As more and more commercial tenants stop paying rent under their leases due to the impacts of COVID-19, much has been written in recent weeks about possible defenses to performance such as force majeure, frustration of purpose, and impossibility. The strength of these defenses varies depending on the nature of the default and the specific terms of the lease, but if the parties do eventually decide to pursue a mutually acceptable form of rent relief, landlords should evaluate the following questions and issues before entering into any formal agreements with such tenants.
1. Review of Lease. The landlord should first review the lease and become familiar with any provisions which may come into play during rent relief negotiations. In addition to the covenants related to the payment of rent, such other provisions may include force majeure, late charge, interest on late payments, continuous operations, co-tenancy, inducement recapture, security deposits, and notice requirements.
2. Impact of Potential Vacancy. If rent relief is not provided and the tenant eventually goes out of business, how severe would any resulting impacts of the tenant’s vacancy be on the overall property and the landlord’s ability to pay its mortgage? How difficult would it be to find a new tenant for the space?
3. Verification of Tenant’s Financial Condition. What financial evidence will the landlord require from the tenant in order to verify the tenant’s current financial condition and inability to pay rent?
4. Lender Consent. If the property is financed, do the loan covenants require consent from the landlord’s lender prior to amending the applicable lease or otherwise granting rent relief?
5. Landlord Defaults. Does the tenant have a reasonable argument that the landlord has also failed to satisfy any covenants or conditions under the lease? How might these impact the landlord’s position while negotiating rent relief? For example, has the landlord closed the common areas? Has the landlord failed to perform any maintenance and repair obligations? How are closures of other businesses at the property impacting any co-tenancy rights?
6. Rent Relief Alternatives. The appropriate form of rent relief will vary based on a tenant’s particular circumstances and the landlord’s tolerances and goals, and may include any one or more of the following arrangements: rent deferral, rent abatement, temporary or permanent rent reduction, waiver of late charges and interest, continued payments of operating expenses, interest on deferred rent, repayment of deferred rent extending over a few weeks or many months, with the first payment due in a matter of weeks, at the end of the term, or anywhere in between.
7. Lease Modifications. It would be reasonable for a landlord to request non-monetary consideration from the tenant in exchange for granting rent relief. Examples include a concurrent extension of the lease term, removal of undesirable operating expense exclusions, additional financial reporting requirements, relocation rights, termination rights, a general release of claims, and the elimination of any exclusive use rights, renewal options, space reduction options, or rights of first refusal. A landlord may also require the tenant to apply for relief under state and federal programs or pursue claims under its business interruption insurance, and apply a portion of any resulting proceeds towards the payment of rent. Note, however, that a tenant’s actual success in such efforts may be limited by then-current funding availability or policy exclusions which have not been overridden by legislation.
8. Eviction Moratorium. Due to the current moratorium on eviction proceedings in California, characterizing any correspondence to the tenant as a formal “Notice of Default” pursuant to the Event of Default provisions of the lease while the moratorium is in place may not be looked upon favorably by the courts. In addressing the default, an alternative approach would be to acknowledge the fact that the tenant has failed to timely pay rent and include a statement that the landlord is expressly reserving all rights and remedies under the lease and all applicable laws. Governmental orders or ordinances may also impact the substance of your communications.
Copyright © 2020, Murphy Austin Adams Schoenfeld LLP. All rights reserved. Please be assured that we make every effort to make certain that the information contained in this alert is current at the time this email was delivered. Because laws and legislation are constantly changing, please contact us if you are unsure whether this material is still current. Nothing contained herein should be construed as legal advice or a legal opinion on any specific facts or circumstances. The contents are intended to be for general information purposes only. We assume no liability in connection with the use of the information contained in this article. Given the rapidly evolving nature of legal and governmental responses to the COVID-19 pandemic, unfolding events likely will supersede many of the issues discussed in these updates. We encourage you to contact our lawyers directly for the most current information and counsel regarding legal and governmental responses to the COVID-19 pandemic. Please contact us to answer any questions you may have.
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Catherine Oh, Commercial Real Estate Law Partner
916-446-2300, Ext. 3076