Are Tenants Entitled to Some Free Rent Courtesy of COVID?
When state governors across the country issued stay-at-home orders over the past several months, office tenants scrambled to find copies of their office leases to see if they were obligated to pay rent while being denied use of their space.
In most cases, tenants found no contractual right to suspend rent payments even though the pandemic and corresponding executive orders constituted a force majeure. As a result, tenants paid their rent and moved on…
Not so fast. Tenants may be deserving of a different form of relief.
Most commercial office leases contain a “force majeure” provision. These provisions recognize that extraordinary occurrences may frustrate a party’s ability to perform its obligations under the lease. Rather than put a party in a default situation because it doesn’t have enough time to perform its obligation through no fault of its own, force majeure provisions provide the affected party with additional time to perform their covenants.
It is important to understand that force majeure provisions do not forgive obligations; they merely provide the obligated party with more time to perform. Thus, if a tenant is responsible under its lease to replace a damaged roof, the tenant is not excused from its obligation if it was not able to get the needed materials due to an industrywide roofers’ strike. If the strike went on for 20 days, the tenant would simply get 20 more days to replace the roof. The landlord ultimately will receive the new roof it bargained for.
Interestingly, after the stay-at-home orders, tenants and their advisors focused their lease reviews almost exclusively on the tenant’s lease obligations and whether they were excused, but spent little time reviewing the landlord’s obligations and whether they were excused.
The Other Side of the Lease Story
The most elementary covenant made by the landlord in a lease is the promise to provide the tenant with use of the space for a specified lease term. What happens, then, if a landlord promises to provide a tenant with use of the space for five years, the tenant pays rent for all 60 of those months, but then – due to an extraordinary event – the tenant only gets use of the space for 58 months? Is the landlord excused from fulfilling its promise for the two affected months? If so, under what theory or lease provision is its promise forgiven?
Possible Theories for Excusing Landlord’s Performance
Is the landlord excused from providing space during the stay-at-home order because of the force majeure provision? Most people would agree that the pandemic and executive orders constituted a force majeure event. As discussed above, these provisions do not excuse an obligation, they simply provide more time for performance in order to avoid a default for reasons outside of a party’s control.
As a result, force majeure provisions shouldn’t excuse the landlord’s promise to make the space available to the tenant, especially when the tenant has continued to pay rent on the space during this period. Instead, in our example of the 5 year lease, the lease should be extended to 62 months with the last two months being at no additional cost to the tenant (since it would have paid rent for the first 60 months). The 60-day force majeure should merely provide the landlord with the ability to satisfy its 60-month obligation in 62 months rather than 60.
Interruption of Service
Some leases excuse a landlord from any liability to the tenant for interruption of essential services including electric services or HVAC. Many of these provisions require the tenant to continue paying rent during these service interruptions or provide some threshold number of days before which rent can be suspended. These provisions contemplate scenarios that are very different from the extended stay-at-home orders in two important respects.
First, these service interruptions typically involve physical damage to something within the building or outside of the building that directly impacts the building. This physical damage is typically the required trigger for a tenant to be able to make a claim under its business interruption insurance if it is unable to use its space. Thus, this type of provision is nothing more than a contractual allocation of risk between the parties which can be anticipated and easily insured over by the tenant at the outset of the lease.
The second difference is that, in most interruption cases, the occurrence is limited to a few days and stop gap measures can be put in place such as space heaters, fans etc. to enable the tenant to get most of the benefit of its space while the disruption is being cured. Interruptions that last for months or more are typically casualties which involve different risk allocations. The stay-at-home orders went on for months and the tenant was legally forbidden from occupying the space during these periods.
If the pandemic and related virus constituted a casualty, the landlord would not be required to provide the affected space and would not be obligated to extend the term of the lease. However, in a casualty, the tenant would not be obligated to pay rent during the time it was denied use of the space.
As a result, landlords would not want to rely on these provisions to justify their inability to fulfill their covenants (while some tenants, on the other hand, have attempted to draw an analogy between the physical virus cells on office surfaces and casualties).
Did the executive orders constitute a temporary taking which excused the landlord from providing the space? Most experts agree that the executive order did not constitute a taking. Were it a taking, the landlord would have a claim against the government in lieu of collecting rent from the tenant.
A lease represents a series of obligations and risks that are allocated, through negotiations, between the landlord and tenant. The COVID pandemic and associated executive orders were not contemplated in most leases but, as things have played out, tenants have continued to pay rent and effectively assumed all the economic risk associated with these events. The problem has been that tenants and their advisors may have been too focused on looking for carve outs for their own obligations and have not focused on the landlord’s covenants and whether they were excused from their obligations as a result of the shutdown.
Tenants never contemplated bearing the risks of the pandemic, they never insured these risks, and yet they have paid for space they were promised but couldn’t use. The fair and perhaps correct result should be that the tenant ultimately gets the use of its space for the full term it contracted for with its landlord, even if it means the lease needs to be extended.
This article was written by Glenn Blumenfeld of Tactix Real Estate Advisors in Philadelphia.