California and other states are taking unprecedented steps to mitigate the effects of COVID-19, including statewide stay at home orders that may have catastrophic consequences on retail businesses and restaurants. In this difficult time, tenants should review the provisions in their current leases to determine whether the lease can afford any potential relief, and landlords and tenants may have to work together on solutions outside of the lease to ensure their mutual survival. The current epidemic can also serve as a valuable lesson during negotiation of future leases.
The first section in the lease tenants should review when seeking relief is whether the lease contains a force majeure provision. A force majeure event is an unforeseeable circumstance that prevents one or both parties from fulfilling a contract. In a lease, a force majeure provision can provide a tenant relief from certain obligations, such as an abatement or reduction of rent or an extension to perform acts required under the lease. A broad force majeure clause can protect a tenant from specific situations such as earthquakes, weather-related issues, terrorist attacks, or pandemics. The general term “acts of God” may also be used to describe unforeseen or uncontrollable events. Even if a pandemic or similar term is not specifically listed, COVID-19 could be interpreted as an “act of God” that triggers the force majeure provision. Although force majeure is generally included as a boilerplate provision in leases, in the event of an economic or natural disaster it can save a tenant’s business, so parties should not ignore the force majeure provision when negotiating future leases. Typically, force majeure will allow a tenant to reduce hours or close temporarily or forego other contractual obligations, but may not eliminate the requirement to pay rent. If this is the case it is critical for a tenant to obtain business interruption insurance for the rent during that period. However, tenants should review insurance policies carefully because many are discovering that they aren’t covered for this pandemic.
If force majeure is not applicable, a tenant whose business is ruined by the effects of COVID-19 may be able to assert the affirmative defense of frustration of purpose in a breach of lease lawsuit. Frustration of purpose is similar to force majeure in that a reasonably unforeseen event must have occurred that was not within the parties’ control that frustrates the purpose of the contract. Frustration of purpose related to COVID-19 may be established when the government orders restaurants or retails stores to close or mandates that residents shelter in place, thus making it impossible for the business to serve its intended purpose.
If a business manages to outlast some of its neighbors in a shopping center during a pandemic but the economic outcome looks bleak, a co-tenancy clause in the lease may be a lifesaver if other avenues are not available. A co-tenancy clause in a lease allows a reduction of rent or a right to terminate the lease if a certain number of tenants leave the retail space, such as a shopping center or strip mall.
In these challenging times, we see tenants and landlords collaborating on solutions to allow tenants to survive the extraordinary measures being taken to combat COVID-19. Voluntary arrangements such as deferment or abatement of rent or a reduction in hours may be necessary when the tenant has few other options. For the landlord, the cost and uncertainty of terminating a tenancy and procuring a new tenant will be higher than exercising leniency with the current tenant in order to give them some breathing space to perform their obligations on a manageable timeline during this period of difficulty.
Before offering such relief to the tenant, a landlord may first encourage the tenant to look to any business interruption insurance the tenant carries, which can cover lost revenue and expenses such as rent and utilities. Even if the lease does not require it, we recommend that the tenant obtain business interruption insurance as part of its insurance coverage. Moreover, small businesses can seek relief under the recently enacted CARES Act from the Small Business Administration, which can provide emergency grants, low interest federal disaster rate loans, loan forgiveness for loans used to make payroll and rent, and debt relief to help small businesses overcome the temporary loss of revenue they are facing. States and municipalities are also enacting their own relief provisions to assist commercial and residential tenants during this difficult time.
The current environment demonstrates the importance of addressing in a lease the occurrence of extraordinary events, no matter how unlikely they may be. During a turbulent time, having lease language that deals with the situation may give peace of mind to both landlord and tenant.
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