The Karlin Law Firm LLP - Business Law Attorney

Providing quality legal services to statewide and national clients in ADA defense, Personal Injury, business and real estate for more than 35 years

Providing quality legal services to statewide and national clients in ADA defense, Personal Injury, business and real estate for more than 35 years

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Can A Closed Business Terminate Its Lease?

The common belief that a tenant remains “on the hook” for rent for the term of the lease regardless of difficult economic times is being questioned in the COVID-19 world.  All landlords and commercial tenants should be aware of three legal doctrines that may become part of a new wave of litigation, even following any the end of any temporary “stay” which might exist in relation to commercial evictions.

Possible New Defenses to Lease Obligations during Pandemic

Today, businesses closed, or partly closed, or otherwise severely impacted by the pandemic may not be able to pay rent, whether they have been forced to cease operations “temporarily,” forced to drastically limit their operations, or have simply been adversely impacted by the pandemic. Even if rent has been deferred, they often see no way of ever catching up and someday becoming profitable again, or, if they do, they do not have the resources to last that long. Unless a lease term is coming to an end, however, the business and any personal guarantors, generally remain liable  — absent a defense — for the unpaid rent and all future rent for the remainder of the lease term (subject to the landlord’s duty to mitigate).  In this regard, landlords and tenants should be aware of three legal arguments that may be raised in an attempt to allow a tenant to terminate his or her lease early and/or to avoid paying rent altogether or for a period of time.

Force Majeure

Many leases contain what is commonly referred to as a “force majeure” clause that could come into play in connection with the current pandemic. These clauses can vary, but the gist of the clause is that the parties will not be required to perform obligations under the lease if the failure to perform is due to a highly unforeseen occurrence outside of the party’s control and notwithstanding the party’s exercise of due diligence. When these are written into leases, the payment of rent is often excluded from these clauses. If the payment of rent is not excluded, the clauses generally list examples of such unforeseen occurrences, such as earthquakes, fires, riots, etc. It might list “pandemic” as a force majeure event, but a failure to explicitly list “pandemic” does not automatically mean that it is not covered by the clause. Assuming “pandemic” is covered by the clause, anyone trying to avoid performing a contractual obligation must show that it is the proximate cause of the inability and failure to perform. Typically, “force majeure” clauses require that notice be given by the non-performing party of the inability to perform due to the “force majeure.”

It should be noted that California Civil Code § 1511 may provide the rough equivalent of a contractual “force majeure” clause that could be applicable in the current pandemic.  It provides, among other things, that a failure of, or delay in, performance may be excused “when it is prevented or delayed by” “an irresistible, superhuman cause” or “by operation of law.” This code section also requires notice.

Impossibility

Under the common law, parties are not required to fulfill contractual obligations that become impossible to perform.  This concept is codified in California Civil Code § 1441.  Literal “impossibility” is no longer required by the courts to excuse performance, however. “Impracticability” due to excessive and unreasonable difficulty or expense may be sufficient.

Frustration of Purpose

Even if a defense of “force majeure” or “impossibility” does not fly because the pandemic has simply made performance harder, the doctrine of “frustration of purpose” may yet apply.  This doctrine excuses performance in situations where performance of an obligation is not impossible (or impracticable), but the purpose for which the contract was entered into has been destroyed.  Put another way, the doctrine applies if “purpose” or “desired object” of both parties has been frustrated.

Priority of Lease

As noted above, when a force majeure provision is found in a lease it often excludes the non-payment of rent.  In that case, the landlord will surely argue that the landlord and the commercial tenant considered the risk of a force majeure event and “shifted the risk” to the tenant, and, as such, the tenant cannot use “force majeure” or other similar doctrines as a defense for the non-payment of rent.

Lease as Contract – Lease as Property Right

Landlords will also argue that while leases have some characteristics of a “contract,” they more closely resemble property or ownership rights. Under basic real property law, a tenant in effect “owns” the real estate for the period of the lease. During that time period, he or she as an owner would bear the risk of any and all catastrophic events unless the landlord expressly assumed the obligation. Landlords will argue that to ignore this historic treatment of rights and responsibilities of property owners and tenants would be to turn all of real property law on its head, with untold and unknown effects on ownership rights, mortgages, liens, and real property investments, all with potentially disastrous economic consequences. Any discussion of force majeure and similar concepts should not simply assume that a lease is a mere contract and nothing more.

Conclusion

The viability of the legal doctrines discussed above in any situation is highly fact-specific, particularly in the context of a pandemic. Complicating the analysis, as noted above, is the fact that the doctrines’ applicability in a pandemic has rarely, if ever, been considered by the courts. This will undoubtedly change soon. Commercial landlords and tenants should check on the most recent developments with a real estate attorney. The Karlin Law Firm is here to provide advice and assistance to both landlords and tenants during these difficult times.

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