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COVID-19: Executive Order No. 7H and General Leasing/Rent Concerns

March 23, 2020

As a result of the COVID-19 crisis, both landlords and tenants are struggling to deal with the myriad of issues arising under their leases. Effective at 8 p.m. today, Governor Lamont has ordered that all non-essential businesses (including nonprofits) must reduce in-person workforces by 100%, effectively closing such businesses, through April 22, 2020. Exempt from this order include essential services such as healthcare providers, grocery stores, big-box stores and wholesale clubs so long as they sell groceries, pharmacies and pharmaceutical companies, telecommunications, critical infrastructure sectors, gas stations and convenience stores, restaurants offering off-premises consumption only (take-out), transportation, utilities, financial institutions, legal and accounting services, banks, childcare, certain manufacturers, construction and package stores, and further include pursuant to Executive Order 7J non-essential retailers offering remote ordering with delivery or curb-side pick-up, and non-essential businesses to the minimum extent necessary to provide security, maintenance and other services deemed essential by implementing guidance. This will cause most brick-and-mortar businesses to close temporarily and businesses failing to comply with this order will be subject to punitive measures, though enforcement of the closure is not expected to include fines. We will endeavor to provide updates regarding this order and Governor Cuomo’s order as the same become available.

While most leasing issues will ultimately be determined by the express terms of a particular lease, the COVID-19 crisis has raised extraordinary concerns by both landlords and tenants specific to the payment of rent. Questions have arisen as to how a landlord can enforce a tenant’s obligation to pay rent and whether, in a hardship situation, a tenant has the right to abate or defer rent. Depending on the type of lease (whether the lease is a so-called “net” lease or a “gross” lease, a ground lease or a building lease, or a retail lease or an office lease), tenants may have rent abatement rights when they are unable to use or access their leased premises during periods of damage or destruction, if there is a governmental action or upon a default by the landlord. Most force majeure clauses, however, explicitly do not allow any delay in the payment of rent.

Even if a landlord may have the right to refuse a rent abatement, it may be in the landlord’s best interest to permit a rent abatement if doing so keeps a tenant open and operating or reflects a decision to protect the long-term economic viability of the property. For instance, shopping center owners may have leases that contain co-tenancy provisions. Many times when a minimum core of tenants close, other tenants may cease paying all or a part of their rent (whether rightfully under their lease or not). Although there is a balance, all decisions should be made based upon addressing both immediate needs and long-term recovery. If keeping a tenant open and operating is not an option, it may be much better in the long term for a landlord to offer temporary rent abatement, rent deferrals and/or closures to give a tenant some breathing room while the crisis plays out. It is expensive to relet a premises and, as such, temporary arrangements with a tenant may be much more cost-effective given the length of most commercial leases. Despite provisions restricting the ability of a particular tenant to close or “go-dark”, a complete government shutdown coupled with a provision requiring a tenant to comply with all legal orders may serve as an exception to this sort of provision; closing without any such order, however, may trigger a default, a right of recapture by the landlord or other remedy available pursuant to the lease.

Although many legal issues may arise as to each of the landlord and the tenant in this sort of situation, there is no substitute for a frank business discussion between the landlord and the tenant which may result in a negotiated agreement to defer the payment of rent in conjunction with a repayment plan or abate it entirely for the duration of this public health emergency.

Nevertheless, for some landlords granting relief may be complicated. The failure of a tenant to pay rent could create an upward cascade of defaults as landlords rely on rental payments to cover the debt service on their properties. Many times landlords will have debt service coverage ratios and other loan covenants that might be breached as rent rolls decline. Often the right to make lease modifications have been assigned to the lender (or prohibited by the lender) and, as such, a landlord may have agreed that rent abatements or waivers trigger a loan default or other remedy. Moreover, any modification to rent may be unenforceable if the lender has not consented and ultimately becomes the owner of the property, and limited or carve-out guaranties may be triggered if a landlord modifies a lease without lender consent. Without flexibility by lenders and other mortgage holders, defaults on loans secured by these properties will give rise to larger issues which may require state and federal governments to incentivize support through monetary relief. Just last week we saw the U.S. Department of Housing and Urban Development enact a 60-day moratorium on certain foreclosures and evictions, with Connecticut courts rescheduling all foreclosure sales previously scheduled to have occurred in April or May to Saturday, June 6, 2020, and amending all “law days” previously set to run in April or May to June 2, 2020, as to the first law day, with all issued executions on evictions and ejectments immediately stayed through May 1, 2020.

These are just a few considerations related to leasing in the COVID-19 crisis, and analysis of these issues requires particular attention to the express terms of the lease and the facts of the leasing relationship. Shipman & Goodwin attorneys possess the knowledge and experience needed to help landlords and tenants navigate leases with functional and pragmatic solutions during these uncertain times. We will endeavor to analyze and explain the relevant law in these areas, and update our Coronavirus Resource Center (specifically, the Real Estate Leasing page) periodically to include relevant Connecticut, New York, federal and local laws, rules and regulations that are enacted during this crisis, as well as court filings and relevant precedent or other topical information, which are being circulated on these matters.

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