In this unprecedented crisis, both commercial tenants and landlords have serious concerns about the terms of their leases, the inability to operate their business in the leased premises, and the payment of rents.
Parties to commercial leases (both tenants and landlords) are seeking guidance regarding the enforceability of lease provisions where the effects of COVID-19 “stay at home” orders have prevented the tenant from opening his business and caused a tenant’s inability to pay. On one hand, commercial tenants are facing upcoming rent obligations without ordinary business income to supplement their payments, while on the other, landlords are concerned with their investments and, if there is debt on the property, debt services to lenders.
Some states, such as New York, have established restrictions on eviction proceedings during COVID-19, and also recently introduced a bill, which has not yet been enacted, that would suspend mortgage payments for 90 days for qualifying small business tenants. However, most states, including North Carolina, have yet to provide such guidance or relief for commercial tenants and landlords. This has required the parties to engage in detailed review of lease provisions (e.g., force majeure clauses and lease purpose provisions) and legal theories (e.g., impossibility and frustration of purpose).
A. FORCE MAJEURE.
Many leases contain a force majeure clause, which excuse a party’s nonperformance when a qualifying event renders the performance impossible. Whether a tenant can justify nonpayment based upon COVID-19 will heavily depend on the precise language of the lease in question. In North Carolina, these clauses are interpreted narrowly, and nonperformance based upon financial hardships alone is generally an insufficient basis to claim force majeure. Therefore, commercial tenants who have been forced to close their businesses are not likely to get nonpayment of rent excused under this doctrine, unless the lease limits use of the premises to only activities which are not possible under the emergency orders.
Force majeure clauses and their applicability to the COVID-19 pandemic are further discussed HERE.
B. FRUSTRATION OF PURPOSE.
The doctrine of frustration of purpose applies when both parties to a contract can perform their contractual obligations, but due to an unexpected event, one party’s performance will now be void of any value to the other. The purpose of the party’s performance was the purpose for entering the contract, which has now been frustrated.
In North Carolina, the party claiming frustration of purpose must show: (1) an implied condition to the contract that a changed condition would excuse performance; (2) this changed condition caused a failure of consideration or the expected value of performance; and (3) the changed condition must not have been “reasonably foreseeable” to the contracting parties.
Sometimes the tenant’s purpose is specifically provided in the lease, which gives the court a foundation to determine whether that purpose was frustrated by COVID-19. Often this language is located in the “use” section of the lease, which defines the permitted purposes for the leased space. However, if the lease provides that the tenant may use the space for “any” or “another lawful purpose”, or if the court determines that COVID-19 was “reasonably foreseeable,” this doctrine may not excuse the tenant’s payment. Also, like force majeure, reduced profits or increased costs alone are generally insufficient to meet the threshold of this doctrine.
C. NEGOTIATION TIPS & TOOLS
1. OBLIGATIONS UPON DEFAULT.
Many standard commercial lease agreements do not include language specifically defining landlord events of default, notice requirements, or any remedies upon default. However, these leases often provide clearly defined obligations, which allow both parties to determine what is expected of them. For example, a landlord’s repair obligations or payment of certain utilities or real property taxes, that if not upheld would be considered a breach of the lease contract. Similarly, a tenant’s security deposit obligations or rent payment, would likewise be considered a breach of contract. While this list is not exclusive of the party’s obligations to one another, if there are such situations outstanding, these may be used as a negotiation tool in coming to a solution.
2. QUIET ENJOYMENT.
All leases contain an implied warranty of quiet enjoyment, which guarantees undisturbed use of the entire premises so long as the tenant is not in breach of the lease agreement. This is often clearly defined in the lease. While rare, tenant’s might want to seek advice from their attorney to determine whether their landlord has failed to provide undisturbed use of the entire premises as defined under this provision in the lease. Likewise, landlords should ensure they are meeting their obligations under this provision by not inhibiting their tenant’s use of the rented property.
3. SECURITY DEPOSIT.
Upon entering into a lease contract, most landlords require their tenants to make a security deposit, which guaranties payment of rent. For tenants, the terms of the lease may also allow a landlord to apply, at its option, the security deposit upon default on rent payments. If this occurs, tenants should negotiate with their landlord to use their security deposit as rent payment to satisfy the default. If the landlord agrees to this, and to ensure the security deposit is replaced, the landlord and tenant should negotiate with one another for the tenant to make payments over the coming months, in addition to their rent payments.
4. LEASE MODIFICATIONS.
Standard language in commercial lease agreements say that modifications to the lease may occur, so long as they are in writing and signed by both the landlord and tenant. If the landlord appears to be open to negotiating a reduction or forbearing rent for the short term, then this language will allow you to do that. Keep in mind that the landlord may require interest to be paid on rent under an amendment or workout.
5. GOVERNMENTAL ORDERS.
While it is rare, parties should be aware that some standard commercial leases contain provisions pertaining to governmental orders, which explain that compliance with such orders can ultimately cost the tenant in excess of a year’s worth of rent, after which the tenant may terminate the lease following 60 days after written notice to the landlord. If a party seeks to terminate their lease due to the effects of COVID-19 causing inability to pay rent, that party’s attorney should review their lease contract to determine whether this provision can be used as an exit strategy.
6. FAILURE TO ENFORCE DOES NOT LEAD TO WAIVER.
Looking on the Landlord side, most leases contain a provision that allows the Landlord to forgive an instance of breach without permanently waiving that term in the lease. So, for example, the landlord could reduce a month’s rent or waive other provisions of the lease, while expressly reserving the right to enforce the provision again at a later time.
7. SOME MONEY IS BETTER THAN AN EMPTY SPACE.
Even where the tenant has an obligation to pay rent, it may not be in the Landlord’s best interest to evict, lock out or force the client to leave. In the uncertain market times, a commercial space may remain empty for months or years, but the tenant may be able to restart his business and pay rent again much quicker than the landlord can fill the space.
8. SOME TENANTS SHOULD NOT BE LOCKED OUT.
North Carolina allows commercial (but not residential) landlords to lock the tenant out of the space. While such action may be perfectly legal in ordinary times, landlords should consider alternatives in the current environment. If the tenant distillery has switched to producing hand sanitizer, the restaurant is serving free meals to first responders, or the outdoor clothing manufacturer is making masks, there could be both legal and public relations issues with a lock out. If the tenant is providing an essential service, it is possible he may be able to get a judge to restore his tenancy. This is an issue which is relatively untested in law but could be analogous to firemen breaking into the neighbors’ house to put out a fire.
Without any real guidance in North Carolina regarding managing commercial leases during the pandemic, we have been encouraging landlords and tenants to engage in creative dialogue in search of mutually beneficial solutions. We are all in this together: a landlord with an empty rental space and no income is likely no better off than the evicted commercial tenant. These discussions may also include the landlord’s lender, as another interested party to the outcome. Our attorneys are dealing with these commercial lease issues daily and are available to help you navigate these uncertain times.
If you have a questions about LEASES or issues affecting your business in this crisis, contact Allen Stahl + Kilbourne
By Derek J. Allen and Olivia Pesterfield
Updated: May 18, 2020
Any statements contained herein do not constitute a formal legal opinion and should not be relied upon as such. These articles are intended for general informational purposes only. Nothing expressed shall be grounds for the creation of an attorney-client relationship. Our attorneys can give legal advice only in the context of an attorney-client relationship after a conflict check, the execution of a representation agreement and a discussion of the specific information and unique issues of your particular circumstances.
The situation surrounding COVID-19/coronavirus is changing constantly; as a result, any discussions that might take place may not necessarily reflect the latest information regarding recently enacted, or pending or proposed legislation or guidance that could override, alter or otherwise affect existing legal analysis.