It has been almost two weeks since New York announced the PAUSE executive order requiring closure of most non-essential businesses and banned bars and restaurants from providing anything but takeout and delivery, an action that the State has now extended until at least April 15th. As the reality of the extent of the epidemic is finally being realized by all levels of society, small business owners are seeing the stark truth that their businesses will need help if they are to survive in the long term. While local, state and federal governments are all passing relief bills, which will include grants and low or no-interest loans for smaller businesses (https://www1.nyc.gov/site/sbs/businesses/covid19-business-outreach.page), all of which depend on the size and scope business; small business owners should also consider the various options already at their disposal to mitigate the damage and preserve the hard-work they’ve expended as entrepreneurs.
As commercial tenants in New York, the state has already stepped in putting a 90-day moratorium on eviction enforcement until at least June 20th, protecting tenants from any landlords that would take the opportunity to try and evict tenants. As the pandemic impacts every single business in the state and particularly in New York City, it is likely to give commercial tenants, for one of the few times in recent memory, the upper hand over landlords in negotiation leverage. With the sheer number of tenants likely unable to pay rent and the potential for substantial bankruptcies throughout the city, which would lead to significant vacancy rates and lower rents, landlords have a strong incentive to work with their tenants to preserve occupancy for the benefit of all involved.
In the last two weeks, tenants all across the state, and especially here in New York City, have increasingly begun to ask their legal counsels what their options are to mitigate their business’s lease costs as a result of COVID-19’s disruption. Below we discuss in general a few essential considerations to assist commercial tenants in formulating their overall response strategy to this epidemic. Of course, each tenant’s rights and obligations will be different depending on the language and terms of their lease agreement and insurance policies, as well as the particular circumstances of their situation. We encourage all commercial tenants to promptly seek counsel to discuss your specific matters and assess your options.
Force Majeure Clauses in Lease Agreements
Generally, a force majeure event is defined as an event that is external, unpredictable and unavoidable. Breaking these elements down briefly, to be external, it must not have been caused by the party claiming the force majeure as an excuse not to perform their obligations. To qualify as unpredictable, the party could not have seen the possibility of the event occurring. Finally, to qualify as unavoidable, nothing the party could have done could have possibly prevented or mitigated the disruption caused by the event. Based on these elements, for most commercial tenants in the state the COVID-19 epidemic would certainly appear to qualify, but that is not the end of the analysis – in New York, force majeure is governed strongly by contract.
New York courts narrowly construe force majeure to the categories listed in the clause - if there is a clause at all - and anything categorically similar. In the present situation, tenants would likely require the clause to reference “epidemic” or “pandemic” to qualify. Arguably, the category of government action, which is commonly in some form leases, could qualify based on the government’s requirement that businesses shut down. However, difficulty paying rent is generally not what is contemplated by such clauses, but rather an inability to perform a duty other than payment of a financial obligation. In fact, most leases with a force majeure may even exclude the obligation to pay rent from the force majeure protections altogether. Due to New York’s strong requirement for explicit terms within contracts for force majeure, those without a clause have even less protection, but that does not mean that commercial tenants are left without options.
Contract Law Defenses
In addition to force majeure, various common law contract claims may also be available to tenants including the claims of ‘frustration of purpose’ and ‘impossibility’ which the courts, given the exceptional circumstances of the epidemic, may accept. But it should be noted that courts give strong weight to leases as negotiated contracts and the failure to include a force majeure of sufficient specificity could be fatal to any claim. Given the unprecedented level of business disruption and uncertainty of the timeline until life returns to normal, however, courts may be more willing to consider such claims as a result of the government actions that have frustrated the purpose of virtually every commercial lease. Current mandates ban most non-essential businesses from operating and thus, especially for the hospitality industry, their lease properties are effectively unusable for the purpose intended. In addition, the doctrine of ‘impossibility’ may apply as it is literally impossible for these businesses to operate in accordance with lease terms, of which many leases require tenants to be in operation or find themselves in default. These claims and potentially others are available to many commercial tenants, however, lease analysis and legal remedies should not be the commercial tenant’s only consideration.
Insurance Coverage
In addition to assessing the options and risks under your lease, commercial tenants can also look to their insurance policies as a means of covering potential losses. Most responsible business owners carry business interruption insurance of some form which may cover the current epidemic. They must carefully review their policies as such policies often have many exclusions, or require additional endorsements outside the normal policy in order to cover various indirect losses. For example, some policies may cover supply chain disruption, but not the indirect losses resulting from government actions like New York State’s ban on operations – such coverage may require a policy endorsement for civil authority coverage for instance. Insurance policies vary widely in terms of their coverage, and they are often complex and confusing to try to decipher. As such, speak to your broker or legal counsel first, but if you are uncertain about your coverage, because timing of notice is important for insurance claims, it may be best to simply file a claim in order to be timely and let your insurance carrier conduct a coverage determination rather than risk your claim being deemed untimely.
Tenant-Landlord Relationship
Finally, and most importantly for many commercial tenants, assess your relationship with your landlord and create a plan for reaching out and negotiating with them for a mutually beneficial solution. Many commercial tenants are on good terms with their landlords and can easily contact them directly, while others may wish to utilize legal counsel to assist directly in negotiations. Regardless, like insurance, it is imperative to put landlords on notice to let them know the extent of the damage to their tenant’s business not just due to lost sales but perhaps also due to supply chain disruptions, increased supply costs and loss of workers, among many other factors. As noted at the start of this article, both tenants and landlords are facing substantial hardships not just during the pandemic but also in the aftermath. The US is not the first and will not be the last country to go through a wave of COVID-19 outbreaks disrupting production and spending. The world supply chains and labor markets will be impacted for significantly longer than the pandemic itself, requiring tenants and landlords to look for a resolution that provides stability in both the short-term when there is no income, as well as to the longer term while revenues slowly normalize and begin to grow again.
Conclusion - Proactive Communication is Key
Based on the harsh realities of this epidemic and the entirely unexpected extent of its impact, commercial tenants should engage with their landlords if at all possible, seeking cooperation and understanding in order to fashion new agreements on rent, whether it is abatement, deferments, or more creative means. There are many options for negotiation and discussion which tenants may wish to consider in consultation with their landlord, insurance providers and legal counsel. Regardless of the ultimate solution you choose as a commercial tenant, it is important to assess all your options, not just the possibility of force majeure and the terms of your lease, but all other avenues of support and negotiation.
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