The Effectiveness of Commercial Leases During COVID-19
During the coronavirus epidemic in the United States, various states have issued stay-at-home and social distancing orders, and a large number of companies have been forced to close their doors. In these times, is a commercial lease previously signed by the business still valid? Can the lease be terminated? Can the tenant request a rent reduction from the landlord? Can the landlord evict tenants who are behind on their rent payments? Is there a win-win plan for renting a room?
Undoubtedly, the coronavirus epidemic has brought challenges for commercial renters. Many industries, especially services which directly interact with consumers, have either closed their stories or can only offer take-out experiences, both of which dramatically decrease income and cause problems with paying rent. For these companies, rent constitutes an important part of the operating cost. Whether the rent can be reduced or not may directly affect the business’s survival. If the tenant applies for rent reduction, exemption, or requests to terminate the lease, what legal basis is there?
First, there may be a force majeure clause. This clause states that if a “force majeure,” defined as an unforeseeable circumstance, occurs and the contract cannot be fulfilled, then the contract can be voided. If the commercial lease includes force majeure clauses, can tenants claim that the coronavirus epidemic establishes force majeure and thereby contend that the contract can be voided? During the epidemic, the Chinese government agencies launched a new business idea by issuing force majeure “certificates” for businesses to help them get out of their contractual obligations. However, in the present moment, the US government has not followed suit. Indeed, force majeure clauses are included in many leases, but the scope of force majeure is limited, generally referring to foreign wars, natural disasters, civil unrest and other events. Pandemic outbreaks or government stay-at-home orders are often not recognized as a force majeure. Moreover, the tenant will be unable to fulfill their rent obligation due to store closure and income reduction. Being unable to carry out the contractual obligations is not related to the ability to perform these duties. For example, an overload freight truck is unable to carry out its contract due to unrepairable blocked roads due to floods. However, the tenant’s ability to pay rent can still be performed. Therefore, under normal circumstances, it is unlikely that the tenant can claim force majeure to cancel the lease. Of course, if the lease explicitly mentions epidemics or governmental executive orders in its force majeure clause, then the tenant can easily invoke the clause to reduce rent or cancel the rent and cancel the lease, exempting them from the rent payment obligation.
Second, there are casualty or condemnation clauses. Many leases have stipulations that if all or most of the leased property is damaged (casualty) or is subject to government takeover
(condemnation), the tenant can reduce the rent or terminate the lease. For store closures caused by the coronavirus epidemic, tenants may argue that the property is unusable, equivalent to complete casualty, but this argument greatly diverges from the typical scope of the casualty clause, because casualty usually refers to physical damage. However, some leases may use the term “untenantability” instead of casualty. If this is the case and the coronavirus epidemic caused the property to be unleasable, then the tenant should be able to request a rent reduction or terminate the lease.
If the government takes over the property and uses it as a hospital, testing site, or a distribution center, then the evicted tenant can claim a rent reduction or terminate the lease. General leases all have condemnation clauses. However, is the practice of staying at home and forcing closures within the government’s temporary condemnation? The law is still a little unclear on this matter. If future tenants treat this as a reason to sue and bring it to the court, and the court rules that the executive order to force store closures establishes condemnation, then the tenant may request a rent reduction, exemption, or termination of the lease.
Third, there are co-tenancy provisions. Retail leases (especially shopping mall leases) may contain co-tenancy clauses. If this clause is invoked, tenants are allowed to pay reduced rents, and in some cases, the lease can be terminated. The co-tenancy provisions state that within a lease term, if the entire building does not reach the agreed occupancy threshold, that is, if the number of tenants is less than a certain percentage, the co-tenancy provision will be invoked, allowing for partial rent reductions. If this circumstance lasts for a long period of time (usually 6-18 months), the co-tenancy provisions often also allow for the termination of the lease. The coronavirus epidemic caused a large number of shops to close and greatly reduced the number of tenants. If there is a co-tenancy provision in the lease, the tenant can claim their rights accordingly.
Fourth, there is constructive eviction or violation of covenant of quiet enjoyment. According to these two terms, if the property is rendered inhabitable due to the landlord, and the tenant is evicted or the tenant cannot enjoy the rented property quietly, the tenant may claim a rent reduction, exemption or terminate the lease. If the tenant wishes to use these specific arguments, the tenant must usually prove the landlord is at fault. The existence of infectious diseases and government measures to stop the spread of infectious diseases are often not sufficient.
However, if the landlord responds to the pandemic with negligence, the tenant may claim rights based on the aforementioned general legal arguments. For instance, if there is clear evidence the coronavirus was introduced into the leased property due to the landlord’s negligence or the landlord did not take effective measures to prevent the spread of the pandemic which results in eviction, then the tenant can invoke the aforementioned legal arguments to request rent reduction, exemption or termination of the lease.
Fifth, there is the frustration of purpose. This is another theory of common law. If the lease states a special use of the property and the government prohibits the property from carrying out that purpose, the tenant may claim that the purpose of the lease contract cannot be achieved, and the lease contract is invalid. However, if the lease allows the tenant to use the property for one or more purposes, then the tenant cannot invoke this argument that a certain purpose cannot be achieved.
The coronavirus epidemic has forced shops to close. If the tenancy agreement clearly stipulated the purpose of the property (such as a restaurant), the tenant might claim that the contract purpose could not be fulfilled and demand that the agreement be terminated. However, the standard for failing to meet the purpose of the contract is very high. It is not clear whether the temporary closure during coronavirus can establish that a legal contract purpose cannot be achieved. There is a classic case of failing to achieve contract purpose in California court: during World War II, Japanese Americans were forced to move out of their original residences and move to concentration camps. A Japanese person rented a property near Los Angeles for a hotel business. The forced eviction order prevented his business from continuing. He sublet the property to another person and simultaneously argued that the purpose of the contract could not be achieved to void the original lease. The Japanese pointed out that this hotel was located in "Little Tokyo" in the Los Angeles area, and 75% of the tenants were Japanese. The purpose clearly stated in the lease was a hotel. When Japanese people were expelled, the hotel had almost no business. The lease had no value and the purpose of the contract could not be achieved. The District Court supported the Japanese claim, but the Court of Appeals overturned it. The Appellate Court reasoned that although the Japanese could not operate the hotel, other people could continue to operate it, therefore, it was possible to carry out the purpose of the contract. They stated the tenant must prove that the value of the lease has been destroyed for everyone who opened the hotel before they can claim that the purpose of the contract cannot be achieved. (See Brown v. Oshiro (1945) 68 Cal. App. 2d 393, 394 [156 P. 2d 976] for more details.) More than 70 years have passed, and the standards established in this case have not been overturned. During the coronavirus pandemic, assuming that a restaurant shop is temporarily closed or can only do take-out business, then the income is greatly reduced and the value of the lease is also greatly reduced. But does it mean that the property is worthless for the entirety of the catering industry? Many fast food restaurants' takeout business is still profitable in the epidemic (for example, the revenue of the fried chicken restaurant Popeyes has substantially increased). In this case, if they claim that the purpose of the contract cannot be achieved, the court may not support it.
Landlords, as well as tenants, have suffered heavy losses in the coronavirus epidemic. The reduction in rental income will directly affect the repayment of landlord mortgage loans. In addition, economic uncertainty has also led to negative expectations for future rental cash flow. Not only that, due to the outbreak, many states have issued decrees which prohibit the eviction of tenants (whether commercial or civil) who do not pay rent during the outbreak. These orders have caused many properties to receive neither rent nor sublet, and landlords have suffered huge financial losses. So, faced with this sudden and difficult moment, is it possible for some win-win solutions for both the landlord and tenant?
- Rent reduction or exemption. At this critical moment, if tenants and landlords can share their burdens, they can actually achieve a win-win situation. We see that many landlords voluntarily reduced their rents in April and May 2020, helping tenants ease the pressure to pay rents; some landlords agreed that tenants postpone the payment of their rents for the last two months and make up for half a year, or some landlords and tenants have reached an agreement to waive the rent for the last two months, but the lease period is extended by two months. The epidemic will eventually pass, and we believe that as long as both sides make concessions, in the long run, both parties can minimize their losses.
- Apply for a relief loan. Since the outbreak, the US federal government has issued a large number of economic relief measures, especially the introduction of the "Paycheck Protection Program" (PPP) for small businesses. The plan allows a portion of the funds to be used for rent, and as long as certain conditions are met, some or all of these loans need not be repaid. Eligible tenants and landlords can apply for this plan and receive assistance.
- File insurance claims. Some commercial insurance policies include compensation for business suspensions. If the landlord or tenant's insurance has such provisions, you can claim compensation from the insurance company because the coronavirus epidemic caused the suspension of normal business activities. However, it should be noted that many commercial interruption insurance policies only provide coverage under casualties, physical damage to property circumstance, often including specific exclusions for epidemics. In this case, the claim may be difficult. In any case, tenants and landlords should take a closer look at the details of their insurance policies.