How Commercial Landlords Can Protect Their Rights and Interests During COVID-19

Firm Publication

As businesses try to navigate the challenges resulting from COVID-19, many commercial tenants are attempting to re-negotiate lease terms as a part of an effort to cut costs. Sometimes forced to choose between meeting payroll obligations and making rent payments, tenants are increasingly requesting abatements and deferrals of (or are simply not paying) lease obligations. Although many courts are substantially restricting most civil cases—including evictions—commercial landlords should take certain steps to protect their rights and interests.

Step One: Provide Notice to Preserve Legal Rights

The first action landlords should take in the event a tenant fails to make a rent payment—usually an explicit “event of default” in a lease—is to provide the tenant notice of such default as required by the lease. Most commercial leases contain a “Notice” section describing the process for providing notice, as well as the parties to whom such notice must be delivered. The lease (or other documents) may also require landlords to provide a copy of the notice of default to additional parties, such as lease guarantors or lenders to landlord or tenant.

Landlords should provide such notice in the method prescribed in the lease (e.g., a certified letter), even where such delivery method may be expected to fail due to a business closure or other extenuating circumstances. Additional steps to provide tenants—and any other required parties—with actual notice of default (e.g., by sending a follow-up email attaching a copy of the certified letter) are generally advisable.  However, landlords should proceed with caution when using more informal means of communication with defaulting tenants.

Step Two: Review Individual Leases for Credit Enhancements 

Next—and before engaging in any negotiations with a tenant—landlords should confirm whether there are any credit enhancements for the tenant’s obligations such as cash or letter of credit security deposit or a lease guaranty. These credit enhancements may be immediately accessible as a result of the missed rent payments. Although perhaps not a resolution of long-term issues resulting from economically distressed tenants, the availability of any credit enhancement may affect the landlord’s strategy in resolving the rent default.

Step Three: Identify and Prepare for Potential Tenant Defenses

Similarly, in these circumstances, landlords should also consider—and plan for—two principal kinds of defenses that a defaulting tenant may raise to excuse the non-performance of its lease obligations. These include the tenant’s doing either of the following:

  1. Invoking a lease provision such as a force majeure clause in its defense.
  2. Asserting one of the common law affirmative defenses to contract enforcement.

Defense One: Force Majeure Clauses

Many commercial leases contain a force majeure clause, which “allocate[es] the risk of loss if performance becomes impossible or [i]mpracticable, [especially] as a result of an event or effect that the parties could not have anticipated or controlled.”[1] Evaluating the application of a force majeure clause requires assessing:

  1. How “force majeure” is defined (if at all) in the lease?
  2. If a force majeure event has occurred, what rights or remedies are available?
Prong One: Has a triggering event occurred?

Definitions of force majeure vary by agreement. Force majeure clauses are often vague but may include some examples of triggering events (e.g., fires, floods and other “acts of God”). Unless the applicable force majeure clause contemplates a global pandemic, it may well be unclear whether COVID-19 triggers the risk-shifting clause. However, if a force majeure clause in a lease uses relatively broad “unanticipated act of God” language, a court may be more likely to read the clause as including the current pandemic.

Prong Two: How does the lease allocate risk?

If a force majeure event has been deemed to exist, the precise obligations of each party depend on the specific requirements of the applicable force majeure clause. Relatively few lease force majeure provisions allow tenants to stop or suspend performance without notice or obligation. For example, many force majeure clauses do not permit the suspension of rent payment. If a tenant’s performance is excused during a force majeure event, most agreements require the tenant to provide notice and updates to the landlord regarding when performance may resume. Some force majeure clauses require a tenant to exercise commercially reasonable efforts to provide a workaround or substitution (e.g., these might include a restaurant offering carryout or delivery dining options) until regular performance can be resumed. What these workarounds or substitutions require and whether there are any limits on the expense the tenant must incur in implementing a workaround or substitution will be unclear under many force majeure provisions.

An agreement may include a backstop right allowing the landlord and/or tenant to terminate the lease if performance is not resumed within a certain period of time. If a party desires to terminate the lease because of a force majeure event, it should be careful to comply with all applicable requirements in the force majeure clause and notice provisions for the termination to be valid.

Defense Two: Impracticability

Absent a force majeure clause—and in some cases even where such a clause is included in a lease—tenants whose businesses have been adversely affected by governmental orders may seek to rely on the common law defense of impracticability to excuse their obligations under leases entered into before the pandemic.[2] As further explained below, the common law rent payment defense is not available to tenants entering into leases with knowledge of the pandemic and its consequences for certain tenants.

Four Prongs

Although the impracticability defense is not codified in the Tennessee Rules of Civil Procedure, Tennessee courts have recognized this affirmative defense in a multitude of contract cases.[3] The common law defense of impracticability has four prongs:[4]

  1. The event preventing the tenant’s performance must be outside of such a tenant’s control.
  2. The non-occurrence of such an event was a basic assumption on which the lease was made.
  3. The occurrence of such an event makes it “practically impossible” for the tenant to perform its obligations under the lease.
  4. Such practical impossibility cannot be “prevented or avoided or remedied by appropriate corrective measures.”

A tenant seeking relief from its contractual obligations carries the burden of proving all four prongs.

Prongs One and Two

The COVID-19 crisis arguably satisfies the first two prongs. As to the first element, the onset of a global pandemic is outside a tenant’s control. Likewise, the governmental orders mandating the closure of non-essential business will likely satisfy the second requirement under the existing case law. Tennessee courts have found the non-occurrence of intervening governmental orders making contractual performance impracticable to be a basic assumption on which the contract was made.[5]

Prong Three: Is it “practically impossible” for a tenant to pay rent?

If a tenant is an “essential” business and thus permitted to remain open under the governmental order, it will be more difficult for the tenant to make a colorable “practical impossibility” argument.  Tennessee courts require a showing of “extreme hardship” to grant relief under the common law.[6]  Even if the tenant’s operations are significantly impaired, the availability of any revenue stream to the tenant (e.g., from carryout in lieu of in-person dining) may undermine a tenant’s assertion that it is “practically impossible” to find the funds to pay its rent.[7]

If a tenant is a “non-essential” business that must close, with no source of revenue while closed, such tenant is more likely to be able to prove that it is “practically impossible” to pay rent.[8]  If a tenant ordered closed has no revenue and quickly uses its reserves to meet payroll obligations, it may be able to establish that it is practically unable to pay its rent.

Prong Four: Can the hardship be remedied by “appropriate corrective measures” by the tenant?

If a tenant is an “essential” business, it must make a good faith attempt to mitigate the consequences of the unforeseen event.[9] Such efforts might, for example, include a restaurant offering carryout dining options or an essential retail store providing online sales or curbside pickup. Tenants not even attempting those kinds of permitted limited operations risk foreclosing any available impracticability defense.

If a tenant is a “non-essential” business and not allowed even limited operations, the potential “appropriate corrective measures” may be much more limited or nonexistent. For example, it is probably not feasible (or in many cases not even permitted) for art galleries, barber shops and many other non-essential businesses to offer the same curbside or delivery services offered by restaurants and grocery stores. For some non-essential tenants, there are simply no feasible corrective measures that can be taken to maintain revenue levels that will enable such tenant to pay its rent.

CARES Act Considerations. Financial assistance may be available to tenants through the Paycheck Protection Program (PPP) created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, signed by the president on March 27. Commercial landlords should consider confirming with tenants whether they have applied for, and received, loan proceeds under a PPP loan. Many commercial landlords are actively assisting tenants with their applications for PPP loans to ensure tenants can continue to pay rent under their leases and re-open when permitted.

The availability of loan proceeds from a PPP loan, and perhaps even the mere existence of the PPP program, may make it more difficult for a tenant to satisfy prongs three and four above. Receipt of loan proceeds from a PPP loan would arguably render possible the payment of some or all rent to landlords. Additionally, whether a tenant was eligible, and applied for, a PPP loan, and the potential availability of loan proceeds, may be considered in determining whether a tenant has taken appropriate corrective measures to remedy any inability to satisfy financial obligations under its lease.

Enforceability of Waiver. Many commercial leases include waiver provisions pursuant to which one party—usually the tenant—agrees to forego its right to bring suit and/or raise certain defenses against the other party. It is not clear whether Tennessee courts will enforce the waiver of common law defenses—like the impracticability defense—based on the presence of such a waiver clause in a lease.[10]   Although reserving the right to overrule the terms of a contract “in the interests of public policy,” Tennessee courts have repeatedly recognized the idea that “contract law in Tennessee plainly reflects the public policy allowing competent parties to strike their own bargains.”[11] Absent a departure from precedent—which is certainly possible in the context of the current pandemic, as discussed below—the existing common law suggests that Tennessee courts may well find that such waivers are effective to waive common law affirmative defenses such as impracticability.

Conclusion

In advising landlord clients confronted by widespread rent payment defaults, lawyers can provide reasoned guidance based on existing Tennessee common law principles. However, the COVID-19 pandemic is unprecedented, and the courts’ response to it may also be unprecedented. It is possible that public policy considerations during a time of crisis may lead Tennessee courts to redefine a more expansive standard for the defense of impracticability.[12]

If you have any questions about protecting your commercial real estate rights and interests during the COVID-19 pandemic, please contact the authors.

[1] Black’s Law Dictionary (11th ed. 2019), force majeure clause.

[2] While some jurisdictions treat the common law doctrines of impossibility and impracticability as separate and distinct legal theories, Tennessee courts have historically analyzed both under one heading—the “Defense of Impossibility.” See, e.g. APAC-Atl., Inc., Harrison Const. Div. v. State, 2013 WL 5883697, at *14 (Tenn. Ct. App. Oct. 31, 2013) and Hinchman v. City Water Co., 167 S.W.2d 986, 991 (Tenn. 1943) (“…The essence of the modern defense of impossibility is that the promised performance was at the making of the contract, or thereafter became, impracticable owing to some extreme or unreasonable difficulty, expense, injury, or loss involved, rather than that it is scientifically or actually impossible.”).

[3] See, e.g. Patterson v. Methodist Healthcare-Memphis Hosps., 2010 WL 363314, at *7 (Tenn. Ct. App. Feb. 2, 2010).

[4] See, e.g. Roth Steel Products v. Sharon Steel Corp., 705 F.2d 134, 149 (6th Cir. 1983).

[5] Tennessee courts have adopted the approach taken by the Second Restatement of Contracts. See, e.g. North American Capital Corp. v. McCants, 510 S.W.2d 901, 903 (Tenn. 1974) and Restatement (Second) of Contracts § 264 (1981) (concluding “if the performance of a duty is made impracticable by having to comply with a governmental order, that order is an event the non-occurrence of which was a basic assumption on which the contract was made.”)

[6] N. Am. Capital Corp. v. McCants, 510 S.W.2d 901, 903 (Tenn. 1974).

[7] See generally RESTATEMENT (SECOND) OF CONTRACTS § 261 cmt. b (1981) (“The continuation of existing market conditions and of the financial situations of the parties are ordinarily not such assumptions, so that mere market shifts or financial ability do not usually effect discharge.”)

[8] Courts will consider the individual facts of a case. If a landlord can prove a tenant has significant reserves or other circumstances make rent payment practically possible, even non-essential tenants may be ordered fulfill lease obligations.

[9] United Brake Systems, Inc. v. American Environmental Protection, Inc., 963 S.W.2d 749, 752 (Tenn. Ct. App. 1997).

[10] Jacqueline Sandler, Waiving the Duty to Mitigate in Commercial Leases, 5 Wm. & Mary Bus. L. Rev. 647 (2014).

[11] Ellis v. Pauline S. Sprouse Residuary Tr., 280 S.W.3d 806, 814 (Tenn. 2009).

[12] Tennessee courts have evolved on the impossibility defense over time. See Hinchman v. City Water Co., 167 S.W.2d 986 (Tenn. 1943).

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Firm Publication

As businesses try to navigate the challenges resulting from COVID-19, many commercial tenants are attempting to re-negotiate lease terms as a part of an effort to cut costs. Sometimes forced to choose between meeting payroll obligations and making rent payments, tenants are increasingly requesting abatements and deferrals of (or are simply not paying) lease obligations. Although many courts are substantially restricting most civil cases—including evictions—commercial landlords should take certain steps to protect their rights and interests.

Step One: Provide Notice to Preserve Legal Rights

The first action landlords should take in the event a tenant fails to make a rent payment—usually an explicit “event of default” in a lease—is to provide the tenant notice of such default as required by the lease. Most commercial leases contain a “Notice” section describing the process for providing notice, as well as the parties to whom such notice must be delivered. The lease (or other documents) may also require landlords to provide a copy of the notice of default to additional parties, such as lease guarantors or lenders to landlord or tenant.

Landlords should provide such notice in the method prescribed in the lease (e.g., a certified letter), even where such delivery method may be expected to fail due to a business closure or other extenuating circumstances. Additional steps to provide tenants—and any other required parties—with actual notice of default (e.g., by sending a follow-up email attaching a copy of the certified letter) are generally advisable.  However, landlords should proceed with caution when using more informal means of communication with defaulting tenants.

Step Two: Review Individual Leases for Credit Enhancements 

Next—and before engaging in any negotiations with a tenant—landlords should confirm whether there are any credit enhancements for the tenant’s obligations such as cash or letter of credit security deposit or a lease guaranty. These credit enhancements may be immediately accessible as a result of the missed rent payments. Although perhaps not a resolution of long-term issues resulting from economically distressed tenants, the availability of any credit enhancement may affect the landlord’s strategy in resolving the rent default.

Step Three: Identify and Prepare for Potential Tenant Defenses

Similarly, in these circumstances, landlords should also consider—and plan for—two principal kinds of defenses that a defaulting tenant may raise to excuse the non-performance of its lease obligations. These include the tenant’s doing either of the following:

  1. Invoking a lease provision such as a force majeure clause in its defense.
  2. Asserting one of the common law affirmative defenses to contract enforcement.

Defense One: Force Majeure Clauses

Many commercial leases contain a force majeure clause, which “allocate[es] the risk of loss if performance becomes impossible or [i]mpracticable, [especially] as a result of an event or effect that the parties could not have anticipated or controlled.”[1] Evaluating the application of a force majeure clause requires assessing:

  1. How “force majeure” is defined (if at all) in the lease?
  2. If a force majeure event has occurred, what rights or remedies are available?
Prong One: Has a triggering event occurred?

Definitions of force majeure vary by agreement. Force majeure clauses are often vague but may include some examples of triggering events (e.g., fires, floods and other “acts of God”). Unless the applicable force majeure clause contemplates a global pandemic, it may well be unclear whether COVID-19 triggers the risk-shifting clause. However, if a force majeure clause in a lease uses relatively broad “unanticipated act of God” language, a court may be more likely to read the clause as including the current pandemic.

Prong Two: How does the lease allocate risk?

If a force majeure event has been deemed to exist, the precise obligations of each party depend on the specific requirements of the applicable force majeure clause. Relatively few lease force majeure provisions allow tenants to stop or suspend performance without notice or obligation. For example, many force majeure clauses do not permit the suspension of rent payment. If a tenant’s performance is excused during a force majeure event, most agreements require the tenant to provide notice and updates to the landlord regarding when performance may resume. Some force majeure clauses require a tenant to exercise commercially reasonable efforts to provide a workaround or substitution (e.g., these might include a restaurant offering carryout or delivery dining options) until regular performance can be resumed. What these workarounds or substitutions require and whether there are any limits on the expense the tenant must incur in implementing a workaround or substitution will be unclear under many force majeure provisions.

An agreement may include a backstop right allowing the landlord and/or tenant to terminate the lease if performance is not resumed within a certain period of time. If a party desires to terminate the lease because of a force majeure event, it should be careful to comply with all applicable requirements in the force majeure clause and notice provisions for the termination to be valid.

Defense Two: Impracticability

Absent a force majeure clause—and in some cases even where such a clause is included in a lease—tenants whose businesses have been adversely affected by governmental orders may seek to rely on the common law defense of impracticability to excuse their obligations under leases entered into before the pandemic.[2] As further explained below, the common law rent payment defense is not available to tenants entering into leases with knowledge of the pandemic and its consequences for certain tenants.

Four Prongs

Although the impracticability defense is not codified in the Tennessee Rules of Civil Procedure, Tennessee courts have recognized this affirmative defense in a multitude of contract cases.[3] The common law defense of impracticability has four prongs:[4]

  1. The event preventing the tenant’s performance must be outside of such a tenant’s control.
  2. The non-occurrence of such an event was a basic assumption on which the lease was made.
  3. The occurrence of such an event makes it “practically impossible” for the tenant to perform its obligations under the lease.
  4. Such practical impossibility cannot be “prevented or avoided or remedied by appropriate corrective measures.”

A tenant seeking relief from its contractual obligations carries the burden of proving all four prongs.

Prongs One and Two

The COVID-19 crisis arguably satisfies the first two prongs. As to the first element, the onset of a global pandemic is outside a tenant’s control. Likewise, the governmental orders mandating the closure of non-essential business will likely satisfy the second requirement under the existing case law. Tennessee courts have found the non-occurrence of intervening governmental orders making contractual performance impracticable to be a basic assumption on which the contract was made.[5]

Prong Three: Is it “practically impossible” for a tenant to pay rent?

If a tenant is an “essential” business and thus permitted to remain open under the governmental order, it will be more difficult for the tenant to make a colorable “practical impossibility” argument.  Tennessee courts require a showing of “extreme hardship” to grant relief under the common law.[6]  Even if the tenant’s operations are significantly impaired, the availability of any revenue stream to the tenant (e.g., from carryout in lieu of in-person dining) may undermine a tenant’s assertion that it is “practically impossible” to find the funds to pay its rent.[7]

If a tenant is a “non-essential” business that must close, with no source of revenue while closed, such tenant is more likely to be able to prove that it is “practically impossible” to pay rent.[8]  If a tenant ordered closed has no revenue and quickly uses its reserves to meet payroll obligations, it may be able to establish that it is practically unable to pay its rent.

Prong Four: Can the hardship be remedied by “appropriate corrective measures” by the tenant?

If a tenant is an “essential” business, it must make a good faith attempt to mitigate the consequences of the unforeseen event.[9] Such efforts might, for example, include a restaurant offering carryout dining options or an essential retail store providing online sales or curbside pickup. Tenants not even attempting those kinds of permitted limited operations risk foreclosing any available impracticability defense.

If a tenant is a “non-essential” business and not allowed even limited operations, the potential “appropriate corrective measures” may be much more limited or nonexistent. For example, it is probably not feasible (or in many cases not even permitted) for art galleries, barber shops and many other non-essential businesses to offer the same curbside or delivery services offered by restaurants and grocery stores. For some non-essential tenants, there are simply no feasible corrective measures that can be taken to maintain revenue levels that will enable such tenant to pay its rent.

CARES Act Considerations. Financial assistance may be available to tenants through the Paycheck Protection Program (PPP) created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, signed by the president on March 27. Commercial landlords should consider confirming with tenants whether they have applied for, and received, loan proceeds under a PPP loan. Many commercial landlords are actively assisting tenants with their applications for PPP loans to ensure tenants can continue to pay rent under their leases and re-open when permitted.

The availability of loan proceeds from a PPP loan, and perhaps even the mere existence of the PPP program, may make it more difficult for a tenant to satisfy prongs three and four above. Receipt of loan proceeds from a PPP loan would arguably render possible the payment of some or all rent to landlords. Additionally, whether a tenant was eligible, and applied for, a PPP loan, and the potential availability of loan proceeds, may be considered in determining whether a tenant has taken appropriate corrective measures to remedy any inability to satisfy financial obligations under its lease.

Enforceability of Waiver. Many commercial leases include waiver provisions pursuant to which one party—usually the tenant—agrees to forego its right to bring suit and/or raise certain defenses against the other party. It is not clear whether Tennessee courts will enforce the waiver of common law defenses—like the impracticability defense—based on the presence of such a waiver clause in a lease.[10]   Although reserving the right to overrule the terms of a contract “in the interests of public policy,” Tennessee courts have repeatedly recognized the idea that “contract law in Tennessee plainly reflects the public policy allowing competent parties to strike their own bargains.”[11] Absent a departure from precedent—which is certainly possible in the context of the current pandemic, as discussed below—the existing common law suggests that Tennessee courts may well find that such waivers are effective to waive common law affirmative defenses such as impracticability.

Conclusion

In advising landlord clients confronted by widespread rent payment defaults, lawyers can provide reasoned guidance based on existing Tennessee common law principles. However, the COVID-19 pandemic is unprecedented, and the courts’ response to it may also be unprecedented. It is possible that public policy considerations during a time of crisis may lead Tennessee courts to redefine a more expansive standard for the defense of impracticability.[12]

If you have any questions about protecting your commercial real estate rights and interests during the COVID-19 pandemic, please contact the authors.

[1] Black’s Law Dictionary (11th ed. 2019), force majeure clause.

[2] While some jurisdictions treat the common law doctrines of impossibility and impracticability as separate and distinct legal theories, Tennessee courts have historically analyzed both under one heading—the “Defense of Impossibility.” See, e.g. APAC-Atl., Inc., Harrison Const. Div. v. State, 2013 WL 5883697, at *14 (Tenn. Ct. App. Oct. 31, 2013) and Hinchman v. City Water Co., 167 S.W.2d 986, 991 (Tenn. 1943) (“…The essence of the modern defense of impossibility is that the promised performance was at the making of the contract, or thereafter became, impracticable owing to some extreme or unreasonable difficulty, expense, injury, or loss involved, rather than that it is scientifically or actually impossible.”).

[3] See, e.g. Patterson v. Methodist Healthcare-Memphis Hosps., 2010 WL 363314, at *7 (Tenn. Ct. App. Feb. 2, 2010).

[4] See, e.g. Roth Steel Products v. Sharon Steel Corp., 705 F.2d 134, 149 (6th Cir. 1983).

[5] Tennessee courts have adopted the approach taken by the Second Restatement of Contracts. See, e.g. North American Capital Corp. v. McCants, 510 S.W.2d 901, 903 (Tenn. 1974) and Restatement (Second) of Contracts § 264 (1981) (concluding “if the performance of a duty is made impracticable by having to comply with a governmental order, that order is an event the non-occurrence of which was a basic assumption on which the contract was made.”)

[6] N. Am. Capital Corp. v. McCants, 510 S.W.2d 901, 903 (Tenn. 1974).

[7] See generally RESTATEMENT (SECOND) OF CONTRACTS § 261 cmt. b (1981) (“The continuation of existing market conditions and of the financial situations of the parties are ordinarily not such assumptions, so that mere market shifts or financial ability do not usually effect discharge.”)

[8] Courts will consider the individual facts of a case. If a landlord can prove a tenant has significant reserves or other circumstances make rent payment practically possible, even non-essential tenants may be ordered fulfill lease obligations.

[9] United Brake Systems, Inc. v. American Environmental Protection, Inc., 963 S.W.2d 749, 752 (Tenn. Ct. App. 1997).

[10] Jacqueline Sandler, Waiving the Duty to Mitigate in Commercial Leases, 5 Wm. & Mary Bus. L. Rev. 647 (2014).

[11] Ellis v. Pauline S. Sprouse Residuary Tr., 280 S.W.3d 806, 814 (Tenn. 2009).

[12] Tennessee courts have evolved on the impossibility defense over time. See Hinchman v. City Water Co., 167 S.W.2d 986 (Tenn. 1943).

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