COVID-19 has brought unprecedented attention to the subject of non-compliance with contracts including residential and commercial leases.
Non-compliance does not only affect the parties to the contract. A breach of one contract has consequences that may affect the ability of others to meet their contractual obligations. An example would be a contract for the sale and purchase of real estate. If the sale falls through because the buyer defaults, the seller may not be able to meet his obligation to purchase a property from a third party. Assume a buyer inspects the property he is scheduled to close on that afternoon and finds that the washing machine included in the sale is not working. Does that permit the buyer to refuse to close? No. As with any contract, the seller must be given the opportunity to cure – to replace or repair the washer.
Imagine the effect that a falling dominos scenario would have on society. COVID-19 has already started to tip the dominos. Tenants can’t pay the rent and landlords can’t cover their costs.
The origins of force majeure dates back to the English common law first espoused in the case of Taylor v. Caldwell in 1863 regarding a concert hall completely destroyed by an accidental fire. The court held that … “in contracts in which the performance depends on the continued existence of a given person or thing, a condition is applied that the impossibility of performance, arising from the perishing of the person or thing, shall excuse the performance.”
In 1871, in the case of Dexter v. Norton, the New York Court of Appeals specifically applied the Taylor holding to cover non-performance under force majeure to New York law in excusing performance for the sale of cotton burned in an accidental fire.
In 1883 in the case of the Tornado, the U.S. The Supreme Court further extended the doctrine of impossibility on a federal level.
To gain expert advice on how force majeure and impossibility or impracticality to perform impact commercial leases as a result of COVID-19, I spoke with Joan Morgan McGivern, of Counsel with the law firm, Tomey, Latham, Shea, Kelley, Dubin & Quartararo.
JMM: Force majeure usually applies to Acts of God – hurricanes and tornadoes, as well as acts of government during times of war, for example. If a contract does not contain a force majeure clause, the party seeking to excuse performance may have to rely on the doctrine of impossibility or impracticality to excuse the failure to perform.
What would be an example of a situation where force majeure might apply?
JMM: When Governor Cuomo issued an Executive Order on March 22nd ordering all non essential businesses to close by 8 pm, commercial tenants had more clear-cut triggers for force majeure as they were clearly unable to use their leased premises in the ordinary course of their businesses. Lease termination – the frequent answer to declaring a force majeure event – was and still is not necessarily a solution for either party. Depending on the force majeure clause, it may only permit rent abatement during the period the leased premises are 100% not available or may not excuse the obligation to pay rent. In the absence of a force majeure clause, tenants may have relied on the doctrine of impossibility or impracticality to excuse their failure to rent during the lockdown period.
But now we’re no longer in a “lockdown phase.” Instead we have entered a period of the “new normal” with phased and partial re-openings and commercial landlords are faced with a new Executive Order, extending the time they are precluded from evicting their tenants through January 1, 2021. While the order does not relieve tenants’ rent obligations, many tenants are still faced with an inability to fully utilize their leased premises, whether due to limitations on customers allowed in or the need in offices for social distancing, and therefore feel entitled to rent breaks. At the same time, commercial landlords are faced with choices of whether to keep demanding the full rent or accept less by negotiating reductions at least for the foreseeable future of the pandemic and attendant “partial openings.”
It seems that that’s a gamble for the landlord that may or may not pay off.
JMM: Yes. A recent case where a tenant filed for bankruptcy provides a cautionary tale for landlords who may want to stick to the original terms of their leases. In that case, an Illinois eatery, Hitz Restaurant Group, the bankrupt tenant evoked the force majeure clause as an excuse not to pay rent, even though it provided that “lack of money” would not excuse the obligation to pay rent. The tenant admitted that during the government ordered shutdown, it could still run a take out service and would use 25% of its square footage to do so. Neither the landlord nor the tenant stepped forward with a proposal on how much rent should be abated, so the court decided to approach it on a percentage basis and reduced the tenant’s rental obligation by 75%: “in proportion to its reduced ability to generate revenue due to the executive order.”
That’s quite a hit, especially if the commercial lease is a standard triple net lease which typically includes base rent plus maintenance/utilities, property taxes and insurance. So what’s a landlord to do? If it looks like the tenant is headed for bankruptcy, it might be best to negotiate a rent abatement for the period of the pandemic and applicable Executive Order rather than have a bankruptcy court do it for you and take your chances.