May 26, 2020 5 minutes to read ∙ 1200 words

Key Considerations for Commercial Landlords and Tenants Relating to COVID-19

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State and local governments are mandating reduced operations or closings for businesses across the country, leaving commercial landlords and tenants scrambling to understand their rights and liabilities. This article discusses common lease obligations that may be impacted by business interruptions or closures relating to the 2019 novel coronavirus disease (COVID-19), including some specific guidance for retail and restaurant leases, and suggests steps parties may take now.

Background

The evolving COVID-19 pandemic is creating uncertainty for landlords and tenants of commercial properties. Landlords and tenants are finding their businesses impacted as:

  • Non-essential businesses, stores, and restaurants are ordered by governments to close or reduce operations;
  • Landlords are ordered by governments to lose buildings or impose access limits, and increase some services, such as common area cleaning; and
  • Tenants are forced to close or limit their operations, face reduced revenues, and are likely to be unable to meet their rent obligations.

Impacted Lease Provisions

Few leases are likely to include specific provisions regarding pandemics of this type, but several typical lease provisions may be relevant to an analysis of the rights of landlords and tenants. In particular, retail and restaurant leases may be uniquely impacted by COVID-19.

Force Majeure Clauses

Parties must review the force majeure or unavoidable delays clause of the lease, if there is one. Force majeure clauses typically extend the time frame within which a party must perform under the lease because of delays caused by an unforeseen and uncontrollable event.

Force majeure may apply to:

  • Construction obligations.
  • Services and utilities.
  • Access to the premises.

Parties should confirm (under the lease and applicable state law) if they must send notices asserting force majeure delays.

Rent Clauses

Parties must confirm their payment obligations under the lease. Most leases make the payment of rent an independent covenant. This means that the tenant must pay the rent irrespective of any closing of the premises or reduction in services provided by the landlord. Force majeure usually does not apply to financial obligations.

However, some tenants may have negotiated for rent abatements in certain circumstances, such as if:

  • The building the premises is located in closes;
  • Access to the premises or the common areas is denied; or
  •  The landlord cannot provide essential services.

Tenants should confirm the conditions that apply to any abatement rights. Abatements are often triggered only if the landlord is at fault and often require that the tenant deliver written notice to the landlord within a specific time period to trigger the abatement. The parties should also verify:

  • Any notice and grace periods for monetary and non-monetary defaults; and
  • Any late fees and interest that the landlord may charge.

Security Deposits

Landlords and tenants should review their leases to confirm the amount of any security deposit provided by the tenant, including the form of security deposit (whether in the form of a cash deposit or letter of credit) and any notice requirements the landlord must provide before offsetting the security deposit against past due rents.

Insurance

Landlords and tenants should review all insurance policies to identify whether COVID-19-related losses are covered by the parties’ respective commercial general liability, business interruption, contingent business interruption, or other insurance policies.

In many cases, coverage is likely to be denied. For example, business interruption insurance typically requires physical property damage before a claim may be made. However, the parties should carefully review the terms of all policies and riders. Parties may also consider putting their insurer on notice of possible claims.

Lease Deadlines

Leases contain a variety of deadlines for:

  • Performance under the lease.
  • The exercise of rights or options.

Landlords and tenants should review all lease files to identify upcoming deadlines and understand the potential implications if reduced staffing or closures prevent a party from meeting a deadline. Common deadlines include:

  • Lease expiration dates.
  • Lease renewal and other option deadlines, including deadlines to calculate prevailing market rents for renewal options.
  • Tenant improvement allowance payment deadlines.
  • Construction deadlines, including
    • contractor payment deadlines to avoid mechanics’ liens;
    • lease commencement dates; and
    • deadlines to opening for business.
  • Audit right deadlines.

Retail and Restaurant Tenants

The COVID-19 pandemic creates particular problems for retail and restaurant tenants. The forced closure of these spaces creates severe problems for these tenants. Tenants should understand their existing rights and obligations under their leases, including:

  • Operating covenants. Leases usually require tenants to operate their business during agreed hours on all days that the shopping center is open. Tenants should confirm their rights to suspend operations.
  • Co-tenancy. Many tenants are not required to operate their business, or may pay a reduced rent, if certain major tenants, or an agreed percentage of all tenants, are not also open for business. Tenants should review their leases to understand their co-tenancy rights, including rights to pay reduced rent and cease operating:
  • Gross sales termination right. Some tenants may have negotiated for a right to terminate the tenant’s lease if gross sales fall below a certain threshold. If the tenant has this right, the tenant must determine what notice and financial documents must be provided to the landlord to exercise this right.
  • Permitted use review. Many restaurants must discontinue on-premises food service and are restricted to pickup services or delivery services. Tenants must verify that their permitted use under the lease and their business licenses allow for this change in delivery options.
  • Percentage rent. Landlords should verify if their share of percentage rent includes sales from restaurants through pickup and delivery services and should also determine the financial impact to the landlord for sales being low and not triggering a break point for payment of percentage rent to the landlord.
  • Landlord lien issues. The tenant should determine if the landlord has lien rights on the tenant’s personal property and equipment in case the tenant needs to sell equipment to generate cash flow.

Practical Implications

Parties should consult with counsel to evaluate possible risks and liabilities, both under their lease agreements and applicable state law, and should proactively negotiate to:

  • Adjust the terms of the lease, either for the duration of the COVID-19 pandemic or permanently.
  • Suspend performance under the lease and, potentially, defer base rent payments for an agreed period.
  • Avoid future lease disputes.
  • Mitigate damages.

Landlords and tenants should also verify if there are any state and local moratoriums on commercial tenant eviction proceedings.

To assist with future negotiations or dispute resolution, tenants should carefully document:

  • The dates when governmental orders become effective against the tenant.
  • All impacts of regulations and orders on the tenant’s business at the premises.
  • All expenses that they are incurring in responding to the COVID-19 pandemic.
  • All efforts by the tenant to perform under the lease mitigate losses.

Landlords may want to:

  • Revise their rules and regulations to add any required directives from state or local authorities concerning COVID-19.
  • Consider how operating expenses may change for the property, including:
    • increased cleaning and security costs;
    • reduced service costs; and
    • rights to gross-up operating expenses to offset costs incurred for empty space.
  • Confirm their rights under existing loan documents to modify leases.

Going forward, landlords and tenants should consider developing standard force majeure language that includes express provisions for governmental closure orders, pandemics, and employee quarantines and negotiating more strenuously to clarify those landlord obligations and tenant obligations to which force majeure should apply.

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This article originally appeared as “Key Considerations for Commercial Landlords and Tenants Relating to COVID-19” on Thomson Reuters Practical Law, March 27, 2020. © 2020 by Thomson Reuters. Thomson Reuters is a Sponsor of the GPSolo Division, and this article appears pursuant to the Division’s agreement with them. This article is not an endorsement by the ABA or the Division of any Thomson Reuters product or service.

Reprinted with permission in GPSolo eReport, Volume 9, Number 10, May2020. © 2020 by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. The views expressed in this article are those of the author(s) and do not necessarily reflect the positions or policies of the American Bar Association or the Solo, Small Firm and General Practice Division.