By: Jeanette M. Flores and Kristin Kowaleski
In these times of uncertainty, it is important for landlords and tenants to review the provisions of their lease agreements to understand their options and to avoid breaching any obligations. Below is a breakdown of some relevant lease provisions that should be reviewed, as well as potential strategies for landlords and tenant to consider with respect to their leases.
Contractual force majeure provisions may provide relief to a party from completing one of it its obligations under the contract, and in extreme cases, may allow for termination of the contract if the event occurs for a certain period of time. These provisions come into play upon the occurrence of an event beyond the parties’ control that would prevent performance of the obligation. Keep in mind, however, that force majeure will likely not excuse failure to perform merely because performance becomes more expensive, difficult, or commercially undesirable.
If the contract does not have a force majeure provision, a party cannot use force majeure to excuse performance. And if the contract does have a force majeure provision, courts review it on a fact-specific basis so it is important to review the specific language of the provision. Most provisions list events or circumstances that would trigger application of the provision, including but not limited to: natural disasters; "Acts of God"; inability to obtain materials or labor; strikes; war, terrorist acts, and civil unrest; and government action such as condemnation.
As of yet, courts have not had to determine whether the impacts of COVID-19 constitute a force majeure event and will likely review the specific language in each provision to determine whether it would excuse performance. We expect that the courts will consider the following questions: If the government deems a business a non-essential business and prevents it from being open, does this governmental action constitute force majeure? Does COVID-19 constitute an Act of God? Additionally, it is important to note that force majeure only excuses performance if the event actually prevents the party from undertaking one of its obligations.
Most pertinent to today’s economic issues is whether force majeure will excuse the payment or rent or other monetary obligations. The overwhelming number of force majeure clauses expressly state that the inability to pay does not constitute an event of force majeure. Accordingly, force majeure will typically not excuse a tenant from paying its rent obligations or excuse a landlord from paying for tenant improvements or allowances for which it would otherwise be obligated. However, each lease should be reviewed in detail to determine whether the inability to pay exclusion is expressly set forth in the lease.
The performance of acts (other than the requirement to pay money) may be excused by a force majeure clause. For example, if a lease requires the tenant to "not go dark" and remain open for certain hours and the government deems its business non-essential or limits hours of operation, then this act would be considered a governmental action that should be excused by the force majeure clause (or possibly constitute a temporary inverse condemnation claim). If a landlord is unable to complete tenant improvements because of shortages of labor or inability to obtain permits or inspections, then the force majeure clause may apply.
If a landlord or tenant believes a force majeure clause will excuse some type of performance under the lease, it is important for the landlord or tenant, as the case may be, to notify the other party, in accordance with the notice provisions of the lease, that an event of force majeure is excusing its performance. Some contracts, especially those concerning construction, may state that a party will lose its right to claim force majeure by failing to notify the other party within a certain number of days.
Interruption of Services
Typically, commercial leases will contain provisions that specify the services, such as utilities, elevator, janitorial and security services, that the landlord must provide to the common areas and premises. If the landlord is unable to provide services because of the building being closed as a result of COVID or the inability of the landlord to obtain labor, the lease should be reviewed to see if it contains an "interruption of service" clause allowing a tenant to abate rent if the interruption continues for a specified number of days. In our experience, these clauses are narrowly drafted and may not provide rent relief as a result of the COVID-19 virus. Some leases only excuse rent if the interruption of services was within the reasonable control of the landlord. If a lease does allow rent abatement for interruption of services outside the control of the landlord, then the force majeure section should be reviewed to determine if the force majeure language gives the landlord a right to suspend services because of a force majeure event, such as governmental action closing the building or inability to obtain labor or materials. These clauses tend to vary from lease to lease and should be reviewed to determine if there is specific language that would provide a tenant with a rent abatement.
Business Interruption/Rental Loss Insurance
Tenants may carry business interruption insurance to pay for their economic losses due to a business interruption outside their control. Similarly, landlords may carry this insurance to provide them with an income stream if their tenants are unable to pay their rent because of a casualty rendering the premises unusable. Typically, business interruption policies require the business interruption loss be directly tied to physical damage to the insured's property such as a fire or flood and insurance companies are stating that COVID-19 does not constitute "physical damage" to a structure. We expect litigation to be pursued to determine whether COVID-19 infection in a building should be considered as physical damage or not. Another limiting clause in many insurance policies is an express exclusion in the policy prohibiting coverage for a virus. The virus exclusions began showing up in the policies after the SARS outbreak, and landlords and tenants will need to review their policies to determine if a virus exception applies.
Leases usually contain a provision allowing a tenant to abate rent in the event of a casualty that leaves the premises unable to be occupied by the tenant because of a casualty. Casualty typically applies only in the event of "physical damage" and these clauses may not provide a rent abatement for virus infections. We expect, however, that the definition of "physical damage" may be litigated in the future.
Impossibility of Performance and Frustration of Purpose
Florida law recognizes the defense of impossibility of performance. Courts, however, have been reluctant to excuse performance based on performance that is not impossible, but merely inconvenient, profitless and expensive. Valencia Ctr., Inc. v Publix Super Markets, Inc. 464 So. 2d 1267 (Fla. 3d DCA 1985). Another defense to contract performance is "frustration of purpose" that may excuse performance by a party where the value of performance regarding the subject of an agreement has been frustrated or destroyed. Similar to the defense of impossibility of performance, Florida courts have been reluctant to allow the doctrine of frustration of purpose excuse contractual obligations. However, the COVID-19 crisis and the emergency orders requiring businesses to shut-down are unprecedented, and we expect that the availability of the defenses of impossibility or performance or frustration of purpose in the context of a pandemic and governmental ordered shut-downs will become the subject of litigation.
In Florida and many other states, eviction moratoriums have been enacted preventing landlords from commencing or proceeding with residential evictions. These moratoriums only apply to residential evictions but some jurisdictions are starting to consider whether similar moratoriums should be enacted with respect to commercial leases. Unless and until moratoriums are imposed with respect to commercial leases, a commercial tenant should respond immediately to any default or eviction proceedings within the deadlines imposed by its lease and applicable law.
Possible Lease Amendment Strategies
While the COVID-19 pandemic is new to all of us, landlords and tenants have a great deal of experience dealing with real estate downturns as a result of the economic downturn of the Great Recession and this history can provide a guide for how to deal with the current COVID-19 crisis. During this recession, we learned that vacant buildings and incredibly long foreclosures and evictions were of extreme detriment to landlords, tenants, and the community. Many of the landlords and tenants who were able to weather the recession were ones that came together on mutually agreeable lease amendments.
Possible strategies for lease amendments may include a landlord willing to provide a temporary rent abatement or reduction if the tenant agrees to extend the length of the lease term. Tenants may be able to offer other incentives to landlords in exchange for rent reductions such as replacing renewal options with fixed rates of increase with fair market value increases, eliminating caps on operating expense increases, or agreeing to pay percentage rent based on their profits after their businesses become profitable once again. Landlords may be willing to offer rent concessions based on a decrease in their operating expenses, such as utility charges, janitorial expenses, security costs and other building and parking garage expenses.
As noted above, it is important for landlords and tenants to review their leases and insurance policies in detail to understand their obligations and rights, avoid breaching their obligations, and determine any notices or other actions that must be provided to preserve their rights. In our opinion, it is equally important for landlords and tenants to discuss the hardships to their respective businesses created by COVID-19, with the hope of reaching some type of mutually agreeable steps to alleviate the damages to their business.