Nearly four years after the depths of the COVID-19 pandemic, issues concerning the legal consequences of executive and legislative orders shutting down business operations are still working their way through appellate courts throughout the United States. Maryland’s second highest appellate court addressed some of these issues in its December 20, 2023 opinion in SVAP II Pasadena Crossroads LLC v. Fitness International LLC.
In 2009, Fitness International LLC (the “Tenant”) leased space in a shopping center from SVAP II Pasadena Crossroads LLC (the “Landlord”) in which the Tenant operated a fitness facility. On March 16, 2020, in response to the outbreak of COVID-19, Maryland’s Governor issued an executive order closing all fitness centers to the public. The Tenant was prohibited from opening its facility to the public until June 19, 2020.
The Tenant did not pay rent for the months of April, May, and June of 2020. It sent a letter to the Landlord asserting that it was excused from paying rent because the Governor’s order was a “force majeure event” that frustrated the purpose of the lease and made performance “both impossible and impracticable.” The Landlord disagreed and sued the Tenant for the unpaid rent plus late charges and attorneys’ fees. The Tenant filed counterclaims against the Landlord, alleging that the Landlord had breached the provision of the lease that the Tenant had the right to use the leased premises for “the operation of a health club and fitness facility” and the covenant in the lease that the Tenant’s operation of the property as such a facility “does not and will not violate any…restrictions on use within the Project.”
While the lawsuit was pending, the Landlord sold the property in which the leased premises were located to Paramount Realty NJ LLC (“Paramount”). The purchase and sale agreement provided that Paramount was to bill tenants for rent, including rent that had accrued before the sale closed, and that Paramount was to remit rents paid for periods before closing to the Landlord. The purchase and sale agreement also provided that the Landlord could not collect rents due for the period before the sale closed or pursue any action against tenants to collect such rents. Based on this provision, the Tenant argued that the Landlord no longer had any right to collect rent from it.
The trial court ruled against the Landlord on its claim for rent and entered a judgment for $35,529.98 plus costs in favor of the Tenant on its breach of lease claims. The Landlord appealed to the Appellate Court of Maryland.
On the issue of whether the Landlord’s agreement with Paramount deprived the Landlord of standing to collect rent that accrued before the sale closed, the Court first noted that sale of a property does not excuse a tenant from paying rent and that Maryland law generally provides that when property is sold, “unpaid accrued rent, unless otherwise provided for, belongs to the person who was the landlord at the time of accrual.” Although the purchase and sale agreement provided that the Landlord would not pursue any action to collect rents due before the sale to Paramount closed, the Purchase and Sale Agreement also had multiple detailed provisions relating specifically to the Landlord’s already pending litigation with the Tenant. Those provisions included one specifying that the Landlord had no obligation to settle that litigation and another in which the Landlord agreed to indemnify and hold Paramount harmless against liability stemming from that litigation. The Court concluded that these specific provisions controlled over the general prohibition on collection of pre-closing rents by the Landlord.
Since there was no dispute that the Tenant had failed to pay rent provided for in the lease, the Court next examined whether the Tenant had established one of the “very similar related defenses” of “frustration of purpose” of the lease or “legal impossibility of performance,” so as to excuse its failure to pay rent. The Court concluded that it had not.
To establish a “frustration of purpose” defense, the Tenant needed to show that the purpose of the lease was “completely frustrated.” The Tenant did not meet its burden because the lease did not restrict the use of the leased premises to operation of a fitness facility, but allowed any “retail or commercial use of the type typically found in a retail shopping center.” Consequently, the Tenant could have used the premises for other purposes while the Governor’s order prohibited public access to fitness facilities. The Governor’s order also did not prohibit payment of rent. Moreover, the three-month period in which the Tenant was prohibited from operating a fitness facility was “a relatively short time compared to the overall lease term” and the Tenant was able to resume normal operations after three months.
Perhaps more importantly, the Landlord and the Tenant had agreed in the lease that “in no event…shall Tenant’s obligation to pay Minimum Rent or Additional Rent pursuant to the terms and provisions of this Lease be excused by a Force Majeure Event.” The Court said that “When parties have allocated the risk of an unforeseen event, extra-contractual defenses do not displace the allocation of risk set forth in the contract.” Even though the Court had discussed frustration of purpose and impossibility of performance at length before discussing the allocation of risk provided for in the lease, the Court said that, because that Tenant had agreed to bear the risk that a force majeure would prevent it from operating its business, its “extra-contractual defenses fail as a matter of law.” Accordingly, the Court concluded that the trial court had erred in ruling against the Landlord on its breach of lease claim.
Moving to the Tenant’s counterclaims, the Court said that the Tenant had not shown that the Landlord had breached the lease. The provision that the premises could be operated as a fitness center merely permitted the Tenant to operate a fitness center, it did not guarantee operation of a fitness center. As the Court summed it up, “The executive orders issued during the early days of the COVID-19 pandemic were the cause of the temporary closure of [the Tenant’s] business-not any action taken by Landlord.” Accordingly, the Court concluded that the trial court had also erred in awarding the Tenant a judgment against the Landlord.
Although the Fitness International opinion contains extensive discussion of “extra-contractual” defenses, in the end, the outcome of the case hinged on the language in the purchase and sale agreement between the Landlord and Paramount and the lease between the Landlord and the Tenant. Although defenses such as frustration of purpose and impossibility of performance are useful when the applicable contract provides no clear answer, because, as the Fitness International Court said, “Contracts play a critical role in allocating the risks and benefits of our economy,” the analysis should always start, and should most often end, with the language of the contract.
