PLEASE... OH PLEASE...What Should I Do with My Lease???
With all the challenges arising from COVID-19, I’ve had several friends, colleagues and clients among others ask my thoughts/opinions/recommendations on what to do with respect to their real estate leases, and the impact that this epidemic may have now and in the future on their tenancy. Let me be very clear, my thoughts are my own, and generally come from an occupier’s perspective. I’m also not an attorney, nor do I claim that these thoughts/opinions are in any way perfect or substantiated by extensive research and facts. These are purely my own practical thinking, putting myself in the shoes of small businesses/owners/entrepreneurs, which is how my personal business functions. In the event any of these resonate, and are relevant to you, or you just want to brainstorm, please don’t hesitate to connect. We’re all in this together!
- Proactively over communicate with your landlord/owner of the building of your current and foreseeable future situation. Bring them into the fold. Let them know there are significant challenges that the current environment is posing to your business, which in turn affect your people, your revenue and likely your ability to pay rent, etc. At this point, you are not taking a legal stand, but you’re being a practical human being and business owner working to mitigate exposure. Chances are that the landlord has a loan on the building and your rent helps them to pay their mortgage, so the sooner you can provide this communication, the sooner they can communicate some similar relief efforts to their lender. Candidly, we are all in this together! This is an opportunity to pursue a true partnership. In some cases, an idea may be to request rent relief for 90-120 days and add that amount of term to the end of the lease, which may interrupt the immediate cashflow, but doesn’t fully devalue their asset. In turn, the landlord can then approach their lender with a similar approach. Other options may be to amortize the abated rent period to future rent payments. These are just a couple practical options to consider.
- While all leases are different, written differently, function differently, etc. there are typically a few lease clauses that may come into play now and in the immediate future. Clauses, such as:
- Force Majeure
- Insurance (Business Interruption, etc.)
- Go Dark Default
- Late Payment Penalties
- Will the Force Majeure clause in the lease offer relief? As is often the case with contracts, the answer is “it depends on the specific wording in your agreement.” That being said, as a practical matter, for a large number of smaller and mid-sized tenants who lack unlimited legal budgets (which is a large share of the marketplace), this provision is unlikely to be a source of relief for a few reasons:
(a) Landlord favorable forms that go unnegotiated. In many leasing settings, tenants lack either the desire or the leverage to negotiate the Lease at a level of scrutiny that reaches to force majeure clauses and other perceived “boilerplate.” (Negotiating terms that address once-in-a-lifetime events flies in the face of a common directive to only address “big picture issues.”) . The result is either having wording in widely used forms, like the BOMA form, which is a fundamentally landlord favorable agreement that only allows the landlord to be excused from performance due to a list of causes.(b) The resulting legal battle will be long and costly. In very few cases will the lease’s force majeure clause wording clearly state that a closure due to government order will relieve the tenant from making rent payments, and as such many landlords in need of collecting rent will push back on any ambiguous wording. For example, a landlord might note that the lease’s requirement that tenant carry business interruption insurance was intended to address this sort of situation, and a governmental shut-down merely impairs tenant’s ability to operate (i.e., comply with “Go Dark” provisions), but not its ability to cut a check. Cash strapped tenants will find it difficult to finance a lengthy legal battle, with the local courts here in Oregon already looking at significant backlogs due to closures resulting from COVID-19 social distancing efforts. As a result, favorable force majeure language and the prospect of costly litigation is better used as a bargaining chip for negotiating a settlement with the landlord, rather than as a simple fix to the problem.
- Will my business interruption insurance cover me? Again, it depends on the exact wording of the insurance policy and the type of policy. Contingent business interruption coverage is often linked to “direct physical loss or damage” – because the policy is obtained in the context of coverage in the event of a casualty occurring. Some policies have a “civil authority coverage” feature, which can be triggered when some level of government limits access to certain areas. This sort of coverage, if part of the policy, would clearly offer better chances of protection, given the broad government-mandated shutdowns that are occurring. However, even in this situation, (i) the question of what is covered will be very specific to the policy, and (ii) there is the issue of how the insurer will calculate the “recoverable financial loss.”
- Consider Subletting/Licensing etc. While these options are probably not going to get much traction in a down economy (available space will be ample; parties looking to absorb shadow space or the like will be few), it is still necessary to consider all means of generating cash and stay afloat.
- Negotiate rent reduction / forbearance or termination. As mentioned above, due to social distancing efforts local courts in the Portland area are operating a minimal capacity for the short term, impairing landlords’ ability to reclaim space from commercial tenants (residential leasing is subject to an even broader set of restrictions in Multnomah County – not addressed here) by their usual legal methods. And, when they can pursue evictions normally again, they are likely to be facing a market flooded with vacant space. As such, many landlords with B and C class properties in particularly hard-hit real estate sectors should have a strong incentive to find a way to try and keep their high-quality tenants afloat while still making their own mortgage payments to their lenders. Certainly, this may be more appealing than using costly legal processes to sue for future rents, with the risk of the tenant and guarantor filing bankruptcy.
- Anything else to consider? – Tenants occupying an entire building, or the majority of a building might want to team up with the other tenants to negotiate a deal with the landlord to temporarily curtail or stop non-essential building services to reduce costs while not operating. (Examples may include reducing the operating hours for HVAC, less frequent landscaping; limiting off-hours lighting requirements; reducing janitorial services; deferring capital work on the building; etc.).
- Don’t landlords have a legal obligation to attempt to mitigate damages from a default? The over-simplified answer is generally yes. However, in a market facing mass vacancies, damages from a lease default still may be very large and unavoidable despite active, good faith commercially reasonable efforts to find a replacement tenant.
- What if I personally guaranteed my tenant’s lease? Many small tenant leases are accompanied by a personal guaranty of the Lease obligations by the principals who own the tenant. Although there are certain legal defenses available to guarantors, as a general matter you should start from the assumption that the obligation will be enforceable and “primary” (i.e., guarantor can be sued, even if the tenant is not), subject to the specific wording of the guaranty and facts of the situation. If your personal assets are at risk, you will want to contact a lawyer immediately to consider all applicable options to mitigate (to the greatest extent possible) the financial damage that may result.