The COVID-19 epidemic presents significant challenges to the commercial real estate market in the United States. As governors impose shutdown orders and Americans are told to shelter-in-place, commercial offices and retail locations sit unoccupied at unprecedented levels. As April approaches, property owners and lenders will be expecting monthly lease and mortgage payments, while tenants and landlords are assessing their obligation (and ability) to pay. How do we define these obligations, and how should landlords and tenants proceed in these uncertain times?
Tenant Rights and Obligations
An assessment of a tenant’s lease obligations begins with the underlying lease document. Tenants will likely start by reviewing any force majeure provision in their lease. As detailed by my colleagues in this article, tenants may face an uphill battle in asserting this defense. Even if a force majeure provision applies to the present situation, these provisions often exclude a tenant’s monetary obligations.
Tenants paying on a percentage rent basis could find some relief in their rent provisions, and other atypical provisions could come into play (for example, an early termination provision triggered by a shopping center’s occupancy falling below a certain level). Absent these, many tenants find that they are still responsible for their lease payments despite being unable to operate at the premises they are renting. Furthermore, for reasons detailed by my colleagues in this article, a tenant may not have a clear path to recovering under a business interruption insurance policy, which intensifies the financial burden.
In the face of these obligations, many tenants have turned to asking nicely. In the past few weeks, property owners have been inundated with requests for rent holidays or short-term rent abatements. Landlords are implored to cooperate and make concessions that will be a “win-win” for both parties in the long run. When assessing these proposals, one primary factor looms particularly large: The landlord’s obligation to its lenders.
Landlord Rights and Obligations
Unfortunately for landlords and tenants alike, the analysis of a landlord’s obligation under its loan agreement tends to mirror the analysis of a tenant’s obligation under its lease. Force majeure or materially adverse change provisions are not likely to excuse the landlord’s monetary performance. Landlords may need the lender’s consent to amend the leases, and the failure by tenants to pay or operate could trip covenants in the loan documents and trigger a default. Moreover, the landlord also may have an uphill battle in pursuing a business interruption claim. The result is that a landlord otherwise willing to cooperate with its tenant may be prohibited from doing so by its loan agreements.
Where permitted by their lenders (or for unencumbered properties), landlords should weigh the short-term burden of granting the relief against any long-term benefit they would receive. We have encouraged landlords and tenants to find mutually beneficial arrangements if available, particularly where the hardship is believed to be short-term.
Where Do We Go From Here?
Unfortunately, there is no one-size-fits-all solution to this problem. Fox Rothschild is monitoring potential federal, state and local relief efforts that might help simplify these discussions and facilitate resolutions.
[View source.]
