Leasing Guidance During COVID-19: A Look at Various Lease Covenants
- As retailers of all sizes have shut their doors in response to social distancing efforts and mandated closures caused by the COVID-19 crisis, many of these businesses are also facing lease obligations that may create additional obstacles.
- In turn, as businesses close or slow down, landlords have been inundated with requests from tenants regarding their financial obligations under their leases.
- This Holland & Knight alert is intended to assist both landlords and retail tenants in their discussions and negotiations regarding financial and performance obligations during the COVID-19 pandemic, including an overview of some of the pertinent lease provisions that should be reviewed and considered.
As large retailers, small shops, restaurants, entertainment venues, gyms and movie theaters have shut their doors in response to social distancing efforts and mandated closures by governmental authorities, many of these affected businesses are also facing lease obligations that may create additional obstacles and impact their decisions and recovery. In turn, as businesses close or slow down, landlords are being inundated with requests from tenants regarding their financial obligations under their leases. In both instances, the end result is that parties to a lease are each left wondering what their rights are in the midst of the COVID-19 pandemic and whether rent payments must be paid.
The below is intended to help both landlords and retail tenants in their discussions and negotiations regarding those financial and performance obligations.
The Elephant in the Room: Is Rent Still Due?
While the answer very much depends on the specific contractual language negotiated between the parties, in most long-term and triple net leases, tenants largely agree to pay rent "without abatement, set-off or deduction" during the term. For example, the allure of a triple net lease to most landlords is that the tenant is required to pay rent continuously with limited rent abatement possibilities, often even in casualty and condemnation situations. Essentially, the tenant takes on most of the risk for the landlord as owner. In turn, most leases have force majeure or excusable delay clauses that carve out the payment obligations of the tenant. While these clauses would toll certain performance obligations affected by the pandemic, such provisions are generally not broad enough to run to the financial obligations by a tenant contained in a lease. In fact, most leases expressly state that events of force majeure do not curtail the tenant's obligation to pay rent. This is in line with the long-standing precedent in most jurisdictions, and in most lease documents, that financial inability/hardship is not a force majeure event.
An important point that may impact the analysis is lease provisions allowing the tenant to "go dark" and allowing either or both parties to terminate leases as of a date certain. Depending on their express terms, such "go dark" provisions may be used by either party to a lease to terminate leases. For tenants that are facing closure of stores or businesses, "going dark" may be a way to minimize their financial burden, while allowing landlords to receive any termination compensation or payment required by such termination.
Operative Lease Provisions
In continuing the discussion of what rights a landlord and tenant have in determining the options for rent abatement and enforcement for each party to a lease, below are some of the pertinent lease provisions that should be reviewed and considered.
- Rent, Default Interest and Late Charges: Top of mind for all parties these days are the implications of COVID-19 and rent. Both parties should be well versed in the contractual implications in their leases as to rent being paid late or not at all. Even in leases expressly permitting tenant closures (whether under a permitted closures provision, "go dark" provision or otherwise), tenants may remain liable for some or all monetary and other obligations under the lease. Also, closures not permitted by operating or opening covenants, as noted in this article, may also trigger additional monetary damages.
- Recapture Rights: If a tenant "goes dark" for a set period of time defined in the lease, the landlord may be entitled to terminate the lease and recapture the premises. This right may require additional landlord notice and payment of a fee, and might be limited by its terms during the occurrence of a force majeure event.
- Exclusive Use: If a lease has granted the tenant the right to an "exclusive" for the use of a particular product or service, such right (and the corresponding restriction on the landlord from leasing to another tenant for any use in violation thereof) may be conditioned upon the tenant's continuous active operations in the space as well as the tenant not being in default under the terms of the lease. If a tenant fails to continuously operate, such failure may open a window of time during which the landlord may agree to lease to other tenants for an otherwise restricted use, or terminate the lease and recapture the space of the violating tenant so that the landlord can lease to another tenant for an increased rent. Although it's not likely that many new leases are being signed at this time, tenants and landlords should be well aware of these provisions and should be well versed in the lease terms under which an exclusive may be forfeited.
- Co-Tenancy Rights/Remedies: Certain leases may grant tenants the right to terminate the lease or reduce rent if the occupancy of a shopping center or retail development falls below a certain occupancy threshold. The rights of the tenant may include rent abatement, reduced hours or even the right to terminate. The impact the coronavirus may have on co-tenancy rights will depend on how the occupancy thresholds are defined and what protections the landlord may have in instances of force majeure events.
- Rights of Renewal, Expansion, First Offer, Termination: Many leases will condition additional tenant rights such as the right to exercise an option to extend the term, or the right to change the use of the space, on the condition that the tenant is open and operating and will continue to be open for a set period of time in all of (or some defined lesser part of) the premises, or not be in default under the lease.
- Operating Covenants and Failure to Open: Many retail leases contain a covenant requiring the tenant to continuously operate its business from the premises for the duration of the lease or for a minimum time period and during certain specific hours. This covenant may also require that, while open, the tenant must be fully staffed, fully stocked and use best efforts to operate in a manner to maximize gross sales (this final item being more common in leases containing percentage rent payments). An operating covenant may also include an obligation by the tenant to open for business to the public by a certain date. If the tenant is unable to open due to government order, or it is not realistic or financially feasible for a tenant to staff, stock and open a business during these times, or a tenant is unable to continue and complete its build out by a set date, this situation may trigger liquidated or other tenant damages as well as landlord rights and remedies, including lease termination.
- Force Majeure: Force majeure and/or excusable delay provisions are often found in leases and typically include conditions such as adverse or extreme weather, casualty, condemnation, war, strike, acts of gods, governmental regulation, etc. As noted above, these provisions usually apply to performance obligations and have traditionally excluded payment obligations. However, it is important to review these provisions to determine if they are broad enough or do cover pandemics and to evaluate what notice, if any, is required for the provision to come into effect. Even with a force majeure provision that requires the payment of rent, some of the performance covenants mentioned above might be tolled if the proper notice is provided to a landlord.
While the COVID-19 pandemic has presented landlords and retail tenants with unprecedented challenges and opportunities, it is important to consider that just because landlords can exercise some of the rights and remedies noted above, whether they should do so is another question. It is critical that the landlord-tenant relationship remain positive and strong in order for both parties to weather this pandemic and succeed in the future.
While in most instances, tenants will remain legally obligated to pay rent, in light of the broad impact of COVID-19, landlords should take a number of business considerations into account prior to responding to tenant requests. To the extent possible for both parties, the recommended answer is to focus more on the business behind these landlord/tenant relationships. While understanding that the applicable lease provisions are important, it is likely more prudent to come up with a mutually satisfactory business solution that will not further strain the tenant and the landlord financially in the long term.
Given how dependent this analysis is on the language of each lease and with so many novel issues raised by COVID-19 on a daily basis, landlords and tenants are advised to consult with legal counsel about their specific situations before making any final determinations about the actions they should take in the current situation, including the preparation and negotiation of any rent deferral agreements.
For more information or questions about your organization's specific lease terms as they relate to COVID-19, contact the authors of this alert or another attorney in Holland & Knight's Real Estate Practice.
DISCLAIMER: Please note that the situation surrounding COVID-19 is evolving and that the subject matter discussed in these publications may change on a daily basis. Please contact your responsible Holland & Knight lawyer or the author of this alert for timely advice.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem. Moreover, the laws of each jurisdiction are different and are constantly changing. If you have specific questions regarding a particular fact situation, we urge you to consult competent legal counsel.