Alerts

COVID-19 – Commercial Leases: What Landlords and Tenants Should Know

Alerts / March 26, 2020

In the wake of the coronavirus (COVID-19) pandemic that has been sweeping the country, commercial real estate landlords are increasingly receiving notices from their tenants asking for relief from rental payments due to the everchanging protocols and mandates by federal, state and local county officials. Landlords are now faced with the daunting task of maintaining business relationships with their tenants while facing the immediate loss of revenue streams, and without certainty of future financial security. As COVID-19 continues to change the face of the real estate industry, it is increasingly important that both landlords and tenants understand their lease rights and obligations.

Force Majeure

Social distancing recommendations, mandates to avoid gatherings of 10 people or more, stay-in-place orders and mandatory closures of nonessential businesses across the United States due to COVID-19 have significantly impacted the day-to-day business operations of tenants, with some opting to completely shut down their operations indefinitely. This has led to an upsurge in notices from tenants claiming that this COVID-19 event has rendered the contractual obligation to pay rent excused. How should landlords respond to these notices? The first essential review is to determine whether there is a force majeure clause in the lease and, if so, whether it applies to the situation at hand.

Force majeure in the literal sense is a “superior” or “irresistible” force or power.[1] A force majeure clause in a lease is a contractual provision negotiated by landlord and tenant that outlines the duties of the parties after an uncontrolled event occurs, which renders the performance of an obligation excusable by the enforcing party. Not all leases are drafted with a force majeure clause, and courts have been reluctant to imply this covenant in the lease. If there is a force majeure clause in the lease, courts apply a narrow interpretation of the clause, looking at whether the purpose of the lease is frustrated by the occurrence of the force majeure event. As such, it is important to understand (i) what constitutes a force majeure event under the lease, and (ii) the parties’ obligations after the force majeure event occurs.

Force Majeure Events

The most common term describing a force majeure event in commercial leases is the term “act of God.” Black’s Law Dictionary defines an act of God as “an overwhelming, unpreventable event caused exclusively by forces of nature, such as an earthquake, flood, or tornado.”[2] In most jurisdictions, acts of God are interpreted as natural disasters; however, some courts have broadened the term to include “all natural phenomena that are exceptional, inevitable, and irresistible, the effects of which could not be prevented or avoided by the exercise of due care or foresight.”[3] Because textual interpretation varies among jurisdictions, most commercial leases expand upon the definition of a force majeure event to cover war, acts of terrorism, government regulations, disasters, strikes and civil disorder. Some, but certainly not all, also address public health emergencies, epidemics and/or pandemics. Whether or not COVID-19 is considered a force majeure event is a factual determination that will be based in large part on how the force majeure clause is drafted in the lease and the specific examples used to describe a force majeure event. Under the principle of ejusdem generis, which is “a canon of construction that ‘[o]rdinarily ... limits general terms which follow specific ones to matters similar to those specified,’”[4] a force majeure provision that includes the words “epidemic,” “pandemic” or “disease” would more likely be construed to include COVID-19 than would a provision that does not include those related terms.

Another point of contemplation is whether the force majeure clause states that obligations under the lease may be excused or delayed where the obligation conflicts with federal, state or local laws, regulations or ordinances. This is another critical factor in determining whether a landlord should honor a tenant’s request for non-performance of their obligations under the lease, as most states have issued ordinances and proclamations declaring mandatory closures of commercial buildings and businesses due to COVID-19.

Obligations of the Parties

As stated above, most courts construe a force majeure clause narrowly and will look to the lease for the effect a force majeure event has on the parties’ obligations. Where the continuing obligation to pay rent is not explicitly stated, tenants may argue that the force majeure clause excuses their obligation to pay rent under the lease; however, there is little precedent to support this notion generally. In fact, courts have found that financial frustration in and of itself is not enough to excuse a party’s performance, even where an unforeseeable event has occurred.[5] In this respect, unless the lease specifically excuses the obligation of a tenant to pay its rent when due, its obligation to pay rent as outlined in the lease is not excused. This determination, however, does not limit the parties’ ability to be flexible under the lease, understanding that leases are often the basis for long-term relationships. It is imperative to the financial viability of landlords and tenants alike to maintain a business relationship throughout the COVID-19 event. Both parties’ businesses have been negatively impacted, and having flexibility during these times may allow for a faster period to rebuild their businesses and restart operations. If the lease does not excuse the rent payments during a force majeure event, landlords may consider alternative ways to provide temporary relief for their tenants, such as rent abatement and/or an extension of time for completion of performance.

For more information on force majeure clauses, BakerHostetler recently issued a Client Alert titled “FAQs: COVID-19 – Force Majeure and Other Defenses to Contractual Performance.”

The Doctrine of Impossibility and Everything In Between

The absence of a force majeure clause in a lease does not mean that a tenant may not raise other arguments in support of a defense for nonperformance. In cases where leases do not expressly include a force majeure clause, the common law doctrine of impossibility may be raised to excuse contractual performance. The doctrine of impossibility is where, “after a contract is made, a party’s performance is made impracticable without fault by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made, and duty to render that performance is discharged, unless the language or the circumstances [of the lease] indicate [otherwise]”.[6] Similar to the force majeure clause, the common law doctrine of impossibility is a factual determination that is narrowly construed. The courts will first look to the lease for guidance for any terms or conditions that may limit the use of this doctrine, such as no abatement provisions. The courts may also look to the lease to see whether the purpose of the lease is able to be fulfilled, even though the unforeseeable event has occurred. It is important to note that in most cases, impossibility is difficult to prove. This is because the impossibility cannot merely be impractical or based on an unanticipated financial hardship. Courts may consider whether the party requesting relief from its nonperformance tried to mitigate the harm and whether additional time or resources would allow the party to fulfill its obligations.

Another similar common law defense to excuse contractual performance that tenants may look to raise is the concept of frustration of purpose. The Second Restatement of Contracts § 265 provides that a party may discharge its performance where “a party’s principal purpose is substantially frustrated without fault by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made.” Both the doctrine of impossibility and frustration of purpose rely on the foreseeability factor; that is, whether or not the event could have been addressed in the lease. Tenants may claim that COVID-19 was not foreseeable, but an argument can be made that the presence of similar pandemics, such as SARS or H1N1, renders the presence of COVID-19 reasonably foreseeable at the time of contracting. Similarly, the absence of a force majeure clause could be a fair argument against applying such theories to a contract since force majeure clauses are generally available for negotiation and the parties could have agreed to address the issues specifically. Although both doctrines depend on the specific terms of the lease analyzed against the associated facts presented by COVID-19, along with applicable laws, these doctrines offer another avenue that tenants may pursue in the event a force majeure clause is not expressly addressed in the lease.

Practical Steps

As many tenants are contacting landlords to seek relief from their rental obligations due to COVID-19, there are some practical steps that both parties can take.:

  1. Check your documents. This includes checking lease agreements for force majeure, default, rent abatement and notice clauses; business-interruption insurance policies; and loan documents, where applicable.
  2. Put it in writing. As parties enter contractual negotiations and discussions on how to mitigate the effects of COVID-19 on the contractual obligations of the parties, it is imperative to memorialize any forthcoming agreements in writing.
  3. Be creative. There are countless creative solutions available that may benefit both the landlord and tenant during the COVID-19 event that will help preserve the business relationship and the financial stability of each. From extending performance dates to abating, extending or recharacterizing rental payments, both parties should be open to explore ways in which short-term relief may be effectuated.

As your business confronts the challenges of COVID-19, BakerHostetler is here to help. We are continuing to develop and publish information about COVID-19 and have developed an online resource to help address and answer legal questions, available here.

Authorship Credit: Amy E. Kellogg, Robert H. Gebaide and Marissa N. John

[1] Black’s Law Dictionary (11th ed. 2019).
[2] Id.
[3] Id at 2.
[4] See RME Petroleum Co. v. Wyo. Dep’t of Revenue, 150 P.3d 673, 689–90 (Wyo.2007).
[5] See OWBR LLC v. Clear Channel Communication, Inc., 266 F. Supp. 2d 1214, 1222 (D. Haw. 2003); see also Valencia Ctr., Inc. v. Publix Super Markets, Inc., 464 So. 2d 1267 (Fla. Dist. Ct. App. 1985).
[6] Restatement (2d) Contracts § 261.

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