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COVID-19: Will Shutdown Orders Excuse A Party's Failure To Perform Under A Retail Lease?

May 22, 2020

For most retailers, it has been a brutal spring. Barbershops, clothiers and myriad other businesses have been precluded under government order from selling their wares and services to customers who walk through their door. Most of these retailers lease their space, leading some to ask why they should pay their rent if they cannot operate the business that was the reason for leasing the space?

Many landlords understand the situation and sympathize with tenants who are not bringing in the revenue that pays their rent. As our colleagues have discussed in earlier posts, landlords have many reasons why they may decide it is in their best interests to work with their tenants and agree to a temporary rent deferral, term extension, or some other restructuring of lease payments. For example, in this recent post, we review how co-tenancy provisions might be triggered if a tenant decides it must cease operations at a given location. But landlords have their own obligations, especially with their mortgage lenders, and they cannot always give an accommodation that they might otherwise be willing to offer.

Given this reality, some of these conversations are not going to end in a virtual handshake. Even though many retailers are now reopening, the reality is that their world has changed and their level of business activity may not return to where it was for quite some time, if ever. Some landlords and tenants will not be able to see eye to eye on the financial terms of a compromise; some may not want to continue a particular lease for other reasons, and therefore will not work diligently to reach a compromise. When a landlord or tenant sues the other party under a commercial lease, the issue of whether the other party has a valid defense by pointing to a government shutdown order is likely to be litigated. Here are three legal principles that both sides should be thinking about.

Most parties by now have reviewed a force majeure clause, if any, in their lease. Our colleagues discuss those clauses here. In short, the force majeure defense is limited to the specific language in the clause; no clause, no defense.

Next, tenants might argue that it was impracticable to pay their rent, which may offer relief if tenants can prove that paying the rent could only be done at an excessive and unreasonable cost. This is a judicially created defense and, thus, does not require particular lease language to be invoked, unlike force majeure. The viability of an impracticability defense will depend greatly upon the factual circumstances, but it rarely succeeds and is not the best fit for this situation. See our discussion of this subject here.

Finally, a retail tenant impacted by a shutdown order may claim that the fundamental purpose of the lease was frustrated, which is a more intriguing argument. Failure to comply with a contract may be excused by the legal doctrine of frustration of purpose. The doctrine provides a defense to a breach of contract claim and also does not require a lease provision to be invoked. A party claiming this defense must prove that a subsequent event has substantially frustrated the contract’s principal purpose, the parties did not contemplate and could not foresee the event, and the event was not her fault.

Defining the principal purpose of a lease and whether that purpose has been substantially frustrated will be a matter of robust debate. Shutdown orders have been temporary in duration, and some retail businesses like restaurants surely took a hit to their sales, but they could stay open and provide take-out or delivery service. A gym or a beauty salon, however, will point to the order requiring them to lock their doors for over two months, with no ability to sell their services. Often, retail leases contain a restrictive use clause stating that the premises “shall be used solely for the operation of” a specified use. If it does contain such a provision, the tenant may have a stronger claim that shutdown orders have substantially frustrated the purpose of the lease. If not, the landlord may be able to argue that the tenant failed to consider alternative uses for the property.

If a tenant was temporarily prohibited from using their space for its primary purpose (which might be the only permissible purpose under the lease), are they excused from paying rent for that period of time? A tenant may be able to succeed on this defense at trial in the right circumstances, but tenants must keep in mind that it is a doctrine to be invoked in a lawsuit, not a magic wand in negotiations with their landlord (although it may create leverage in negotiations). If a tenant gets the chance to prove this defense, it will only be after the relationship has broken down, the lease has likely been terminated by the landlord for default, and the tenant has left the premises (or been evicted) and may have been sued for damages. The tenant will also need to overcome the landlord’s response that the purpose of the lease was for the landlord to lease the premises to the tenant, which it did, even during the shutdown orders -- that is, why should the landlord lose when it did not cause the problem?

Keep in mind that courts consider whether the problem was anticipated by the parties, which can be established if the issue is addressed in the lease agreement.  A termination provision covering a pandemic or forced shutdown situation would deprive a tenant of a frustration defense. Given the extraordinary nature of the COVID-19 pandemic, barring an applicable lease provision, it would be very difficult to show that a party could have foreseen what has happened. Suffice it to say, however, that the frustration of purpose doctrine will be more difficult to invoke with respect to leases signed after March 2020; from now on, a party to a retail lease will have a hard time proving that the parties did not contemplate that a pandemic could happen.

We are available to help landlords, tenants and property owners navigate difficult situations in light of the ever-changing rules and orders being issued on the state and federal level during the COVID-19 pandemic. For additional updates, see our Coronavirus Resource Center (specifically, the Real Estate Leasing page).

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