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March 17, 2020

Stroock Special Bulletin

By: Kim Pagotto, Trevor T. Adler

Businesses — large and small — are being gutted by the COVID-19 pandemic and government restrictions to stem the tide of infection. Recent directives require that restaurants and bars close (with the exception of certain takeout and delivery services), that sporting, concert and other large-scale venues cease holding events, and that gyms shut their doors until further notice. Business disruption is a given, although the extent of its impact is an unknown.

As business owners and landlords assess the damage, they should review key aspects of their commercial leases. While some provisions may permit landlords to accelerate payment obligations or draw down letters of credit in the event of non-payment, others may create exceptions to continuous operation and other tenant covenants or present novel grounds to demand rent abatements under government taking theories.

Parties also should consider the practical impact of the pandemic on the legal system in devising a strategy on whether and how to enforce their rights. This calculation should take into account assistance that may be offered by federal, state and local governments to mitigate the impact of COVID-19 on businesses and their employees.

Lease Provisions

1. Force majeure. Force majeure clauses typically require rent payments, even in the face of events outside of the tenant’s reasonable control that prevent the tenant from performing its other obligations under a contract.  Thus, even if the COVID-19 pandemic qualified as a force majeure event under a commercial lease, rent likely is still due.  In any event, in most jurisdictions, including New York, a force majeure clause that generally describes circumstances outside a party’s control may not be enforceable unless the conditions at issue relate to those specifically enumerated in the clause (for instance, where a force majeure clause did not specify “inability to procure and maintain insurance” as a force majeure event, a crisis in the insurance market that made it very difficult to purchase insurance did not excuse the failure to obtain required coverage even though it included the general language covering “other similar causes beyond the control of such party.”)  If your force majeure clause includes broad general language such as “any cause whether similar or dissimilar to the foregoing,” it is more likely to cover events that are not specifically enumerated in it.

If the force majeure clause in a lease contemplates a pandemic or has broad general language, it may relieve the tenant of the obligation to continuously operate or maintain the property in particular ways.  It may also, depending upon the language in the particular lease, permit either the landlord or tenant to terminate if force majeure is applicable for an extended period of time.

2. Casualty clauses. A casualty clause also generally provides tenants and landlords the option to terminate, or requires a landlord to provide the tenant with a rent abatement, in the event that the property is substantially damaged. Although tenants’ ability to operate their businesses has been disrupted by the pandemic, a casualty clause is usually drafted to cover fire, floods, explosions or similar occurrences that degrade the physical or structural integrity of the premises, but typically does not address circumstances where tenants cannot productively use leased space that remains physically available (including as a result of a communicable disease).

3. Insurance provisions. To the extent insurance is required by the landlord, tenant or both under a commercial lease, it is important to understand, based on the language of your particular contract, which party’s insurance is triggered by closures or disruptions arising from COVID-19 — the landlord’s insurance, the tenant’s insurance or both policies. Owners or tenants of restaurant spaces may be more likely to have business interruption or contingent businesses interruption coverage based on infectious disease than owners and tenants of other types of retail spaces. In the event that you do have applicable insurance coverage, expect delays in collecting funds based upon anticipated increases in time for processing claims consistent with isolated acts of terrorism or weather events that impact a large geographic area.

Stroock recently issued an alert on business interruption insurance in this context.

4. Condemnation/Eminent Domain. Tenants may reach for novel angles, like eminent domain, arguing they are entitled to rent relief. Some tenants may contend that government action requiring businesses to close temporarily to prevent the rapid spread of COVID-19 effectively converts leased spaces for “public use,” requiring government compensation.

Sophisticated tenants often negotiate with their landlord for the right to file their own eminent domain action to recover if the government has “taken” the property where they operate their business. Tenants directly impacted by government closures likely have the most direct claims to make against the government for just compensation, as opposed to landlords for whom the business impact is indirect/secondary (i.e., the landlords are impacted because the tenants are impacted).

Tenants may also have options to terminate their leases or, at a minimum, demand short-term rent abatements, if the government closes their establishments or drastically curtails their hours or conditions of operation. Most eminent domain provisions provide the landlord or tenant with the right to terminate the lease in the event of a permanent taking. The same provisions also typically specify that the tenant is entitled to a rent abatement in the event the government taking is for a shorter duration, such as 60-90 days. If government closures related to COVID-19 are deemed takings and last only for a short duration, many tenants may pursue rent abatements under the language of their particular leases. Again, this theory is untested and would shift the burden to commercial landlords to process their own taking claims against the government.

5. Monetary default provisions. If tenants unilaterally elect not to pay rent based upon a theory arising from any clause in their lease or otherwise, most landlords have the right to deliver a notice of monetary default, requiring tenants to cure the default quickly. If tenants fail to cure the default, landlords in many instances will have the right to accelerate all lease payments with possible immediate recourse to guarantors and/or letters of credit. Tenants in New York that do not pay on any theory should be prepared to defend their decision by immediately making Yellowstone filings as a placeholder to protect their rights, even though there is presently a moratorium on commercial (and residential) eviction proceedings in New York State, with other jurisdictions likely to follow suit.

Legal/Political Landscape

Whatever the specific language of your particular lease, landlords and tenants are likely to take differing positions about its meaning, resulting in potential litigation. In considering the appropriate course of action, landlords and tenants should practically assess the inevitable lag time given that courts will not be fully available to redress conflicts in the short term and, if so, on what timeline. Moreover, both owners and tenants should consider the availability of emergency monies to aid businesses on the federal, state and local levels. Working together to find stopgap funding to keep leases in place and employees employed, even where the government has required our local businesses to stop operating, may be the best method to minimize the damage to all of us in the aftermath of this crisis.   

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For More Information

Kim Pagotto

Trevor T. Adler

This Stroock publication offers general information and should not be taken or used as legal advice for specific situations, which depend on the evaluation of precise factual circumstances. Please note that Stroock does not undertake to update its publications after their publication date to reflect subsequent developments. This Stroock publication may contain attorney advertising. Prior results do not guarantee a similar outcome.