Defaults: How should missed payments be addressed? Are there defenses to missed payments?
Early data indicates that as many as half of all small U.S. businesses did not make their full rent or mortgage payments in April, with tenants in the retail, restaurant, and consumer service industries among the first to seek rent relief from landlords.1 Even nationally listed tenants have stated publicly that they do not intend to make April rent payments.2 Some tenants are seeking longer forbearances, with some requesting rent abatements into July or later. While both landlords and tenants have arguments to support payment or nonpayment of rent, ultimately parties will need to find a negotiated solution that works for both (and any lender that may be involved).
Tenants may seek to rely on any force majeure language included in their leases to delay or avoid rent payments. These provisions vary from lease to lease, but generally can excuse delayed performance or nonperformance of a lease covenant by a tenant or landlord due to an “act of God.” Although such provisions must be closely examined in each lease, in general these provisions almost always contain carveouts requiring the payment of rent regardless of any force majeure claim, so force majeure alone may not be helpful for tenants.
Nevertheless, tenants are not without possible arguments to excuse their defaults. Tenants can suggest that other provisions of their leases, such as abatements in the event of a casualty or condemnation, might act to permit a rent abatement. Closure of a retail store by government action, the argument goes, effectively constitutes a (possibly temporary) condemnation, and therefore entitles the tenant to any remedies under such a provision. Tenants may also argue that their inability to use their leased space because of a closure by the landlord (whether or not mandated by the government) is a landlord default under the “quiet enjoyment” provision of their lease. Landlords may also be unable to deliver services mandated by the lease or by law, triggering another possible default. Frustration of purpose, impossibility, constructive eviction, and other common-law doctrines are other avenues tenants can explore to excuse their missed payments.
Finally, tenants and landlords can look to actions by all levels of government to bolster their negotiating positions. Varying state and local laws, ordinances, and regulations, ranging from eviction moratoriums3 to rent freezes4 to required closures, place both landlords and tenants in novel positions. Since many courts are closed to filings, a landlord’s ability to enforce any remedies or evict a nonpaying tenant is also limited. Government action taken to date is more likely to benefit tenants than landlords, though landlords may be able to point to similar relief when speaking with their lenders about possible renegotiations.
Amid the widespread economic turmoil brought about by the pandemic, both landlords and tenants will need to work together to find negotiated modifications to key terms of their leases. Legal arguments may matter less than common-sense negotiations and accommodations, but such actions will need to take place in the context of this rapidly-evolving legal landscape.
Not declaring a default: What other options might landlords and tenants have?
Even if tenants do not pay rent, landlords may resist declaring a default for several reasons. In addition to the limitations imposed by court closures and other government actions described above, landlords may wish to avoid antagonizing a tenant in a market where finding a new tenant might be extremely difficult. As bad as a tenant paying partial rent would be, vacant space might be worse. Additionally, landlords may avoid default declarations if their loan documents penalize them for tenant defaults. Government responses may also make a formal default declaration difficult or impossible. Nevertheless, landlords still have several options short of default declarations to pressure compliance from tenants or wring additional cash flow from their properties.
Landlords (and tenants) should examine their insurance policies to determine whether coverage may be available to mitigate expenses or pay rent. Landlords can also negotiate rent payment plans, accelerate or reallocate any abatements or credits they might otherwise have in their leases, or waive or negotiate other charges that might apply to their leases. Landlords may also be limited by consent requirements of lenders or other capital providers for material changes to leases, but government actions have encouraged banks to work with borrowers in negotiating relief.5 Some jurisdictions are considering permitting the use of security deposits to cover existing rent obligations.6 Landlords could also demand that any government funds be used to pay rent, and some may even provide assistance (financial or otherwise) to tenants in applying for such funds. Assistance may be available for landlords and tenants under the federal CARES Act, though, [as detailed in a prior client alert], many landlords may be less able to avail themselves of some portions of this law than tenants due to their asset-heavy, employee-light business model. Finally, some landlords and tenants may consider whether, in light of the ongoing uncertainty and the nature of their financial obligations, it may make sense to terminate a lease early and amicably.
Conclusion
Landlords and tenants will be best able to emerge from this crisis if they are flexible, creative, and cooperative. Both stand to lose from doctrinaire insistence on strict adherence to lease terms. Negotiating a modification in the shadow of new laws and new economic circumstances may be difficult, but the options outlined above should provide a framework for such discussions.
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.
For more information on the legal and business implications of COVID-19, visit the Reed Smith Coronavirus (COVID-19) Resource Center or contact us at COVID-19@reedsmith.com
- "Half of Small Businesses Haven’t Paid Full April Rent, Early Poll Suggests,” Wall Street Journal (April 3, 2020), (accessed April 15, 2020).
- See, e.g., Cheesecake Factory Inc.’s statement that it will not make April rent payments.
- See, e.g., New York State Executive Order 202.8, dated March 20, 2020.
- See, e.g., Washington, D.C. COVID Emergency Response Bill, passed April 7, 2020 and described here (accessed April 15, 2020).
- “Regulators Urge Banks to Give Relief to Customers Affected by Pandemic,” American Banker (March 13, 2020), (accessed April 15, 2020).
- "NYC Tenants Could Pay Rent with Security Deposits Under Plan,” Bloomberg, March 30, 2020, (accessed April 15, 2020).
Client Alert 2020-248
