Many commercial tenants suffering financial distress related to COVID-19 are unable to make their monthly rent payments. Commercial landlords are seeing a wide variety of requests from their tenants, including rent deferment, rent abatement, lease renegotiation, and outright lease termination. Some tenants already have simply abandoned their space and turned over the keys.
But before either side takes drastic action, such as terminating a lease, abandoning the premises, or initiating litigation, landlords and tenants should openly discuss the issues. If each side understands the other’s needs, there may be a way to salvage the tenancy and preserve the landlord-tenant relationship. Here are the top things commercial landlords and tenants suffering financial impacts related to COVID-19 should consider:
- What Does the Lease Say? Whether it is a commercially produced form or a custom drafted document, the analysis of options for both landlords and tenants should always start with the actual language of the lease. Lease terms vary widely, and a thorough review of the agreement is the first step.
- Is There a Quick and Easy Solution? Often the tenant just needs a little time. A simple short-term deferral of rent may be enough. Deals can be structured to allow the tenant to make up the deferred rent by the end of the calendar year, or by a certain date in the next calendar year. Some landlords have agreed to allow tenants to pay 50% of their rent for up to 90 days or have agreed to defer 100% of base rent while the tenants continue to pay all their triple net expenses. For more complex situations, the parties will need to be a bit more resourceful. Landlords might seek additional security, such as personal guarantees, in exchange for concessions.
- Can the Tenant Sublet the Space? Where a simple deferral of rent is not enough, tenants will want to consider whether the lease allows them to assign or sublet the space (it usually does, with the landlord’s consent), and whether they should seek a subtenant to take over some or all of the premises. This may be difficult in the current market. And while a sublease might alleviate immediate rent pressures, it generally does not eliminate them. Tenants usually remain liable if a subtenant fails to pay rent.
- Can the Tenant Abate Rent? Tenants also will want to see if the lease allows rent abatement, and under what circumstances. Often abatement is permitted only where there has been physical damage to the premises, such as a fire, or a hazardous substance condition has arisen. Leases do not typically allow rent abatement for financial distress caused by an unforeseen viral pandemic.
- What About Force Majeure? Much has been written about force majeure lately. Creative arguments notwithstanding, most force majeure clauses are not helpful. They often do not specifically reference pandemics as a justification for delaying performance, and even if some useful language exists, it may not apply to the payment of rent. Tenants similarly might seek refuge in California Civil Code section 1511, the statutory force majeure provision. But here again, applicability in a pandemic is far from clear. Much will turn on the specific facts and circumstances of the lease in question.
- Are There Other Legal Defenses to Ease Rent Payments? Tenants also should investigate the legal doctrines of impossibility and commercial frustration. In California, commercial frustration is interpreted more liberally than in other states, so tenants will want to explore that issue thoroughly with their legal counsel. Case law exists that could prove helpful. Under some circumstances it may give tenants a basis for relief, possibly even termination of the lease.
- Does the Landlord Have Other Recourse? Landlords should determine if they can access the tenant’s security deposit to offset rent. Landlords also should check to see if any personal guarantees were executed with the lease. Even if the tenant has defenses under the lease to the payment of rent, the landlord might have personal recourse against one or more individuals that can provide significant leverage in any negotiations with the tenant.
- Should the Parties Modify the Lease? The parties generally should at least attempt to modify their lease terms. If a tenant claims it is unable to meet its rent obligations due to financial impacts related to COVID-19, it should be prepared to demonstrate those impacts to the landlord. And the landlord should insist on some evidence substantiating the impacts to the tenant. In many cases, the landlord is probably better off trying to modify the lease because the landlord’s hands are somewhat tied. With courts functioning only in a limited capacity, there is little opportunity, at least in the short term, to pursue legal remedies against a defaulting tenant. And once access to the courts resumes, landlords may experience significant delays in their matters as courts struggle with the backlog of cases. Landlords unwilling to compromise also may find an unsympathetic judiciary, and juries may not look kindly on them if they have not tried to resolve the issues with their tenants (leases may contain jury trial waivers, but such waivers are not enforceable in California). Tenants need to realize that landlords might be in a difficult financial situation and have little flexibility to deal with them on rent. Landlords must pay bills too. Many landlords have substantial debt obligations and may not able to work with their lenders to defer loan payments. They rely on rental income and without it might be at risk of defaulting on their loans and losing their property to foreclosure. If the parties can reach agreement, an amendment to the lease, even a simple 30-day abatement of rent, should be put in writing. Each party should consult legal counsel to ensure the modifications are properly documented to help avoid any future disputes.
- Can the Tenant Be Evicted if it Stops Paying Rent? In short, yes, but probably not right away. In addition to limited access to courts and delays in eviction proceedings, many local jurisdictions, such as the City of San Diego, have adopted emergency ordinances that temporarily prohibit evictions of commercial tenants due to an inability to pay rent because of COVID-19. Tenants who can show a substantial business loss related to COVID-19 may be able to defer rent for a brief period and be relieved of the threat of immediate eviction. Even though these ordinances may soon expire, they might also be extended while the economy gradually reopens. For example, the City of San Diego’s eviction ordinance was recently extended to September 30, 2020. It is also important for tenants to note that these programs typically provide only for a deferral of rent, not an abatement, or forgiveness, of rent. Ultimately, the tenant will have to pay all unpaid rent or face eviction once the moratorium is lifted.
- Should the Tenant Walk Away? This is a big decision, but some tenants have no choice. The COVID-19 pandemic has already destroyed their business and they must dissolve or file bankruptcy. For tenants likely to survive, in addition to exposure to monetary damages, there are future credit implications to consider before abandoning the premises. This should be an option of last resort, and one taken only after careful consideration and consultation with legal counsel. It is generally better to negotiate a termination agreement.
- What Can the Landlord Do if the Tenant Walks? If a tenant threatens to hand over the keys and stop paying rent, the landlord should consider its options and determine what legal remedies are available. While the landlord has a duty to mitigate its damages and will try to lease the premises to another tenant as soon as possible, that may be tough in this market. Until the landlord finds a new tenant, the prior tenant will probably be liable for unpaid rent (and other costs, such as attorney’s fees) until a new tenant is found. If the landlord pursues legal action and obtains an award of damages, the tenant could be liable for all unpaid rent that would have been earned until the time of the award, and for the balance of the lease term, less only any amount of rental loss that the tenant proves could have been reasonably avoided. This could be a substantial sum, but the landlord will need to evaluate whether any judgment against the tenant will ultimately be collectible. If the tenant has little or no assets, legal action may not be worthwhile.
These are difficult and unprecedented times. Many of the claims made and arguments offered by both landlords and tenants have not been tested in court and likely will not be tested for quite some time. In the meantime, landlords and tenants should take a hard look at their relationship and try to preserve it, if possible. Other options may not serve either party well overall.
The attorneys at Higgs Fletcher & Mack are here to help both tenants and landlords adjust their leases while they navigate the COVID-19 pandemic. Please contact us for further guidance.