April 16, 2020
Disruption of business and government-mandated closures related to the COVID-19 pandemic are creating significant stress on commercial landlords and their tenants. Although we encourage an open line of communication between landlord and tenant, we also strongly recommend completing a thorough review of the lease and applicable law as a prudent first step in assessing each party’s risk exposure and preparing to mitigate damages. Because each leased property, each lease and each lease default is unique, the parties should consult with counsel for guidance in determining their respective rights and obligations so that they are better equipped to navigate the current uncertainty and determine the appropriate time for taking action. Some general guidelines follow.
Review Applicable Lease Provisions. Prior to engaging the other party, both landlords and tenants should review the lease to determine which provisions may apply to COVID-19 events, including:
- force majeure (note that even if COVID-19 events qualify as force majeure events, rent is still likely due as force majeure clauses typically excuse performance of non-monetary obligations, but not payment of rent) and, if not applicable, applicability of equitable doctrines of impossibility or frustration of purpose;
- covenant of continuous operation or minimum opening hours (compare to likely inconsistency with tenant’s general covenant to comply with all laws), including similar covenants in leases with other tenants;
- permitted use, restrictions and exclusives (e.g. where tenants have been forced to adapt their use to continue operating);
- landlord’s covenant of quiet enjoyment (e.g. where premises are voluntarily closed absent government mandate);
- eminent domain or taking;
- landlord’s obligation to provide basic services, and exculpation or termination rights for interruption in or failure to provide same;
- general rent abatement provisions; and
- applicable notice requirements.
Prerequisites to Granting Relief. Prior to considering granting any relief to a tenant, landlords can generally be expected to require that the tenant submit a specific written request for relief and demonstrate financial hardship by means of:
- confirming application and approval for an SBA loan or other disaster assistance available under the CARES Act;
- making a claim under any available business interruption insurance policy; and
- supplying current financial statements or projections, to the extent available.
Options for Relief. Possible solutions for providing relief to tenants, and consideration therefor, include:
- rent deferment (repaid in lump sum, amortized over all or part of remaining lease term, or a tenant promissory note in the case of a short term lease);
- rent reduction;
- rent abatement (base rent only, or to include triple-net/CAM charges), with or without commensurate extension of lease term or mandatory exercise of extension option;
- forbearance on late charges and interest;
- application of security deposit to rent (to be replenished at later date);
- grant of more favorable lease terms or relinquishment of other negotiable tenant rights such as rights of first refusal, options or expense caps; and
- addition of personal guaranty, security or other credit enhancement
Landlord Lender Considerations. Landlords should review their loan documents and engage with their lender early in the process, considering the applicability of:
- loan covenants or SNDAs restricting or prohibiting lease amendment or termination without lender consent;
- loan covenants obligating landlord to use commercially reasonable efforts to enforce leases;
- effect on debt service coverage ratio and other financial covenants and MAC covenants; and
- possible imposition of liability under nonrecourse guaranty carve-out for failure to obtain required lender consents or admitting to insolvency.
Operational Issues. Landlords and tenants should consider the effects of COVID-19 events on operational and administrative issues, such as:
- ongoing maintenance and security obligations, and increased costs for same;
- responsibility and protocol for addressing positive-tested persons within the premises and general prevention of the spread of COVID-19;
- access rights to leased premises and common areas;
- deadlines for delivery of premises, build-outs, use of tenant improvement allowances and the like; and
- fair market rent valuations for extension options.
Documenting Lease / Loan Document Amendments. All rent concessions, loan modifications or forbearances, and related agreements should be documented in a formal, written lease or loan amendment, executed by both parties and any guarantors. In addition to the business terms, landlords may consider including the following in any lease amendment:
- prohibition against tenant double-dipping on disaster relief;
- requirement that tenant pursue all insurance claims;
- increased tenant financial reporting obligations;
- requirement that tenant comply with CDC guidelines;
- estoppel language confirming no landlord defaults;
- waiver of (or revisions to) any force majeure clause;
- waiver of common law defenses and all claims against landlord; and
- confidentiality provision.
General Considerations. Underlying all of the above considerations are:
- effect of governmental moratoriums such as Arizona Executive Order 2020-21 (effective through May 31, 2020), which suspends evictions and other remedies under commercial leases for small businesses, as well as imposes additional obligations and restrictions on both landlords and tenants;
- cost-benefit of an informal forbearance given the indefinite duration of the COVID-19 events and possible future avenues of financial assistance;
- unintended consequences on other contractual arrangements; and
- how current decisions may be viewed in hindsight, by business partners and also by the courts in a litigation context.
About the Author: Kurt Peterson assists clients in the areas of real estate, commercial finance and general business law. Drawing on over 30 years of experience, Kurt’s commercial transactional practice includes real estate acquisitions, financing, leasing, operation and disposition as well as a diverse general business practice representing business owners on corporate formation, risk management, acquisitions, contracts and operational matters. [email protected] | 602.222.4951
Disclaimer: This article is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this article. If you need legal advice, consult with a lawyer.