Impact of COVID-19 on Force Majeure and Rent Abatement in Commercial Leases
Many businesses have suffered greatly in the wake of the measures taken to slow the spread of COVID-19.
One immediate impact is the flood of requests from commercial tenants to their landlords for rent reduction or deferral. Commercial landlord-tenant relationships are typically long term, so of course, it often makes sense for the parties to work together through temporary difficult times. And, it is critical that each side appreciate the unique issues the other faces. For example, the tenant's revenue may be in jeopardy because of the restriction on customers, and the landlord's ability to service any debt on the leased property may also be in danger.
There are no easy answers, and there is no "one size fits all" solution. There is, however, a path for getting to a resolution. The commercial lease document is the lodestar, so it makes sense for the parties to first revisit the language in their leases to understand the parties' contractual obligations and rights. North Carolina law provides the framework to interpret and apply that language. Once the lease is read through the lens of North Carolina law, the parties will have the best platform from which to attempt to understand and resolve the issues.
Baseline Legal Principles
North Carolina does not have a comprehensive statutory structure that regulates commercial landlord-tenant relationships (of course, there are some guiding statutes, but the reach is limited). Rather, parties to a commercial lease are deemed to be sophisticated businesses that are able to negotiate with one another at arms-length, so by and large the lease between them comprises the deal. That said, the contract concepts of North Carolina common law generally apply to those leases.
The full weight of North Carolina common law is beyond the scope of this article, but there are a few baseline concepts to get the parties started. First, if asked to interpret a contract such as a commercial lease, a Court will read the plain language of the contract for ambiguous or vague terms. Then it will look at the subjective and objective meanings of the terms. The interpretations of the meanings will stem from the parties' understandings at the time of contract and not a post-contract understanding.
In addition, the concept of "force majeure" is critical. A force majeure clause excuses performance by the obligated party when an event occurs that is outside of the party's reasonable control. The court analyzes the effect that the catastrophe had on the party's obligations under the lease agreement, including under the force majeure clause, and how the parties allocated the risk of the casualty. The parties' rights and obligations are dependent on the facts of the situation and the contract. We have already written this concept, and you can find that article here.
One Real World Example
Most North Carolina commercial leases are drafted using the North Carolina Association of Realtors Standard Form 592-T or 593-T (Commercial Lease Agreement) ("Realtor Form Lease") or are custom leases. Since custom leases all differ from one another in meaningful ways, we will focus on one real-world example from the Realtor Form Lease. On March 17, 2020, Governor Roy Cooper announced that North Carolina restaurants and bars would be closed to sit-down service and limited to take-out or delivery orders. This has, obviously, had a dramatic impact on restaurant revenue, which has triggered many requests for rent deferral or reduction. For landlords and tenants dealing with this situation who have the Realtor Form Lease in place, certain provisions may provide some guidance. Specifically, the Realtor Form Lease provides that the tenant, at its own expense, agrees to comply with the orders of any governmental authority. But, there is relief for the tenant in the form of a relief valve, in that it also states that the landlord and the tenant agree that if the cost to comply with such order exceeds a sum equal to one year's rent, the tenant may terminate the lease by giving written notice. The termination becomes effective sixty days after the landlord receives notice unless, within thirty days of receiving notice, the landlord agrees to be responsible for the compliance.
The clause referenced above serves as a good example of the need to start any conversation about modifying or seeking rent forgiveness under the terms of a lease with an analysis of the specific terms of that lease.
Reasonableness and due care should be driving forces as we all strive to navigate these difficult, delicate, and uncertain times. That goes for both commercial tenants and their landlords.
Tenants seeking rent deferral or reduction should not assume that landlords are required to accommodate those requests, and should be prepared to explain why it is needed and what measures they have taken to address their difficulties, perhaps in the form of seeking Small Business Association loans or exploring cost-cutting measures. Landlords, conversely, should consider the long-term ramifications of the impact of this situation, and their response to it, on their tenants. If needed, they should reach out to their lenders to see what options may be available for a comprehensive solution. After all, the success of the landlords and the tenants are not separate but joined. These legal issues are novel and often require consultation with legal counsel. Good counsel can assist the parties by helping them to understand the contract and the legal interpretation of that contract, and by framing up potential mutually agreeable solutions.
At the time of publication, several jurisdictions across the country, including San Francisco, New York City, and Los Angles, have recently imposed regulations on the landlords' rights to enforce lease terms in those jurisdictions, including limiting a landlord's ability to evict a tenant and a lending institution's ability to foreclose on a mortgage or deed of trust. We encourage you to consult with your legal counsel to understand the current regulations applicable to your property.