Commercial tenants nationwide faced a stark reality when the pandemic hit in March 2020: Covid-19-related government orders required them to either suspend or reduce business operations to prevent the spread of the coronavirus. While many businesses moved to a remote working environment with minimal interruption, thousands of businesses that relied on in-person operations suffered a substantial drop in income. Less income meant they could not pay rent.
Unsurprisingly, property owners sought to recoup their losses by filing lawsuits against their tenants for back rent, spawning litigation across the country. Yet, the results are mixed, with neither landlords nor tenants being the clear winner.
The overarching lesson from these cases is that a court’s decision is likely to hinge on the specific wording used in each lease. A court will closely examine use, force majeure, compliance with laws, and other risk allocation provisions to evaluate whether the pandemic frustrated the purpose of the lease, or whether the lease otherwise designates who should bear the economic burden.
No Uniformity in Commercial Leases
The commercial lease case law stands in a stark contrast to the tsunami of insurance disputes that flooded the courts. Many business owners sought to recoup their pandemic-related losses by filing claims on their property insurance policies. To their dismay, hundreds of state and federal courts, both at the trial and appellate level, have found overwhelmingly in favor of insurance companies.
One reason the insurance industry saw a clear winner, but the commercial leasing industry did not, is the nature of the contracts at issue. The insurance industry largely relies on form insurance policies that are pre-approved by each state, with changes made via pre-approved endorsements.
With substantially similar, if not identical, provisions at issue, courts in different jurisdictions are likely to interpret them similarly. Insureds typically have little leverage to negotiate specific provisions in their policies.
But there is no such uniformity in commercial leases, where each provision is subject to negotiation. Thus, courts generally must interpret a lease without the benefit of previous courts having interpreted nearly identical provisions.
For example, most leases identify what uses are permitted at the property, and some even specify what uses are prohibited. Many times, use provisions are drafted broadly to give tenants flexibility should their needs change during the lease term.
Other times, use provisions are narrower. These provisions are the product of negotiations between the parties and the business reasons for limiting or expanding permissible uses.
Legal Outcomes of Lease Terms
Such differences led to opposite results in neighboring states, where one tenant was relieved from paying rent, while another was found liable and forced to pay its landlord’s damages (including attorneys’ fees).
In Massachusetts, a court found for the tenant in a lease that stated that the only permitted use of the premises was in-person dining and explicitly prohibited all other uses. Because the Covid-19-related orders barred in-person dining and the lease did not allow any other purpose, the tenant coffee shop’s main purpose of running a café with on-site consumption was frustrated. Thus, the tenant did not have to pay rent during the shut-down period.
Conversely, the Connecticut Supreme Court found against a tenant that operated a fine dining restaurant. Here, the lease did not limit the use of the property to one purpose, nor did it include any prohibitions. The lease also allocated the risk of compliance with law, including executive orders, to the tenant.
Given these provisions, the court found the purpose of the lease was not frustrated since the tenant could shift to other uses such as takeout and delivery services, which were allowed under the lease.
The difference between the tenant’s success in Massachusetts and the loss in Connecticut, turned, in part, on the specific lease provisions and how the parties allocated risk, terms that easily could have been overlooked during negotiations.
As such, tenants should consider the following factors when engaging in future negotiations.
If a tenant has a clear intended use in a given space, such as fine dining, it is best to state that use and specify that no other use is permitted. While a specific use provision does have its drawbacks, especially for those tenants who need to change their use of a certain location occasionally, it can help make a tenant’s defense of frustration of purpose more viable if there is another crisis, like the pandemic and the resulting executive orders.
Negotiate for a force majeure provision that will allow a tenant not to pay rent for events outside of their control and include “pandemic” in the laundry list of disaster examples. Delete anything that would require tenant to continue to pay rent notwithstanding such disasters or create a special carve out for pandemics that will allow a tenant to stop paying rent temporarily.
If the property owner rejects outright rent relief, consider alternatives such as a temporary pause on rent with a corresponding extension of term, or amortization of the paused rent over the remaining term.
Understand your risk allocation provisions and consider carefully defining for what the tenant and property owner are responsible. You can also include force majeure carve outs. That way, any agreement on risk allocation cannot be applied in circumstances brought on by unforeseen disasters.
Commercial tenants should closely evaluate the economic burden they are agreeing to assume when negotiating a lease. Leases that allow multiple permitted uses, disallow rent abatement during a force majeure event, or shift the responsibility for compliance with laws onto the tenant could have severe financial consequences if the landlord and tenant are confronted with unforeseen circumstances. Without careful consideration, a commercial tenant can find itself unable to use its space for the primary intended purpose, yet still continue to owe full rent.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Manleen Singh is counsel at Robins Kaplan LLP in Boston. She advises businesses of all sizes on all facets of corporate transactional law, including mergers and acquisitions, commercial real estate, international transactions, contract drafting and negotiation, corporate formation, and general business counseling.
Peter Foundas is an associate at Robins Kaplan LLP in Boston. A commercial litigator and transactional attorney, he negotiates and litigates complex contracts, fiduciary matters, financial fraud, and corporate governance issues.