Indeed, the current situation raises different legal issues depending on the sector of activity and the position of the parties to the contract, landlord, user, owner, contractor, investor, asset manager, etc.
This legal alert focuses on performance of contractual obligations and exemptions under the main real estate contracts, i.e. commercial leases, construction contracts, management contracts and deeds of sale.
- Commercial lease agreements
Article 1 of the ministerial order of 14 March 2020 establishing various measures to fight against the spread of the Covid-19 virus ordered the closure until 15 April 2020 of many categories of French regulated “établissements recevant du public” (ERP), establishments intended to receive the public. These include shopping centres, restaurants and bars, theatres, dance and game halls, sports facilities, documentation centres, libraries and museums. However, an exemption is permitted for restaurants and bars that are allowed to maintain their take-away and delivery activities.
In this context, the main issue in real estate matters concerns the suspension of rent payments. The answer to these questions can be analysed with regard to the exception of force majeure (i) and the application of the theory of unforeseeable circumstances (ii) and depends on the categories of establishments affected by the closure measures, such as bars, restaurants, shops, particularly those located in shopping centres, theatres, hotels, offices, logistics warehouses.
Depending on the request of the contracting party and on the presence or absence of derogatory clauses in the agreement, the grounds for force majeure and unforeseeable circumstances may be invoked cumulatively or alternatively. Indeed, a party to the contract could invoke force majeure resulting from the epidemic in order to temporarily exonerate itself from contractual obligations, but could also plead unforeseeable circumstances in the light of the current economic situation in order to renegotiate the contract. This is only possible if no contractual clause has ruled out force majeure or unforeseeable circumstances.
(i) Exemption by force majeure
It is well known that prior to the reform of contract law which took effect on 1 October 2016, force majeure was defined by case law as "the occurrence of an external event, unforeseeable at the time of the conclusion of the contract and irresistible during its execution". The courts applied very strictly the conditions of unpredictability, irresistibility and exteriority and rarely recognized the occurrence of a force majeure event.
Force majeure is now codified in article 1218 of the Civil Code, which provides that “there is force majeure in contractual matters where an event beyond the control of the debtor, which could not reasonably have been foreseen at the time of the conclusion of the contract and whose effects cannot be avoided by appropriate measures, prevents the performance of his obligation by the debtor”. The same article adds that "if the impediment is temporary, performance of the obligation is suspended unless the delay which would result from it justifies termination of the contract. If the impediment is permanent, the contract is terminated ipso jure and the parties are discharged from their obligations under the conditions set out in articles 1351 and 1351-1. »
Even if case law has not always accepted the qualification of force majeure for epidemics that have occurred in the past, the seriousness of the current sanitary crisis, the recognition by the WHO of the pandemic situation as well as the measures taken recently (closure of ERPs, containment...) lead to the conclusion that the present situation could be qualified as force majeure by the courts. Moreover, this term has been used several times in recent official statements.
In the context of the current outbreak, could a tenant argue force majeure in order not to pay his commercial rent?
The answer is different depending on the purpose of the commercial lease.
As this is an essential obligation of the tenant under Article 1728 of the Civil Code, a corollary of the landlord's obligation to deliver under Article 1719 of the Civil Code, it seems difficult for the tenant to avoid it by invoking force majeure, except in certain special cases directly impacted by mandatory closure measures.
In respect of the closure of many categories of establishments intended to receive public pursuant to the decree of 14 March 2020, tenants of shops located in shopping centres, theatres, bars and restaurants or any establishment receiving public affected by the closure measures, will have to suspend the performance of contractual obligations and in particular the payment of rent on the basis of force majeure. The criteria of Article 1218 of the Civil Code appear to be met in this case.
In this regard, several property owners owning shopping centres have informed their users that the current rents would not be called.
It should be noted, however, that the exception of force majeure cannot be raised by a tenant whose commercial lease contract was signed after the beginning of March 2020 (and perhaps even after February 2020) insofar as the sanitary context could suggest that measures similar to those taken in China or Italy were going to be applied in France. Likewise, this exception could not be raised by tenants of restaurants and bars whose take-away and/or delivery business is maintained since exploitation is still possible.
Office leases are not affected by mandatory closure measures and tenants are not legally prevented from operating their premises. In practice, however, such exploitation is very limited given the general confinement imposed on the population and thus on the employees of service sector companies. Under the terms of the decree of 23 March 2020, the only employees or occupants who can visit the offices are those whose business trips cannot be postponed. Due to the low occupancy of office premises, many users are questioning the application of force majeure in order to suspend the payment of rent. However, this is not a legal case of exemption and any commercial rent will therefore be due to the landlord as long as the landlord does not breach its obligation to deliver and allows the use of the premises despite the context of confinement. In practice, most companies organise a permanent, though reduced, presence on their premises. Though, due to the novelty of the situation, tenants may approach their landlord to negotiate an agreement to suspend or stagger current rents.
Regarding hotel leases, the application of force majeure, and consequently the suspension of the commercial rent, could be partial since the hotel operator is partly impacted by the closure measures applying to hotel restaurants and bars, therefore reducing its revenue. A practical solution could then be to reduce the commercial rent by taking into account only the hotel activity, excluding the operation of restaurant and bar areas. If the case of force majeure is justified, at least in part, and unless otherwise stipulated, a prior discussion with the landlord is also to be preferred.
The tenants of logistics warehouse leases are less affected by government measures. For warehouses not affected by mandatory closure measures, business remains very strong and several logistics players are even recruiting employees to meet demand. In principle, the tenants will therefore be able to meet their rent payments.
(ii) Exemption by unforeseeable circumstances theory
The second ground for exemption that may lead to the suspension of the payment of the rent and/or cause a renegotiation of the contract is unforeseeable circumstances.
Prior to the reform of contract law (2016), the application of the theory of unforeseeable circumstances had been ruled out by the Supreme Court (French Cour de cassation), even in the event of a profound change in circumstances.
In 2016, the legislator introduced unforeseeable circumstances in Article 1195 of the French Civil Code, which provides that "if a change of circumstances unforeseeable at the time of the conclusion of the contract makes performance excessively onerous for a party who had not agreed to assume the risk, that party may request a renegotiation of the contract from his co-contractor. It shall continue to perform its obligations during the renegotiation.“ The article also provides the regime by stating that "in the event of refusal or failure of the renegotiation, the parties may by mutual agreement request that the judge adapts the contract. Failing this, a party may ask the judge to terminate the contract, on the date and under the conditions that the judge determines.”
As for force majeure, it should be noted that given its suppletive nature, the unforeseeable circumstances may be set aside by the clauses of the commercial lease, which is very often the case in “investor” leases. In this hypothesis, the unforeseeable circumstances will not apply.
In the present case, the epidemic, government measures and the resulting economic crisis may constitute a change in circumstances unforeseeable at the time of the conclusion of the contract and thus render its performance excessively onerous, provided, however, that the party relying on it can justify it.
This exception could therefore be raised by the tenant in support of his request for suspension of rent payments and/or renegotiation of the contract, if he is experiencing economic difficulties due to the closure or containment measures imposed by the regulations.
It should be noted that a recent decision of the Court of Appeal (French Cour d’appel) of Versailles might however challenge the application of the theory of unforeseeable circumstances to commercial leases.
In a decision dated 12 December 2019 (no. 18/07183), the Court of Appeal of Versailles explicitly ruled out the application of Article 1195 of the French Civil Code to commercial leases in connection with a tenant's request for a rent review, considering that "since the statute of commercial leases provides many special provisions relating to the revision of the lease contract (three-year revision, indexation clause), there is no need to apply the general provisions of the aforementioned Article 1195, the latter having to be set aside in favour of the special rules of the statute of commercial leases."
A question remains as to whether this decision will be followed by the Supreme Court (French Cour de cassation), in which case many commercial tenants could be denied any claim based on the unforeseeable circumstances.
Once again, the preferred approach, without waiting for court decisions on the application of the unforeseeable circumstances and in view of their judicial uncertainty, is to immediately enter into negotiations with the landlord on the suspension or reduction of current or future rent payments or, more generally, on the revision of the contract due to the economic impact of the epidemic.
Regarding landlords, management contracts such as property management agreements or asset management agreements may be amended on a case-by-case basis depending on whether the activity ceases or is very substantially altered by its increasing or decreasing scale or by the nature of the missions carried out by the service provider or by the manager.
- Construction agreements
Article 1 of decree no. 2020-293 of 23 March 2020 regulating travel in the context of the fight against the spread of the Covid-19 virus prohibited all travel until 15 April 2020, with the exception of certain specific cases, in particular travel between home and the place of professional activity when it cannot be postponed.
However, this authorization to travel requires that the hygiene measures recommended by the government must be put in place, in particular observing safe distances, cleaning of hands with soap or hydroalcoholic gel, wearing masks or gloves depending on the situation and, more generally, the absence of a group of people gathering together.
Although these legal conditions do not exclude, as a matter of principle, the continuation of construction sites, many clients and contractors nevertheless ask themselves the same question: should works in progress be suspended?
While the current position of the Government is to continue works under the current public contracts, the private works market players are faced with a dilemma. The owner may indeed be concerned about meeting the delivery date of his building, a delivery which is sometimes eagerly awaited, particularly in a context of company relocation with all the consequences that a delay causes (occupation indemnities, maintenance costs of the previous site, social costs, etc.) and the contractors are under considerable economic pressure including, among other things, the payment of their subcontractors and the postponement of payment deadlines.
The Government and three federations of the building sector (FFB, FNTP and CAPEB) met on 21 March 2020 and concluded an agreement providing the distribution of a guide of good practices in the coming days. This guide will provide companies with a series of recommendations to ensure satisfactory sanitary conditions on building sites and to continue activities. Regarding complex worksites, time may be needed to define suitable procedures. In the same way, particular attention will be paid to the case of building sites in the homes of private individuals when they are present.
Crisis units have also been set up since 18 March 2020 to provide concrete responses to the practical situations experienced by company managers in this unprecedented economic crisis.
From a practical point of view, since March 17, it has been recommended that works in progress should be suspended and that construction sites should be closed, especially if they can be postponed, in order to limit the risk of spreading the virus, in accordance with the precautionary principle.
Indeed, even if legally all the conditions are met for the continuation of works, it is advised to go "beyond the law" because the sanitary precautions seem hardly compatible with the continuation of the activity. Construction site meetings or construction activities in confined spaces that limit the respect of safety distances of one meter are propitious to the spread of the virus, especially if the workers cannot wash their hands regularly. An exception could be considered in case of construction sites taking place exclusively outdoors, where the new sanitary rules could be applied without risk.
In any case, the owner or the contractors could be held liable. In other words, a strict application of the regulations may not be exempt from liability, particularly with regard to the obligations of safety and protection of persons.
It will be necessary to make a very precise analysis of the adequacy of the de facto situation with regard to the regulatory and legal criteria (in particular regarding the criterion according to which the works could be deferred).
Discussions between the contracting parties and an amicable approach will always be preferable in this context in order to estimate the risks incurred and to judge, as the case requires, the impact of the closure of the worksite on the operation and on all those involved.
- Real estate purchase agreements
Following the application of Decree No. 2020-260 of 16 March 2020, replaced by Decree No. 2020-293 of 23 March 2020, the introduction of containment by the Government has obviously had an impact on the mobility of the French persons in the form of an almost total restriction on their comings and goings.
As such, a large majority of companies and institutional investors have had to adapt to these containment measures by closing their premises and introducing teleworking measures for their entire workforce.
In terms of transactions, the situation differs according to whether the transaction is supported by an authentic deed or a private deed (in particular for sales of shares in real estate companies or assignment).
The notary offices, which are responsible for authenticating deeds for the acquisition of real estate assets, were affected by this measure, as notaries and research staff were required to work at distance.
As a result, for current real estate transactions, during which meetings for signing deeds and transferring ownership of real estate assets must take place, the parties' notaries can no longer carry out their mission under normal conditions (meetings to review contractual documentation or to monitor the fulfilment of conditions precedent to the sale or financing of assets, pre-closing, etc.).
The confinement of all the parties has therefore, in almost all cases, the effect of delaying the completion of many real estate transactions, the parties having no other solution than to discuss in view to agree on a postponement of the transfer of ownership.
With the exception of signatures relating to an imperative necessity (which is understood to be a human necessity such as the risk of death or loss of employment) which can be held in a dematerialised manner by giving power of attorney to the notary, the signature meetings will have to be postponed.
In this context, how can the finalisation of real estate transactions be organised?
Depending on the degree of progress of a transaction, the parties have tools at their disposal to extend, modify or even terminate their contractual relationship.
In the event of a transaction for which the parties would have only expressed an agreement in principle by means of a letter of intent (LOI) and whose completion is slowed down by the containment measures (in particular with regard to the time required to carry out legal and technical audits or to consult the parties' governance bodies, etc.), the purchaser and the seller should discuss in order to negotiate an extension of the effects of the LOI. It is to be expected, then, that the periods of exclusivity of these transactions will be extended.
In the event of a more advanced transaction for which a purchaser and a seller have entered into a conditional sale agreement (French promesse de vente), the seller could not invoke the sanitary crisis to request the suspension of the agreement. In such a case, it is in fact the failure to lift the conditions precedent stipulated in the contract that could lead to the suspension of the sale. Regarding the condition of granting bank financing, it is to be feared that the revenues of companies in the hotel and retail sectors, which have been particularly affected by the current sanitary crisis, may weaken, possibly making credit institutions reluctant to grant them financing. It is likely, then, that it will be difficult to lift the conditions for obtaining real estate financing in the coming months.
In general, it is recommended to negotiate extensions of the deadlines for fulfilling the conditions precedent for obtaining loans.
In the case of a real estate transaction which would not be subject to a condition precedent of financing, taking into account the economic situation, if the purchaser intends to continue the transaction in order not to lose the sums paid on deposit, it is, once again, to be expected that the parties meet to discuss an adjustment of certain conditions, in particular the financial conditions of the transaction.
Likewise, the parties are advised to anticipate the fact that the deadlines for the completion of the promises to sell may be too short due to the regulations in force and to meet as soon as possible to extend these deadlines.
In the case of share deals, this could take place, as they are not necessarily subject to notarization. As with direct sales of assets, these types of sales are often accompanied by conditions precedent. A physical meeting will be necessary most of the time to lift the conditions precedent and thus materialize the transfer of ownership of the shares. For this reason, it is strongly recommended that the contracting parties get into contact with each other in order to postpone their signing and closing dates.
Moreover, it is clear from the provisions of Article L. 211-40-1 of the French Monetary and Financial Code that the unforeseeable mechanism provided under the provisions of Article 1195 of the Civil Code is not applicable to sales of shares issued by joint-stock companies (French Sociétés par actions). By way of deduction, sales of shares issued by partnerships (French Sociétés de personnes) fall within the scope of Article 1195 of the French Civil Code. The purchaser of shares in a partnership could therefore take advantage of the unforeseeable mechanism and request the renegotiation of the terms of the transfer contract in the event of a "change in circumstances unforeseeable at the time of the conclusion of the contract" making "performance excessively onerous for one party".
For a conditional transfer of shares in a French Société civile that would have been signed before the sanitary crisis occurred and that is to be reiterated after March 2020, could be reconsidered, as long as contractual provisions have not excluded the application of Article 1195 of the Civil Code on contingencies.
If a clause has been included in the contract to adapt the application of the unforeseeable circumstances (Material Adverse Change clause) or to exclude the unforeseeable circumstances (non-Material Adverse Change clause), this clause should be applied in order to determine under which conditions the terms of the contract could be renegotiated.
The contracts related to the transaction, such as the selling mandates, will also have to be amended, if necessary, in particular to extend their validity date.
In any case, the parties should discuss in view to negotiate postponements of the next steps of their pending transactions and possibly modify the terms and conditions of the transaction.
Our Reed Smith Coronavirus team includes multidisciplinary lawyers from Asia, EME and the United States who stand ready to advise you on the issues above or others you may face related to COVID-19.
Client Alert 2020-170