We Americans face unprecedented and unparalleled times as we attempt to heed the warnings and follow the directives of the Centers for Disease Control and Prevention and the World Health Organization. These warnings and directives, along with a growing number of governmental mandates and orders, have created a landslide of doubt and are poised to create uncertainty for the future of many commercial real estate landlords and their tenants. This article provides insight into the applicability of a force majeure clause from both the landlord and the tenant perspective in the context of the novel coronavirus, COVID-19.
The basis of the relationship between a landlord and tenant is a contractual one—the lease. Certainly, these times are causing landlords and tenants alike to review their leases to determine what happens now—or what happens when—and those reviews will inevitably focus on force majeure.
“Force majeure” as translated from French means “superior force.” As defined in Merriam Webster’s Dictionary, it means “an event or effect that cannot be reasonably anticipated or controlled.”
In the context of a commercial lease, the force majeure provision generally provides a mechanism to postpone or suspend the performance of a duty under the lease due to unforeseeable circumstances that are beyond the control of a party. A landlord and tenant will include a force majeure provision in a commercial lease as a means to allocate risk among them in case an unforeseeable event makes it impossible or impracticable for a party to perform. In the event that a commercial lease does not contain a force majeure clause, the impacted party will not have a contractual basis to claim an excuse for delay or non-performance; however, it may have an equitable claim under the doctrines of frustration or impossibility.
When included in a commercial lease, generally, a force majeure clause contains four parts: identification of who is excluded from performance (landlord, tenant, or both); a list of events that qualify; the obligations of the party that is impacted; and remedies for the other party.
Nearly every force majeure clause is drafted so as not to apply to a party’s monetary obligations. This means that if an unforeseen event occurs and a party is unable to make a payment, then the affected party may not invoke force majeure as a reason for its non-payment. For a landlord, this means that your tenant must continue paying rent and, if you have obligations requiring you to make payments to your tenant (i.e., a tenant improvement allowance), then the force majeure clause would not shield you from having to make that payment.
A force majeure clause may set forth a list of events—act of God, lockouts, strikes, riots, shortages of labor or materials, war, terrorism, unavailability of utility service, action by a governmental body, pandemic, or epidemic—or it may more broadly state “unforeseeable events” or “events beyond the reasonable control of the affected party.” Even without the inclusion of specific “pandemic or epidemic” language within the list of unforeseen events, a typical force majeure clause may apply to non-monetary obligations of the parties under a lease in the context of disruption in performance relating to COVID-19. This assertion is reasonable especially if your force majeure clause contains a broad “catch-all” provision like “events beyond the reasonable control of the affected party.”
As each day passes, city, county, state, and federal governmental agencies and officials are instituting policies that will, in all likelihood, disrupt and block commerce and travel, disrupt and suspend labor forces, and interrupt and interfere with manufacturing and supply chains. These governmental actions will have both foreseeable and unforeseeable impacts on landlord-tenant relationships, with widespread ripple effects throughout business operations of all types and at all levels.
Force majeure clauses exist to protect parties from matters that cannot be reasonably anticipated, and courts are loathe to uphold a force majeure defense based on matters that were either known to or reasonably foreseeable by the parties at the time the agreement was executed. Therefore, with respect to new leases or lease amendments that are being negotiated during the COVID-19 pandemic, landlords and tenants must address the impacts of COVID-19 that are contemplated by the parties at the time of lease execution. For landlords and tenants, this means addressing holdover issues as tenants move to new space, potential delays in preparation and approval of plans and specifications, permitting and inspection delays, material and labor shortages, and governmental regulations that severely restrict or prohibit construction activities and most day-to-day business operations, and carefully crafting lease provisions that minimize cost exposure for parties if performance is delayed or rendered impossible, including landlord or tenant termination rights in some cases.
Considerations for Landlords
What should each landlord do? First and foremost, abstract each lease. What the landlord is looking to do through this analysis is understand when it can invoke a force majeure provision if these governmental edicts halt its ability to fulfill non-monetary obligations under a lease and what rights the tenant has should the landlord not be able to perform. Specifically, a landlord should:
1. Review the force majeure clause—whom does it cover, what does it cover, what are the remedies, is there an obligation to notify the other party, and if so, when must that happen? Is there a time limitation on how long a party can use force majeure as a shield?
2. Identify the specific obligations the landlord has under the lease—for example, plan approval and permitting, construction (commencement and/or completion), delivery timelines, and maintenance.
- Closures or reduced hours of operation of a city or county’s planning department may delay or make it impossible for a landlord to obtain a building permit or certificate of occupancy.
- Shelter-in-place orders may reduce/eliminate the labor force necessary to (i) commence and/or complete construction at property, or (ii) maintain a property, each in the condition required under the lease.
3. Identify the specific penalties or remedies that a tenant may have for a landlord breach of these obligations—monetary damages, extension of time lines, and termination rights. It will be critical to identify potential exposure and how to minimize or mitigate that exposure. This can be accomplished by understanding obligations for notice, cure periods, and extension rights.
4. Be proactive and attempt to identify the areas where a tenant might endeavor to raise a claim under the protection of the force majeure clause. For example, store closures may result in a tenant attempting to avail itself of the protections and remedies under its co-tenancy clause. Where might tenants try to use a requirement that the landlord is unable to control? Again, understanding the potential for exposure will be key in formulating the right response.
5. Review insurance policies and consult with legal counsel and industry professionals regarding coverage, notice requirements, and potential claim opportunities. Many landlords carry loss of rent coverage that will help compensate a landlord for lost income in the event that a property is unusable due to an insured peril; however, the trigger for a property insurance policy is physical damage to the insured property. Although it is yet to be seen how the insurance industry will respond, it is likely to assert the argument that COVID-19 is neither an insured peril nor the cause of direct physical loss of or damage to insured property, despite the fact that COVID-19 was unforeseen. This will be an area of continual development that landlords should continue to monitor.
6. In the event that the property is encumbered by debt, then a landlord should review its obligations under its loan documents—for example, notice requirements should the landlord receive force majeure notices from its tenants, or as it sends out force majeure related notices to its tenants; when it needs to obtain consent from its lender to modify the terms of an existing lease; and when it needs to provide copies of default notices sent to or received from tenants.
Considerations for Tenants
As with landlords, a tenant’s first priority should be to understand its rights and options under each lease, not just with respect to force majeure, but also other lease remedies to stem potential losses during the COVID-19 pandemic.
1. Review the force majeure clause: Here the tenant’s objective is the same as the landlord’s. Get a firm handle on rights and obligations.
2. Insurance protection: Nearly every commercial lease requires the tenant to carry property insurance on its personal property. Many property insurance policies provide some coverage for loss of business income related to physical damage to insured property, often covering up to 12 months of business income. Policies vary, and it is unclear if business losses related to COVID-19 are covered losses. With courts slowed by the pandemic, clarity will be slow to arrive and tenants should act quickly to consult insurance professionals and legal counsel to assess coverage. Further, there is mounting political pressure to require insurers to fund COVID-19 business losses, and tenants should monitor these developments closely.
3. Express abatement rights: Some leases allow a tenant to abate rent for any event that makes it impractical or impossible for the tenant to use some or all of its premises (including governmental restrictions on use or operation) and, provided the tenant in fact does not use some or all of the premises, the tenant may be entitled to a full or partial rent abatement during the period of non-use. For example, a restaurant tenant that can only serve customers for delivery or curbside pickup may be able to claim an abatement of rent for all but its kitchen area, if not for the entire premises.
4. Operating covenants and use restrictions: Many leases, particularly retail leases and amenity leases in office and mixed-use projects, require tenants to remain open during minimum business hours. These same leases frequently prohibit operations that violate applicable law. If governmental action requires the tenant to close for business, such closure creates a conflict between the operating covenant and the restriction on prohibited uses, and tenants should act quickly to assert their right to cease operations while governmental restrictions are in place. With many cities enacting moratoria on commercial evictions, and with expected difficulty replacing tenants going out of business entirely, a tenant’s default and eviction risk here appears low.
5. Co-tenancy provisions/go-dark rights. In the retail sector, some shopping center tenants have co-tenancy rights, which allow the tenant to either reduce rent, cease operations, or terminate its lease if certain named tenants (typically anchor tenants and national retailers) or a percentage of the retail area of the shopping center fails to remain open for business. Other leases may permit tenants to cease operations entirely if a percentage of other tenants is not also open and operating during certain specified hours. Going further, some leases grant tenants an absolute right to cease operations, though typically with an ongoing obligation to pay rent until the premises are re-let. Co-tenancy failures frequently have a cascading effect, such that tenants may use closures as leverage to gain short-term deferral or abatement of rent during the pandemic, as retail landlords are motivated to preserve occupancy, even if overall project rental revenue drops significantly.
6. Holdover rights: In some cases, tenants are ending one lease and starting a new lease elsewhere during the COVID-19 pandemic. With shelter-in-place orders and other factors that may delay move-out and move-in, it is important that tenants and both their current and future landlords are working together to reduce holdover exposure. Tenants should consider options like extended holdover agreements and temporary use of as-is swing space for business operations or storing personal property.
In all instances, it is important for landlords and tenants to understand their rights and that each party has an obligation to notify the other party of the occurrence and timing of an unforeseeable event that makes it impossible or impracticable for such party to perform. If a lease is silent on when parties must invoke remedies, the equitable doctrine of laches provides that a party can lose force majeure and other defenses if it does not act promptly once it has full and complete knowledge of relevant facts. With responses to the COVID-19 pandemic evolving rapidly, it is also important that notices from one party to the other specifically identify the event(s) giving rising to non-performance while clearly reserving the right to identify additional force majeure events that are unforeseen or unknown at the time notice is given. As the parties try to navigate these uncharted waters, communication between landlords and tenants will be key in maintaining a good relationship between the parties, and it will also preserve rights each party may have should it need to avail itself of legal action in the future.
Landlords and tenants must also appreciate that while understanding force majeure rights and remedies is invaluable, proving actual impact and damages is difficult and litigating these rights and remedies is costly, expensive, and, in a time when courts are either closed or have limited capacity, not susceptible to speedy resolution. Consequently, when parties are armed with knowledge of the rights and remedies in their leases, the most effective resolution is a negotiated one that balances the needs of the landlord and the tenant and, in many cases, the landlord’s lender.
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