COVID-19 Rent Relief: The Anticipated "Commercial Lease Workout"
As the reality of the novel coronavirus pandemic continues to be realized, the severe impact on the commercial real estate industry has become evident. Customers are scarce, orders are drying up, and supply chains are becoming difficult to manage and might even be broken. On top of these depressed economic conditions, New York and other jurisdictions have implemented restrictive measures intended to contain the spread of the virus, including state-wide closure of nonessential businesses. Accordingly, on a rapid basis, commercial tenants and landlords are being forced to address the looming inability of tenants to generate enough revenue to sustain their rental obligations.
Set forth below are threshold points to consider in connection with a tenant seeking rent relief and a landlord entertaining such requests for rent relief. As explained with more specificity below, the starting point is the lease agreement itself, as it certainly (unless insurance or governmental legislation steps-in) will be the definitive guide to the rights and obligations of the respective parties.
Few leases will provide the tenant with rent abatement rights simply because business has deteriorated due to actions beyond its control, whether by reason of a pandemic, inability to obtain supplies or labor, or even by reason of required governmental closures. Force majeure clauses (which our previous article covered in more depth) are contained in many leases and are intended to permit a party to delay performance of its obligations when unusual events beyond the parties’ control (such as, natural disasters, acts of God, labor disruptions and governmental moratorium) interfere with a party’s ability to perform within the required timeframe. However, almost invariably, force majeure clauses exclude payment obligations from this right to suspend performance.
A lease may provide for a rent abatement if certain circumstances occur. Common clauses found in leases which may allow for rent abatement include (i) a landlord’s failure to provide access to the space, and (ii) a landlord’s failure to provide required services. However, in most cases rent abatement clauses are specifically limited to a negligent or willful failure of the landlord. Potentially, where a tenant had significant negotiating leverage prior to executing the lease, more tenant-friendly abatement rights may be included that are not ‘fault” based, in which event a governmental closure or other events associated with the coronavirus may trigger the abatement.
It should be noted that a lease may have other conditions, the failure of which triggers a rent abatement (such as co-tenancy requirements found in many retail center leases), which may have now failed due to the impact of the coronavirus therefore triggering a rent abatement.
Esoteric common law arguments may also provide rent relief. Constructive eviction, which typically requires a “wrongful act” of the landlord such that a tenant cannot use its space for its permitted use and, as a result, has in fact vacated, is one example. In addition, doctrines such as “impossibility” and “frustration of purpose” may be considered. However, given the potential lengthy and costly legal action that pursuing these rights would entail, and the fact that the elements necessary to support these arguments may be tenuous, it is highly unlikely that pursuing such a case would provide an effective solution for most tenants. A tenant may decide to make such claims and unilaterally cease paying rent based thereon, but such action may have material risks for the tenant as discussed below.
Business Interruption Insurance
The possibility that a tenant’s business interruption insurance, or a landlord’s rent loss coverage (as part of its property insurance), may cover losses incurred due to the coronavirus pandemic is the subject of wide-spread discussion. Similar to the need to review the lease in order to understand the landlord’s and the tenant’s respective rights, it is advisable to have the applicable insurance policy reviewed by an insurance advisor or risk manager. In addition to establishing whether coverage exists, there may be applicable conditions, limitations and deductibles.
In general, an insured party seeking to make a claim under business interruption or rent loss insurance may confront at least two issues: (i) pandemics are often specifically excluded from coverage (although some policies have “civil authority coverage”, providing for coverage in the event of a government ordered business closure, which may supersede the pandemic exclusion); and (ii) the loss must be caused by a “direct physical loss or damage ” to the property resulting from a specific peril (e.g., fire, wind, earthquake, etc.). Whether an argument can be made that the coronavirus constitutes direct physical damage to property is an open question. The common position of insurers (not surprisingly) is that the pandemic does not constitute such physical damage and, accordingly, these polices do not insure against rent losses. Notably, as of the date of this article, this issue is currently the subject of litigation and potential legislative action across the country, so a resolution may still be forthcoming.
In light of the fact that a potential claim may apply under business interruption or rent loss insurance, both landlords and tenants are well advised to speak to their insurance advisors regarding what records and documentations they should preserve and what other actions they should take in order to best preserve a claim under the policy.
As of the date of this article, no such legislation has yet been passed concerning rent relief or insurance coverage for rental obligations under commercial leases. It should be noted that no such legislation was passed in the wake of 9/11. But the legislative reaction to COVID-19 remains extremely fluid and it is possible that legislation will be enacted on an expedited basis.
Practical Advice for Tenants
After consulting with your insurance advisor and carefully reviewing the lease documents with your legal counsel, a tenant seeking rent relief should approach its landlord prepared to explain (i) how the coronavirus pandemic is adversely affecting its business, (ii) the rent relief the tenant seeks (being as specific as possible), and (iii) the tenant’s revised business plan to operate its business through the anticipated period of the current pandemic and beyond. Potential accommodations will include a range of alternatives, including a waiver of late fees and default interest, rent deferrals (with the deferred rent payable at a later date(s) over an agreed-upon schedule) and/or short-term forgiveness or partial reduction of rent.
Tenants should bear in mind that landlords may be amenable to working out reasonable rent relief solutions, as opposed to having to pursue remedies for a defaulted tenant in court (where many courts are not open or are not presently accepting filings for eviction, as is the case in New York, and where courts may allow for leniency in favor of tenants impacted by this crisis) or find a substitute tenant in a currently distressed marketplace. This is especially true if the landlord believes that the tenant (and/or its guarantor of the lease) is otherwise in good standing and has long-term viability and the landlord is receiving appropriate consideration in exchange (see below).
However, tenants must be careful before acting unilaterally in withholding rent. A failure to pay rent may trigger a right of the landlord to terminate the lease with little or no notice. In addition, such action by the tenant may create leverage for the landlord (who may now be armed with the argument that the lease has been terminated) in connection with any subsequent renegotiation of the lease after the current crisis ends, including the leverage to extract increased rents.
Practical Advice for Landlords
Landlords should carefully review their leases to understand the circumstances under which tenants may be able to claim a rent abatement. Landlords are also advised to review any applicable loan agreements, to confirm when a lender’s consent will be required to modify leases, including amendments which contemplate rent reductions. Putting aside legal considerations, a landlord will have to make a business determination as to the risk and reward of accommodating tenants, which may have to be made on a case-by-case basis.
Prior to entering into any discussions with tenants concerning rent relief, it is best to make it clear (in writing) that any discussions are for settlement purposes only, and should not be construed as a waiver of any of the landlord’s rights or remedies or the tenant’s obligations under the lease (given the current circumstances, an email should suffice). In addition, a landlord should consider requesting the tenant’s updated financials and business plans to make it through the current crisis and beyond, before any material relief will be considered.
In connection with agreeing to give a tenant rent relief, the landlord should certainly consider how it may "improve" the lease (e.g., increase future rents, increased security deposit or other collateral, extension of the lease term, and the like), in exchange for such accommodation to the tenant.
Tannenbaum Helpern is actively monitoring developments in addressing the rent relief crisis resulting for the coronavirus pandemic and we will keep you posted. For more information on the topics discussed in this update, please contact any member of Tannenbaum Helpern’s Real Estate Law practice or your usual contact at the firm.
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03.26.2020 | PUBLICATION: Note From The Real Estate Group | TOPICS: Real Estate | INDUSTRIES: Real Estate