[co-author: Emma Keyser]

On April 6, 2020, Governor Doug Ducey issued Executive Order 2020-21, “Prohibiting Small Business Evictions,” which delays commercial eviction actions against certain small businesses and nonprofit organizations until May 31, 2020.  The Governor previously issued an order providing similar protection to residential tenants.

The Order contains four essential components:

• First, the Order suspends all evictions of for-profit entities and certain nonprofits with fewer than 500 employees who are “unable to pay rent due to the financial hardship caused by the COVID-19 pandemic.”
• Second, the Order requires a commercial tenant seeking a delay in an eviction or lockout or requesting a reduction or deferral in rent to “notify the landlord or property owner in writing as soon as practicable with any available supporting documentation of their inability to pay rent.” 
• Third, the Order requires any tenant receiving financial assistance from COVID-19-related public programs to apply a portion of their assistance to “any past or currently due rents.” 
• Fourth, the Order strongly encourages landlords, tenants, and financial institutions to explore options, such as lease restructuring, rent relief, and forbearance, but does not require that landlords or financial institutions take any specific action. 

By its explicit terms, the Order does not relieve “any individual or business of the obligation to pay rent.”  Furthermore, all eviction actions preceding March 11 may still go forward as planned.

This Order will provide temporary relief to those small businesses most affected by the State’s closure of non-essential businesses.  However, as much of the order is not mandatory, it remains to be seen whether and to what extent the provisions of the Order not directly related to eviction can and will be enforced.

Options for Commercial Landlords and Tenants

The Order encourages landlords to enter into discussion with tenants regarding possible solutions and lease restructuring. The Order recommends that commercial tenants seeking rent relief notify their landlord in writing and provide supporting documentation that evidences their inability to pay.  Commercial landlords might consider developing a brief application process that outlines what documents a requesting tenant should provide for review.  It is important to note that Landlords may offer individualized responses to different tenants, depending on several factors including the nature of each tenant’s business, the size of the tenant, the length of the lease term remaining, and the impact of COVID-19 on each tenant’s business. Commercial tenants may want to come prepared to discuss rent relief options with copies of relevant financial information, a business model, and/or a proposed plan to pay back any postponed rent sum.  Clear procedures and an objective streamlined process may help both sides assess carefully and plan efficiently.

While there are many potential lease restructuring options, they frequently could involve one or more of the following key aspects:

• A rent abatement or rent deferral program, which can apply to base rent only or to common area expenses;
• An abatement of rent for a number of months while extending the lease term and implementing a gradual rent escalation;
• Deferral of monthly rent and have the tenant amortize that payment over the course of the remaining lease term or a fixed time period;
• Apply the security deposit towards the rent, and request that tenant pay the amount necessary to restore the security deposit to its full amount over a specific term;
• Offset future payments from the landlord for tenant improvement allowances (in other words, reduce the future amount of allowance owed by the amount of rent relief given);
• Assign the proceeds from future aid from the government or insurance to the landlord.

As a best practice, both landlord and tenant may want to ensure that any lease amendment is in writing and executed by all parties, including applicable guarantors.  To avoid ambiguity, the parties may also want to avoid unintentionally agreeing to certain terms via phone or email.  Additionally, a landlord might consider requiring the tenant and its guarantor to provide other documents, such as an estoppel, waiver and/or ratification with respect to other claims or defenses available under the lease documentation or at law.  It may be important for landlords and tenants to involve their legal counsel in the early stages of these negotiations to be fully informed of how the prospective lease amendment impacts the other lease terms and interconnected contracts.

Implications and Considerations of Rent Restructuring

While commercial landlords and tenants come to the table to discuss rent abatement strategies, both parties may want to consider what impact rent relief might have on any third party to the transaction, such as a lender.  Before modifying a lease or accepting abated rent, a commercial landlord may want to consider whether a scenario is permitted under their loan documents.  For more information on loan modifications and financial institutions whose customers are affected by the COVID-19 pandemic, see this Legal Alert . For commercial tenants, another third-party worth consulting is your insurance provider.  You may have business interruption/income insurance available to help mitigate losses.  For more information on possible insurance coverage, see this Legal Alert. Additionally, certain impacted third parties may require additional documentation.  For example, amending a lease may trigger the need for internal approvals and/or consents from any managing members, board of directors, or partners.  Or, in a case where a franchise is involved, certain lease modifications may necessitate approvals from the franchisor.

Of course, each situation and set of circumstances is unique. If you are a commercial landlord or tenant who is seeking legal advice relating to COVID-19, consider consulting with your legal counsel.