The COVID-19 pandemic has greatly affected the operations of businesses around the globe. Following the World Health Organization’s declaration of COVID-19 as a “pandemic,” governments have begun imposing restrictions on the operations of restaurants, shopping centers, schools, large event gatherings, and similar spaces where there might be large groups of people. These restrictions have not only affected the operating businesses but their landlords as well. The effects of COVID-19 have left many businesses in financial hardship and unable to pay their bills, including rent. It is unknown right now how long we will be feeling the effects of COVID-19, therefore landlords should take proactive measures to ensure that their operations are minimally affected.
The purpose of this memorandum is to give our clients a high level overview of the issues and possible solutions. Please give one of our attorneys a call if you have a specific situation that needs to be addressed.
The Lease Provision That Will Most Likely Have an Impact
The most important provision to look for in all of your leases is the “Force Majeure” provision. Force majeure clauses can come in many different forms, but the essential purpose is to excuse performance under the lease in the event of an unforeseeable event which renders performance impossible or impractical. An example of a force majeure clause is shown below:
If Tenant or Landlord shall be delayed, hindered, or prevented from performance of any of its obligations by reason of Force Majeure, the time for performance of such obligation shall be extended for the period of such delay. As used herein “Force Majeure” means an act of God (including fire, flood, earthquake, storm, hurricane or other natural disaster), war, invasion, act of foreign enemies, hostilities (regardless of whether war is declared), civil war, rebellion, revolution, insurrection, military or usurped power or confiscation, terrorist activities, nationalization, government sanction, blockage, embargo, labor dispute, strike, lockout or interruption, or other event beyond the party’s reasonable control which prevents Landlord or Tenant, as the case shall be, from the performance of any act required of it hereunder. If a party asserts Force Majeure as an excuse for its failure to perform the party's obligation, then the nonperforming party must prove that (A) the party took reasonable steps to minimize delay or damages caused by foreseeable events, (B) the party substantially fulfilled all non-excused obligations, and (C) the other party was timely notified of the likelihood or actual occurrence of an event of Force Majeure.
If a force majeure provision is triggered, all obligations of the parties are delayed for the period of the force majeure event. Unless specifically excluded, this includes the Tenant’s payment of rent. In order for most force majeure provisions to be triggered, performance must be rendered “impossible”. In most jurisdictions, “impossibility” is not limited to strict impossibility. Impossibility also includes “impracticability because of extreme and unreasonable difficultly, expense, injury or loss involved.”
The determination of whether an event constitutes a force majeure event will be based in large part on how a force majeure event is defined in the lease agreement. Determining whether the COVID-19 pandemic constitutes a force majeure event will require a close review of your lease agreement. If the force majeure clause specifically references “pandemics”, then COVID-19 will, in most instances, be covered. Without a specific reference to pandemics, it is not entirely clear whether COVID-19 will trigger a force majeure clause. However, even if a pandemic is not specially mentioned in a force majeure clause, it may be covered under catch-all language similar to the language in the force majeure clause provided above (“or other event beyond the party’s reasonable control”). Whether or not COVID-19 will trigger a particular force majeure clause will also depend on how the tenant is affected by the effects of COVID-19.
Even if COVID-19 itself does not constitute a force majeure event, the forced closures and cancellations imposed by city and state governments will likely result in your tenant’s invocation of the force majeure clause. If these forced closures and the drastic loss of revenue due to such closures make it impossible or extremely and unreasonably difficult for tenants to make rent payments, then tenants may be justified to stop making rent payments until they become fully operational again.
If you would like a thorough analysis of what the implications are in your leases, please promptly contact one of our attorneys at Hall Estill. However, if you decide to review your force majeure clause yourself, here are some problem areas to look out for:
- "Other than the payment of sums due hereunder”: Often a force majeure clause will excuse performance except for payment of amounts owed. If your lease has this language, then your tenant will still be obligated to make rent payments even if the force majeure clause is triggered.
- “Or other event beyond the party’s reasonable control”: As discussed above, a force majeure clause only applies to the specific events mentioned. If there is a catch-all clause such as the one above, then it can be interpreted to go beyond the specifically mentioned events and may include any event which was unforeseeable and which makes performance impossible or impractical.
- “The party took reasonable steps to minimize delay or damages caused by foreseeable events”: Many force majeure clauses require certain mitigating efforts be taken by the party affected by the force majeure event in order for performance to be excused. For example, one of these efforts may be that the affected party is required to take steps to minimize any damages they may incur from foreseeable events. This language will be very important to landlords if the COVID-19 pandemic triggers the force majeure clause in their leases. Tenants became aware of the possibility of forced closures and cancellations several months ago when other countries, such as and China and Italy, began implementing measures similar to what U.S. cities are doing right now. If this language is in your force majeure clause, tenants have an obligation to minimize their damages before they can claim that they are entitled to stop making rent payments.
- “The other party was timely notified of the likelihood or actual occurrence of an event of Force Majeure”: Sometimes force majeure clauses require that the affected party notify the other party of the triggering force majeure event. This language is also going to be very important for landlords to look for. If this language is in your force majeure clause, then tenants must timely notify you of their intent to stop paying rent; failure to do so may result in tenants forfeiting their right to claim the benefit of the force majeure clause.
What If There Is No Force Majeure Clause
Most jurisdictions (including Oklahoma, Colorado, and Arkansas) recognize a principal called the “Doctrine of Impossibility”. If a contract does not include a force majeure clause, then the Doctrine of Impossibility acts as a common law substitution. Under the Doctrine of Impossibility, performance will be excused if it is “impossible” for a party to perform. As previously mentioned, impossibility does not only mean strict impossibility but also includes “impracticability because of extreme and unreasonable difficultly, expense, injury or loss involved.” Unlike a force majeure clause, which is triggered by the happening of an event, the Doctrine of Impossibility will only excuse performance if it is impossible or extremely difficult for a tenant to pay rent. Tenants who are highly liquid or who can still make their rent payments without unreasonable hardship may not be excused from making rent payments under the Doctrine of Impossibility regardless of their lack of revenue. On the flip side, tenants without sufficient cash reserves who see a significant loss in revenue are more likely to be excused from making rent payments.
Ways to Minimize Loss and Risk
With Tenants
The best way for landlords to minimize their losses if a tenant stops paying rent is to negotiate a lease amendment with the tenant that will govern the landlord-tenant relationship during the COVID-19 pandemic. If a landlord solely relies on the force majeure language in the lease, tenants will likely be wholly excused from paying rent until they are able to resume normal operations. However, landlords can negotiate lease amendments with tenants where the tenant is still obligated to make modified payments to the landlord or extend the lease term to account for any months where rent will not be paid, or both. Examples of lease amendments that could be beneficial to both landlord and tenant include:
- Reducing the rental rates during the force majeure period
- Extending the lease term for one month for each month where the tenant is paying reduced rent or paying no rent
- Allocating the rent which is not paid during the force majeure period to be paid over the remaining term of the lease
Negotiating lease amendments can help landlords take control over the effects of COVID-19 on their leases.
Landlords may also minimize risk by utilizing their business interruption insurance coverage. Business interruption insurance is intended to cover losses resulting from direct interruptions to a business’s operation. Most policies exclude coverage for business interruptions related to pandemics, but landlords should review their policy closely to assess their coverage. The same analysis would include any rent loss insurance that may be carried by landlords.
With Lien Holders and other Creditors
If tenants begin paying reduced rental rates or cease paying rent at all, this could result in significant financial hardship to landlords. If you are unable to make loan payments or credit card payments due to a loss in rental income, you should review your loan agreement or your credit card company’s terms and conditions closely for a force majeure provision or other language which would excuse your non-payment during the COVID-19 pandemic. Even if your loan agreement does not have a force majeure provision, most banks have indicated that they are willing to offer financial relief during this time. Both Fannie Mae and Freddie Mac are offering forbearance and suspended foreclosures for anyone who is affected by COVID-19, and many commercial lenders are offering the same. Similarly, most major credit card companies have assistance programs that can help cardholders when they need assistance. If you have been adversely affected by COVID-19, be sure to reach out to your bank and credit card company for assistance.
If you are experiencing a situation covered in this memorandum, Hall Estill has a real estate group in each of our locations in Tulsa, Oklahoma City, Denver and Northwest Arkansas who specialize in these issues. Please contact your Hall Estill Attorney directly.
