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March 24, 2020

The Impact of Coronavirus on Existing Commercial Leases

Coronavirus: Real Estate Advisory

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Coronavirus (COVID-19) is impacting the ability of businesses to operate in their leased spaces. Governments are requiring closures of certain types of businesses or buildings, and in some instances landlords are electing to close their properties voluntarily. So what should a landlord or a tenant consider if a tenant is not permitted to operate from its leased space?

Businesses are looking to their property damage and business interruption insurance policies to see if they will cover any of their losses. These types of insurance, however, do not typically cover losses arising from pandemics and diseases. Absent an endorsement for losses arising due to bacteria and viruses, these policies may be interpreted as being limited to providing coverage for losses arising from physical damage to a property. Even insurance for civil authority action (covering certain closures due to government orders) may not cover closures due to viruses and bacteria. We anticipate litigation under these policies, including claims for losses directly arising from the coronavirus being present on the surfaces in a premises or a building and building closures as well (including clean-up costs). Going forward, it is possible that the federal government will step in to establish an entirely new insurance regime for future claims, much like flood or terrorism insurance.

Tenants and landlords are looking at their leases to see if tenants have any remedies where access to the premises is restricted or prohibited. A typical lease states that payment of rent is an independent obligation from landlord's obligations under the lease. There is normally no right to offset rent under a lease unless this right has been negotiated into the lease specifically. Landlord's initial drafts of leases tend to state that landlords have no liability (and there shall be no rent offsets) for closure of the building or for failure to provide services, access and utilities in emergency situations, subject to the landlord using reasonable efforts to reinstate the same.

In addition, most leases include a force majeure clause that states that performance of landlord's (and sometimes tenant's) obligations are excused to the extent prevented or delayed by listed acts and other events not within the party's reasonable control (specifically excepting the obligation of tenant to pay rent). Note that courts tend to read these force majeure clauses restrictively, so the language would need to be broad enough to capture delays and inability to perform due to disease. If the coronavirus pandemic constitutes a force majeure under the particular lease, close attention should be paid to how that might affect lease provisions relating to interruption of services, utilities and access, delays in delivery of a premises, and delays in completion of leasehold improvements. Depending on how these clauses are written, a lease might provide more time for remediation of interruptions of services, utilities and access, delivery of the premises and completion of work. This could impact both rent abatement remedies and lease termination rights.

It must be determined if a landlord has contractually agreed to provide twenty-four hours a day, seven days a week access to the premises. If such a clause exists, are there exceptions to that obligation? Some leases explicitly allow the landlord to close the building or suspend services, utilities or access in the event of an emergency, if the landlord has a reasonable concern of damage to the building or personal injury to the occupants, and, in some instances, as a result of government orders or actions. The interpretation of landlord's obligations and tenant's remedies may differ depending on who elects to close off the access - the government, the landlord or the tenant. Some negotiated leases provide remedies (from abatement to, after particularly long periods of interruption, termination rights) after a certain period of time (and in some cases subject to notice from tenant to landlord) if there are interruptions of certain services, access and utilities attributable to the landlord. Other leases go further to cover the tenant after a specified period of time if the interruption in access or services occurs for any reason other than the tenant's fault, which may implicate situations where the government has interfered with access or use. Parties need to review their leases to see if those provisions cover interruption of access (and not just essential services and utilities).

Tenants may also look to other clauses in their leases. Most leases include a covenant of quiet enjoyment, where a landlord agrees not to interfere with the tenant's possession of the premises absent default. Some leases (though not many) may address abatement due to temporary condemnation by the government. Tenants may look beyond the four corners of their leases to assert defenses of impossibility and frustration of purpose. Tenants may also make claims against the government for inverse condemnation arising from the government orders to close all non-essential businesses and failure to provide just compensation as required by the Fifth Amendment of the Constitution.

The reality is that most leases are favorable to the landlord, and therefore will not protect a tenant for closures as a result of the coronavirus pandemic. The widespread impact of the virus on business activity, however, has led to a groundswell of requests by tenants to seek some rent relief from landlords for a limited period of time. Landlords will need to determine if their cash reserves and lenders will allow them to negotiate short term rent relief, in particular for those tenants who cannot operate their business remotely. We expect the government to provide some support for the entities being most severely impacted by the closures, such as operators of hotels, restaurants and other retail establishments. That assistance, however, may not arrive for at least a month or two. In the meantime, April rent is due and landlords may see a significant decrease in revenues received. The terms of each lease, the business prospects of each tenant, and the idiosyncrasies of each landlord's rent roll and debt service obligations ultimately will determine which leases get worked out, which are breached, and how the landlord/tenant relationship will survive the coronavirus.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.