May the Force (Majeure) be with You
Force majeure clauses took center stage as the COVID-19 Pandemic raged in 2020. Stay at home orders forced businesses to close down, limit occupancy or change their way of doing business. Suddenly, this often forgotten clause, likely tucked at the back of a commercial lease, became the focus of every landlord and tenant across the nation.
An inability to perform or force majeure clause is intended to cover those instances when a party simply cannot perform due to a cause outside of its control. In these instances, performance has generally been excused for the period of the delay. However, in many cases, these clauses have been drafted to specifically carve out monetary obligations, such that the parties remain obligated to pay monetary obligations, regardless of the situation.
Each lease clause requires a separate analysis, as there is no universal clause for force majeure. Some may have included “viruses” or provisions regarding monetary obligations, while many did not. If we fast forward now by more than a year, many are demanding that COVID-19, any “COVID-19-Like” incident and viruses generally be specifically called out with monetary provisions for relief. These incidents are generically being defined as “special circumstances,” a “pandemic occurrence,” a “governmental restriction” or other terms. While many may disagree with allocating the monetary risk of a pandemic, something that neither Landlord nor Tenant caused or controls, the alternative is to face the unknown where tenants simply stop paying rent until a deal can be negotiated. Moratoriums on eviction and the closure of many courthouses forced landlords to the table to negotiate, as their arsenal of remedies was severely depleted.
As you consider the new generation of clauses related to COVID-19, there are a number of factors to consider:
- Insurance. Is there business interruption or rent loss insurance that covers a loss of income or rent due to COVID-19? Following the SARS incident of 2002-2003, many policies have now been written to exclude viruses. Following COVID-19, there will likely be revised language in this regard. Insurers seem to be holding their ground in court when these provisions have been challenged, but insurance policies may contain different language on viruses or the definition of a loss and each has to be checked carefully. In any event, to the extent either party has insurance to cover the event, it should be tapped first.
- Essential vs. Non-Essential Business. Is the business an essential business or non-essential business? The risk of a COVID-19 event depends on the likelihood of that business to close. While jurisdictions differ on the strict definition of an essential business, primary medical offices, grocery stores, pharmacies, gas stations, banks and manufacturing facilities were generally deemed essential. At the other end of the spectrum, sit-down restaurants, concert and banquet facilities and gyms and health clubs were among the “most” non-essential businesses, remaining closed for longer periods of time than other retail and service businesses.
- Period of Closure. Will the closure reduce occupancy or require a complete shutdown of the business? Certain closures limit the occupancy or capacity level rather than mandate a complete closure of the business. This can make for an easy allocation of risk, but could be skewed in favor of one party or the other. For example, if retail stores are limited to 50% occupancy, it may not be fair to reduce rent by 50% for a store that never operates at or close to full capacity. It also makes it difficult to determine the percentage in the event of pick up and delivery, but the parties could compare sales in that instance.
- Type of Shutdown. What type of shutdown are the parties contemplating—a governmental mandate or a governmental recommendation, a mask mandate or recommendation or the determination that a party is uncomfortable operating its business? Determining whether a party is absolutely forced to close or prohibited to operate is different than allowing discretion for a party to close and could lead to abuse of the provision.
- Length of Time. How long will the remedy be effective? In our current situation, as states outlined phases for reopening, there was no certainly on when certain types of uses, such as banquet halls and concert facilities, would be allowed to open and operate at full capacity. Leaving any period of relief open ended makes it difficult for one party to shoulder the risk over another and there should be some limitation of time after which the risk will shift back. This period could also coincide with any deferral of mortgage payments to tie the period to a metric.
- Abatement or Deferral. Will the monetary obligations be forever forgiven or should the business catch up at some point in the future? Our experience shows that the decision to abate or defer rent was based on a number of factors. In many cases, the parties continued to pay for maintenance, taxes and insurance, as those were out-of-pocket costs that were not being deferred for landlords. In cases where abatement was agreed, there was often another incentive tied to the decision, such as an extension of term, resolution of an ongoing debate on operating expenses, waiver of a use clause or other provision. While deferral is preferred from a landlord perspective, there remains a concern as to whether the tenant will be able to withstand additional rent obligations upon reopening and often provides for an acceleration of the deferral obligations in the event of a default.
- Opening or Ongoing Operation. Will different remedies be allowed if the pandemic prohibits the opening of a new business rather than a business in existence? When a new business is unable to open or the parties are even unable to come out to finalize inspections or delivery, it seems that more deference would be given to the business owner in terms of rent abatement, since that business has yet to develop a revenue stream, clients or customers or any reserves with which to fund rent.
- Lender. What does the loan require in the event of a lease default or modification? While negotiating a creative deal may be the best resolution, the terms of financing may dictate the terms of any deal. In certain instances, landlords were forced to push back on deals regarding rent abatement or deferral in order to obtain a loan deferral. Depending on the size of the lease or the terms of the financing, new leases or lease modifications may also require lender approval.
After completing this analysis, the parties then have to put pen to paper and draft the clause. There is still no “one size fits all” or even “one size fits most” provision for these situations. However, we have seen that many courts are receptive to enforcing the terms of an agreement allocating the risk of a force majeure type event, so long as it is clear. There are still outliers in which the courts have tried to impose their own interpretation, but more clarity in these provisions will further limit those instances.
Force majeure is just one area in which the pandemic is being addressed. COVID-19 shutdowns are also being addressed in other provisions, such as covenants to operate, co-tenancy and delivery provisions. Each of these will require careful analysis and consideration.
Marcia Owens is a Partner at Honigman LLP. Her practice focuses on representing developers and investors and spans all aspects of commercial real estate, from acquisition and disposition, to commercial leasing, finance, workouts and restructuring. Marcia was recently named to the Top 50 Women in Law list by Chicago Lawyer and has been recognized as a Leading Lawyer, SuperLawyer and Best Lawyer for multiple years.