Commercial Leases: A COVID-19 Perspective
Authors: Sean J. O’Donnell and Carter G. Perks
Reading Time: 5 minutes
These blog posts are meant to provide educational content and should not be taken as legal advice.
Commercial Leases: Initial Considerations
As COVID-19 continues its spread across the globe, commercial businesses are beginning to feel the economic impact. Many landlords and tenants are growing concerned as to their rights, obligations, and options during this difficult time. The government measures that have been implemented or recommended to slow the spread of COVID-19 are forcing business owners to make difficult decisions and ask important questions.
Can a landlord insist on a tenant paying rent when the landlord has closed the building down? What remedies exist for landlords and tenants arising from COVID-19? Can a tenant unilaterally choose to shut down operations? The starting point for these questions is to review the terms of the lease. While a thoroughly drafted lease endeavours to contemplate every reasonable eventuality, very few leases will contemplate COVID-19, or a pandemic in general, and even if they do, courts will apply a narrow interpretation as to the language in order for the clause to be enforceable. In other words, any ambiguity could render the provision unenforceable in the circumstances.
Standard Lease Provisions
In a standard commercial lease agreement, the tenant is required to pay rent, “without abatement, setoff, or deduction”, throughout the term of the lease, except in circumstances of material damages or destruction. As previously discussed in SJO Legal’s article on “Rent Payment and Residential Lease Enforcement”, the risks associated with current governmental shutdowns coupled with the obligation to pay rent is certain to put significant stresses on the landlord and tenant relationship.
What is a continuous operating covenant?
In a standard commercial lease agreement, the tenant has an obligation to carry on its business from the premises in an active and continuous manner. Failure to meet this obligation is often considered an event of default which may result in the tenant being required to pay an increased level of rent for the duration of time in which the tenant is not operating. In some cases, and depending on the language of the lease, such a default can permit the landlord to terminate the lease.
What is a quiet enjoyment/possession covenant?
Known to be one of the most fundamental provisions in a commercial lease, a quiet enjoyment/possession covenant is granted by the landlord in the benefit of the tenant to provide the latter with exclusive possession of and access to the premises without material disruption from the former.
How does COVID-19 impact my commercial lease?
In order to assess the impact of COVID-19 on a particular lease, the following considerations, in addition to the precise language of the lease will apply, including:
- Nature of the commercial lease building (is it a single tenancy building or a multi-tenancy project);
- To what extent does the landlord rely on the individual tenant;
- The ability and willingness of the landlord to weather COVID-19 (keeping in mind a landlord’s fixed expenses such as mortgage payments, operating costs, and property taxes);
- Potential applicability of recently announced government programs and economic assistance; and
- Moral and ethical considerations in response to COVID-19.
Can a landlord require a tenant to pay rent during COVID-19?
This is one of the most common questions landlord and tenant clients have during this unprecedented time. Provided that the lease agreement does not provide a clear right for the tenant to abate rent or cease operations during COVID-19, it is unlikely that a court would allow a tenant to withhold rent, even in these circumstances. However, the answer to this question becomes less clear when landlords are not meeting their obligations to provide the tenant with the quiet enjoyment of the premises. In circumstances where a landlord has been forced by provincial governments to close its doors, there is an argument for rent abatement. However, the landlord can argue that the government ordered closure is more akin to an event of ‘force majeure’ (discussed below), in which case the clause would not excuse the tenant from paying rent, despite it rendering the landlord excused from its obligations to provide services and access.
Rent Deferral Agreements
A Rent Deferral Agreement allows a tenant to defer rent payment for a specified period of time. Typically, in these agreements, landlords will mandate that the tenant is still obligated to pay a portion of the full rental amount during the rent deferral period. At the conclusion of the specified time, the tenant will then resume full rent payments in addition to paying the deferred rent through a payment schedule agreed to by the parties. In these arrangements, it is important for the tenant to be aware that rent deferral is not the same as rent forgiveness. Instead, full payment of rent is still required, it is simply delayed or deferred in order for the business to operate and/or remain in its current lease without having to breach the lease agreement.
Before engaging in a Rent Deferral Agreement, a tenant should consider the following:
- The status of its current financial position;
- The ability to pay in the months ahead;
- Short and long-term business viability;
- How government assistance may help in this regard; and
- What other fixed term costs are still required.
From a landlord’s perspective, all the above would be relevant, in addition to the following:
- Whether rent deferral would be unduly onerous (i.e. stress test);
- Restrictions in the landlord’s mortgage agreement that would prevent the amendment to the lease agreement;
- History of the landlord-tenant relationship; and
- Whether other suitable tenants are available.
In the present circumstances of COVID-19, many landlords are appropriately considering this as an option for their tenants. Rent Deferral Agreements provide for the requisite flexibility for both tenants and landlords. There is ample room for negotiation in the terms of the agreement that can best suit the long-term business needs of both parties. While tenants have no legal right to extract new agreements from landlords, landlords are being encouraged do their part in trying to strategize and formulate appropriate modifications to their current lease agreement so that both parties can remain in business. While each factual scenario is different, and as a result so to will the advice, landlords who are unwilling to consider alternate arrangements in response to COVID-19 might find themselves out of pocket large sums of money. While the option to sue for breach of contract nevertheless remains untouched, the pressure of COVID-19 as an unprecedented event calls for reasonable cooperation between landlords and tenants.
What to include in a Rent Deferral Agreement?
A non-exhaustive list may include the following:
- The portion of rent to abate;
- The length of the deferment period;
- Scheduling the payment period;
- Provisions outlining breaches to the Rent Deferral Agreement;
- Option to include interest on the deferred portion of the rent;
- All existing indemnifiers to the lease; and
- The ability to allow for digital signing/execution.
As demonstrated above, there are several factors for tenants and landlords to consider before entering into a Rent Deferment Agreement. Counsel should be engaged to ensure you are advised as to the rights and risks of these agreements.
What is a ‘force majeure’ clause and does it apply?
A force majeure clause is “a contractual term by which one (or both) of the parties is entitled to cancel the contract or is excused from performance or is entitled to suspend performance […] upon the happening of a specified event or events beyond [his or her control]”. In other words, it excuses non-performance of a contractual obligation upon the occurrence of a specified, yet unforeseeable (or at least unpredictable) event or circumstance that is beyond the parties’ control, but which would not rise to the level of frustration. Viewed in this light, a force majeure clause can serve to allocate risk in a contract.
The impact of COVID-19 relative to force majeure clauses depends, to a large extent, on the exact wording of the clause itself. Force majeure clauses are to be interpreted narrowly, with close attention to the specific language used in the impugned clause.
There are four key factors that determine whether a party can rely on a force majeure clause relative to COVID-19, including:
- Whether COVID-19 falls within the scope of the force majeure clause;
- Whether COVID-19 has sufficiently impacted an obligation of the relying party;
- Whether the relying party has taken sufficient steps to avoid and mitigate COVID-19’s impact; and
- Whether additional contractual conditions are met.
A typical force majeure clause may state that the parties will not be liable for failure to perform their contractual obligations due to an event of force majeure, without providing details or specific events that would give rise to its applicability; instead, leaving it to the parties to argue what events fit the definition. On the other hand, some force majeure clauses will provide a non-exhaustive list of events that fall within the scope of a circumstance beyond the control of the parties. Such common examples will often include acts of war, terrorism, strikes, pandemics, or adverse weather conditions.
If you have questions relative to a force majeure clause, please feel free to contact us.
What does the immediate future hold?
We anticipate that there will be a number of situations where landlords are forced to close their leased locations but still demand rent from tenants. Likewise, we anticipate that tenants will be forced to temporarily cease operations and will demand either rent abatement or rent deferral until a time they are fully operational. It is not enough to simply review the terms of the commercial lease. Consideration must also be given to applicable laws, recently passed legislation, and current orders by federal, provincial, and municipal health authorities.
The first point of redress for landlords and tenants must be a cordial discussion relative to the impacts of COVID-19 and their respective business positions. Being creative, understanding, and transparent throughout this pandemic will be crucial to the success of maintaining these relationships. Keeping lines of communication open between landlords and tenants will be pivotal in the months to come. Early communication is another tip in navigating this process; it will help ensure mutual understanding and reduce unnecessary tension between the parties.
When both parties operate on the premise that reasonable concessions will be met in order to reserve their respective business operations, the discussion can be less about the legal principles and more towards the economic and social impacts of COVID-19.
If you require legal advice relative to the above or have questions regarding an issue not contained within this article, please feel free to contact us.