COVID-19 & COMMERCIAL TENANT CONCERNS

Particularly as “stay-at-home” restrictions spread nationwide, the effect of the COVID-19 pandemic is felt throughout all sectors of the American economy. The crisis is affecting U.S. real estate interests in different ways (hospitality and retail are hit particularly hard) and the extent and duration of these impacts are simply not discernible at this time.

However, there are several coronavirus issues affecting commercial tenants that are ascertainable and can be addressed now. Here are a few questions being asked by office and retail tenants and our best answers to those concerns.

Q: Does the force majeure provision in my lease excuse my obligation to pay rent?
A: In all likelihood, no.

The standard force majeure provisions in leases are designed to suspend a party’s performance obligation and often expressly exclude application to the tenant’s obligation to pay money (i.e., rent). These provisions excuse a party from liability for delay in performance of a lease obligation where the delay is caused by an inability to perform due to war, civil unrest, labor disturbance, shortage of labor or materials, governmental action or other “act of God” beyond the control of a party to the lease. For example, a strike by a construction union might excuse a tenant’s obligation to build out its space or to make repairs following a casualty within a stated time period. In contrast, the enactment of stay-at-home regulations or business closing orders does not directly prevent a tenant from making rent payments. Consequently, in the vast majority of cases, the force majeure provision will offer no protection for a tenant unable to pay its rent.

BUT…  A growing number of large retailers have notified their landlords that they intend to suspend rent payments, invoking the protection of force majeure clauses in their leases. And, the answer may be different for retail tenants whose leases require payment of “percentage rent” (i.e., a portion of sales revenue), even where the lease contains a “continuous operations” covenant.

Q: Will my business interruption insurance cover my rent?
A: In all likelihood, no.

Business interruption insurance typically covers loss of business income due to an insured’s inability to conduct business because of damage to the business premises caused by fire or other catastrophe (e.g., hurricane or tornado). For coverage to exist, there generally must be actual, physical damage and the coverage applies to revenue lost during the period of reconstruction or repair.

[Note: Many business interruption policies specifically exclude loss resulting from a virus. Legislative efforts to prohibit this exclusion are underway in New Jersey and other jurisdictions.]

BUT…  Just as with regard to force majeure provisions, the limits of business interruption insurance coverage are also under challenge by tenants affected by the coronavirus outbreak. Restaurateurs in several states have brought litigation, notably a declaratory judgment action asking a California court to determine whether a business interruption policy covers losses occasioned by restaurant closings mandated by emergency COVID-19 declarations.

Q: What if I am unable to pay my rent?
A: You may be able to negotiate a rent relief arrangement with your landlord.

Although it is still early in the stages of the COVID-19 crisis, certain patterns of commercial behavior have begun to emerge. In particular, at this time landlords appear willing to agree to some form of rent relief. The motivations for this cooperation are clear: Beyond the economic consequences, landlords do not want a wave of lease defaults occurring in their properties, for fear of triggering the financial covenants in their mortgage agreements.

[Note: In some jurisdictions, a landlord’s ability to pursue customary remedies for a tenant’s breach of the lease has been restricted. For example, on March 20, 2020, the Governor of New York announced a 90-day moratorium on evictions applicable to residential and commercial leases. Similar action has been taken in California, Seattle and Miami and is likely in other states and, possibly, at the federal level.] 

Some landlords are agreeing to a “rent holiday” (say, 90 days), coupled with a recovery of the deferred rent over some portion (or all) of the balance of the lease term. In other cases, the tenant will not be obligated to pay rent for the duration of the rent suspension and the term of the lease will be correspondingly extended to allow the landlord to “recover” its foregone rent. Note: Before pursuing rent relief negotiations, a tenant should be prepared to demonstrate to its landlord the actual need for financial accommodation.

Conclusions

The effects of the COVID-19 pandemic on the rights and obligations of tenants under commercial leases – like the impact of the disease on our country generally – are simply unknown and unknowable at this time. The interpretation and enforcement of force majeure clauses and the coverage of business interruption insurance policies will depend upon the exact wording of the provisions under scrutiny and the nature of the judicial approach to their review and implementation, not to mention possible legislative (or executive) intervention. In the interim, landlords (and lenders) are likely to be guided in their response to these issues by their better business judgment to negotiate and resolve rent payment and other lease issues in commercially reasonable fashion.

So, now is the time for tenants to examine their rights under their leases and business insurance policies and to take steps to protect and preserve those rights. The attorneys at BurgherGray are ready to assist our tenant clients in understanding these rights, in engaging in negotiations with their landlords and insurers, and in addressing any other issues that may arise in these challenging times.