COVID’s IMPACT ON LEASES

As tenants and landlords brace for partial closings, lease disputes and funding issues in the midst of the pandemic, many are calling their real estate attorneys to discuss possible protections like force majeure and business interruption insurance. Huddleston Law Offices represents landlords who are receiving calls from their commercial tenants (e.g., restaurants, bars, gyms, & salons that were forced to close), and residential tenants asking for rent concessions, or simply informing the landlords that they cannot (or will not) pay their rent. In many cases these leases do not have rent abatement provisions other than for casualty losses or condemnation. Some complex leases may have force majeure clauses, or commercial tenants may rely on the doctrine of force majeure anyway.

Force Majeure And Business Interruption Insurance May Not Be The Solution CRE Hopes

This post will discuss the effect of force majeure provisions in leases and the applicability of business interruption insurance.

Force Majeure.

A typical “force majeure” provision in a lease excuses each party from any delay in performance of that party’s obligation under the lease to the extent that the delay is caused by “strikes, riots, acts of God, shortages of labor or materials, war, terrorist acts or activities, governmental laws, regulations, or restrictions, or any other causes of any kind whatsoever which are beyond the control of such party”.

a. Is the COVID-19 pandemic a force majeure event? Yes, but not in a bad way for landlords. COVID-19 is included within the definition of most lease force majeure clauses. Using the definition above, COVID-19 (and/or the inability to open for business due to COVID-19) falls within one or more of acts of God, …governmental laws, regulations, or restrictions, or any other causes of any kind whatsoever which are beyond the control of such party.

  1. But does the tenant still have to pay rent? Yes. Most force majeure clauses carve out from the force majeure definition the mere obligation to pay money. As a result, under a typical force majeure provision, a tenant who could not be open for business due to governmental restrictions, such as a shelter in place order, would not be in default for breach of a “continuous operations” clause of a lease. However, a typical force majeure provision will not excuse that same tenant from the non-payment of rent (such being an obligation that is performable by the payment of money). Each lease force majeure clause must be separately reviewed. Some unfortunately worded clauses may fail to exclude the obligation to pay money as an event of force majeure, or may even excuse all other tenant performance, including rent payment, during the existence of the force majeure event.
  1. What are the landlord’s options if the tenant doesn’t pay rent? If the tenant is not paying rent in accordance with the lease, the landlord has all rights and remedies provided under the lease.
    • Most leases include, among landlord’s remedies for a tenant default, the right to terminate the lease or terminate the tenant’s right to possess the premises. In electing whether or not to enforce those remedies, a landlord needs to consider whether, at the end of this pandemic, it prefers a leased space (even if it has not collected full rent for some period of time) or vacant, unleased premises. The answer will differ on a project by project and tenant by tenant basis.
    • Landlords should also be prepared for tenant requests for rent abatement. Preliminarily landlords can point tenants to new state and federal SBA disaster loan programs offering zero percent loans that may be converted into grants as a way to assist tenants to make payroll and pay rent. Another option is to negotiate some temporary deferral of rent in exchange for an extension of the lease term, or a “payback” period. State specific emergency declarations may affect the rights and responsibilities of abatement-requesting tenants, and landlords should be aware of same, if any, before negotiating with a tenant.
    • Keep in mind that the laws are changing during this pandemic, and landlords may not have all of the rights and remedies that are set forth in their leases. Temporary moratoriums on eviction (both residential as well as commercial) are already in effect in Oklahoma, and there are rumors that freeze legislation may be enacted at the federal level.
  2. What about force majeure as it affects Landlord’s obligations? The particular landlord lease obligation most likely to be delayed by COVID-19 is the tenant improvements, or construction/delivery obligation. This is a lease-specific issue, but most landlord work or premises delivery provisions include a force majeure concept, pursuant to which the landlord is not penalized for late delivery to the extent it results from force majeure.
    • Landlords need to confirm whether there is a limit on force majeure delays for construction. Sometimes a tenant will not agree to unlimited delays, and instead the parties negotiate a “cap” on force majeure delay days, after which penalties will kick in.
    • Be sure to confirm whether the landlord is obligated to notify the tenant of force majeure delay days as they occur, at the risk of having waived those delay days if it fails to do so.

Business Interruption Insurance.

a. Does business interruption insurance cover losses due to the COVID-19 pandemic? No.

  1. Business interruption insurance generally covers a company’s actual loss of business income (e.g., lost rent and similar lost revenues) to the extent that the loss of business income directly results from a casualty such as fire, tornado and the like, during the period of reconstruction and restoration. For business interruption coverage to apply, there must be a “direct physical loss” of the premises caused by a covered cause.
  2. Most policies specifically exclude all coverage for damage or loss “resulting from” a virus. These exclusions began being added to policies between 2003 and 2006 in response to the SARS outbreak.
  3. To the extent that a policy includes civil authority coverage (e.g., losses resulting from “shelter in place” orders), such coverage typically will still require physical damage or direct loss, either to the insured property or an adjacent property in close proximity and will usually be limited to thirty (30) days of coverage.
  4. Some landlords who have maintained more expensive policies may have applicable coverage through endorsements and the like. Prudent landlords will want to obtain an expert review of existing insurance policies to confirm whether coverage exists.

b. Other related issues. The currently existing exclusions of COVID-19 from business interruption coverage are being contested as we speak. Legislative efforts to ban the virus exclusions are under consideration in multiple jurisdictions. Some bills under consideration would require business interruption policies to be “construed” to cover business interruption due to Covid-19 virus.   

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