COVID-19 has profoundly impacted retail around the world. Federal, state and local governments have implemented an array of restrictive laws, orders and regulations, including mandatory business closures that prevent retail stores from opening their doors. Because of their inability to operate from their leased locations, many tenants have analyzed their leases to determine whether they remain obligated to pay rent during this uncertain period, while many landlords have undergone the converse analysis to determine whether they may require tenants to continue their payments.
For landlord and tenant alike, that analysis frequently begins — and often prematurely ends — with the “force majeure” provision. At first blush, the FM clause (sometimes titled “unavoidable delays” or the like) may initially seem to resolve the issue. But in many cases, the generic nature of these clauses and the particular effects associated with the pandemic make the analysis more nuanced than at first it might appear. Retail landlords and tenants should be sensitized to these nuances as they evaluate their respective positions concerning the enforceability of rental obligations. We explain below.
COVID-19 AND FORCE MAJEURE CLAUSES
A FM clause generally excuses a party’s nonperformance when specified events hamper a party’s ability to fulfill its contractual obligations. These clauses take on a variety of forms, some more expansive in scope than others. The critical question courts consider is whether the FM clause encompasses the event claimed to be causing nonperformance.
Here is one typical example of a broad FM clause:
If, by reason of (a) strike, (b) labor troubles, (c) governmental preemption in connection with a national emergency, (d) any rule, order or regulation of any governmental agency, (e) conditions of supply or demand which are affected by war or other national or state emergency, or (f) any similar cause beyond a party’s reasonable control, such party shall be unable to fulfill, or be delayed in fulfilling, any of its obligations under this lease, no party shall have any liability whatever to the other party. In no event shall either party be excused for any payment obligations (including tenant’s obligation to pay rent hereunder).
This sample is expansive not only in terms of the scope of the events contemplated, but also its catch-all language in (f) above. If a contingency applies, this carve-out for rental obligations would seem to end the analysis regarding whether those obligations are temporarily excused.
However, a tenant may argue that it is not seeking to excuse nonpayment due to a delineated FM event. Rather, the tenant may claim that no FM event has rendered it “unable to fulfill” its “obligations,” but rather that the very purpose of the lease has been frustrated. In other words, it’s not that the tenant is unable to pay rent, but rather that the very point of entering into the lease in the first instance — space in exchange for money — has been rendered impossible and/or frustrated.
In response, a landlord may argue that inability to operate is directly attributable to the relevant governmental shutdown order precipitated by COVID-19 and is therefore covered within the FM events, thus rendering unaffected the tenant’s rental obligations.
Other leases include narrower FM clauses, such as the following:
In the event that either party hereto shall be delayed or hindered in or prevented from the performance of any act required hereunder by reason of strikes, lockouts, labor troubles, inability to procure materials, failure of power, riots, insurrection, war or other reason of a like nature not the fault of the party delayed in performing work or doing acts required under the terms of this lease, then performance of such act shall be excused for the period of the delay.
This provision shall not operate to excuse tenant from the prompt payment of rental or any other payments required by the terms of this lease.
Here, neither governmental regulations nor pandemics are referenced in the FM, so that a tenant could argue the clause is inapplicable. A tenant may also contend that it has not been “delayed” or “hindered” from performing its obligation to pay rent at all. Rather, as in the earlier example, the tenant may argue that its obligation has been nullified because of impossibility and/or frustration of purpose.
A landlord, on the other hand, might identify the COVID-19-related restrictions as “other reason[s] of a like nature” that may prevent performance, in which case the tenant must continue paying rent.
The success or failure of these nuanced interpretations may well depend on the location of the establishment, or in legal parlance, the jurisdiction in which the property is situated, because, in addition to the varying government restrictions affecting retail establishments, courts around the country treat FM clauses differently. For example, courts in some jurisdictions require a level of precision from the clause to find it applicable to a given case, whereas others are much more lenient in their approach to interpretations.
Relatedly, the interpretation of these clauses may turn on catch-all language (e.g., “any similar cause” or “other reason of a like nature”). In jurisdictions that interpret FM clauses narrowly, the catch-all language is typically extended only to other similar triggering events, whereas jurisdictions that interpret the clauses more broadly may conclude that the unrelated events are covered within the operative clause.
Because the COVID-19 pandemic was unforeseeable, equitable doctrines affecting contractual performance must also be considered in evaluating lease obligations.
The equitable doctrines of impossibility and impracticability and frustration of purpose exist to enable courts to reach fair outcomes when the parties have not accounted for a given event in their contracts. These doctrines traditionally have been invoked as defenses to claims of breach of contract in order to permanently excuse a party from performance, or in other words, to terminate the lease. Here, however, many tenants may not wish to terminate their lease, but rather, to be temporarily excused from performance. Landlords may anticipate that tenants will utilize these doctrines and the present uncertainty concerning their application to COVID-19 to negotiate mutually beneficial resolutions.
Impossibility and Impracticability
The doctrine of impossibility (or in some jurisdictions, “impracticability,” which by definition is less stringent) may be invoked to excuse nonperformance when the subject matter of a contract or means of performance is made objectively impossible due to unforeseen and unanticipated circumstances.
To successfully invoke the doctrine of impossibility to excuse nonperformance, generally, a party must establish: (1) an event unexpected and unanticipated at the time of contracting occurred; (2) the parties’ agreement assumes the absence of the occurrence of such event; and (3) the event made contractual performance impossible. Importantly, mere financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy, does not constitute an unforeseen event warranting invocation of the defense of impossibility.
Here, the basic premise of the lease bears repeating — use of space in exchange for rent. By focusing on whose obligations have, in fact, been impeded by the pandemic, parties to leases can have productive discussions focused on maximizing the long-term value of the leases to both parties.
Frustration of Purpose
Frustration of purpose applies if an involuntary and unforeseeable event frustrates the purpose of the contract, even though literal performance is still possible. In response to the pandemic, for instance, a tenant may invoke this doctrine by arguing that its obligation to pay rent has been nullified because the purpose of the lease, space for rent, has been frustrated.
In evaluating frustration of purpose, the key question is whether the purpose of the contract ceases to exist on account of the unanticipated event. To successfully argue frustration of purpose, generally a party must demonstrate: (1) the event is substantially frustrating a party’s principal purpose for entering into a contract; (2) the nonoccurrence of the frustrating event was a basic assumption of the contract; and (3) the frustrating event was not the fault of the party asserting the defense.
Typically, frustration of purpose has been invoked to rescind agreements — that is, to place parties back in the position they would have been in had they never contracted. In most cases, the circumstances surrounding the pandemic are more compatible with the doctrines of impossibility and impracticability rather than frustration of purpose, but understanding all defenses under a lease is key to evaluating one’s options for tenants, and important for landlords to understand in challenging these arguments.
Each retail lease and varying jurisdictional approaches to FM clauses and equitable doctrines present challenges for retail tenants and landlords addressing their lease obligations in light of the COVID-19 pandemic. It is therefore imperative to consult with counsel to determine rights under a retail lease and to consider creative approaches, including the potential applicability of equitable defenses.
Eric D. Sherman is a partner at Pryor Cashman LLP in New York and member of the firm’s real estate and litigation groups. His practice includes a focus on complex commercial lease disputes, primarily for clients in the fashion, luxury goods, retail and entertainment industries.
Marion R. Harris is counsel at Pryor Cashman LLP in New York and a member of the firm’s litigation group. His practice focuses on complex commercial disputes and regulatory inquiries and investigations.
Matthew Lamb, an associate in the firm’s litigation group, assisted in the preparation of the article.