COVID-19 is having a significant impact on the business operations of both commercial landlords and tenants and their ability to fulfill lease obligations. As a result, many landlords and tenants are reviewing leases to evaluate whether they can be excused from the performance of their respective lease obligations based on the force majeure clause in the lease as well as common law doctrines of impracticability, impossibility and frustration of purpose. Although each case will require individual analysis based on the specific language in the lease and the factual circumstances, the following is a general summary of the issues to be considered.
Set forth below is a brief summary of common law in the District of Columbia, Maryland and Virginia relating to force majeure and the doctrines of impracticability, impossibility and frustration of purpose as applied to commercial real estate leases, followed by practical considerations in addressing current circumstances presented by COVID-19 and mandated government closures.
Common Law in the District of Columbia, Maryland and Virginia
Under District of Columbia law, force majeure provisions are construed narrowly and courts will likely uphold the specifically bargained for language of a force majeure provision. It is also likely that the COVID-19 crisis could qualify as an Act of God in District of Columbia courts because it is a “force of nature outside the control” of the parties and it is likely “of such character that it could not have been prevented or avoided by foresight or prudence;” this would allow a tenant, if it has rights under a force majeure clause, to excuse performance (whether relating to store closures, build-outs or possibly even rent payment) under the Act of God language. While a party could argue that foresight (for example, the purchase of specialized insurance policies) might have prevented certain damages related to the COVID-19 crisis, the crisis itself was not preventable. Nonetheless, as “human interference or influence on what could otherwise be considered an act of God” could render a force majeure clause inapplicable, it is critically important that both landlords and tenants take all possible steps to mitigate any damages and perform to the maximum extent possible under their leases. With respect to the doctrine of frustration, the claiming party must establish that (i) the purpose that is frustrated must have been a principal purpose of that party in making the contract, (ii) the frustration must be substantial, and (iii) the non-occurrence of the frustrating event must have been a basic assumption on which the contract was made. With respect to the doctrine of impossibility or commercial impracticability, the claiming party must establish (i) something unexpected must have occurred, (ii) the risk of the unexpected occurrence must not have been allocated either by agreement or custom, and (iii) the occurrence of the unexpected event must have rendered performance commercially impracticable. The District of Columbia Court of Appeals cautioned that “a party's alleged financial inability to perform a contract that it voluntarily entered would rarely, if ever, excuse non-performance.”
Maryland courts have also narrowly construed force majeure provisions and are likely to respect the clear and plain language of a force majeure lease provision. It is uncertain as to whether the COVID-19 crisis qualifies as an Act of God in Maryland in the commercial real estate lease context. Maryland courts have generally limited Act of God events to physical damage or destruction arising from natural causes (e.g., lightning, strikes, floods, etc.). In Maryland, with respect to leases, “the doctrine of frustration has been limited to cases of extreme hardship. In any event, the lessee must prove that the risk of the frustrating event was not reasonably foreseeable and that the value of the leased premises was substantially or totally destroyed.” The doctrine of impossibility may be available where performance is subsequently prevented or prohibited by a judicial, executive, or administrative order, in the absence of circumstances showing either a contrary intention or contributing fault on the part of the person subject to the duty. Maryland courts have further limited this doctrine in requiring that “performance under the contract must be objectively impossible” and “the financial inability of one of the contracting parties” to perform under a contract was not “ground[s] upon which to grant rescission of a contract on the basis of impossibility of performance.”
When interpreting a force majeure provision in a commercial real estate lease, Virginia courts will look to the clear and bargained-for-language. The Supreme Court of Virginia held that an event qualified as an Act of God when it “appear[ed] that the act of God was the sole proximate cause of the injury” and that “all human agency [was] excluded from creating or entering into the cause of mischief.” In light of this high bar, both parties to a commercial real estate lease should take all possible steps to mitigate damages and perform to the maximum extent possible under their lease. With respect to the common law doctrines of frustration of purpose and impossibility of performance, the Supreme Court of Virginia has held that “it is well settled that where impossibility is due to domestic law, to the death or illness of one who by the terms of the contract was to do an act requiring his personal performance, or to the fortuitous destruction or change in the character of something to which the contract related, or which by the terms of the contract was made a necessary means of performance, the promisor will be excused, unless he either expressly agreed in the contract to assume the risk of performance, whether possible or not, or the impossibility was due to his fault.”
Force majeure clauses in leases typically provide that a party’s performance of its obligations under the lease may be delayed or suspended due to unforeseen circumstances beyond such party’s control. In evaluating whether the specific force majeure clause in the lease is applicable, the parties need to consider whether COVID-19 qualifies as a force majeure event. The specific language is important as force majeure provisions are typically interpreted narrowly by courts so that only the events listed or substantially similar to the events listed will be covered. If a force majeure clause does not expressly include pandemics, epidemics, disease or substantially similar words, it is likely that disputes will arise as to whether the force majeure clause applies to COVID-19 under more general terms such as an “act of God” and governmental action. The determination depends on the specific language in the lease, the particular facts of each case (for example, whether the business is essential or nonessential) and the applicable law of the jurisdiction.
Even if COVID-19 qualifies as a force majeure event under the lease, typical force majeure clauses only apply to performance obligations and operational covenants under the lease such as construction, opening, and continuous operation requirements as well as service, repair and maintenance obligations. Force majeure clauses often expressly provide that it will not excuse a tenant’s obligation to pay rent regardless of the occurrence of a force majeure event. The force majeure clause will need to be carefully reviewed to determine if it contains language that is different from the typical language and includes any applicable exclusions as well as any other limitations on the applicability of a force majeure event. For example, some force majeure clauses will limit the number of days that a specific obligation may be excused due to a force majeure event regardless of the actual number of days of delay. Thus, if a lease provides that a party’s construction or operating requirement is subject to force majeure delays that shall not exceed thirty days in the aggregate, then such party may only be excused from such obligation for such additional thirty day period before the other party may be entitled to pursue its remedies. The parties to a lease must also consider the potential domino effect of a party’s inability to perform its obligations under the lease with respect to co-tenancy covenants. The anticipated closures of many retail businesses will likely mean that many affected retail shopping center landlords will be unable to satisfy specific co-tenancy requirements under retail leases that include requirements that specific anchor tenants or a certain percentage of tenants be open for business at a shopping center. These operational covenants in leases need to be carefully reviewed on a case by case basis as a tenant may be entitled to certain rent abatement and/or termination rights if the co-tenancy requirement is not satisfied. Ultimately these issues and the rights of the parties depend on the specific language of the force majeure clause and other relevant covenants and provisions in the lease as well as the specific facts of the situation.
The parties must also make sure to comply with any notice requirements in the force majeure clause. For example, the force majeure clause may provide that the party invoking the clause must provide written notice to the other party within a certain number of days after the force majeure event occurs. It is important to comply with the notice requirement in a timely manner to avoid the risk that force majeure is not available because of a party’s failure to comply with the notice requirement.
It is likely that force majeure provisions will become a more significant business issue in future lease negotiations as the parties seek to allocate the risk of future pandemics, as well as the possibility of a second wave of COVID-19, and government shutdowns. As part of such negotiations, the parties need to consider whether to provide for any rent abatement and/or termination rights under specific circumstances if a tenant is unable to operate its business because of such events.
Impracticability, Impossibility and Frustration of Purpose
If COVID-19 does not qualify as a force majeure event under the lease, or if the lease does not contain a force majeure clause, a party may still be able to assert the doctrines of frustration of purpose and/or impossibility of performance to excuse the performance of its obligations under a lease. To apply these doctrines, a party must establish that the contract’s principal purpose has been substantially frustrated and/or its performance is made impracticable, without the party’s fault, or by the occurrence of an event the non-occurrence of which was the basic assumption on which the contract was made. Arguably, these doctrines could apply to COVID-19 and, in particular, to leases where the tenant’s business operations are deemed to be non-essential and have been forced to shut down due to governmental action, as opposed to essential businesses that can continue to operate. The determination of whether these doctrines are available depends on the particular facts of each case and the common law of the applicable jurisdiction.
The parties also need to be aware of any lender restrictions included in loan documents before entering into lease amendments or early termination agreements. Loan documents typically restrict a landlord’s ability to amend leases or to terminate a lease early without the lender’s consent. Tenants must also review any subordination, non-disturbance and attornment agreements that were executed by a tenant in connection with a landlord’s loan to determine if there are restrictions on the tenant’s ability to amend the lease or terminate the lease without the lender’s consent. Any solutions will require joint cooperation between landlords, tenants and lenders.
Practical Steps and Conclusion
Given the unprecedented nature of the COVID-19 pandemic, it is unclear how courts will apply force majeure clauses to current leases as each case will be fact specific. Both landlords and tenants need to consider both the legal issues as well as the business issues in determining how to proceed. In most instances, it will be in the best interest of both parties to reach an agreement to allow the tenant to continue to operate its business and to continue the lease, which agreement may require rent abatement and/or rent deferral solutions. In almost all cases, landlords will not benefit if a tenant is forced to go out of business because any legal proceedings will take time and it is likely that the landlord will experience difficulty in back-filling the space. The following are a few practical step for the parties to take as they consider their options:
Review the existing lease to determine whether COVID-19 qualifies as a force majeure event, if there are any limitations on the applicability of the force majeure provision with respect to any specific operational covenants under the lease and comply with any notice and deadline requirements.
Communicate with the other party to discuss potential delays and impacts on the business operations of the parties to develop a creative solution that allows the tenant to remain in business and continue the lease. The parties should also determine whether there is any business interruption insurance coverage and/or available government stimulus programs.
Review loan documents, as well as any subordination, non-disturbance and attornment agreements, to determine whether the lender’s consent is required in connection with any lease amendments or early termination agreements.
As part of any future lease negotiations, the parties should make sure that pandemics and government-mandated shutdowns are expressly considered in the force majeure provision and consider whether there should be any rent abatement and/or termination rights if a pandemic, government-mandated shutdown or similar event occurs in the future.