Client Alert: FAQ: Commercial Real Estate Leasing, Lending, and Related Issues During the COVID-19 Health Crisis
My company is unable to use its rented space during the 100% in-person workforce reduction mandated by Gov. Cuomo. Are we still required to pay rent?
Currently there is no law or Executive Order relieving residential or commercial tenants of their obligation to pay rent during the COVID-19 outbreak. A bill currently being considered in the NY legislature, S8125A, would suspend for 90 days the rent obligation of any residential or small business (< 100 employees) commercial tenant in New York that has “lost income or has been forced to close their place of business as a result of government ordered restrictions in response to the outbreak of coronavirus disease.” The bill would not merely defer the obligation to pay rent; it would permanently relieve the tenant of that obligation for the prescribed 90-day period (it states that the tenant “shall not and shall never be required to pay any rent waived during such time period.”) The bill goes on to provide that landlords with mortgage obligations would similarly be relieved of their obligation to service their mortgage debt during the same period, in accordance with a formula stated in the bill (and like a tenant’s rent obligation, a landlord’s mortgage obligation during the time period in question would not simply be deferred). Note, however, that it remains uncertain whether this measure or one like it will ever become law. Certainly the financial implications of it provide ample grounds for doubting the likelihood of its passage, but the extraordinary circumstances created by the COVID-19 pandemic may prove to motivate lawmakers to enact extraordinary measures like this one.
If no new law relieves my business of its obligation to pay rent, are there any other grounds for withholding payment?
A typical commercial lease states that payment of rent is an obligation independent from a landlord’s obligations under the lease; a commercial tenant ordinarily has no right to offset rent unless such a right has been negotiated into the lease. Commercial leases commonly, but not always, state that landlords have no liability (and there shall be no rent offsets) for closure of the building or for failure to provide services, access and utilities in emergency situations, subject to the landlord using reasonable efforts to provide or reinstate same. So the first step would be to review the lease to see what specific provisions might provide grounds for relief from the obligation to pay rent due to the COVID-19 health emergency. Here are some issues to consider:
Force Majeure: Most leases include a force majeure clause stating that performance of a landlord’s (and sometimes a tenant’s) obligations are excused to the extent prevented or delayed by listed acts and other events not within the party’s reasonable control (but specifically excepting the obligation of a tenant to pay rent). Courts tend to read these force majeure clauses restrictively, so the language would need to be broad enough to capture delays and inability to perform due to disease. If the coronavirus pandemic constitutes a force majeure under a lease, close attention should be paid to how that might affect lease provisions relating to interruption of services, utilities and access, delays in delivery of a premises, and delays in completion of leasehold improvements. Depending on how these clauses are written, a lease might provide more time for remediation of interruptions of services, utilities and access, delivery of the premises and completion of work. This could impact both rent abatement remedies and lease termination rights.
Interruption or Suspension of Access and Services: A lease may provide that a landlord shall provide 24/7 access to the premises. If such a clause exists, are there exceptions to that obligation? Some leases explicitly allow the landlord to close the building or suspend services, utilities or access in the event of an emergency, if the landlord has a reasonable concern of damage to the building or personal injury to the occupants, and, in some instances, as a result of government orders or actions. The interpretation of a landlord’s obligations and tenant’s remedies may differ depending on who elects to close off the access – the government, the landlord or the tenant. Some leases provide remedies (from abatement to termination rights after particularly long periods of interruption) after a certain period of time (and in some cases subject to notice from tenant to landlord) if there are interruptions of certain services, access and utilities attributable to the landlord. Other leases go further to cover the tenant after a specified period of time if the interruption in access or services occurs for any reason other than the tenant’s fault, which may implicate situations where the government has interfered with access or use. Parties need to review their leases to see if those provisions cover interruption of access (and not just essential services and utilities).
Quiet Enjoyment: Most leases include a covenant of quiet enjoyment, where a landlord agrees not to interfere with the tenant’s possession of the premises absent default. Some leases may address abatement due to temporary condemnation by the government.
Casualty: Damage to or destruction of leased premises that renders them wholly or partially unusable is usually addressed in the casualty provisions of a lease. Damage that renders the premises permanently unsuable may give the tenant the right to terminate the lease, whereas damage that renders the premises temporarily or partially unusable may give the tenant a right to a rent abatement. While tenants may try to argue that the actual or potential presence of COVID-19 within the demised premises constitutes damage from a casualty, this would represent a significant departure from the typical application of a standard casualty clause. Broader lease provisions that refer to “untenantability” of – rather than physical “damage” to – the leased premises could potentially support a different outcome, but it is far from certain that a tenant would be entitled to terminate its lease or obtain a rent abatement under such a provision. In interpreting statutes that allow a tenant (usually in the absence of a casualty provision in the applicable lease) to terminate its lease because a casualty has rendered the premises unfit for occupancy, courts are likely to resist claims that the presence of an epidemic constitutes adequate grounds for such a termination.
Impossibility of Performance or Frustration of Purpose: Looking beyond the written terms and conditions of a lease, a tenant may assert that the imposition of a 100% in-person workforce reduction renders performance of the lease by both parties impossible, and/or that the essential purpose of the lease has been frustrated as a matter of law.
The reality is that most leases are favorable to the landlord, and therefore may not protect a tenant for closures as a result of the COVID-19 pandemic. The widespread impact of the virus on business activity, however, has led to a groundswell of requests by tenants to seek some rent relief from landlords for a limited period of time. Landlords will need to determine if their cash reserves and lenders will allow them to negotiate short term rent relief, in particular for those tenants who cannot operate their business remotely.
What happens if we don’t pay rent?
In all commercial and residential leases we have reviewed or prepared, a tenant’s failure to pay rent constitutes a default under the lease unless the landlord has authorized the tenant to withhold payment of rent. Such default invokes the landlord’s rights in the event of a default under the lease. Those rights undoubtedly include the right to recover possession and the amount of unpaid rent, plus the landlord’s reasonable attorneys’ fees.
However, the landlord is prevented from exercising those rights until April 19, 2020 at the earliest. Under Governor Cuomo’s Executive Order 202.8, the filing or service of any legal action, notice, motion or demand is prohibited until April 19, 2020. In addition, under an Administrative Order by the Chief Administrative Judge in New York, all evictions in New York are stayed for a period of 90 days retroactive to March 23, 2020. Keep in mind that, if the pandemic continues to disrupt the economy, the possibility exists that these prohibition periods may be further extended.
When read together the two Orders prevent a landlord from serving a default notice until April 19, 2020 at the earliest and actually evicting a tenant until June 21, 2020 at the earliest. So while there will be no immediate consequence resulting from a tenant’s failure to pay its rent, the two Orders do not relieve the tenant’s obligation to pay the rent at some future date.
Our lease says the landlord can serve a notice of default with a demand to cure, and that if we don’t cure within the time required the lease will be terminated without further notice. Can that still happen? Is there a way to stop it from happening?
As discussed above, the landlord is prohibited from serving a default notice until April 19, 2020 at the earliest. In all residential or commercial leases we have reviewed, the cure period is calculated from the date the default notice is served. So, until April 19, 2020, the landlord cannot issue a default notice and cannot start the cure period running.
After April 19, 2020, the tenant can still stop the cure period from running by commencing a lawsuit to declare that the tenant is not in default under the lease and seek a “Yellowstone” injunction to stop the cure period from running. These actions must be commenced, and the injunction must be obtained, before the cure period expires so the tenant must be prepared to act quickly. Please consult our firm for advice if you are interested in obtaining a “Yellowstone” injunction.
What are commercial mortgage lenders’ and borrowers’ rights and obligations?
Under Gov. Cuomo’s Executive Order 202.9, financial institutions in New York have been ordered to provide 90 days of “forbearance” on loans and mortgages to individuals and businesses who are experiencing hardship due to the COVID-19 pandemic. What “forbearance” means in any specific case depends upon the particular circumstances of the borrower and lender, but borrowers experiencing hardship should consider this an invitation to contact their bank or financial institution to initiate discussions.
What are commercial lenders’ and borrowers’ rights and obligations regarding (i) debt secured by something other than real property (Pledge of stock, LLC interests, life insurance etc.) and (ii) unsecured debt
As a general rule, absent specific relief issued by the State in an Executive Order of otherwise, lenders’ and borrowers’ rights and obligations under secured and unsecured lending agreements remain in effect and unaltered by the COVID-19 crisis. No E.O. issued or legislation passed to date affects these rights and obligations. That said, to the extent the pandemic may provide grounds under existing provisions in lending agreements for avoidance of an obligation or enforcement of a right (e.g., force majeure, impossibility of performance, frustration of purpose), that analysis should be undertaken with a view to, in the first instance, communicating with one’s lender or borrower, as the case may be, to ascertain whether there is substantive disagreement and, if necessary, formally notifying the other party of one’s position so as to preserve one’s rights and make the appropriate record should the dispute mature into a future legal proceeding.
How is this affecting land use deadlines? Approvals?
Most municipalities are continuing to hold their regularly scheduled land use meetings, remotely or otherwise in compliance with State guidelines. There are procedures in effect for the proper submission and review of the applications and the appropriate notice and conduct of the hearings necessary for most land use approvals to proceed.
Accordingly, existing land use deadlines should be followed and the Boards are available to hear applications for extensions or modifications, if necessary. As always, circumstances in every municipality can be different, so make sure you confirm with the local municipalities how best to proceed in your case.
How are transactions deadlines, such as mortgage commitment periods, and lease extension deadlines, being affected?
As a general rule, absent specific relief issued by the State in an Executive Order or otherwise, the deadlines contained in private contracts, leases or agreements remain in effect. No E.O. issued or legislation passed to date affects deadlines in private agreements.
However, this pandemic is uncharted territory for all. Litigation over these issues is certain and the parties and the Courts will eventually resolve these questions. In the interim, we feel it is best to keep the lines of communication open, so that the parties can understand where they stand and whether additional steps must be taken to protect your interests.
My business is currently leasing space and the lease is about to expire, but the construction of our new space in another building is being delayed because of COVID-19. How does this affect my company’s holdover rights?
As noted above, Landlords are prohibited from evicting tenants for 90 days, commencing March 23, 2020. Other than that prohibition on eviction, the rights and responsibilities of the parties is still governed by the terms of their lease.
As noted above, this pandemic has affected landlords and tenants alike, and we recommend staying in contact with your current and future landlords as well as the construction companies and other interested parties. Understand how each of these parties is planning on moving forward help to determine how best to proceed under the circumstances.
What new lease/mortgage provisions do we need in documents going forward?
The obligations of the parties to pay rent are generally governed by the terms of the agreement, including the following clauses: Force Majeure; Interruption or Suspension of Access and Services; Quiet Enjoyment and Impossibility of Performance or Frustration of Purpose. Consideration should be given to revising these and related standard lease provisions so as to anticipate circumstances like the COVID-19 pandemic which we now know can create considerable uncertainty concerning a landlord’s and tenant’s rights and obligations absent explicit provisions addressing them.