Real Estate Client Alert – May 2020
The novel Coronavirus (COVID-19) and executive orders from Governor Northam requiring businesses to either close or significantly reduce operations have affected many businesses throughout Virginia. The resulting crisis has led to an economic environment where experts are indicating that COVID-19 could cause a global recession or possibly a global depression. During this pandemic, the federal government is providing monetary relief to businesses to pay rent through programs like the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act was a more than $2 trillion bill signed by President Trump on March 27, which established, among other things, the Paycheck Protection Program (the “PPP”).
PPP allows small businesses with 500 or fewer employees to apply for federal loans of up to eight weeks of payroll costs (including benefits and overhead costs) in order to pay employees, as well as costs associated with mortgage interest, rent, and utility. The amount that a company can receive from PPP is capped at $10 million but is otherwise limited to 2.5 times the amount of the companies monthly payroll costs. However, in only 13 days, the initial funds of PPP were completed depleted. As a result, Congress injected an additional $310 billion into the program through the Paycheck Protection Program and Health Care Enhancement Act. Industry experts believe that this additional funding will run out just as quickly as the initial funding of PPP. Accordingly, property managers, landlords, and tenants may be unable to take advantage of any current and future programs because they may not meet all of the requirements to receive proceeds or they might not be able to receive the necessary funding before the PPP funds are depleted. Therefore, it is important to understand additional options that are available to property managers, landlords, and tenants of commercial property in order to mitigate losses that occur from COVID-19.
Properly Document Everything in the Lease Amendment
Property managers, landlords, and tenants of commercial property are trying to fend off the potentially lethal blow from COVID-19 by modifying their lease agreements and implementing new policies so that they do not have to solely rely on monetary relief from the federal government to survive. Commercial landlords should consider implementing a comprehensive, unique plan for each of its tenants because a plan that works for one tenant might not be ideal for another tenant. Because each situation is unique, landlords should seek a nondisclosure agreement so that the details of the agreement will remain confidential and the landlords’ desire to help a tenant won’t undermine future negotiations it has with other tenants. Here are some possibilities that a landlord and tenant should consider when modifying their lease agreement:
- Abate rent for an agreed-upon period in exchange for an extended termination date or restrictive use provision. This modification to the lease agreement would allow a tenant who is lacking enough capital to pay rent to not worry about potentially being evicted or defaulting on the lease agreement. The tenant would also appreciate the landlord understanding the tenant’s current situation and doing all it can do to help the tenant survive. It would be beneficial for the landlord because the landlord could extend the termination date, which would allow the landlord to minimize the vacant spaces that it has during a period of time where tenants aren’t really looking to relocate. A landlord could also agree to the amendment in exchange for requiring the tenant to restrict the use of the premises. This would be ideal where the tenant has a really strong business portfolio in a certain area and the tenant was looking at changing industries. Although a landlord would lose money by choosing to abate rent for a tenant, it would benefit the landlord by allowing the landlord to keep the premises occupied. After the executive orders are lifted and businesses start to come back to work, the landlord can later terminate the abatement and bring back the initial rental agreement. In addition, landlords should not agree to rent abatement in exchange for an extended termination date or restrictive use provision if the tenant is not in a good financial situation. Accordingly, landlords should first consider its own financial stability and the tenants’ financial strength before agreeing to abate the rent.
- Defer rent for an agreed-upon period with a requirement for the tenant to use proceeds from government or insurance that become available now or at a later date to pay rent. This modification to the lease agreement would benefit a landlord since it would prevent the space occupied by a tenant from becoming vacant in a time period where it would be extremely difficult to find another tenant. It would also allow the landlord to collect the full payment of rent from the tenant at a later agreed upon time. Additionally, landlords who modify the lease agreement by using this method would know that a tenant who receives government or insurance proceeds now or at a later time would have to use the proceeds to pay the landlord. In addition, landlords should assess the finances of a tenant and the strength of its particular industry before agreeing to defer rent for an agreed-upon period. If the tenant is financially sound and is in an industry that will likely recover from this economic downturn, then the tenant would be a prime candidate to agree to a deferment. Accordingly, if a tenant is not financially sound prior to COVID-19 or has become financially unsound during COVID-19, it should seek another method to amend the lease.
- Defer rent for an agreed-upon period to mitigate losses from a tenant who is unable to pay. This modification to the lease agreement will benefit landlords who think the tenant will be able to weather the storm of COVID-19 and remain in business. Although the landlord won’t recover rent when it was initially due, deferring rent will allow the landlord to eventually recover rent from the tenant. However, landlords should prefer to defer rent with a requirement for the tenant to use proceeds from government or insurance since the tenant would be required to pay rent if it receives aid from the government or its insurance. If a landlord doesn’t mandate that a tenant use proceeds that it receives from government or insurance proceeds, then a tenant could use the proceeds for another reason even though it had the resources to pay the rent. Additionally, this method would not be advantageous for a landlord who has debt obligations in the immediate future and is uncertain if it can recover enough money from other tenants to make up from not being able to recover rent from the tenant who had their rent deferred. Accordingly, a landlord should only defer rent in order to mitigate losses from a tenant who is unable to pay rent if it is financially sound and confident that the tenant will survive post-COVID-19.
- Defer rent for an agreed-upon period with repayment amortized over the remaining term. The landlord will still be able to recover the full amount of rent by using this method at a later time.
Reduce rent for an agreed-upon period. Reducing rent for an agreed-upon period will help the landlord mitigate its losses by being able to recover a portion of the rent. Landlords should consider this option for tenants who are struggling financially but will still be able to pay a part of the initial agreed-upon rent. However, landlords should be aware that agreeing to accept a reduction in rent will result in the landlord not recover all of the initial agreed-upon rent. Landlords who are strapped for cash should be wary of this option since it might result in them being unable to meet their obligations to lenders.
- Suspend late fees and interest. A landlord should consider suspending late fees and interest if the tenant is financially stable and hasn’t been late on paying rent prior to COVID-19. This will benefit a tenant who might not be able to pay rent on time because of COVID-19 but is still stable enough to pay rent a little later than normal. This option will likely strengthen the relationship between the landlord and the tenant. The tenant will appreciate that the landlord isn’t penalizing it for paying rent late during a strained economic period and the landlord will still be able to receive rent from the tenant. Landlords should once again consider the financial stability of the tenant. If the landlord thinks the tenant might not survive COVID-19 or the tenants’ industry was already struggling prior to COVID-19 (e.g. retail), then the landlord should consider an alternative way to amend the lease.
- Expand or reduce leased premises. This modification of the lease agreement should be considered if the landlord is having trouble retaining tenants or if the landlord has vacant space available to give a financially sound tenant. A landlord should be careful when reducing leased premises because it will likely result in reduced rent and might make it more difficult for the landlord to satisfy its own debt obligations. On the other hand, if a landlord has a financially sound tenant and is worried about the property’s vacancies, a landlord can attempt to keep a financially sound tenant by expanding the leased square footage of the tenant at a reduced rate. Landlords should avoid this option if they do not have a lot of vacancies in their office or if the tenant is not financially sound and unlikely to survive post-COVID-19.
- The landlord should make sure that the wording in the lease agreement expressly limits the tenant’s rent relief to basic relief and not additional rent (e.g. operating expenses, taxes, electricity charges, etc.). The tenant will still have an obligation to pay for additional rental expenses during this period, which would mitigate the losses that the landlord experiences during business closures. A landlord should not use this option if a tenant is in dire straits and would need to receive relief for additional rent as well. A landlord could check the tenants’ financials by looking at the PPP application form of the tenant.
- Incorporate provision in the lease agreement to accelerate payment of relieved rent if the tenant defaults on terms of the lease. This method would create a safety net for the landlord if the tenant is unable to pay relieved rent at the agreed-upon time. Additionally, it increases the tools that a landlord has at its disposal if the tenant is unable to adhere to the terms of the lease.
If the tenant or landlord is struggling financially, negotiate a lease termination agreement to avoid future litigation.
- Consider relocating the tenant to a more desirable space in building if the tenant can afford the rent. This modification of the lease agreement is a great option if the landlord has available space and a financially sound tenant who can afford the likely increased rent wants to move into a more desirable space of the building. This is also a great option for the landlord because they will be able to keep a tenant who has a greater chance of surviving and paying rent during COVID-19 than tenants who are struggling financially. However, a landlord should first make sure that the tenant is financially stable and can afford to pay an increase in rent before agreeing to let the tenant move to a more desirable space in its building. A landlord can achieve this by looking at the tenant’s financial records from the previous year. Accordingly, a landlord should only consider this option if the tenant is financially stable and wants to stay on the landlord’s premises for the foreseeable future.
- Consider a pre-negotiation agreement that sets forth rules that would govern a lease amendment between a landlord and tenant. Having a pre-negotiation agreement in place will set forth the guidelines for future discussion concerning amending the lease and it will also lower the likelihood of miscommunication between landlord and tenant. However, landlords should ensure every guideline it wants is in place in the pre-negotiation agreement if it plans on using one. Otherwise, a landlord might find themselves unable to circumvent the pre-negotiation agreement to include a guideline that wasn’t in the pre-negotiation agreement.
Benefits of Using Rent Abatement or Rent Deferment
The tenants who are struggling to operate during this pandemic will likely ask its landlord for a rent abatement or rent deferment. A landlord should first take into consideration its loan covenants with its own lenders before agreeing to a rent abatement or rent deferment. If the landlord thinks it’s more likely than not that it will default on its loan with a lender, then it should refrain from giving a tenant a rent abatement or rent deferment. Generally, a landlord should seek a rent deferral instead of a rent abatement because they will be able to at least recover part of the rent. In addition, the tenant will greatly appreciate receiving rental relief and the landlord will still be able to fully collect the rent at a later date. Another benefit of a landlord opting to give the tenant a rent deferment is that it can require the tenant to use proceeds that it receives from governmental or insurance programs (e.g. PPP). In order to ensure tenants use government or insurance proceeds to pay the rent, landlords should add language in the lease agreement requiring the tenant to use the funds it receives from PPP or any other future proceeds to repay the landlord and offset any rental relief. However, landlords should be aware that giving a rent deferral to a tenant will saddle the tenant with heavy financial obligations whenever the novel COVID-19 subsides and the lease resumes. Landlords should be sure that the tenant will be able to satisfy those heavy financial obligations before giving a rent deferral, especially if parties agree that the tenant will face penalties if it is unable to pay rent when the lease resumes. Regardless of whether a landlord gives the tenant a rent abatement or deferment, the landlord should make sure that the tenant waives all rights, defenses, and entitlements (e.g. force majeure, impossibility of performance, frustration of purpose, loss of quiet enjoyment, etc.) that it might have as a defense because of COVID-19. By doing so, the landlord and tenant will both benefit from the tenant receiving a rent abatement or rent deferment. Whenever a rent abatement or deferment is requested by a tenant, the landlord should consider the following factors:
- Tenant’s potential to remain profitable after COVID-19 subsides. If the tenant had strong finances prior to COVID-19 and is in an industry that experts believe will thrive post-COVID-19, then a landlord should consider doing all it can to keep the tenant afloat. A landlord should consider rent abatement or rent deferment if the tenant will struggle to maintain operations and pay rent during COVID-19, but is able to show through its PPP application that it has enough money to pay employees and keep the company afloat during COVID-19 in the immediate future. By keeping a good tenant afloat, a landlord will maximize its chances of keeping the tenant after businesses are allowed to come back to the office. However, a landlord should not consider giving a rent abatement or rent deferment to a tenant who struggled to pay rent prior to COVID-19 and doesn’t have strong finances shown in its PPP application form.
- Payment history of the tenant. If the tenant has struggled to pay rent on time to the landlord prior to COVID-19, then it is advisable that the landlord preclude the tenant from a rent abatement or rent deferment. Additionally, this could be a good opportunity for the landlord to get rid of a tenant who has not been paying its rent. If, however, a tenant of a landlord has consistently paid rent on time, then the landlord should consider giving the tenant a rent abatement or rent deferment if it will help the tenant stay in business. In addition, a tenant who has had a prior history of paying rent on time has a greater likelihood of using proceeds that it receives from government or insurance proceeds to pay rent. Accordingly, a tenant who has a good history of paying rent is an ideal candidate for a landlord to help by giving a rent abatement or rent deferment depending on that tenant’s particular needs and financial situation during COVID-19.
- Duration of the lease. Landlords should ensure that they have a start and end date for COVID-19 rent relief arrangements with its tenants. If COVID-19 lasts longer or is shorter than expected, the landlord can always extend or shorten the term of the lease at a later time. The typical period of time that many landlords have been doing is around three to six months. It is advisable that landlords refrain from specifying the duration to an unknown period (e.g. for as long as COVID-19 lasts) because such wording is ambiguous and the tenant could hypothetically argue that COVID-19 hasn’t ended even if cases have substantially declined in order to retain its ability to continue receiving rent deferment or rent abatement.
- Whether the tenants’ financials from the prior year to the current year can demonstrate an impact due to COVID-19. If the tenants’ financials from the prior year to the current year can’t demonstrate an impact because of COVID-19, then the tenant has not been negatively affected by COVID-19. As a result, a landlord should not harm its own finances by giving that kind of tenant a rent abatement or rent deferment. In addition, the tenant not affected by COVID-19 likely has a better chance than those affected by COVID-19 to pay rent, so there is no benefit for a landlord in this situation to give a tenant a rental abatement or rental deferment. If, however, the tenant financials does demonstrate that there was an impact because of COVID-19, then the landlord should help the tenant with a rent abatement or rent deferment.
- Remedies available to the landlord. If a landlord decides to agree to a rent deferment, it should ensure that remedies are available if the tenant does not adhere to the lease agreement. The primary remedy that a landlord should invoke is that rent will become immediately due and payable if the tenant (1) defaults under the relief agreement or lease; (2) assigns or subleases all or part of the premises during the period of rent deferment; (3) terminates the lease; or (4) receives government proceeds and refuses to use the proceeds to pay rent. However, a landlord should avoid these remedies and possibly look at extending a rent abatement to a tenant if the tenant has heavy financial obligations and was already struggling prior to the novel coronavirus (COVID-19).
- Availability of tenant to use federal government programs to pay rent. A landlord should consider whether a tenant is eligible to use federal government programs to pay rent before agreeing to abate or defer the rent for the tenant. If the tenant happens to be a smaller company, then there is a greater likelihood that the tenant will be eligible to receive any governmental proceeds (e.g. PPP). Even if the government doesn’t limit how to use any future governmental proceeds, a landlord could consider amending the lease to include a provision that requires the tenant to use at least a portion of proceeds to pay as much rent as possible, regardless of whether the tenant has agreed to an abatement or a deferment.
- Landlord cash flow needs and financial obligations. If a Landlord has debt obligations, then it should refrain from extending too many abatements or deferments to its tenants. By extending too many rent abatements or rent deferments, a landlord could risk being unable to satisfy its own financial obligations. Accordingly, a landlord should first look at its own financial obligations first before deciding whether or not to give a tenant or tenants rental relief in the form of a rental abatement or a rental deferment.
Putting COVID-19 in Force Majeure Clauses
A commercial landlord and tenant can protect themselves by looking at the force majeure clause in their lease agreement. A force majeure clause is a provision in the lease agreement that excuses performance of the lease if an extraordinary event happens that is beyond the landlord and tenants’ control. Recently, parties in a contract have referenced specific pandemics that are genetically related to COVID-19 (e.g. SARS, MERS). Other parties have referenced the generic term pandemics in force majeure clauses to ensure that the other party would still be obligated to perform under a contract if any sort of pandemic occurs. Generally, landlords construct the force majeure clause narrowly to ensure that the force majeure clause does not apply to rent payment. However, if it is not explicit that the force majeure clause does not apply to rent payment, property managers, landlords, and tenants should be aware that courts in Virginia will enforce the plain and unambiguous meaning of the force majeure clause in the lease. Accordingly, property managers, landlords, and tenants should consider the following questions when they look at the force majeure clause in their lease agreement:
- Is COVID-19 or the generic term pandemics referenced in the force majeure clause? In Virginia, courts will enforce the plain and unambiguous meaning conveyed in the force majeure clause. As a result, the wording in the force majeure provision will decide whether the tenant is exempt from paying rent because of COVID-19. If the wording in the force majeure clause is broadly construed to encompass any kind of pandemic that might arise, then a court in Virginia will likely conclude that a tenant is exempt from paying rent because of the novel Coronavirus COVID-19. In this situation, it is advisable for landlords to give the tenant a rent abatement, deferment, or some other form of relief in exchange for the tenant agreeing to waive any defenses they might have had in the initial lease agreement (e.g. force majeure, frustration of purpose, etc.). Accordingly, the landlord should incorporate wording into the amendment to the lease agreement that will preclude the tenant from using COVID-19 or any other kind of pandemic as an excuse to not pay rent.
- Is it better to work out a force majeure dispute than it would be to proceed to court? Landlords should seek to quash force majeure disputes with their tenants before the matter proceeds to court. This is because it will likely take a long period of time until the landlord and tenant are able to present their issue in front of a court because of COVID-19. It is also likely that courts will hear cases in phases—first hearing the more important criminal cases where a defendant has a right to a speedy trial. Because of this, it is reasonable to think that it will take much longer for a landlord and tenant to settle a force majeure dispute in court than it would otherwise take during a normal environment. In addition, it would be advantageous for both parties to sit down and work out a deal if they believe their finances are strong enough to get them through COVID-19. Although a landlord might have to accede to rental relief or another form of relief for a tenant, it will likely be a lot less expensive than proceeding to argue the dispute in court.
- Is a party trying to be excused from performing the contract or paying rent? Generally, many landlords have wording in force majeure clauses that prevent tenants from using the force majeure as an excuse to not pay rent. Even if there is no wording in the force majeure clause preventing the tenant from using the force majeure clause as an excuse to not pay rent, an act of God will typically only occur when it is expressly stated in the force majeure clause. Accordingly, the tenant is very unlikely to be excused from paying rent because of COVID-19 in Virginia.
Was COVID-19 the sole proximate cause of the tenant’s injury? In Cooper v. Horn, the Supreme Court of Virginia held that an act of God must be the only proximate cause of the injury. If the tenant could have mitigated the nonperformance of rent, then the tenant will not be exempt from paying rent because of COVID-19. This is because COVID-19 wasn’t the only reason why the tenant couldn’t pay rent, but it stemmed from the tenant’s own negligence (e.g. landlord offers tenant rent abatement, but tenant rejects and tries to terminate the lease because of COVID-19).
Business Interruption Insurance Exclusions from COVID-19
Property managers, landlords, and tenants should look at their business insurance policies to try and recover money because of COVID-19. Since COVID-19 has ravaged our economy, many insurers are claiming that the virus is not covered, because there has been no actual physical damage to the property. However, courts throughout the United States have ruled that physical damage to the property is not necessary to recover insurance if the building was rendered unusable by physical forces. COVID-19 can be seen as a physical force that is sufficient to trigger business interruption coverages since there is ample scientific evidence showing that the virus can remain on hard surfaces such as doorknobs or counters for days. It is important for property managers, landlords, and tenants to submit claims promptly because the failure to promptly file a claim could result in the claim being denied. Accordingly, property managers, landlords, and tenants should consider the following claims:
- File a notice of claim even if your insurance policy says you’re not covered for a virus-caused emergency shutdown. In TRAVCO v. Ward, the federal court held that there doesn’t need to be physical damage if the building was rendered unusable by physical forces. Property managers, landlords, and tenants can all argue that their premises were rendered unusable because they can’t use their facilities. In addition, COVID-19 is a contagious virus that stays on hard surfaces for days at a time, further strengthening the argument that COVID-19 caused physical damage to the building. Accordingly, there is enough evidence to suggest that property managers, landlords, and tenants should all consider filing a notice of claim even if the insurance policy says you’re not covered for a virus-caused emergency shutdown.
- Civil Authority Coverage. Most insurance policies have a civil authority provision that could apply if any level of government prohibits a property manager, landlord, or tenant from entering their premises because of the direct physical loss of damage to the property from a covered cause of loss. Property managers, landlords, and tenants should carefully read their insurance policies because each policy will differ and the terms and conditions of the insurance policy will prevail over assumptions or generalizations.
- Business interruption insurance coverage typically allows a business to recover losses if the business losses are a result of physical damage or loss that prevents a business from operating (e.g. suppliers, customers). Property managers, landlords, and tenants should look carefully at their policies because insurers could have an exclusion designed to preclude coverage from viral outbreaks (e.g., SARS, MARS, etc.). Regardless of whether the insurer excluded viral outbreaks, this claim will likely be unsuccessful because a business interruption is unlikely to be considered as physical damage to the business of the insured as a covered loss.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2020.