Like so many business sectors and industries, the real estate sector is experiencing a revenue decrease. COVID-19-related shelter-in-place orders are impacting families and family businesses drastically. Privately-held trusts and family-owned companies, lenders, borrowers, landlords, and tenants face unprecedented issues in the collection of revenue and payment of debt. This article examines some of the legal and business considerations in navigating these challenges.
Lease Defaults and Deferrals
Government-mandated shut downs and social distancing requirements in connection with COVID-19 are leading to tenant rent defaults and deferral requests. Landlords seeking to enforce lease provisions should be prepared for today’s changed economic and legal environment.
- Litigation. Absent the pandemic, a landlord might not hesitate to commence litigation. However, Massachusetts, Rhode Island, and many other states have limited landlords’ ability to commence eviction proceedings in order to leverage rent payment (see related articles here and here). Once restrictions begin to ease, judges’ dockets will be backlogged. In addition, courts have not addressed many of the legal issues the pandemic will present.
- Force majeure. A common question will be whether a force majeure provision will excuse a default in a given situation. Burns & Levinson wrote a simple letter that enabled a client to use the theory of force majeure to avoid a contractual requirement that would have obligated his business entity to pay for exorbitantly-priced space. Tenants may also pursue common law defenses such as impracticability or frustration of purpose.
- Good faith negotiations. The lease of family owned real estate, especially commercial real estate, turns on relationships with tenants. Indeed, good faith negotiations may promote and enhance future relationships between family businesses who are negotiating deferrals to avoid defaults. As discussed here, landlords and tenants that are able to agree on alternate terms during the pandemic should enter into a forbearance agreement or lease amendment. Common approaches include an “amend and extend,” pursuant to which the landlord will allow, for example, the deferral of rent for a three-month period, in exchange for which the term of the lease is extended for three months. Under other arrangements, the tenant may pay (for a limited time) fixed rent but not shared operating charges, or pay an equivalent of the landlord’s overhead for the leased space, with the balance of rent repaid over the remainder of the lease. Before finalizing an agreement, landlords should review their loan documents and, if necessary, obtain any required lender consent. This will preserve relationships with the tenant business and protect the family landlord for years to come due to good faith dealings.
Loan Defaults and Deferrals
- Communicate early. Family real estate companies who are borrowers who anticipate falling behind in loan payments should communicate early and often with their lenders.
- Consider modifications. Loan modification agreements can be flexible and tailored to meet the objectives of the family holdings on a short term and a long term basis: interest only payments, escrow (tax and insurance) only payments and partial payments are some options. As with lease modifications, family lenders and family borrowers should document any amendment so that there is a clear understanding of what is expected, and what happens if the modified terms are not met. In family businesses, this documentation is of particular importance as a protection to the family in the event of an untoward family event so as to identify impacts to family assets and prevent dissipation of family assets due unexpected to family lifecycle events and family challenges.
- Be prepared to answer questions. Absent agreement to the contrary, reflexive defaults can result in late fees, credit ramifications and potential acceleration of the total amount owed under the note. When contacting the lender for a modification, anticipate questions, including: has your business been shut down or curtailed by government order? What is your plan for resuming business once restrictions are lifted? Have you applied for a Payroll Protection Program loan? What type of payments can you make?
- Litigation as a last resort. Understandably, lenders are seeing borrower payment defaults and other, more technical, loan defaults. Borrowers are not meeting financial covenants, such as debt service coverage ratios, as well as loan agreement catch-all clauses such as “material adverse changes to the financial condition” of borrowers. But for similar reasons as those facing landlords, real estate lenders should consider litigation as a last resort in responding to borrower defaults during the pandemic. Further, government regulators have encouraged lenders to pursue loan modifications rather than declaring defaults during the pandemic and have indicated they will be flexible in reviewing such arrangements.
Privately-held trusts and family-owned businesses, lenders, borrowers, landlords, and tenants will continue to weather difficult circumstances for the foreseeable future.