In a recent webinar, Wendel Rosen LLP partners Daniel Myers, Gregg Ankenman, and Albert Flor, Jr. shared important legal lessons they’ve learned from the COVID-19 pandemic and provided several predictions as to how the pandemic will impact real estate law in the future, with a particular focus on issues facing commercial landlords and tenants.
Lesson One: The language of the lease is key and common law concepts are still important.
During the pandemic, both landlords and tenants pulled out old leases to see how they addressed closures due to the pandemic. In particular, did the force majeure provision in the lease cover the pandemic and excuse the payment of rent? While shutdowns due to the pandemic were covered by most force majeure provisions in leases, they often stated that payment of rent was not excused by force majeure. As a result, many tenants looked to common law concepts, like frustration of purpose, impossibility and impracticability, for relief. These doctrines, that used to be mainly discussed in law school, have now become familiar to all commercial real estate lawyers. While in limited circumstances, some out-of-state courts have held that the doctrines apply, the panelists were not aware of any published opinion to date from a California appellate court specifically excusing the payment of rent during the pandemic under these common law doctrines. We note, however, that a recent California Court of Appeal case, The Inns by the Sea v. California Mutual Ins. Co. (2021 DJDAR 11813, November 15, 2021), held that an insured could not recover under its business interruption insurance policy because governmental COVID-19 closure orders did not constitute a physical loss or damage to property triggering coverage. Of course, practitioners should continue to monitor published opinions to see if there are new caselaw developments.
Lesson Two: In extreme situations, state and local governments will try to protect commercial tenants – which will significantly impact commercial landlords.
Because existing lease language often did not provide relief for commercial tenants due to pandemic-related closures, state and local governments stepped in to do so. The State of California allowed cities and counties to adopt eviction moratoriums protecting commercial tenants. The typical commercial eviction moratorium prohibited landlords from evicting tenants for the non-payment of rent. The last of the state-authorized commercial eviction moratoriums expired on September 30, 2021. However, many ordinances have repayment periods (for past due rent accrued during the pandemic) lasting well past September 30. As a result, landlords looking to enforce non-payment of rent actions should carefully review the language of the applicable ordinance. In many cases, the inability to enforce tenant defaults caused landlords to seek negotiated settlements with tenants.
Lesson Three: Courts will not always be accessible.
For the first time in recent memory, courts were closed on a statewide basis and parties could not obtain standard judicial relief. Even though courts have now reopened, there continues to be significant backlogs and delays. Parties must keep this in mind as the inability to gain access to court directly impacts both strategies and the ability to redress rights. Parties should consider including alternative dispute procedures, such as binding arbitration or judicial reference, in lease agreements. While courts became largely inaccessible, private judging continued unabated during the pandemic.
Lesson Four: Parties can negotiate many different alternative payment structures to keep leases in place.
Despite everything, many commercial landlords and tenants were able to reach negotiated agreements to address rent relief and payments going forward. These agreements included rent abatement for certain periods of time, deferral and repayment obligations and changes in rent structures – such as percentage rent tied to sales or rent tied to certain occupancy percentages, sometimes combined with lease term extensions. These agreements often relaxed operating covenants for tenants and in some cases changed co-tenancy requirements for landlords. These agreements were negotiated on a case-by-case basis so no one-size fits all standards were adopted. The parties should note that except in obvious circumstances, to grant rent relief, landlords typically required tenants to provide specific evidence as to how the pandemic impacted the tenants’ financial condition.
Lesson Five: Landlords have found alternatives to unlawful detainer proceedings to enforce rights under leases.
Because of the ban on unlawful detainer proceedings, commercial landlords were forced to find other ways to protect their rights. To the extent lawsuits were filed, they were typically based on breach of contract/lease claims. Although in a breach of contract/lease action the landlord cannot recover possession for the failure to pay rent, the landlord can recover past due rent and related damages. To further increase leverage, a landlord in such a case can also seek a temporary protective order or writ of attachment. A writ of attachment enables a creditor to put a lien on the debtor’s property prior to a judgment. For undisputed commercial contract claims with damages in liquidated amounts, a party can file a motion to obtain a writ of attachment in the amount of the claim that the party is likely to recover, plus anticipated attorneys’ fees and costs. In such a case, a sheriff may levy on bank accounts, real property, or other available assets. The assets will then be held by the sheriff until judgment. Although it takes some time for the court to move to an ultimate judgment, a breach of contact/lease case coupled with attachment provides a way for a landlord to exert leverage. Once an attachment is issued, most cases move toward settlement or bankruptcy.
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First Prediction for the Future: Certain lease provisions will change because of the pandemic.
Because of the pandemic, commercial landlords and tenants are re-examining a wide range of standard lease provisions. Both landlords and tenants are more carefully drafting force majeure provisions to address future pandemics and other unexpected events. Some parties are specifically addressing rent abatement and other rights in the event of government mandated closures. Tenants are asking for more flexibility in operating covenants, which require tenants to continuously operate their store for a set number of hours and days per week. Similarly, landlords in shopping center leases are seeking to change or are refusing to grant co-tenancy rights. A co-tenancy clause allows a tenant to reduce rent and, in some cases, terminate the lease, if core tenants leave or a certain percentage of square footage the retail center becomes vacant. The idea is that the co-tenancy provision provides the tenant with some form of protection to compensate for the loss of traffic. However, landlords are re-examining the entire purpose of these co-tenancy provisions and they will undoubtable change in the future. Landlords are also reviewing how “gross sales” are calculated to determine a tenant’s obligation to pay percentage rent. As e-commerce strategically integrates with brick-and-mortar locations (e.g., order on-line and pick up or return at stores, order at store at on-line kiosk for home delivery, etc.), these definitions will continue to evolve.
Second Prediction: As courts remain backlogged, parties will need to plan for alternative ways to adjudicate and enforce rights.
Prior to the pandemic, obtaining a court date was often a frustrating process due to many delays. With our new normal, courts are even less accessible. As a result, binding alternative dispute resolution options will become even more important to address the unavailability of traditional courtrooms. Examples of these include:
- Binding Arbitration – Arbitration is the most common form of alternative dispute resolution as it allows for a neutral arbitrator to render a binding decision at the end of a hearing. Arbitration is faster than a court proceeding and most remedies in a lease setting are available. While the parties will have to pay an arbitrator, which can be costly, the time savings and less formal environment usually translates into lower attorneys’ fees.
- Judicial Reference – This is similar to an arbitration except that the judicial referee is required to follow the law and the award may be appealed. This option eliminates the courts and juries and proceeds with a court-appointed judicial referee presiding over a trial. The referee prepares a statement of decision that stands as the decision of the court. Judicial reference can save time as referees have a shorter deadline to provide a decision than judges.
- Mediation – With the assistance of a neutral third party, mediation allows for negotiation between the parties. Mediation is not always recommended as it can become unproductive if both parties are not adequately motivated. Successful mediation occurs when both parties have equal incentives to reach a solution. Because motivation is a key factor in any mediation, we do not recommend mandatory mediation clauses in leases as a mandatory mediation can often be a waste of time and money.
Third Prediction: Landlord/Tenant flexibility and negotiated exit strategies will be important.
As society emerges from the pandemic, parties continue to look for flexibility in leasing. Landlords and tenants both fear being locked into leases in uncertain and unpredictable times. Tenants will require shorter leases with various exit rights. Tenants may also ask for smaller spaces with more autonomy to utilize the space how they see fit. Landlords will want to continue to have some control and may ask for termination rights for underperforming tenants. No matter what, parties must continue to find creative solutions as the future is unpredictable.