Summary of the Legislation
The Legislation adds a new section 22-1005 to the Administrative Code of the city of New York (the Code), which prohibits the enforcement of guarantees and other “personal liability provisions” in “commercial leases or other rental agreements” involving real property and to which a business is a party as a tenant, subject to the two following conditions:
- The default or other trigger event occurred between March 7, 2020 and September 30, 2020.
- The tenant must satisfy one of the three following conditions:
- The tenant was required to cease serving patrons food or beverages for on-premises consumption, or to cease operations pursuant to Executive Order 202.3 (i.e., restaurants and bars).
- The tenant was a non-essential retail establishment subject to in-person limitations under state-issued guidance pursuant to Executive Order 202.6 (i.e., gyms, fitness centers, and movie theaters).
- The tenant was required to close to members of the public pursuant to Executive Order 202.7 (i.e., barber shops, hair salons, tattoo or piercing parlors, and related personal care services).
The Legislation also amends section 22-902 of the Code, which prohibits landlords from engaging in “commercial tenant harassment.” Landlords are now prohibited from “attempting to enforce a personal liability provision that the landlord knows or reasonably should know is not enforceable pursuant to section 22-1005 of the Code.” Landlords are also restricted from threatening a commercial tenant based on the commercial tenant’s status as a person or business impacted by COVID-19, or the commercial tenant’s receipt of a rent concession or forbearance for any rent owed during the COVID-19 period. Landlords will need to exercise caution when communicating with tenants to minimize the risk of claims of “commercial tenant harassment.”
Challenges to the Legislation
It is expected that landlords will raise many challenges to the legality and scope of the Legislation. Well-funded trade organizations, such as The Real Estate Board of New York, advocating on behalf of real estate owners and landlords, brokers, and managers, have already argued that the Legislation as written is unconstitutional and imprecisely drafted.
Constitutional Challenges
The Legislation may be challenged as unconstitutional, violating the Contracts Clause of the United States Constitution (article I, section 10, clause 1), which prohibits state governments from passing (1) any law interfering with private contracts and their corresponding contractual obligations, or (2) any ex post facto law, which means that state governments are not permitted to pass any law that retroactively changes the legal consequences or status of actions that were committed, or relationships that existed, before the enactment of the law. The Legislation does not simply impose a moratorium on the enforcement of the personal liability provisions. Instead, it permanently prohibits enforcement of such provisions in connection with a default or other triggering event occurring during the period of March 7, 2020 through September 30, 2020. It may be argued that this cancellation of private contracts will fall under the Contracts Clause of the United States Constitution.
Imprecise Drafting
The Legislation can be challenged in several ways due to its imprecise drafting.
As written, the Legislation does not expressly prohibit the enforcement of separate lease guaranty agreements made by individuals that are not contained in the body of the applicable lease or rental agreements. Although there are some commercial leases that incorporate personal guaranties within them, most guaranties are commonly documented separately and in conjunction with their related lease agreements. In addition, a guaranty is not a “rental agreement.” A guaranty is a separate agreement which backstops a tenant’s obligation to pay rent and perform its obligations under its lease.
The Legislation, as written, invalidates any provision by which someone will “become” liable for certain payments “upon the occurrence of a default or other event.” Most guaranties do not state that the guarantor will “become” liable in the future. Typically, a guaranty provides that the liability of the guarantor is in effect from the delivery of the guaranty, and not “springing” upon certain events.
The Legislation, as written, does not prohibit enforcement activities against corporate guarantors of commercial leases. Parent companies or other companies unrelated to the business itself that guaranty the lease obligations of tenants would not be protected under the Legislation, which apparently seeks only to shield natural persons (as opposed to business entities) from the adverse economic impacts of the COVID-19 pandemic. It is unclear from the Legislation, as written, whether a guarantor that is a C-corporation (owned by a single individual shareholder) or an LLC that is wholly owned by an individual would be treated as a “natural person” and benefit from the Legislation. Not all retail businesses are intended beneficiaries of the Legislation. Challenges may arise as to what constitutes a “retail establishment.” For example, are service providers such as gyms, hair and nail salons, dry cleaners, or medical offices included as “retail”? Note that personal guarantors of leases for office space are not intended beneficiaries of the Legislation.
As it is expected that landlords will raise these challenges and others to the Legislation, guarantors need to be prepared when negotiating with landlords for relief under their personal guaranties.
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
Client Alert 2020-442
