Commercial Lease Obligations During the COVID-19 Pandemic: Understanding Your Rights and Remedies in Light of Government Mandated Closures
Nearly every state has now issued an executive order mandating that most businesses cease operating from their physical locations and that “non-essential” employees work from home until further notice. These measures, though designed to ensure and promote the public’s health and safety during the COVID-19 pandemic, have severely impacted businesses throughout the country. In light of the inability for most business to continue normal operations (and, therefore, generate revenue) from their regular place of business, commercial landlords and tenants are facing uncertainty related to their respective rights and obligations under existing lease agreements.
LEGAL RIGHTS AND REMEDIES
Lease Provisions Control
As a first order of business, both landlords and tenants should carefully review their lease agreement for a full understanding of their contractual rights and obligations. Although rare, some commercial lease agreements may include a tenant’s express right to withhold rent during periods in which it is unable to operate from the premises or, alternatively, upon the occurrence of a force majeure event. In the absence of such provisions, landlords will need to understand their contractual rights and remedies in the event of a tenant’s failure to timely pay rent, and tenants will need to understand the legal consequences of a failure to pay rent in order to make an informed risk assessment before taking any action.
Potential Legal Theories
Most lease provisions do not provide an express right of a tenant to withhold payment of rent, even if it is unable to use the premises for its intended purpose. And those lease agreements that do contain rent abatement provisions are typically limited to situations where the inability to operate is a direct result of the landlord’s acts or failure to act under the lease. Notwithstanding this, most landlords have already begun to see tenants invoke one or more of the following legal theories in an effort to avoid their rental obligations during this unprecedented time:
- Force Majeure/Acts of God
- Breach of Covenant of Quiet Enjoyment
- Breach of Obligation to Provide Services
- Casualty Damage
- Regulatory Taking/Condemnation
- Impossibility/Impracticability of Performance
- Frustration of Purpose
Both parties should understand, however, that in the absence of a lease provision expressly allowing a tenant to withhold rent, courts have historically construed a tenant’s rental obligation as a completely independent covenant under the lease. This has held true whether the landlord breached its obligations under the lease or an outside factor prevented the tenant from operating; in each case, courts have almost always held that the tenant must continue to pay rent. Although the legal theories listed above (and others) will undoubtedly be raised over the coming weeks and months, it is far from certain at this time that any will be sufficient to excuse the tenant’s rental obligation. It is therefore important for tenants to consider reaching out to their landlords about potential relief before taking unilateral action.
Regardless of the contractual or other legal rights and obligations of landlords and tenants, the fact of the matter is that these are unprecedented times and many tenants will simply be unable to make full rental payments at this time. Conversely, most landlords rely on an uninterrupted rent stream to service debt and pay other costs associated with the property and thus may be unable to provide any necessary relief. Although these competing interests may make an amicable solution difficult to achieve, it is still advisable for the parties to communicate with each other frequently over the coming weeks and months.
Furthermore, while the tenant’s obligation to pay rent may remain in place as a matter of law and contract, many states have implemented various forms of moratoriums on the commencement of eviction proceedings. Ultimately, in either eviction proceedings or civil lawsuits to collect rents, courts will be evaluating competing arguments between landlords and tenants with respect to tenants’ failures to pay rent during the current pandemic. In most states, the judges who will evaluate these arguments have the statutory authority to make equitable decisions as they evaluate otherwise clear lease and statutory language. It will not be surprising if judges look sympathetically at tenants whose businesses have been directly impacted by the pandemic in attempting to craft remedies that are fair to both parties.
Each lease situation is obviously unique and will require its own, independent analysis. That said, there are certain common considerations that landlords and tenants should take into account when negotiating any potential rent relief:
- Assess your relative leverage and attendant risks, including:
- Financial wherewithal of tenant and any existing guarantors;
- Strength of legal remedies under the lease: ability to charge default interest and/or penalties for late payment, terminate lease and accelerate rent, seek consequential or special damages, and/or recoup legal fees and costs;
- Lease provisions requiring landlord to mitigate damages;
- Importance of tenant’s rent for debt service or other third-party costs;
- Requirement for lender consent;
- Enforceability and collectability of existing guarantees;
- “Go Dark” provisions regarding anchor tenants, rent adjustments and shopping centers;
- Impact on other tenants.
- Short-term rent deferral (as opposed to rent abatement or reduction), with repayment required by a date certain or amortized over remainder of term
- Suspend/forbear (as opposed to waive) default interest and late fees
- Work with tenants to reach agreements regarding monthly maintenance obligations as a cost-savings measure
- Apply existing security deposit, with obligation to replenish by a date certain or over time
- Additional guarantors, or other security, in exchange for granting rent relief
- Reduce rent in exchange for a longer term (i.e., “blend and extend”)
- Require tenants to waive any defense to obligation to pay rent in exchange for relief
- Assess your relative leverage and attendant risks, including:
- Lease provisions which may excuse rental obligation;
- Collectability of tenant and any existing guarantors;
- Strength of landlord’s legal remedies under the lease–see above;
- Percentage rent provisions and adjustments;
- Potential impact of lease default/termination on tenant’s business or finances.
- Abatement or reduction of rent (as opposed to temporary deferral)
- Agree to relinquish certain unique rights (expansion, early termination, renewal, etc.) in exchange for rent relief
- Offer additional guarantors in exchange for rent relief, or a limited guaranty to cover any abated/deferred rent
- Extend lease term in exchange for reduced rent
No particular strategy will work the same for all situations, and not every problem will have the same solution. But, from the landlord or tenant side, one strategy that should be implemented is communication. Unilateral action by either side without an effort to “work with” the other side will not engender good will between the parties and will likely be looked upon poorly by a judge evaluating a dispute in the future. With the right counsel and guidance, landlords and tenants will be better equipped to successfully navigate through the current sea of uncertainty over their rights and obligations under existing lease agreements. Many situations may lend themselves to working with the parties to preserve the longer-term underlying well-being and financial viability of both parties. Please reach out to your Butzel attorney or any member of the Butzel Long leasing team for additional information and assistance with your lease. We have several decades of collective experience counseling commercial landlords and tenants in lease negotiations, re-negotiations, workouts and legal disputes, and are more than happy to use that experience to your benefit.