April 06, 2021 Articles

The Empire Strikes Back: After Recent Tenant-Friendly Decisions, a Victory for Commercial Landlords

The highly influential U.S. District Court for the Southern District of New York issues pivotal decision for COVID-19 commercial lease disputes.

By Cara Mittleman Kelly
The court’s decision sends a message: The pandemic is nothing more than an economic hardship.

The court’s decision sends a message: The pandemic is nothing more than an economic hardship.

VisualCommunications via GettyImages

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In what may be viewed as a milestone in the landscape of COVID-19 related commercial lease disputes, on March 8, 2021, U.S. District Judge Laura Taylor Swain issued a memorandum opinion and order in The Gap Inc. v. Ponte Gadea New York, LLC, Case No. 1:20-cv-04541-LTS-KHP, granting summary judgment in the landlord’s favor and dismissing the tenant’s complaint. In the wake of some recent tenant-friendly decisions, a couple of which were covered by an article and Practice Point, this decision reflects a return to the landlord-favorable judicial environment that has preponderated during the course of the pandemic.

Background of Dispute and Relevant Lease Provisions

Located at the corner of Fifty-Ninth Street and Lexington Avenue in Manhattan—arguably one of the most highly trafficked retail intersections in the city—the tenant, Gap, operated a Banana Republic and Gap store (referred to in this article as “the premises”) under a commercial lease with defendant Ponte Gadea New York LLC (referred to in this article as “the landlord”). The 2005 lease included the following provisions relevant to the court’s analysis.

Force Majeure

The lease’s force majeure provision is a fairly typical example found in most commercial leases, and defines a force majeure event to mean “a strike or other labor trouble, fire or other casualty, governmental preemption of priorities or other controls in connection with a national or other public emergency or shortages of fuel, supplies or labor resulting therefrom, or any other cause beyond Tenant’s reasonable control.” The force majeure provision does not specifically include a worldwide pandemic or similar language.

Casualty

Article 16 of the lease set forth the parties’ restoration and rent obligations, as well as termination rights, in the event of a “fire or other casualty.” For example, the Gap is obligated to notify the landlord in the event of a fire or casualty, and the parties’ restoration obligations could be excused should the lease terminate as a result of the casualty event. Importantly, the Gap is entitled to a rent abatement if any part of the premises were deemed “unusable” for 14 days or longer. The landlord could terminate the lease, if the damage caused by the fire or casualty event would require substantial restoration of the building; the Gap could terminate the lease, if the restoration work were estimated to take 18 months or longer, or if the landlord were to fail timely to perform that work. Finally, either party could terminate the lease under the casualty provision, if the event were to occur in the final year of the lease’s term.

Event of Default

Article 21 of the lease governs an event of default. In addition to its failure to pay rent, the Gap’s failure to perform any other covenant under the lease would likewise trigger an event of default. Article 21 also states that an event of default would not occur, to the extent that the Gap was unable to cure a non-monetary covenant default within 30 days after a force majeure event. Upon an event of default, however, landlord could terminate the lease, in which case Gap must surrender possession, but would remain liable for all lease obligations.

Holdover Rent

The lease also imposes a rental obligation, should the Gap become a holdover tenant following the lease’s term by expiration or termination.

As set forth in the decision, New York City began experiencing significant disruptions in brick-and-mortar retail commerce beginning in March 2020, starting with New York State’s March 7 emergency declaration. On March 19, the Gap closed its stores at the premises. The following day, all of New York’s non-essential businesses were effectively ordered to close. Beginning in March 2020, the Gap stopped paying rent under the lease, consistent with its suspension of all North American commercial lease rent obligations.

On June 8, 2020, the landlord served the Gap with a notice of termination for its failure to pay rent. That same day, New York City entered “phase one” of reopening, which allowed retail stores, like the Gap’s stores at the premises, to offer curbside pickup—which one of the stores in the premises did begin to offer. Following the notice of termination and during the summer and into early fall 2020, the stores on the premises remained closed to in-person shopping and were used for online order fulfillment. Notably, the Gap opened other Manhattan retail locations for in-person shopping. In September 2020, the Gap expressed its intent to vacate the premises by October 15, 2020.

On June 12, 2020, the Gap sued the landlord, asserting claims of breach of contract, declaratory judgment, rescission, reformation, money had and received, and unjust enrichment. The landlord asserted counterclaims for declaratory judgment and breach of contract, based on the Gap’s failure to pay rent under the lease and for possession of the premises.

The Issues Presented to the Court

The Gap’s case rested on the argument that its March 2020 closure of the two stores in the premises in response to the COVID-19 pandemic, the federal and state governmental regulations imposed in response to the pandemic, and the shift in foot traffic near the premises justified a complete release from its lease obligations. Each of the Gap’s claims hinged on its argument that, as of March 2020, the lease was either terminated, rescinded, or reformed as a result of the COVID-19 pandemic. As a result, and under the Gap’s theory, it was not liable for rent following the March 2020 closure of its stores.

In support of its case, the Gap asserted five main arguments: (1) the COVID-19 pandemic constituted a casualty under the lease; (2) the lease’s purpose was frustrated; (3) as a result of the pandemic, its performance under the lease was rendered impossible, illegal or impracticable; (4) there was a failure of consideration under the lease due to the pandemic; and (5) there was a mutual mistake as a result of the parties’ failure to address a worldwide pandemic in the lease.  The landlord argued that the lease was properly terminated effective June 15, 2020 and, because the Gap occupied the premises thereafter, the landlord was entitled to holdover rental payments.  In addition, the landlord argued that the lease’s force majeure provision only prevents certain non-monetary defaults and does not excuse the payment of the Gap’s rental obligation. Finally, it was undisputed, the landlord argued, that the Gap failed to make timely payments under the lease.

The Court’s Reasoning

As noted above, ultimately, the court sided with the landlord, finding that the Gap was not released from its rent obligations under the lease, and granted the landlord’s summary judgment motion. In making its ruling, the court first addressed the Gap’s casualty argument and whether the COVID-19 pandemic constituted a casualty under the lease, thereby relieving the Gap of the duty to make rental payments. In reviewing the lease’s plain language, the court reasoned there was “no doubt” that a casualty under the lease meant singular incidents, “like fire, which have a physical impact in or to the premises.” It did not mean something that occurred over a period outside of the premises, like the pandemic and resulting governmental shutdowns. Indeed, the lease provides for the landlord’s repair obligations and the Gap’s right to rent abatement in certain instances, triggered only by physical damage to the premises. The court also considered recent New York State court decisions interpreting the term “casualty” in commercial leases as physical damage, and which decisions ultimately concluded that the pandemic is not a “casualty” for the purposes of such lease provisions. The court also reasoned that the lease’s definition of “casualty,” coupled with other decisions from the New York state Supreme Court, Appellate Division’s First Department, defined the term to mean a singular event causing physical damage in or to a property. The court concluded that, because the COVID-19 pandemic was not a “casualty” as defined in the lease, the landlord was entitled to summary judgment dismissing the Gap’s breach of contract claim, to the extent it relied upon a “casualty” occurrence permitting rent abatement under the lease.

Next, the court addressed the Gap’s frustration of purpose argument. Noting that the doctrine discharges a party’s performance duties under a contract, the court cited several federal court decisions emphasizing that, to be invoked, the frustrated purpose must be “so completely the basis of the contract” that otherwise the contract contemplated by the parties “would have made little sense.” The court referenced several decisions holding that, simply if a transaction were to become less profitable, or were to impose an economic hardship on a party, these eventualities do not rise to the level of a frustration of purpose, thereby excusing performance. Here, the court noted that the governmental shutdown orders were not “wholly unforeseeable” given the lease’s force majeure provision that specifically referenced governmental “preemption of priorities or other controls in connection with a national or other public emergency.”

In addition, the Gap had not shown that the purpose of the lease—to operate a first-class retail business—was “so completely” frustrated by the pandemic that the transaction made little sense. Belying the Gap’s position was that its other retail stores opened for in-person shopping after March 2020, and the premises’ store offered curbside pick-up. The court concluded that, “while undeniably unfortunate,” the COVID-19 pandemic did not amount to a frustration of the lease’s purpose. Moreover, the Gap apparently made a business decision to close its stores at the Premises to in-person shopping, and thus the adverse financial consequences from the COVID-19 pandemic did not amount to a frustration of purpose. The court cited several other decisions supporting its holding that the effects of the COVID-19 pandemic did not amount to a frustration of purpose under the Lease. In conclusion, the court held that the landlord was entitled to summary judgment dismissing the Gap’s claims, to the extent they relied on the theory that the lease terminated because its purpose was frustrated.

The court went on to address the Gap’s third theory: that the lease terminated in March 2020, because its performance under the lease was rendered impossible, illegal, or impractical as a result of the COVID-19 pandemic and related shutdown orders and restrictions. Recognizing that the theory of impossibility or impracticability is a defense to a breach of contract action when performance is rendered “objectively impossible” by an unforeseen event, the court relied on cases holding that the impossibility defense should be applied narrowly and only in extreme circumstances. The court again cited the lease’s force majeure provision in reasoning that governmental shutdown orders purportedly rendering the Gap’s performance impossible were, in fact, foreseeable to the parties. To the extent the Gap was relying on the COVID-19 pandemic itself, rather than the governmental regulations, the court noted performance was not “impossible” since the Gap operated curbside pickup and in-person shopping at its other retail locations. Even though performance was burdensome, the court reasoned that such burden did not amount to performance being “objectively impossible.”

Next, the court rejected the Gap’s argument that the pandemic led to a failure of consideration under the lease and, as a result, the lease should be rescinded. The court recognized that, despite its argument, the Gap continued to receive the consideration promised under the lease: a retail premises for its store operations. Even if there existed a partial failure of consideration, under New York law, there was no basis for rescission.

Finally, in addressing the Gap’s argument that the Lease should be reformed as a result of the parties’ mutual mistake in failing to address the possibility of a pandemic, the court noted that the Gap failed to proffer evidence that the landlord intended to “shoulder the entire risk of a pandemic-related downturn in the retail business.” The court cited New York state caselaw holding that reformation is only proper based on mutual mistake when a party can show that an oral agreement was reached, but, unbeknownst to either party, the signed writing does not express that agreement. There exists a “heavy presumption” that a signed writing properly expresses the parties’ intentions. The Gap argued that, had the parties been able to foresee a COVID-19 pandemic at the time of their lease negotiations, they would have put in writing that the Gap was not obligated to pay rent, and that the term “first class retail business” was not properly defined to exclude operating a business during a pandemic. The court rejected the Gap’s arguments and noted its evidence was insufficient to support a “mutual mistake” defense under New York law. Indeed, the court noted that mistaken assumptions about the future “do not amount to mutual mistake warranting rescission of a contract.”

In concluding that the landlord was entitled to summary judgment dismissing the Gap’s claims, the court noted that the Gap did not create any genuine factual dispute that would support any basis for termination, rescission or reformation of the lease. Since each of the Gap’s claims turned on its “unsupported and legally flawed assertion” that it had no obligation to pay rent after March 19, 2020, the court concluded that the landlord was entitled as matter of law to the dismissal of the Gap’s complaint in its entirety. The court ruled that the lease was properly terminated by the landlord effective June 15, 2020, and that it was entitled to payment for holdover rent following that date.

Implications for COVID-19 Related Commercial Lease Disputes

The Gap filed this case relatively early in the pandemic, presenting several equitable arguments, which were, at the time, rather novel in the then-rapidly evolving area of the law concerning the interplay of contract terms, intended to manage and allocate risk, equitable remedies and defenses to contract obligations, and the pandemic. Unless overturned on appeal, this decision will be heavily relied on by commercial landlords responding to similar tenant claims.

The court emphasized the lease’s plain language and relied on the parties’ bargained-for agreement as the starting point for its analysis—signaling to drafters and litigators alike that a commercial lease’s provisions will not be expanded beyond the parties’ clear intent to cover the particular exigency of the pandemic. The court’s determination that a “casualty” is defined as a single incident that physically damages a property ends the debate as to whether the COVID-19 pandemic is a “casualty,” despite it commonly being referred to as the most “unprecedented event” of our lifetime. In addition, the court’s analysis of what the Gap did as a tenant in other locations, under other leases with other landlords, is instructive and serves as a cautionary tale to parties making similar arguments.

Also interesting to note was the court’s evaluation of the force majeure provision, seemingly relying on its language referencing “governmental preemption of priorities or other controls in connection with a national or other public emergency[,]” in deciding that the COVID-19 pandemic and resulting governmental regulations were not unforeseen by the parties as a matter of law. In holding that the COVID-19 pandemic and governmental regulations did not frustrate the purpose of the parties’ lease, one could foresee the possibility of a similar case with a different result: for example, if the Gap’s business model were so fundamentally based on the shopping experience, as opposed to merely a storefront for the sale of merchandise also available online, then perhaps this change in framing would have resulted in a different outcome. While the court did not address the specific nature of the Gap’s retail business model, it might be arguable that its frustration-of-purpose analysis has a more limited application. Finally, the court’s decision seems to send a message to the retail world: Ultimately, the COVID-19 pandemic is nothing more than an economic hardship whose burden should not be shouldered by commercial landlords.

Cara Mittleman Kelly is a shareholder with Greenberg Traurig in Austin, Texas.


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