By Jigar Desai
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COVID-19 has brought us into an unprecedented time. Currently, the impact of the virus has played a large impact on businesses, forcing many to close their doors. Current estimates state that over 630,000 US retail locations have been closed. As businesses begin the sale or closure process, they are left with their contractual obligations on their rent. This guide will help you manage navigating through that process.
A common reason for business closure is the sizeable rent being charged against business owners. Businesses are not currently in operation or are limited in operation during the virus but are still being charged rent. There is a negative return on investment as businesses are being charged without making profit to offset the charges. In a typical lease, the obligation of the landlord is independent from the obligation of the tenant. This means that while a business is not occupying a rented space due to the coronavirus, they can still be charged rent by the landlord. This is a list of options that tenants can further apply to delay the rent collection process. Each option may not apply, so please look at your specific contract.
Insurance
Businesses will commonly look to their property damage and business interruption insurance policies to see if they will cover their losses. Initially the insurance industry has come out and stated that it will not be covering rent due to the pandemic. The blanket denial by the industry is an expected response, but upon closer examination, we can see that each rental agreement is different. While many contracts use common boilerplate form, the terms and definitions in them may vary. Boilerplate form means a basic template contract that most rental agreements use. Each policyholder is recommended to review their contract and demand coverage where necessary.
What should you look for? Policyholders should check for 1) the property damage “trigger,” (2) the existence and terms of any additional coverage extensions, and (3) the terms and structure of any exclusions that their insurers may seek to apply. These issues may require a lawyer to resolve; check out Pillsbury Law for help. Commercial property insurance is generally triggered by “physical loss or damage to property.” Thus, coverage is applied dependent on the insurer finding a case of physical damage. However, many of the “damages” suffered by business owners is financial and not physical loss. Natural disasters, such as earthquakes and hurricanes, come to mind when thinking about damage to property. But, we must think past what we can see with our eyes. Owners can claim the presence of a physical loss if the COVID-19 contagion is present in their location. Due to the virus’ nature of surviving a few days on surfaces, business owners may claim that the loss of operation is attributed to the loss of physical items. Businesses would be recommended for removing items or closing features that have been exposed to a case of COVID-19. This loss of physical property generally constitutes a “business interruption.” Courts have generally held that contamination does constitute a physical loss or damage to the insured property. But once again, that matter should be reserved for a lawyer for review.
As a supplement to the aforementioned clause, tenants may also look to find a civil authority clause in their contract. A civil authority clause applies when a civil authority (local, state, or federal governments) prohibits access to the insured property. When “access to the area immediately surrounding the damaged (contaminated) property is prohibited by civil authority” or when “civil authority is taken in response to dangerous physical conditions resulting from the contamination,” then a claim may be made. For example, if a fire damages a property, authorities may block off the entire area for public safety. The purpose of the civil authority clause is to expand the business interruption coverage. In order to qualify for this clause, an owner must qualify for the business interruption coverage. In our modern case, a claim may be made for businesses that have been closed by local government due to COVID-19 exposure. For businesses that do not operate under a quarantine order, civil authority coverage covers a prohibition of access. This requires an official order from the government banning business operations.
A unique clause that may apply is an ingress/egress clause. Ingress means entering and egress means leaving. This clause is an extension of the business interruption clause and does not require physical damage to the insured property. The clause states that this damage prevents the movement to and from business premises. Some examples include the prohibition of entering into a store, goods unable to be shipped from the store, or materials unable to be shipped into the store. This is a viable option for businesses not operating in a state that is under shelter-in-place order. The ingress/egress clause operates independently from a civil authority clause. This allows protection for businesses that do not operate under a shelter-in-place order that have been affected by states and customers who are under a shelter-in-place order. An example would be businesses that ship a majority of products to other states.
Insurers may claim that a stay-at-home order is focused on people rather than a business, thus nullifying a civil authority order. But, many governments have listed specific businesses from operating as non-essential businesses. Here is a list of some businesses exempt and not exempt in San Antonio’s most recent order. Insurers will also likely claim that the COVID-19 related civil orders do not completely close access to the building, but only restrict access to the building. This requires a further examination of an owner’s contract to see if a complete restriction is required. A prohibition of a majority of business operations may meet this standard as well. Few policies have explicitly ruled out loss from contaminants, thus emphasizing the need to review each policy before moving forward.
Rent Deferral
A business owner can deal with the landlord directly with regard to rent deferral. Many businesses are in the same boat as you, so landlords could potentially lose a sizeable stream of income at once. Owners can work to reach an agreement to defer all or a portion of rent (taxes, operating costs, insurance) for a set period of time -- 60, 90, or 120 days. The deferred rent would then be paid in a lump sum on a stated date or over a period of time. This provides the landlord with certainty and the tenant with relief. The lack of immediate cash flow for the landlord can prohibit making a deal, but this can be offset by restructuring additional months to the original term, amortization over the remaining term, or a balloon payment at a future date. A key concept in working with a landlord is to manage give-and-take. This can be accomplished by ensuring that the landlord will receive a benefit in the future for a tenant’s relief in the present. A similar option would be to apply the security deposit towards the rent and then having the opportunity to replenish the deposit. This option may be a short-term option as compared to the other options. Tenants may also be able to sell their contractual options. Options, such as their Right of First Refusal or Right of First Offer, can be sold back to the landlord for short-term relief.
Force Majeure
A force majeure clause is a clause that excuses a party from performing its obligations in a contract due to acts of God. This clause essentially relieves parties from their obligations when events beyond their control interfere with their ability to perform. Usually, this clause causes permanent relief from a contract, but in our rent scenario, it can be used to temporarily delay the time rent is due. Under common boilerplate contract forms, the force majeure clause has specifically defined events but also has a “catch-all” at the end. American Bar Association provides a complete definition of the clause and examples. This is important because the force majeure clause only applies to a specified scenario in a contract. There is little wiggle room outside of what is specified. This could also mean that a deadly virus may not be specified, but a government ban prohibiting business could be mentioned under the force majeure clause.
Use of the Property
All tenants have the right to use and enjoyment of their property. All contracts state this right whether or not it is specified. Tenants may claim that the fact they have to pay rent for barred property frustrates the purpose of the entire contract. Common sense would indicate that it is not fair to make someone pay in the age of COVID-19. Contracts have this fundamental fairness to them that is implied beyond past the literal words of the contract.
This fairness is exemplified in the common idea of “impossibility.” The principle is based on whether the landlord and tenant can carry out their contract or whether it is impossible to do so given the circumstances at no fault of either person. A tenant must determine whether it is truly impossible to occupy the property, rather than a situation that makes it difficult to do so. The second hurdle to cross is to search within your contract for an “no abatement” clause. An abatement clause is one that releases a tenant from rent obligation where an act of God prevents the occupancy of the building.
Alternative Options
If there is no possibility to delay or renegotiate the rent, these are a tenant’s remaining options. A tenant can sublease a portion or entire working space to cover the months’ rent that the tenant will be missing. If you are a business, whose operations have been suspended under shelter-in-place laws, subleasing to a business that operates as an exception would be an ideal option. Subleasing requires approval by the landlord. Keep in mind that you are still responsible for the lease and will be liable for any damages and lease violations that occur during the sublease. A similar option is assigning your lease, which is similar to subleasing, but instead turning over their entire terms of the lease. Assignment is the last option since you would be turning over the right to the property to another individual.
A tenant can buy-out the remaining lease through negotiation with the landlord. By providing a lump sum payment, a tenant can sever their ties with the contract and the landlord can begin their search for a new tenant. During these difficult times, a landlord would also be seeking a guaranteed flow of income from a tenant.
Conclusion
We have laid out a few options on how to grant yourself rent relief. Some options require more diligence on the part of the tenant. When forming a solution with your landlord, put your newly formed agreement in writing. This would help with any possible disputes and creates a clear guideline. Before perusing an option, please review your rental agreement, local governances and consult a lawyer if you have more questions. COVID-19 has caused the world to enter into an unprecedented time, but relief is possible.
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