Real Estate in the Age of the Coronavirus
Real Estate Alert 04/01/20 Jason F. Wood, Mary Ann Murray, Kirsten A. Morelli
As our government and healthcare systems rush to address the coronavirus (“COVID-19”) pandemic, we are only beginning to understand the scope of its impact on the real estate industry. While COVID-19 has created challenges across all aspects of real estate, the most common questions relate to the effects of the pandemic on commercial leasing and purchase and sale transactions.
In determining how to respond to the COVID-19 crisis, commercial landlords and tenants affected by the pandemic should carefully review their leases for force majeure, co-tenancy, “go dark”, condemnation and casualty provisions. Consideration should also be given to potential sources of relief from damages due to forced closures, such as business interruption insurance. Parties who are proactive in understanding the rights and remedies available to them under lease agreements, as well as possible relief available pursuant to the Coronavirus Aid, Relief, and Economic Security Act, effective March 27, 2020 (“CARES Act”) are more likely to emerge from this crisis with a positive outcome.
Many commercial leases contain a force majeure clause which excuses or allows parties to delay performance or allows for termination of the lease due to an “Act of God” or other similar unforeseen causes which may prevent a party from satisfying its obligations under the lease. Clients have questioned whether the current forced business closures and “shelter in place” proclamations qualify as a force majeure and therefore allow tenants to avoid paying rent or terminate a lease.
There are several considerations in determining whether the current COVID-19 pandemic constitutes force majeure. First and foremost, review the specific language contained in the lease. Force majeure clauses are generally interpreted narrowly by courts; however, if the force majeure language includes closures due to pandemics, epidemics, acts of God, or other “unforeseeable events”, it is likely that COVID-19 will be interpreted as a force majeure event under the lease. If the force majeure provision includes language which could arguably include the COVID-19 pandemic and resulting business closures, the next step is to examine the remedies available under the provision. Many leases only excuse performance that has become truly impossible (rather than just less desirable or uneconomic), while others may excuse or delay all performance under the lease. Often, specific obligations may be expressly excluded from force majeure, in particular, payment of rent and other sums under the lease.
The exact wording of the lease is critical to this analysis. Landlords and tenants should take a proactive approach in reviewing these clauses to avoid missing notice deadlines or taking required action to mitigate damages, which may limit the availability of remedies under force majeure provisions.
Co-tenancy Provisions and “Going Dark”
Co-tenancy provisions are most often present in retail leases for properties within shopping centers or malls. In these types of leases, the location’s value (and therefore the rent paid by a retail tenant) is highly dependent upon the proximity to other tenants, which are often large national chains (“anchor tenants”) who drive customer traffic to the location. Co-tenancy provisions either outline specific retailers that must be open and conducting business or set a minimum occupancy threshold for the shopping center or mall as a whole. If those thresholds are not met (often for a specific amount of time), these clauses allow tenants to exercise certain remedies. Remedies for breach of a co-tenancy provision vary, but often consist of rent abatement or reduction and may also eventually allow a tenant to terminate their lease.
Again, landlords and tenants should review their leases and flag any co-tenancy provisions. Unless the co-tenancy provisions provide exclusions for force majeure (and the definition of force majeure can be read to include the COVID-19 pandemic as a covered event) or a landlord proactively argues that some other common law doctrine excusing performance applies, if required co-tenants cease operations as a result of COVID-19’s spread or related government regulations, tenants may exercise the remedies provided for in the lease under the co-tenancy provisions.
Each tenant should also carefully review its lease for any “go-dark” provisions. These provisions obligate tenants to remain open for business (sometimes for specific hours during each week) and may give landlords a right to terminate the lease and recapture the premises if tenants fail to remain open and operational for longer than the closure period permitted by the lease, if any. “Go dark” provisions are often subject to force majeure, however.
Condemnation and Casualty Clauses
Leases may contain provisions allowing a tenant to terminate if the building is damaged by casualty or condemned by the government. These provisions typically refer to physical damage of the leased premises, but if the lease language is broadly drafted, it may support an argument that the current pandemic qualifies as a casualty event. Condemnation clauses may also apply if a leased premise was taken for use by the government, but it is unclear if a forced closure of businesses by the government constitutes a “taking,” triggering a condemnation clause. While each state has its own condemnation laws, the U.S. Constitution also prohibits the government from unlawful takings of property, either physically or by a regulatory order. Tenants seeking to terminate under these provisions may argue that the “taking” is of a regulatory nature causing the loss of use; however, it is likely that the courts would hold that any “stay in place” orders are a valid use of the police power given to states pursuant to the Tenth Amendment.
Business Interruption Insurance
Both landlords and tenants should consider making a claim under their insurance policies that include business interruption insurance for losses resulting from interruption to operations as a result of COVID-19. While these types of policies typically exclude pandemics, some policies can also cover actions by civil authorities. Companies should review their policies to see if the losses due to the COVID-19 crisis may be covered. For more information, please see the Quarles & Brady update regarding business interruption insurance and COVID-19 here.
Purchase and Sale Agreements
In addition to the impact of COVID-19 on commercial leasing, related government shutdowns, “stay in place” orders, and social distancing have and will continue to have profound effects on the negotiation and performance of Purchase and Sale Agreements (“"PSA”). Buyers and sellers should pay particular attention to how their PSA addresses the performance of due diligence, the requirements for closing, and the availability of remedies for a breach.
Both legal and practical challenges exist with respect to the performance of real estate due diligence. Most PSAs include an inspection contingency allowing the buyer to evaluate the real property before the earnest money becomes non-refundable (or “goes hard”). Buyers’ evaluations typically include ordering an ALTA/NSPS survey, reviewing the title commitment and underlying documents, and performance of a Phase I environmental assessment, preparation of a property condition and/or zoning report, and obtaining estoppels related to the performance of the tenants leasing portions of the property from the Seller.
While nearly every PSA has an inspection contingency, few have force majeure clauses that would extend or excuse performance by the parties. Accordingly, if a buyer fails to timely deliver its objection notice because the surveyor cannot survey the property in a timely fashion, force majeure would not typically provide additional time for them to do so. That said, buyers may argue that commercial frustration, impossibility of performance, and other common law doctrines excuse or extend the time for performance under the PSA. As perceived risk enters the market, many buyers will reevaluate their deployment of capital, and some may argue that force majeure or common law doctrines excuse their performance and entitle them to a return of the earnest money. The success of these arguments will, of course, vary. As a general rule, however, the parties should promptly seek to amend the PSA to provide any required (or negotiated) flexibility and to address any performance issues that might arise as a result of the pandemic.
In addition to the challenges in due diligence and pre-closing performance, buyers and sellers are also facing substantial obstacles related to closing their transactions. While obtaining wet signatures has always been difficult, obtaining notaries for recorded documents can be especially daunting for institutional and retail clients when they are ordered to work from home. Moreover, title companies and recording offices are increasingly restricting access to the public and lowering their staff count, which has resulted in delays in recording of deeds and other closing documents.
To address these obstacles, parties need to take proactive steps in preparing for closing, including reaching out to title companies early to schedule a closing, staying up to date about closures at the applicable recorder's office or register of deeds (and the implications of the same), new state orders amending any notary statutes during any “stay in place” orders and considering the availability of a notary for document execution. For example, if a local recording office is closed or significantly delayed, the title company may require a gap indemnity from the Seller, refuse to provide a gap endorsement, and/or include an exception for all matters arising from the failure of the deed and other closing documents to record on the closing. Depending on the capital stack of the project, these types of last minute changes may cause a lender or equity partner to delay the closing or request other concessions. As a result, buyers seeking financing or a simultaneous equity closing should proactively address these issues with their debt and equity partners and timely object to any related requirements or exceptions that appear in an amendment to their title commitment.
Remedies available in the event the Buyer or Seller fail to perform under the PSA as a result of the COVID-19 crisis are already and will continue to be impaired. Most PSAs include the right for the non-breaching party to terminate the contract and recover the earnest money deposit, and many PSAs give the Buyer a right to sue for specific performance (sometimes within a specific time period), money damages, and pursue other remedies under the PSA. Since many courts across the country have closed as a result of the COVID-19 pandemic, a Buyer may find itself with limited options to enforce its remedies for an indeterminate amount of time. Accordingly, new PSAs and amendments to current PSAs should address the possibility of court closures and backlogs, and should consider whether any timelines for a party to enforce its remedies are realistic in light of the pandemic.
Given the rapidly changing environment surrounding COVID-19, businesses that are experiencing challenges in connection with their real estate interests should closely review their leases, Purchase and Sale Agreements, and related documents for relevant provisions and proactively reach out to other parties and advisors to determine available options. In times like these, early planning is critical to success.
For more information about your rights or obligations under these documents, please contact your Quarles & Brady attorney or: