Do Tenants Owe Rent When COVID-19 Closes The Business?
March 30, 2020
Small business owners are understandably concerned about the financial impact of COVID-19. Hardly anyone is immune to the recent closure of “non-essential’ businesses and the diminished operations of “essential” businesses.
If you are a tenant or a landlord, you probably have questions about your lease. Does the tenant owe rent if the government orders the business to close? What if the tenant’s business is still open but there is a significant shortfall in business due to the virus? What if the business closes for sanitation after an employee or customer was found to have COVID-19?
In typical lawyer-speak, the answer is: it depends.
Before you can determine your rights, you must review your lease. The lease is a written contract between the landlord and the tenant. There are several clauses pertinent to COVID-19 that might be in your lease.
This is the clause everyone is examining. This clause excuses a party’s obligation to perform an obligation (such as paying rent) if a ‘force majeure’ event occurs.
Each lease is different. Some specifically define ‘force majeure’ events and others are more general. After SARS and MERS, some larger commercial landlords added specific language about viral infections. Locally, I am certain this is not the case. Still, read your lease.
It unlikely a court will find a force majeure when the tenant remains open but there is a significant loss of business. This is because businesses naturally face competitive threats, consumer fickleness, and waning popularity, and other events that cause a business to lose customers.
Even if you have a force majeure clause and it covers COVID-19 events, the tenant might still be required to pay rent, as explained next.
Payment of Rent as an Independent Covenant
Most retail leases require payment of rent as an independent covenant. This means even if there is a qualifying force majeure event or landlord breach, the tenant must still pay the rent on time. Tenant’s failure to pay rent breaches the lease.
I recently reviewed 16 commercial leases and found 14 specifically required the tenant to pay rent during the force majeure event. If you operate a retail business, chances are your lease contains similar language. If you are the landlord this is good news. If you are the tenant, this is not good news.
Casualty / Damage
Most leases include a casualty clause that waives or prorates the rent when the leased space is damaged or destroyed. Typically, this refers to fire, flood, and the like. Some destruction clauses specifically limit casualties as those events covered by insurance.
In most cases, the casualty/damage clause will not apply to COVID-19 because there is no actual damage to the premises. Even if the premises are closed for sanitation, the physical structure is not damaged.
Many retail leases (think shops, salons, and restaurants) require tenants to remain open for business during the normal business hours of that particular industry. This is especially true in malls and shopping plazas where landlords do not want “dark” storefronts.
The continuous operation clause is waived during a force majeure or government-ordered closure, but if closure due to COVID-19 is voluntary, the tenant breaches the lease. In these times, it is unlikely a landlord would sue a tenant for breach of lease for “going dark” during the pandemic.
Eminent Domain / Condemnation.
These clauses concern a “taking” by the government so that you cannot use part or all of your property.
Historically, eminent domain and condemnation have required a formal legal action by the government against the property.
There is a lot of discussion among lawyers regarding whether the COVID-19 situation will be considered ‘eminent domain’. Many lawyers agree there is a strong case that government-mandated closure is a form of ‘taking’. This ‘taking’ is not a judicial action, though. The government will not compensate the tenant for lost use of the premises (except indirectly through some of the new small business loan programs). Still, the government is prohibiting the otherwise lawful use of the property. That means the tenant arguably is unable to use its property and unable to comply with the terms of the lease.
Large, commercial landlords and tenants will likely fight this matter in court. Locally, though, it will be a matter or negotiation between the landlord and the tenant. The cost to litigate this issue will be more expensive than to simply pay the rent.
Sometimes landlords require the owner of the business to sign a personal guaranty. This document is similar to co-signing your child’s car loan. You are responsible for paying the rent if the business fails to do so. Review the lease to determine whether the tenant signed a personal guaranty.
A personal guaranty will make it more difficult for a tenant to challenge whether it must pay rent during a government-ordered closure. This is because the landlord already deemed the tenant to be at risk of default and so required the personal guaranty to ensure rent would be paid even if the business lacked the finances to do so.
What Should a Tenant Do?
If you are a tenant, what can you do if you are struggling to pay rent due to a business closure or a significant downturn in revenue due to COVID-19?
Lawyers across the nation are discussing this on lawyer list serves and blogs. Here are some of the ideas:
Negotiate a temporary change. This could be in the form of:
- Rent Holiday. This allows the tenant to break up the rent payments due during the COVID-19 period into smaller chunks and pay it over a series of months. For example, if rent is $1000 per month and the tenant cannot pay rent during March and April, the landlord could allow the tenant to pay that $2000 over a four-month period (or, $500 per month) in addition to the regular rent owed during the months May, June, July, and August.
- Rent Reduction. The landlord may consider reducing rent during the affected period.
- CAM Only payments. Many businesses located in multi-tenant spaces, such as office complexes or malls, pay a portion of their rent as “CAM” (Common Area Maintenance). CAM covers the landlord’s cost of maintaining the common areas, property taxes, and insurance. If the tenant pays CAM and its business is closed because it is a “non-essential” business, the Landlord could forgive rent during the affected period and require only payment of the CAM portion.
Look at possible defenses to breach. Consult legal counsel to determine whether the defenses of “impossibility” or “frustration of purpose” are available.
- The defense of impossibility is essentially your claim that the purpose of the lease (operating a business) is impossible due to the government-ordered closure. Since it is impossible to operate your business, you should be excused from paying rent during that period. I expect it will be very difficult to succeed with this defense due to nearly every tenant in the country suffering the same difficulties.
- The defense of failure of purpose is similar to “impossibility”. Failure of purpose occurs when an event occurs that substantially frustrates the principal purpose of the lease. Here, the tenant is saying the purpose of the lease is to operate a business and the event (government-ordered closure) frustrates the primary purpose of the lease. In other words, the only reason for renting the space is to operate the business. This is fact-specific. Courts will look to whether the event was foreseeable and could have been addressed in the lease.
While many renters are anxious about how to pay rent when their business is closed, renters must remember that the landlords are also business owners. Most rental properties in our area are mortgaged, meaning the landlord also has a duty to pay the lender each month. We will see a trickle-down effect when renters default, causing landlords to default. It is an unfortunate situation for everyone.
What Should a Landlord Do?
- Talk to your tenants. First, they will appreciate the opportunity to discuss their fears. Second, you will learn whether they are likely to default, go out of business, or be able to negotiate a change in rent.
- Consider negotiating rent. This pandemic affects all of us. We all have bills to pay yet our incomes are down. If at all possible, consider negotiating a temporary rent reduction or allowing rent to be paid over a longer period.
- Talk to your lenders. Don’t be afraid to do this. They are getting many calls about this issue and may be able to assist you with a change in your scheduled payments.
- Sanitize common areas. This is the time to step up your cleaning schedule for common areas, such as hallways, restrooms, and common waiting rooms.
Landlord-tenant leases are very fact-specific. I encourage you to consult an attorney if you have questions about your lease or if you are experiencing financial difficulty. An attorney will both advise you as to your rights and help you negotiate a temporary arrangement with the other party.