Leases, Mortgages and Court Proceedings in the Age of COVID-19
What are your options for seeking relief?
American business was functioning rather well before the COVID-19 pandemic. Contracts were predictable to follow, based upon ordinary operations and expectations.
COVID-19 changed all that. Overnight, American business had to contend with local and state executive orders to stay at home, engage in social distancing and substantially limit, if not cease, certain business operations.
As a result, many companies have experienced a downturn in business. Based on shelter-in-place orders, some have closed and others have resorted to video consultations.
Challenging Governmental Orders
The decrease in business income has caused some tenants, such as Pier I, to file for Chapter 11 protection. Other businesses sought to challenge the municipal and state executive orders on constitutional grounds.
Business owners have yet to successfully challenge Connecticut’s stay-at-home and related executive orders. A recent decision discussing Connecticut’s executive orders held that one restaurant and bar owner did not demonstrate sufficient evidence to support a temporary restraining order to stay enforcement of the orders (Amato v. Elicker, 2020 U.S. District Lexis 87758).
Indeed, given the severity of the health crisis, successful challenges in hard-hit states may be few and far between. It is noteworthy that the governor of Wisconsin’s orders were reversed entirely on procedural grounds, due to a failure to follow that state’s rulemaking procedure in an emergency. However, beyond challenging governmental orders, private parties have litigation options.
Litigation Options
In the Pier I Chapter 11, the debtor, a tenant, sought to delay its rent obligations for a short period of time, by invoking the equitable powers of the bankruptcy court under Section 105. The landlords naturally objected, but the court sided with the debtor, noting the delayed rent payments would still be due, and insurance, utility and related payments would continue to be made by the debtor. It was also interesting the bankruptcy court noted the following:
While landlords may be able to take advantage of the funding recently made available under the Coronavirus Economic Stabilization Act of 2020 (CARES Act), the Debtors are unable to obtain such funding due to certain eligibility and solvency requirements associated with receiving funding under the CARES Act promulgated by the Small Business Administration.
Courts will continue to deal with exercising equitable powers to administer bankruptcy and other cases involving leases and other contracts. The doctrines of frustration of purpose, impossibility of performance and force majeure may provide relief to parties who were unable to perform contractual obligations during the COVID-19 pandemic.
Black’s Law Dictionary defines force majeure (French for “superior force”) as an event or effect that can be neither anticipated nor controlled. The term is commonly understood to encompass both acts of nature, (e.g., floods and hurricanes) and acts of man (e.g., riots, strikes and wars). Black’s Law Dictionary further defines force majeure clauses as contractual provisions that address circumstances in which contractual performance becomes impossible or impracticable due to events that could not have been foreseen and are not within a party’s control. It is important to note force majeure clauses do not generally provide for termination of an agreement; rather, they generally suspend a party’s obligation to perform under the agreement for the duration of the force majeure event.
The rationale behind force majeure clauses is there will always be events that cannot be anticipated and addressed and for which neither party to an agreement is responsible. In such circumstances, it is equitable and reasonable to suspend performance and extend contract deadlines. However, contracts can and usually do include terms as to what qualifies as a force majeure event and what notice requirements must be met to obtain relief from required performance.
Finding Resolution
Both landlords and tenants should benefit from negotiations to resolve rent, expense and modified space issues. Increases in common operating expenses for cleaning leased space will be required to be compliant with current health requirements. Space may need to be modified to meet distancing guidelines, and some tenants, like restaurants, may need outdoor dining to stay afloat in the COVID-19 world or face closing their doors.
A landlord with a rent abatement request from a tenant may be well advised to accommodate such a request. Some employers may be considering reducing existing office space as more employees work from home, so having a tenant vested in a long-term relationship should provide sufficient incentive to negotiate.
Of course, there are always disputes that cannot be resolved. Parties wishing to go on the offensive can seek declaratory relief and damages from the courts. Courts faced with leases that lack a force majeure provision will be asked to invoke equity to solve contractual disputes. A landlord anticipating rents to satisfy mortgage obligations may need to exercise litigation rights immediately to avoid a default under a mortgage loan. The short-term federal stimulus programs may have alleviated some of those concerns for the time being. Once the federal stimulus process is exhausted, commercial property owners will see the tenants that remain as long-term business partners.
For investors with commercial mortgages that may be in default, many state courts either are not permitting foreclosure judgments to enter or are not currently accessible for court proceedings. The bankruptcy courts appear to have continued their operations. At least one bankruptcy court has approved an auction of property during the COVID-19 pandemic. In that case, which involved a luxury single-family home on waterfront property, the court approved an auction during this pandemic. In its opinion, the Court stated as follows:
Perhaps on the sunniest of summer days, when potential buyers would be wearing not just dark-tinted glasses, but rose-colored ones as well, such circumstances may converge to yield a substantially higher sale price. However, absent the presence of such optimal conditions, and given the administrative expense burn rate and the Debtor’s corresponding inability to cover those administrative costs, the stayed state court foreclosure, the major economic disruptions caused by the Covid-19 pandemic, and the logistical and health concerns associated with attempting to re-market and auction a substantially encumbered trophy property under the present circumstances, the Objectors claims are simply not founded in credible evidence or common sense. Most importantly, they are not founded upon any admissible testimony or recognized empirical data.
Obviously, not all collateral can be classified as a “trophy” property. Nevertheless, the Court’s rationale in approving the auction makes practical business and legal sense. Time will instruct whether such a rationale is applied by state courts around the country as nonperforming assets are sold as part of foreclosure or other legal process.
