Commercial Leasing in Crisis

Posted on Mar 27, 2020

As business owners and landlords consider next steps during this crisis, one of the first actions they take should be reviewing key aspects of their commercial leases.

Within some commercial leases are provisions which create exceptions to performance under the lease, including the demand for continuous operation or rental payments under force majeure or government taking theories.

LEASE PROVISIONS

Force Majeure
The most common definition of a force majeure event is an “act of God.” Black’s Law Dictionary defines an act of God as “an overwhelming, unpreventable event caused exclusively by forces of nature, such as an earthquake, flood, or tornado.” Simply put, under the force majeure doctrine, “No man is responsible for that which no man can control.”  Cal. Civ. Code § 3526. 

A force majeure clause in a contract essentially renders contractual performance too difficult or even impossible where an event (or series of events) triggers a force majeure clause, thus suspending, deferring, or releasing a party of their duties to perform without liability.  See Cal. Civ. Code § 3531 (“The law never requires impossibilities.”).

In a commercial lease, if a force majeure clause is present, it will generally describe circumstances outside a party’s control that upon occurrence will excuse or delay a party’s performance, for instance, an act of terrorism, earthquake, flood, epidemics, and government action. Depending upon the language in the particular lease, the force majeure clause may permit either the landlord or tenant to terminate or suspend performance, if force majeure is applicable, for a period of time.

Insurance Provisions
In many commercial leases, insurance is required by the landlord, tenant or both. Other considerations landlords and tenants should understand is whose party’s insurance is triggered by closures or disruptions arising from COVID-19. Whose insurance (the landlord’s insurance, the tenant’s insurance or both policies) is triggered may depend on the specific language of the lease.

Additionally, although most businesses interruption coverage does not cover infectious disease, it is important to check with your insurance provider to see if you do have applicable insurance coverage. Due to the increasing time for processing claims and to meet notice requirements from insurance companies, it is strongly encouraged that clients promptly discuss their coverage polices with their insurance providers.

Condemnation/Eminent Domain 
Under an eminent domain theory, many tenants and landlords may argue they are entitled to rent relief. Some tenants may contend that government action requiring businesses to close temporarily to prevent the rapid spread of COVID-19 effectively converts leased spaces for “public use” or a benefit to the public, requiring government compensation. Similarly, landlords may file their own eminent domain action to recover if the government has “taken” the property indirectly, because their tenants are impacted due to government action.

If an eminent domain provision is present in a lease, it will often provide the landlord or tenant with the right to terminate the lease in the event of a permanent taking. If government closures related to COVID-19 are deemed takings and last only for a short duration, many tenants may pursue rent abatements under the language of their particular leases.

Doctrine of Frustration of Purpose and Impossibility In the absence of a force majeure clause in a lease, there are other legal theories that may support a defense for nonperformance. The common law doctrine of impossibility may be raised to excuse contractual performance. The doctrine of impossibility is where, “after a contract is made, a party’s performance is made impracticable without fault by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made….” See Restatement (2d) Contracts § 261.

When invoking discharge of performance on a theory of impossibility, the courts will first look to the lease for guidance for any terms or conditions that may limit the use of this doctrine. The courts may also look to the lease to see whether the purpose of the lease is able to be fulfilled, even though the unforeseeable event has occurred.

Frustration of purpose is another similar common law defense to excuse contractual performance. The doctrine of frustration of purpose is available as a defense where contractual performance remains feasible but has become pointless. See Second Restatement of Contracts § 265. To succeed in asserting a frustration defense, the purpose or contemplation of both parties for which the lease was entered into must be frustrated.

Although both doctrines depend on the specific terms of the lease the difficulties presented by COVID-19, along with the associated government actions, these doctrines offer options to parties of a lease where a force majeure clause is not expressly stated in the lease.

As your business confronts the challenges of COVID-19, we are here to help. The following online resources are helpful address and answer questions concerning the impacts of COVID-19:

Santa Barbara Public Health
https://publichealthsbc.org/

Santa Barbara County Ready – Economic Recovery
https://readysbc.org/economicrecovery/

California Coronavirus Response
https://covid19.ca.gov/

Alcoholic Beverage Control COVID-19 Updates
https://www.abc.ca.gov/law-and-policy/coronavirus19/