Tenants and landlords should consider whether certain provisions such as force majeure, frustration of purpose, and/or impracticability of performance can protect them under current leases—and whether to include such provisions in future leases—as a result of the current coronavirus (COVID-19) pandemic.
Both landlords and tenants are suffering major losses due to the impact of COVID-19. Forced closures of businesses have put a strain on many tenants, preventing them from being able to satisfy their obligations under their leases. While each lease has particular terms and provisions that must be considered prior to taking any specific action, the two major lease concepts that we are already seeing landlords and tenants invoking, or considering invoking, are force majeure and frustration of purpose/impracticability of performance.
Under these concepts, a tenant seeks to terminate the lease or obtain an abatement of rent, while a landlord could use such concepts to excuse unmet obligations such as tenant improvement deadlines. We caution both landlords and tenants that if they plan to raise such defenses to any actions, the other party could counter-argue an anticipatory breach of contract, thereby potentially putting the party raising the defense in default under the lease. In any event, no matter which defense is asserted, and what arguments are raised, the potential threat of default for nonpayment of rent or for failure to complete obligations has become a real risk to landlords and tenants.
Although not generally a matter of intense focus during lease negotiations prior to COVID-19, landlords and tenants are now considering the precise language of the force majeure provisions in their leases to address the current pandemic. Force majeure provisions are drafted to take into account unanticipated events beyond the control of the contracting parties. The terms of the provisions vary widely and the specific language used is important because the courts generally strictly construe such force majeure clauses. If words similar to “disease,” “epidemic,” “pandemic,” “public health emergency,” “quarantine,” or “acts of government” are not specifically identified in the force majeure clause, it may be an uphill battle for the party seeking to use the force majeure clause as a defense to timely perform under the lease as a result of COVID-19.
To the extent that leases are still being negotiated, both landlords and tenants should modify the force majeure provision to include the following language:
All epidemics, pandemics, viruses, diseases, quarantines, acts of government, public health emergencies, and/or any health condition that requires tenant to vacate the premises or not operate its business by law or otherwise (including, but not limited to, any coronavirus), and/or any local, state and/or federal closures applicable to such lease and/or the parties thereto.
In considering enforcing the force majeure defense, courts will generally ask the following three questions:
As this defense is specifically applied to leases, landlords or tenants may try to use such a defense for failure to (1) complete various obligations under a lease, such as completing any required fit-out obligations within the timeframes provided under the lease, or violation of quiet enjoyment clauses if landlords are required to close buildings due to governmental mandates; (2) provide services required under the lease; (3) pay base rent, additional rent, or reimbursements required under the lease (provided such payment obligations are not specifically excluded from the force majeure clause included in the applicable lease); and/or (4) comply with continuous operation clauses (such as “go dark” clauses included in many retail leases).
Even if a party can successfully satisfy the force majeure test set forth above, other provisions of the lease may still prevent a successful assertion of the force majeure defense. For instance, many leases specifically carve out the obligation to pay rent from the force majeure clause. While tenants can try pushing back on the rent payment exclusion from the force majeure clause, landlords will likely resist or limit the abatement right due to force majeure to a very short duration, perhaps providing only a one-time exception to the rule.
If the force majeure defense is not an option, another defense is to argue frustration of purpose and/or the impracticability of performance principles. These concepts use similar arguments to reach a successful defense. The common law doctrine is typically viewed by courts as narrow and restricted. For frustration of purpose or impracticability of performance, a court would generally consider the following:
The frustration of purpose argument may be raised more in retail or office leases rather than warehouse/industrial or medical leases, which premises may remain open during the COVID-19 pandemic (depending on the restrictions being placed on the specific businesses). For example, if a lease was intended for normal office use, COVID-19 and the government-mandated closures would have frustrated the use if the office building was closed (or if people were not allowed to go into the office due to quarantine rules).
For leases signed before COVID-19, there would be a strong argument that the current levels of closures were not foreseeable. It is unclear whether a court would favor abatement of rent or termination of a lease in the situation of a national crisis, as such a benefit to a tenant’s business would adversely affect a landlord’s business. In addition, the court might have to consider the public policy implications of allowing a termination of a lease or abatement of rent defense in one case, as that could be invoked by essentially all tenants within the jurisdiction. Even though this defense is not typically successful when there is a written lease, landlords might still want to consider including a provision in the lease expressly providing that a tenant is restricted from being able to rely on any common law doctrines of frustration of purpose and/or impracticability of performance principles.
A landlord whose building remains open during the pandemic may incur extra expenses relating to additional cleaning costs, such as extra disinfecting and additional cleaning staff required for higher frequency of cleaning in the building. Leases in multitenant buildings often include an operating expense provision containing a list of items that are expressly allowed to be passed through to the tenants and another list of items that are expressly excluded from being passed through to tenants.
In the case of COVID-19, expenses to clean on a much more thorough and frequent basis could be substantial. Depending on the language of the lease and leverage of the parties, who will ultimately bear these additional costs, it may vary, but typically this will be a pass-through cost to tenants. However, if not specifically listed, tenants may contest paying the additional cleaning costs if there is an audit of the operating expenses.
Rent Abatement Negotiations
As quarantines are lengthened, landlords may begin to experience an increasing number of tenants defaulting under their leases or requests from tenant to abate their rent. Rather than terminating the leases or suing for failure to pay rent, landlords may agree to negotiate with tenants instead (as this could also help landlords through the period in which they are unable to generate revenue from the building if tenants cease payment altogether). These rent abatement or rent forgiveness negotiations are likely expressly excluded from operating costs.
Notwithstanding, if a landlord is considering granting any type of rent abatement or rent forgiveness, landlords should carefully review their debt instruments and obtain the consent of their lenders before entering into any agreement with a tenant to reduce, abate, or forgive rent. Most tenants are not a party to their landlord’s debt instruments (e.g., mortgage or deed of trust), other than occasionally signing a subordination non-disturbance and attornment agreement (SNDA).
Tenants should note that landlords’ debt instruments typically require that all amendments, reductions in rent, and rent abatements and holidays generally require lender consent. In addition, tenants should review any SNDA executed in connection with their lease to determine whether any of the proposed negotiations would cause a violation of such SNDA. If such negotiations are successful, it could result in a better position for both parties if they can avoid litigation costs and termination of the lease.
Whether you are a landlord or tenant, if you are concerned about the impact of COVID-19 on your leasing obligations or rights, please do not hesitate to contact us. We can assist in your review of the relevant provisions and provide guidance concerning your specific lease.
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If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers: