March 24, 2020

How Does the Pandemic Alter Your Lease Obligations?

Given the current circumstances arising from the COVID-19 pandemic and associated government-ordered closures, landlords and tenants both must analyze how their leases and the obligations thereunder are impacted. The answers may change depending on the span of the pandemic and additional governmental restrictions.

In either instance, one first must look to the language in the lease applicable to several issues: continuous occupancy, force majeure, rent obligations, and possibly casualty.

A tenant will be relieved of continuous occupancy obligations if to operate would be a violation of the law. Both tenants and landlords will be relieved of operating requirements when malls and enclosed centers are required by law to close. However, a deeper dive into the lease will be necessary if a tenant that is allowed to operate (i.e., grocery store) elects to reduce operating hours from what is required in its lease.

The next question is if a tenant is prevented from or otherwise elects not to operate (i.e., doctor’s office), is that tenant relieved of its obligation to pay rent? Unless a force majeure provision in the lease explicitly provides a tenant with a defense to perform its payment obligations under the lease, the governmental prohibition does not provide such a defense.

Certain leases with percentage rent clauses require a tenant to pay a deemed liquidated amount for percentage rent if a tenant ceases to operate. There is no current case law interpreting such a clause where the tenant is prohibited by law from operating.

Other questions will arise as we find our way in this “new normal.” What about the tenant’s obligations to maintain its premises and carry insurance? Will business interruption or rent insurance provide some economic protection for landlords and tenants? If a landlord, with no obligation to do so, voluntarily waives rent for a period of time, will a rent interruption insurer that might have provided coverage not be required to do so because the landlord’s act was voluntary?

A landlord or tenant with an obligation to build out the premises may also be impacted by the pandemic and governmental restrictions. Even if permitted to enter the premises to build, force majeure may be important if there is an inability to obtain materials or if workers are unavailable.

Somewhat archaic contract principles that might be applicable are a frustration of purpose, an impossibility of performance and an impracticability of performance. Any of these concepts may find new life, but are likely not applicable if the only impact of COVID-19 is to make performance more expensive.

The same force majeure and contract principles may have an impact on a landlord’s obligation to make loan payments. It is highly unlikely that any loan documents provide for force majeure as a defense to a borrower’s obligation to make payments and satisfy financial covenants, but we can be assured that as borrowers and lenders work through the process, novel theories will be propounded and new law will be made.

Many of these questions pose a case of first impression. We do suggest that lease reviews be completed earlier rather than later and that landlords and tenants be sure to preserve their rights even when agreeing to temporary waivers.

The team at RMG is here to help you navigate these uncharted waters. Please reach out to Gail Stern at gstern@rosenbergmartin.com with any questions.