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The impact of coronavirus on commercial real estate contracts

Jonathan Lilley is a partner and commercial litigator at Blaser Mills Law

The commercial real estate market is fast-moving and complex at the best of times and, like many other industries, it is now being turned upside down by the coronavirus pandemic.

The sector is starting to see the first signs of stress as businesses are seeking to move out of office spaces they can no longer afford, and the pandemic has left many extremely wary of committing to anything long term.

Companies that formerly viewed working from home as detrimental to productivity are now questioning whether it is worth spending lots of money every month on rent, and many landlords are wondering where they stand when it comes to their commercial real estate contracts. Here are some of the main points landlords need to be aware of.

Can commercial tenants terminate a lease because of the pandemic?

Even if your tenant chooses to close their business or can no longer afford to pay their rent, they cannot terminate their lease unless it includes a break clause allowing them to do so; or it specifically permits them to declare that a force majeure event has occurred in order to excuse performance of their obligations/tenancy, however such clauses are not commonplace in commercial leases. Even more fraught with difficulty, the tenant can argue that the lease has been ‘frustrated’ which is a complex contractual argument – of which more is mentioned below.

‘Force majeure’ is a term meaning ‘superior force’ which is used in legal documents to reference an intervening act entirely outside of a party’s control, such as volcanic eruption, war and earthquake.

Tenants may assume they are covered if their tenancy agreement includes such a clause. However, although Covid-19 is an event outside their control, it doesn’t necessarily mean they can cancel their tenancy agreement without penalty.

In English law, the courts are especially strict in the interpretation of the meaning of such a clause. To use a force majeure clause to protect themselves against a claim, the tenant will need to convince the court that the event was beyond their control, has prevented or hindered their performance of the contract and that they have done all that is reasonable to comply with their obligations under the contract.

What if there is no force majeure clause in the tenancy agreement?

As force majeure clauses are not commonplace in leases, your tenant may instead hope to rely on the doctrine of ‘frustration’ to terminate the lease and their liabilities under it. Frustration is only applicable where unforeseeable circumstances either radically alter the nature of the parties’ obligations or make it impossible for them to perform their obligations under the lease.

It is not enough to argue that things have just become more difficult. Although it is accepted that a lease can, in principle, be frustrated by a change in circumstances beyond the reasonable control of one or more of the parties, the threshold is exceptionally high and, in the past, the courts have taken quite a restricted line to the principle of frustration.

We are not aware of any reported instances of the doctrine of frustration having been used successfully to discharge a party’s obligations under a lease, so tenants are unlikely to succeed by using this as a tool to seek early termination.

Can landlords evict their tenants if they can’t pay their rent?

Tenants are still be liable for their commercial rent, but you do not currently have the grounds to evict them if they fail to make payments. The Chancellor’s package of temporary measures to support businesses through the current period of disruption states that tenants struggling to afford the payments because of Covid-19 will be protected from eviction, and no business can be forced out of their premises if they miss a payment up until 30th June.

Does business interruption insurance cover Covid-19 related losses for landlords?

Many commercial landlords affected by missed rental payments are wondering whether these losses are covered by their business interruption insurance policies. Generally speaking, income losses won’t be covered under such policies, as the typical business interruption insurance policy requires that the suspension of business operations must be caused by direct physical loss or damage to property.

It also requires that the suspension of business is caused by or results from a covered loss, and many policies contain endorsements that specifically exclude coverage for ‘viruses, bacterium and pandemics’.

What else does a landlord need to consider?

On 23rd April 2020, Business Secretary Alok Sharma encouraged landlords to “show forbearance” and tenants to pay what rent they can afford, while putting into place restrictions to prevent “aggressive tactics” to collect rent. This of course is a plea for goodwill to be shown on both sides.

Ultimately, therefore, and aside from whatever the strict legal position may be, the effects of the current circumstances, which potentially impact so severely upon landlords and tenants alike, stand a better chance of being managed to a position with which both parties can be content if historical goodwill has been fostered between landlord and tenant during the course of the relationship prior to this crisis occurring.

Conversely, if any party to a lease has behaved badly to the other in the past, then it is at times like this that such behaviour can start to produce ‘bad fruit’ in that relationship. This time may therefore cause the overly aggressive landlord, as well as the ‘anti-landlord’ tenant to reflect upon such past conduct in this relationship, possibly leading to some modification in any future dealings.

There is also an opportunity here for either party to a previously bad relationship to ‘mend the fences’ as it were, by taking a stance in light of this crisis that demonstrates a change of style, which in turn could produce ‘good fruit’ for the future of that relationship.

What can landlords do if they are still unsure where they stand?

We are facing unprecedented times and, for commercial landlords, knowing your legal obligations when it comes to tenancy agreements and understanding if you are covered for any losses can be a complicated matter. Anybody unsure should seek external advice from a qualified legal professional with experience dealing with commercial real estate contracts. They will be able to review your contracts and help you reach the best possible outcome.