Money for Nothing? Commercial Lease Covid-19 Considerations
Author: Stephen T. Toohill
A number of commercial tenants impacted by Covid-19 are continuing to pay rent on space that they are unable to occupy. The obvious initial thought is that it seems totally unfair. Unfortunately, the ability to cease paying rent or to abate rent depends upon the terms of the commercial lease, which typically favor landlords. In addition, most provisions which could arguably apply to provide for some rent abatement, including force majeure provisions and utility/use interruption provisions are not broad enough to cover a Covid-19 type situation. Other potential arguments under common law include frustration of purpose, impossibility and impracticability. What are a tenant’s options?
Set forth below is a checklist of issues to review relating to obligations under an existing lease, as well as a few negotiating strategies to consider in the event a tenant is contemplating a new lease where there may be more ability to consider Covid-19 related lease impacts. While the following checklist and items are not comprehensive and do not intend to address all of the relevant issues, it may provide a useful tool when reviewing an existing lease or considering issues to negotiate in a new commercial lease transaction.
I. Existing Lease Obligations/Tenant Lease Review Considerations
A. Tenant Rent Obligations
- Negotiation of Rent Abatement or Rent Deferment. Many landlords obviously understand Covid-19 impacts and are negotiating rent deferments with their tenants. A rent deferment would typically defer one to three months of base monthly rent with the tenant remaining obligated to pay the operating costs/common area maintenance costs passed through by the landlord. A goal would be to repay this deferred rent, perhaps in equal monthly installments in 2021, hopefully without interest.
- Seeking Rent Abatement. Typically, if the tenant is requesting rent abatement as opposed to rent deferment, the landlord will want some quid pro quo. The most commonly requested landlord concession would be for the tenant to extend the lease term in consideration for receiving some rent abatement. If rent abatement is granted, typically it is partial, such as a 50% rent abatement for some months of the lease term. The landlord may also want the rent abatement to be conditional upon performance, with the abated amount due and payable to the landlord in full if there is an uncured default by the tenant under the lease.
- Rent Abatement Based Upon a Force Majeure Event. Most commercial tenants have reviewed their lease to determine whether Covid-19 would constitute a force majeure event under the lease permitting the tenant to cease paying rent. Typically, force majeure clauses are not broad enough to cover a Covid-19 situation or even if they are, commercial leases often indicate that a force majeure event would not affect the tenant’s obligation to pay rent under the lease.
- Lease Utility/Occupancy Interruption Clauses. A commercial tenant will often negotiate a lease provision indicating that an interruption in the tenant’s ability to utilize the Premises results in rent abatement. Although it is worth reviewing these clauses, typically they only relate to utility interruptions even if other events result in the tenant not occupying the premises.
B. Other Considerations
- Local Ordinance Protections. Many jurisdictions, including the City of San Diego, have adopted ordinances which limit the ability of a landlord to evict a commercial tenant and/or charge the tenant a late charge for not paying the rent. The tenant needs to comply with the obligations under the ordinance, including providing notices to the landlord prior to the time that rent is due, indicating that the tenant cannot pay rent due to Covid-19 financial impacts.
- Potential Insurance Coverages. Obviously, there has been significant review of insurance policies and claims filed against insurance companies based upon an argument that business interruption insurance should provide some coverage for tenant losses, including, but not limited to, the obligation to continue to pay rent. As the terms of insurance policies on this issue may vary, this is an issue that commercial tenants should review with their insurance broker or risk manager.
II. NEW LEASE CONSIDERATIONS
- Tenant Leverage/Flexibility Options. For a substantial period of time prior to the recent Covid-19 impacts, landlords have wielded substantial negotiating power in this market. A financially strong commercial tenant potentially now has much more negotiating leverage with a landlord due to anticipated market vacancies and commercial tenants reconsidering and downsizing their commercial space needs. Such leverage allows commercial tenants to incorporate greater flexibility in a new lease, including, but not limited to, potentially adding lease termination/buy-out provisions, as well as expansion and/or contraction rights.
- Incorporating Use Interruption Clauses/Rent Abatement Rights. There will obviously be substantial attempts by commercial tenants to modify force majeure provisions to incorporate rights to abate rent based upon force majeure events which result in the tenant not being able to occupy space. However, another and perhaps more fruitful approach for a tenant would be to expand rent abatement rights under the lease clause which typically relates to utility interruptions. These clauses often have a time period prior to tenant being in a position to exercise rent abatement rights and could potentially be expanded to include situations other than utility interruptions where a tenant has no access to the space.
While it is important for a commercial tenant to review an existing lease to determine what potential rights the tenant has or can raise with its landlord, the issues set forth above hopefully provide a roadmap on a number of issues which would typically be reviewed and considered. Also, a tenant entering into a new lease or an extension of the lease in this market should have substantial leverage due to potential landlord issues arising out of the myriad of Covid-19 market impacts.