretically be addressed in two sections of a lease: the “force majeure” section and the “casualty” section. In the instance that a lease has no relevant force majeure or casualty language, there is much less guidance for the landlord or tenant. It is more open for debate and therefore ripe for litigation.
The force majeure and casualty sections are just two sets of terms that may apply to a landlord/tenant relationship in the context of the Covid crisis. A lease may have other sections that touch upon government-mandated shutdowns or large-scale changes in consumer behavior. For clarity I will only focus on the force majeure and casualty sections.
Force Majeure: In short, force majeure language should excuse performance of contract terms due to unforeseen and uncontrollable external forces. To what extent the language actually does that depends on the wording. Consider these three examples.
EXAMPLE ONE: “If landlord’s performance of a term in this lease is delayed by strike, lock-out, shortage of material, governmental restriction, riot, flood, or any cause outside of landlord’s control, the time for landlord’s performance will be abated until after the delay.”
MY COMMENTS: This force majeure clause squarely fits the Covid crisis. Unfortunately for the tenant, no help is granted. A landlord may arguably extend the time to provide the leased premises to the tenant beyond the lease term. Most likely that would be a matter that the landlord and tenant agree on privately.
EXAMPLE TWO: “In the event that either party shall be delayed, hindered in, or prevented from the performance of any required act under the lease to be performed by such party, and such delay or hindrance is due to causes entirely beyond its control such as riots, insurrections, martial law, civil commotion, war, fire, flood, or other casualty or acts of God, then the performance of the required act shall be extended by the same number of days in the period of delay. A force majeure event shall not be deemed to commence until the 10 days before the date on which the party who asserts some right, defense, or remedy arising from or based upon such force majeure event gives written notice to the other party. No extension of time for or excuse for a delay in the performance of a required act will be granted for rain, snow, wind, cold temperatures, flood or other natural phenomena of normal intensity for the locality where the premises are located.”
MY COMMENTS: This is an even-handed and relevant treatment of a situation like the Covid crisis. Note that the party wishing to be protected by the force majeure terms must give written notice to the other party that a force majeure event has happened.
EXAMPLE THREE: “In the event that the landlord or the tenant will be unable to fulfill, or shall be delayed or prevented from the fulfillment of any obligation in the lease by reason of municipal delays in providing necessary approvals or permits, strikes, third party lockouts, fire, flood, acts of God or our Country’s enemies, riots, insurrections, or other reasons of like nature beyond the reasonable control of the party delayed or prevented from fulfilling any obligation in the lease and provided that such party uses all reasonable diligence to overcome such unavoidable delay, then the time period for performance of such an obligation will be extended for a period equivalent to the duration of such unavoidable delay.”
MY COMMENTS: This very long sentence squarely and evenly protects the landlord and tenant from demands for performance during a situation like the Covid crisis. Note that this force majeure section, along with some of the example sections above it, only gives the delayed party more time to perform its obligation – such as paying rent – until the force majeure event is ended. It does not necessarily mean that the tenant or landlord has the right to terminate the lease.
The Casualty Section: A casualty section is meant to protect the tenant and landlord in a situation where the leased premises are unusable due to some event outside of anyone’s control. Casualty terms can apply to general events or specific events, like fires or floods. Whether that section affects a Covid shutdown depends on how broad the language is. The following three examples will bear this out.
EXAMPLE ONE: “Tenant must immediately notify landlord of any casualty loss in the leased premises. Within 20 days after receipt of Tenant’s notice of a casualty loss, landlord will notify tenant if the leased premises are less than or more than 50% unusable, on a per square foot basis, and if Landlord can substantially restore the leased premises within 120 days after tenant notifies landlord. If the leased premises are more than 50% unusable and landlord can substantially restore the leases premises within 120 days after tenant notifies landlord of the casualty, landlord may either (i) terminate the lease; or (ii) restore the leased premises to substantially the same condition as before the casualty. If landlord chooses to restore and does not substantially restore the leased premises within the time required, tenant may terminate lease. If the lease does not terminate because of a casualty loss, rent will be reduced from the date tenant notifies the landlord of the casualty loss to the date the leases premises are substantially restored by an amount proportionate to the extent the leased premises are unusable.”
MY COMMENTS: This is a general treatment of a casualty event. The tenant is not required to pay rent for the period of the casualty loss, assuming the tenant gives written notice. This could apply to the Covid crisis. While some businesses are 100% inoperable due to Covid restrictions, some are partially inoperable. For example, a restaurant could argue that by losing its dine-in business, it should not be required to pay rent for the square footage of the dine-in area.
EXAMPLE TWO: “If the premises is damaged or destroyed by fire or casualty which cannot, despite diligent, good faith efforts be repaired or restored within 180 days following the date on which such damage occurs, then tenant may terminate the lease effective as of the date of such damage. Within 30 days after the date of such damage, the parties shall reasonably determine how long the repair and restoration will take. After that determination has been made, tenant shall have a period of 30 days to terminate the lease by giving written notice to landlord. If tenant does not give written notice to terminate, then landlord shall diligently repair such damage so that the premises are restored to a condition of similar quality, character and utility for tenant’s purposes existing in the premises prior to such damage. If landlord is required to repair or restore the premises and tenant’s use of the premises is affected by the damage or repairs, then until landlord completes such repair or restoration, all rent shall abate from the date of destruction based on the degree of impact such damages and repairs have on tenant’s operations within the premises as measured by the proportionate reduction in tenant’s sales volume.”
MY COMMENTS: This is a tenant-friendly casualty section. However, the language describing the abatement of rent suggests that this section would not apply directly to a Covid crisis scenario.
EXAMPLE THREE: “If the premises, or any part of the premises, is partially damaged by fire or other casualty not due to tenant’s negligence or willful act or that of the tenant’s employee, the premises will be promptly repaired by the landlord and there will be an abatement of rent corresponding with the time during which, and the extent to which, the premises may have been unusable. However, if the premises should be damaged, to the extent that the landlord will decide not to rebuild or repair, the term of the lease will end and the rent will be prorated up to the time of the damage.”
MY COMMENTS: This section does not fit a Covid crisis shutdown squarely, but an attorney for the tenant could try to shoehorn an argument that it does apply. In that case, a casualty would not require the tenant to pay rent while the casualty event is “unrepaired.”
If you noticed that these sections can be interpreted in multiple ways to apply to the Covid crisis, that is the point. In any lease term the advantage could be with the landlord, tenant, both, or neither. Even if the landlord feels like it has a strong case for termination and eviction, an attorney for the tenant could make reasonable arguments that the tenant cannot be held responsible for rent or an alleged breach during the Covid shutdowns. (On a separate but related topic, many courts have suspended eviction proceedings during the Covid crisis.)
Before anyone hires an attorney to fight about the interpretation of these sections, all parties should consider what they hope to win by fighting. Everyone on all sides of the real estate market are suffering during this crisis. A struggling tenant is not necessarily a sign of a bad tenant or failed business model.
From the landlord’s perspective, even with a strong legal case for eviction, the landlord’s reward at the end would be an empty space to lease. Finding new tenants costs time and money, and it is uncertain what demand will be for commercial space in the coming months. Landlords should also consider that if they take an aggressive posture with tenants, they may scare the tenants into filing bankruptcy. In short, a bankrupt tenant puts the landlord in a more inconvenient position than before. A more practical option could be for the landlord to ask its lenders to suspend loan payments for several months, or at the least to suspend payments towards the loan principal. That could help the landlord wait until a tenant can pay full rent again.
From the tenant’s perspective, even with a strong case to terminate the lease, the tenant should consider negotiating with the landlord to adjust terms that might keep the business alive. Many business models will need to be revised to fit whatever new economic reality awaits us. A pragmatic landlord and tenant may both recognize this and cooperate with each other to keep the property productive.
Thank you for reading this article, I hope it was helpful. If you are in Texas and would like to discuss specific questions, please contact me directly. As an attorney, and a real estate and retail business operator, I am acutely aware of the challenges that landlords and tenants are facing right now. I enjoy working with business owners to solve their problems as if they are my own.