Lease Issues in the COVID-19 Environment [Part 2]

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The COVID-19 crisis has significantly impacted the ability of parties to satisfy their respective obligations under their commercial leases.  As mentioned in Part 1 of this series, many parties are discovering that the language of force majeure clauses often lacks the specificity to adequately address this unique situation.  Part 2 of this series explores the approaches being taken by parties to resolve the practical issues in leases caused by COVID-19.

While remedies provisions tend to favor the rights of landlords, many landlords are realizing that being “legally right” may not be the optimal solution.  For the most part, tenants and landlords have been taking a collaborative approach with lease workouts in this unprecedented time. 

Many landlords may be disinclined to use their remedies, and courts may be unavailable to grant relief, due to current suspension of non-essential proceedings and shortage of personnel to file claims. In other words, it may take a long time to obtain judgments, and recovery under such judgments may be impractical in the current environment.  Accordingly, many landlords have been taking a pragmatic approach, rather than digging through lease provisions and making arguments regarding the parties’ respective responsibility.  In general, landlords are recognizing that responsiveness, flexibility, and collaboration will be appreciated once the crisis has passed and will better serve the landlords’ interests in the long run.

Many landlords have indicated their willingness to grant said relief largely depends on how tenants conduct themselves.  It is best for tenants to have a well-planned, realistic strategy when requesting rent relief.  In general, the strength of the need for rent relief needs to mirror the magnitude of the “ask.”   An informed, well-supported approach is more likely to render a favorable result than simply a blind request.

Any procedures required by landlords for rent reduction request must be satisfied, which may include tenants disclosing (i) how COVID-19 has impacted their business, (ii) what steps have been taken to adjust operations and manage their income stream, (iii) financial records for the past several years, and (iv) whether small business loan assistance has been requested or provided.  Notwithstanding the foregoing, many landlords have complained that many tenants are asking for rent reductions without even providing the most basic or salient information requested by landlords to make this determination.

Many landlords have been more willing to work with local tenants, whereas many national tenants have taken a less cooperative and more unilateral approach.  Many national tenants have sent notices affirmatively stating that they intend not to pay rent and insisting on rent reduction.  It is generally not recommended to send a notice of anticipatory default, particularly with no supporting information, as to how COVID-19 has adversely impacted the tenant’s operations.

It would also be helpful for tenants to understand the landlord’s structure, incentives, and position, so that the parties can creatively collaborate to arrive at the best solution.  For example, many landlords cannot grant lease modifications without obtaining the lender’s approval and/or investors’ approval for any lease modifications. Therefore, it is important that any modification remain subject to the approval of the landlord’s lender.  It is worth noting that if a landlord is dealing with a CMBS lender, the process will be more protracted and difficult than if dealing with a conventional lender, and, in most cases, the process will not even begin until the borrower/landlord signs a pre-negotiation letter with its lender.  

Tenant should also review their insurance policy to explore what coverage may apply. Many tenants have encountered the issue that business interruption insurance tends to only apply to losses due to physical damage (or there may be an express exclusion to pandemics under the tenant’s insurance policy).  It is important that tenants discuss insurance coverage with their insurance advisors as soon as possible, to determine whether coverage may exist, so that timely claims can be filed.

One common solution that parties have been implementing is to defer payments for 90 to 120 days, with the understanding that deferred rent payments will be paid within 12 months thereafter. To demonstrate good faith, tenants should be willing to continue to pay operating expenses during the deferred payment period.  In general, tenants should expect trade-offs and concessions for any deferral of payments under the lease.  Landlords may require lease extensions by tenants and/or waivers of tenant-friendly provisions, such as rights of first refusal and rights to expand, in connection with the forbearance of rent payments.

As a rule of thumb, the language of the lease should shape the discussion and facilitate a reasonable outcome between the parties.   Prior to entering lease workout discussions, parties should first consult with their attorneys, to determine their rights, obligations, and alternatives. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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