With COVID-driven litigation ongoing across the nation, close analysis of commercial lease language is now more important than ever as many questions remain unanswered. The first wave of commercial lease disputes dealt in large part with whether commercial tenants were required to pay rent while forced to close due to the pandemic and related governmental orders. Now, new disputes are arising based on the lingering impacts of the pandemic and certain key clauses like co-tenancy, sales kickouts, operating covenants, casualty clauses and force majeure provisions are likely to play a crucial role.
For example, retail leases commonly contain co-tenancy clauses that allow tenants to reduce their rent or, in some cases, terminate the lease if key tenants or a certain number of tenants are not open and operating. These provisions are front and center given the government-mandated closures, curfews and social-distancing requirements that forced businesses to significantly alter and/or reduce their operations. As with every lease, it is important to read and understand the fine print. Some questions that we have seen arise with respect to co-tenancy clauses are:
- When do rent reduction or termination rights ripen? Often, co-tenancy provisions have a time delay and reduced rent and/or termination rights apply only after a certain number of months. But what happens if a co-tenant opens, then closes in the wake of a surge in COVID-19 cases?
- What does it mean for a co-tenant to be open for purposes of satisfying the co-tenancy provision? The language can vary between leases. For example, a lease may specify that a co-tenant must be open and operating a retail business in substantially all of its premises in order to count towards the co-tenancy test. What does this mean for businesses opened for limited hours, or engaged only in limited operations such as takeout or curbside pick-up?
- Is there an operating covenant? Some co-tenancy provisions require that the lessee be open and operating in order to avail itself of the co-tenancy provision. In some cases, even if there is an operating covenant, lessees may have an argument that the force majeure provisions excuse the lessee from operating. However, the landlord may argue that the operating requirement is a condition, and the co-tenancy provisions simply do not apply if the condition is not met.
- How does force majeure impact the analysis? Some landlords have argued that force majeure provisions excuse them from “complying with” the co-tenancy provisions. However, traditionally, the law has not treated co-tenancy provisions as “covenants” or “obligations” that create a breach if not satisfied. In other words, the landlord does not “promise” to meet the conditions; instead, such provisions simply establish contingencies and a “tiered rent structure.” See Old Navy, LLC v. Ctr. Devs. Oreg., LLC, No. CIV. 3:11-472-KI, 2012 WL 2192284, at *11 (D. Or. June 13, 2012). Typically, force majeure provisions are written to excuse duties to act, not the occurrence or non-occurrence of conditions. See San Mateo Cmty. Coll. Dist. v. Half Moon Bay Ltd. P’ship, 65 Cal. App. 4th 401 (1998) (force majeure clause that applied to “obligations” did not excuse failure of conditions); Jenkins v. Eckerd Corp., 913 So. 2d 43, 54–55 (Fla. Dist. Ct. App. 2005) (recognizing anchor-tenant provision as an express condition and refusing to excuse its failure).
Similar questions apply in disputes over sales kickout clauses, which may provide a right of early termination if a commercial lessee’s sales do not meet or exceed a certain threshold. For example: Does failure to operate per the operating covenant impact a lessee’s right to exercise the sales kickout clause? If so, Lessees might argue that failure to operate for any period of time may be excused by co-tenancy or force majeure provisions. Landlords would likely argue that the operating requirement is a condition, and the sales kickout clause does not apply if the condition is not met, regardless of co-tenancy and force majeure provisions.
Another important consideration is how the sales are calculated. In order to determine what constitutes a sale that counts; the time period for which sales should be measured and how closures impact sales kickout thresholds, the first step is to closely read and understand the lease language.
Many of these issues are beginning to be addressed now, but have not yet resulted in published decisions. As COVID-driven litigation regarding leases continues to unfold, parties to commercial leases should analyze these provisions carefully and keep an eye out for forthcoming legal precedent.