WOODEN McLAUGHLIN COMMERCIAL LEASING BULLETIN;
THE BURDENS OF COVID-19 UPON ONGOING LEASE PERFORMANCE
The global COVID-19 coronavirus pandemic has presented many parties to commercial leases with contractual performance issues not of their making. Whether related to massive drops in retail consumer patronage, governmental advisories and shut-downs, or disruptions to the supply, staffing, or service chains (or perhaps some combination of these or other factors), landlords and tenants alike are being forced to evaluate whether they can continue honoring lease obligations and, when they cannot, whether applicable lease provisions or legal principles offer any amount of guidance or relief. This bulletin provides preliminary discussion of some relevant issues, but it must be noted that factual circumstances and lease provisions will necessarily differ from case-to case. This bulletin should not be construed as legal advice, which can only be offered upon consideration of your unique facts and circumstances.
Force Majeure Clauses; The Impact of Unforeseen and Uncontrollable Events Upon Lease Performance
Although infrequently triggered under typical circumstances, force majeure clauses can be found in many commercial leases and are the logical starting point for this sort of analysis. But first things first: what is a force majeure clause? Essentially, it is a clause meant to account for the uncertainty of events affecting lease performance that the parties could never have foreseen. As stated by Black’s Law Dictionary, a force majeure clause is a “contractual provision allocating the risk if performance becomes impossible or impracticable, especially as a result of an event or effect that the parties would not have anticipated or controlled.” This is certainly a useful concept, but parties must be careful to note that force majeure is not a rigidly applied, one-size-fits-all term of art – at least not in Indiana, where Courts refuse to apply the concept in accordance with tradition or definition, opting instead to carefully analyze the parties’ specific contractual language to determine what they actually intended their force majeure clause to mean.
Specifically, it is important to carefully parse force majeure language in order to answer (at least) three very important questions: First, has a force majeure event even occurred as defined by the contract? Second, if a force majeure event has occurred, which party is entitled to relief? Third, what relief does the force majeure clause afford?
With respect to the first question – whether the COVID-19 pandemic is a force majeure event – the answer is arguably yes under most force majeure clauses, which will typically apply to such defined events as “acts of God,” “natural disasters,” “labor or supply shortages,” “riots,” “insurrection,” “fire,” or “governmental edict.” Moreover, many force majeure clauses contain broad residual provisions to encompass unforeseeable events such as, for example, “any other reason not within the reasonable control of the parties.” In at least one Indiana case [Specialty Foods of Indiana, Inc. v. City of South Bend, 997 N.E.2d 23 (Ind. Ct. App. 2013)], the Court focused upon the non-foreseeability of an otherwise non-defined event to conclude that a force majeure event had occurred. Again, a lease’s specific force majeure language will control, and a determination will likely turn on whether it is broad enough to encompass the effects of the COVID-19 coronavirus if the word “pandemic” is not specifically included therein.
With respect to the second question – determining which party to the lease the force majeure clause is intended to benefit – most such clauses will be created to benefit at least the landlord, while many are reciprocal and might benefit either the landlord or tenant – or both – depending upon the circumstances. To elaborate, we need the context of considering the third question, which is: what types of relief is a given force majeure clause designed to provide?
In some instances, a force majeure clause might only be designed for the landlord’s benefit, often to protect it from breaching the covenant of quiet enjoyment if it either fails to timely deliver the leased premises, or must exclude the tenant from access once possession has already commenced. For example, if the landlord has agreed to complete a build-out and to deliver leased commercial space by a certain date, a force majeure provision might save it from default if the COVID-19 coronavirus pandemic has disrupted the supply chain for labor or materials necessary for construction. Or perhaps the tenant must be excluded from the leased premises by some governmental edict such as, for example, a mandatory prohibition against the operation of restaurants or other hospitality establishments. One key consideration will be whether the force majeure provision merely suspends the landlord’s obligation to perform, or goes further by allowing the landlord to terminate the lease.
Sticking to the topic of restaurants and other retail and hospitality businesses, a force majeure clause might provide for reciprocal relief to landlord and tenant, depending upon the circumstances, and might act to protect a tenant in the event that the coronavirus has been so impactful – regardless of whether there have been any governmental restrictions – that they no longer have the stream of business required to justify continued operations. However, it must be noted that it would be unusual for a force majeure clause to explicitly provide for the forgiveness of rent, and so tenants in this position might only be excused from breaching a covenant of continued business operations – with rental obligations continuing to accrue as scheduled. Again, specific contract language would dictate the outcome under the particular facts.
Continuing on with the restaurant example, Indiana and most other states have prohibited inside dining, but not carry-out and delivery. As a result, many predominantly or exclusively dine-in restaurants are temporarily adapting their business models by providing only carry-out or delivery services. Unfortunately, many of these restaurants will inevitably close or be forced to temporarily suspend operations. Only time will tell, but it will be interesting to see whether Indiana Courts consider these closures or suspended operations to have been the result of: (a) governmental restriction that mandated the exclusion of tenants from some or all of the leased premises, or (b) bad luck, but a failure to succeed under prevailing market conditions. If the former, tenants may be armed with a slightly better argument – regardless of which party exercised the force majeure clause or whether it provides for suspended rental obligations – that they may still escape rental liability due to the entirely separate contractual theories of either impossibility of performance or frustration of purpose.
The doctrines of impossibility of performance and frustration of purpose are often referred to interchangeably, although they are actually different concepts. The former refers to contractual performance that has become impossible in a literal sense (for example, a contract for the sale of a building that burns down before closing), while the latter refers to events that do not prevent performance but have frustrated the contract’s primary purpose. Arguably, the central purpose of a lease that specifies restaurant-use is frustrated by governmental edict against dine-in service. Nevertheless, in Indiana at least, Courts have refused to apply the frustration of purpose doctrine, and have instead required parties who attempt to avoid contractual performance to meet the much higher burden of establishing impossibility. Thus, one can see how the limited governmental restriction of only dine-in restaurant service cuts against a tenant’s impossibility defense. Moreover, some would argue that a commercial lease is as much a land-conveyance as a contract, such that the tenant has taken an estate in the property subject to the risks of whatever conditions might develop to hinder use – especially in the case where the parties did attempt to quantify and account for unforeseeable and uncontrollable events via a force majeure clause. A complex and circular analysis, to be sure, and one that is ripe for case-to-case variance and sensitivity.
A final word is required on the subject of notice. Force majeure clauses often contain stringent formal notice requirements, and parties should always be abundantly cautious to make sure such notice provisions are strictly adhered to.
Business Interruption Insurance and Other Potential Relief Under the CARES Act
There is certainly the school of thought that tenant rental obligations should not be suspended due to unforeseen and uncontrollable events, because business interruption insurance could or should have been purchased. But COVID-19 presents a potential complication to this issue. Specifically (and subject to the caveat that policy holders must always review their specific policy language), most business interruption coverage contains well-defined exclusions in the event of a “pandemic.” Nevertheless, any landlord facing requests for rental abatement under today’s circumstances should require evidence of a tenant’s applicable insurance, and of its efforts to obtain insurance proceeds to meet its rental obligations.
Additionally, the federal government has recently enacted the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which allows certain small businesses to obtain federally subsidized small business loans as a way to meet payroll and, to a lesser extent, rental obligations. These loans are even wholly dischargeable if borrowers meet certain requirements. This is an obviously fluid situation, and it remains to be seen whether federal funding allocated to these CARES loans will be exhausted, or perhaps whether additional CARES funds are on the way through further legislation. Regardless, where tenants find it necessary to request rental abatement assistance from their landlords, those landlords would be prudent to first learn whether CARES assistance has been sought. Lastly, while the CARES Act has not afforded direct relief to landlords – whether in the form of mandatory lender forbearance agreements or CARES-like small business lending – landlords would be wise to follow developments from Washington D.C. to determine if (or when) such relief is on the way.
Rent Loss Insurance
Similar to business interruption insurance, many landlords procure rent loss insurance in connection with their property and casualty protection. For example, landlords obviously cannot charge rent for premises destroyed by storm or fire, and rent loss insurances serves to protect the rental income stream while the property is rehabilitated. Landlords are obviously not afforded rent loss coverage for tenants who simply vacate and stop paying rent under typical circumstances, but where does rent loss attributable to COVID-19 fall on this spectrum? Again, the specific language of any given policy controls, but insurers are likely to point first to the same sorts of “pandemic” and “virus” exclusions as previously discussed in connection with business interruption insurance. Nevertheless, many factors will come into play – such as whether there have been governmental mandates for the closure of businesses, or whether legal arguments begin to gain traction throughout the courts of our country that COVID-19 has constituted physical invasion into property that has actually damaged it. Only time will tell, and these issues are likely to be litigated for years to come.