Real Estate Leasing Issues During the COVID-19 Pandemic
In light of the COVID-19 pandemic and with the recent limitation on operations excepting essential services, the Midwest is quickly feeling the economic effects of the coronavirus. In leasing, many tenants, landlords and lenders are reaching out in an effort to be proactive and even collaborative about how to best approach this unprecedented impact on our modern global economy. What follows is a brief summary of Indiana’s laws which may be implicated in leasing during this pandemic.
THE FOUR CORNERS
What does your lease say? It would be remiss to overlook the “four corners” of your written lease. It is doubtful that many, if any, leases expressly address a pandemic, but you can look to whether your lease contains force majeure provisions which contemplate extraordinary circumstances.
Force Majeure Clauses
Force majeure clauses in leases serve to excuse or toll the period for performance in the event of certain circumstances which render performance impossible or impracticable. These clauses allow contracting parties to contract around common law doctrines such as impossibility and good faith, the so-called “gap fillers” in the absence of a written agreement. Indiana courts will examine the specific contract language of a force majeure clause and will not rewrite a contract or interpret it in a manner in which the parties never intended. The courts objective will be to determine the intent of the parties at the time the contract was made by examining the language used in the contract, which will be considered in light of the circumstances existing at the time it was made.
A typical clause may provide: “Each party will be excused from performing any obligation or undertaking provided for in this Lease (other than payment of monetary amounts when due), if such party’s failure to perform is prevented or delayed by an act of God, fire, earthquake, flood, explosion, action of the elements, war, invasion, insurrection, riot, mob violence, sabotage, general shortage of or inability to procure labor, equipment, facilities, materials or supplies, strike, lockout, or orders of government or civil or military authorities.” Even though this clause contemplates acts of God and orders of government, circumstances which arguably apply in light of the pandemic, this clause would be limiting in that it specifically excludes payment of rent, thereby benefitting the landlord.
A more expansive clause might provide: “‘Force Majeure Events’ shall include, but not be limited to, any strike, lockout, labor trouble, civil disorder, inability to procure or delay in procuring materials, failure of power, restrictive governmental laws and regulations, riots, insurrections, war, shortages of fuel, equipment or materials, accidents, casualties, acts of God, and any other circumstances beyond the control of Landlord or Tenant.” This clause is more protective of a tenant in that it does not exclude payment of rent and leaves the application of the clause open to “any other circumstances beyond the control” of the parties. However, absent an agreement between the landlord and tenant regarding the application of this clause during a period of the pandemic, the burden will be on the tenant in Indiana to prove its circumstances delayed or excused performance, and for how long and to what extent.
A restrictive clause, rejecting force majeure, might provide: “This Lease and either party’s obligations hereunder shall in no way be affected, impaired or excused, nor shall either party have any claim against the other for damages, because the non-performing party, due to force majeure, is unable to fulfill any of its obligations under this Lease, including, but not limited to, any obligations to provide any services, repairs, replacements, alterations or decorations or to supply any improvements, equipment or fixtures.” This clause is clear that the parties have “opted out” of making a force majeure argument at all.
If your lease has a force majeure clause, consider whether the party claiming delayed or excused performance cannot perform its obligations. Does the clause include that performance is only excused “to the extent” affected by circumstances? If there is money in a tenant’s reserves, for example, it may be that those reserves must first be used for rent before performance is excused. But no one benefits, in that same example, if the tenant goes bankrupt in order to pay its rent. The language may also rely on whether a circumstance is foreseeable. The institution of global wide closures were not likely contemplated by any party when they negotiated their lease. A global pandemic is not likely part of the “gamble a party takes” when entering a contract.
There may also be an obligation to notify the other party under the lease for the force majeure clause to apply. The contract may also include a “no waiver” clause, providing that a party’s failure to insist on a right does not constitute a waiver of the right. If that provision is written so that a waiver does not constitute a subsequent waiver of the right, there may be some argument that the application of the force majeure right was only invoked for the period after notice was given.
If you are a tenant, should you notify a landlord that circumstances might worsen or approach your landlord to negotiate terms for relief? Some leases include the concept of anticipatory breach in the default provisions, whereby a landlord can assert its remedies under a lease if it has reasonable cause to suspect a tenant is insolvent or will become insolvent. Given the vast number of tenants who may be affected by the economic climate brought on by the COVID-19 pandemic, it would seem imprudent for landlords to invoke their rights under an anticipatory breach clause. It is in the interest of the parties in most cases to continue the leasing relationship, but tenants should be sensitive to their lease provisions and seek the advice of counsel before approaching landlords for relief.
In the absence of a clear force majeure clause, a party may invoke common law equitable doctrines if it is unable to perform its contractual obligations.
The doctrine of impossibility excuses a party’s performance when it would be unreasonably costly or impossible for a party to carry out its contractual obligations. In Indiana, it has been noted that to invoke this defense, it must be shown that performance is absolutely impossible, owing to the act of God, an act of the law or other circumstance. It is further noted that “the proper question in an ‘impossibility’ case is not whether the promisor could not have performed his undertaking but whether his nonperformance should be excused because the parties, if they had thought about the matter, would have wanted to assign the risk of the contingency that made performance impossible or uneconomical to the promisor or to the promisee; if to the latter, the promisor is excused.” This is a significant burden of proof to the party invoking this defense. It may have been impossible to operate in the premises, but if payment is still possible and rent is a separate and independent lease covenant, it calls into question the applicability of the doctrine.
The doctrine of impracticability is codified in UCC cases, and though not necessarily dispositive in lease interpretation, is useful to examine. This defense turns largely on foreseeability. The parties should ask, essentially, if the risk was so unusual and the consequences so severe that, without bargaining for the contingency, one party is significantly advantaged. If we look merely at the landlord-tenant relationship, it might be argued that the landlord is significantly advantaged by receiving payment of rent, but most landlords have separate obligations to pay their mortgage lenders. It may be reasonable to conclude that the COVID-19 risk is unusual and its consequences severe, but whether the landlord is really advantaged over the tenant is still questionable.
Frustration of Purpose
Indiana does not currently support the doctrine of frustration of purpose, but the NIPSCO case suggests the argument may be ripe for reanalysis in Indiana under the proper set of circumstances. The doctrine provides that a party may terminate a contract where performance is not impossible but the achievement of the contract’s purpose was frustrated because of changed conditions. The doctrine arguably applies in the current environment: the ability to operate in the physical premises is presumably an implied basis, if not the crux, of the leasing relationship.
Constructive eviction occurs when an interference with possession is so serious that it deprives the lessee of the beneficial enjoyment of the leased premises. In commercial leasing, the parties can opt out of constructive eviction. As Indiana law now stands, this claim relates to the acts or omissions of landlords, and this would somehow have to shift to apply to the dispossession of premises due to the COVID-19 virus.
At this time, we do not know how long the economic effects of this pandemic will be felt. If a tenant clearly cannot pay its rent, landlords may benefit from restructuring leases to extend lease terms and tolling or abating rent for a period of time in the immediate future. Landlords, of course, also have obligations to their lenders, so landlords will want to coordinate with their lenders to ensure they will be able to restructure mortgage payments in line with what can be offered to tenants. On the other end of the spectrum, if landlords are experiencing difficulty providing full services to buildings, or are unable to meet construction deadlines, it likewise benefits the tenants to work out agreements with the landlord. Maintaining amicable contractual relationships are more important than ever in this economic climate.
The COVID-19 virus is likely to have far reaching impacts on real estate. Every state’s laws with respect to these issues vary, and the laws are likely to evolve based on cases that invoke the foregoing doctrines following the pandemic. We encourage tenants, landlords and lenders to reach out in an effort to be proactive and even collaborative about how to best approach this unprecedented impact on our modern global economy. Additionally, we continue to watch as new federal packages are proposed and enacted to help bridge the gap for businesses.
Contact an attorney in the Bose McKinney & Evans Real Estate Group to help you navigate this territory.