Legal Update
Apr 24, 2020
COVID-19 and Retail Tenants — Early Lessons Learned
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On March 13, 2020, the United States declared a national emergency related to the rapid, global spread of COVID-19, the disease caused by the novel coronavirus, SARS-CoV-2. The retail industry has been feeling the fall-out ever since. The vast majority of states and many municipalities have issued stay at home orders, covering more than 95% of US residents.1 Many states have also issued executive orders requiring non-essential businesses to remain closed. With customers staying home and businesses closing, the drop in revenue for retailers has been sudden and dramatic, forcing many retailers to seek relief from rental and other lease obligations. At the same time, retailers are grappling with what reopening will look like, as federal and state governments begin to offer guidelines for life and business following the lifting of stay-at-home orders.
As our tenant clients navigate the pandemic, we have been advising them with respect to their existing leases and have been helping them negotiate new ones. We have also been advising our clients on return-to-work issues. This alert outlines some early lessons learned for leasing going forward into a post-pandemic world. Whether you are negotiating a lease modification or a new lease, be sure to give thought to the following guidance.
Address COVID-19 Directly
Address COVID-19 issues directly in your leases. Force majeure provisions have garnered much recent attention, in large part because their application to COVID-19 issues is not clear. Rather than relying only on force majeure, include provisions in your lease that address COVID-19 head-on. Bear in mind that COVID-19 may emerge in a second wave, so will remain a relevant risk even after governmental restrictions are eased. Be sure to refer to global pandemic generally as well as to COVID-19 specifically; unfortunately, other pandemics may emerge in the future.
Build-Out Periods
The COVID-19 crisis is affecting all aspects of the construction process. Some municipalities have instituted construction moratoriums. Even in those that have not, the permitting process has slowed as government employees at all levels are working remotely and public hearings have been delayed or moved to virtual meetings. Finding workers and materials is also proving difficult.
If your lease has a set time period for the completion of tenant improvements, be sure to include a day-for-day extension for any COVID-19 related delay, or you may find yourself at the end of your “build clock” but not ready (or unable) to open.
Also examine your landlord’s delivery obligations. Consider asking for a termination right if Landlord is unable to deliver your premises by a firm outside date that is not tolled due to COVID-19 delay. It is reasonable for landlords to ask for the tolling of their delivery periods for COVID-19 issues, but tenants should not be expected to wait forever. After a certain point in time, you should have the option to move on to another location. To the extent that both landlord and tenant have construction obligations, we have seen mutual COVID-19 delay/force majeure accommodations emerging as the new norm.
Continuous Operation Covenants
If your lease includes a covenant requiring you to be open and operating for a minimum number of hours on a set number of days, seek to permit temporary closure for COVID-19 related issues, including government mandated closures, inability to staff required employees due to stay-at-home orders, and supply-chain interruptions. Also seek permission to close temporarily if you cannot otherwise operate profitably or safely due to the COVID-19 pandemic. As the economy begins to reopen, states are most likely to replace strict stay-at-home orders with social distancing and other health and safety regulations that may make it impracticable or unprofitable to operate some retail businesses. The inability to operate profitably is unlikely to rise to the level of force majeure in any version of that provision; hence the need to address continuous operation covenants directly in order to provide protection from the consequences of COVID-19 or other pandemic.
Rental Abatement Provisions
Most force majeure provisions do not relieve tenants from the requirement to pay rent or other monetary obligations, thus you will not likely be entitled to rent relief due to COVID-19 restrictions unless your lease directly addresses this issue. Seek to include a rental abatement provision in your leases that is triggered if you are forced to close or reduce your operations due to COVID-19 or other pandemic. This is likely to be a hotly contested request, but given the severe economic impact of COVID-19, tenants can argue that the economic risk of a pandemic like COVID-19 should be shared between landlord and tenant. The rental abatement and risk sharing can be structured in a variety of different ways. If operations are limited but not impossible, consider including an alternative rent structure that reduces or eliminates base rent in return for percentage rent based on actual sales. If you are required or forced to close due to landlord or governmental action, seek a full or partial rental abatement. Landlords may find the request more palatable if you have a “waiting period” of anywhere from three days to two weeks before the abatement kicks in, or if you cap the length of the abatement period. Consider offering an abatement period that ends ten days after any applicable state of emergency or stay-at-home order is lifted. The amount of abatement could also be tiered, e.g., a 25% abatement for the first 30 days, a 50% abatement for the next 30 days, a 75% abatement for the next 30 days, and 100% abatement thereafter. If the abatement continues for a long period of time, consider including a mutual termination right, allowing either party to walk away from the lease.
When structuring your rental abatement provision, be sure to include a period of time for “ramp-up” following the end of the COVID-19 interference. It will take time to recall employees, re-stock and re-engage with customers after COVID-19 interference ends, and you will want rent relief during this ramp-up period.
List COVID-19 as a Force Majeure Trigger
Many jurisdictions, including New York and California, narrowly construe force majeure clauses. In these jurisdictions, a force majeure clause will usually only excuse your failure to perform if the event that prevented your performance is specifically identified in the force majeure clause.2 Even if a force majeure clause includes a “catch-all” provision covering any other events beyond your reasonable control, courts will often limit the application of the catch-all clause. New York courts will typically excuse performance only for events specifically listed in the lease, although they may permit unlisted events to trigger force majeure pursuant to a catch-all clause, if those unlisted events are of the same kind or nature as the particular matters mentioned in the lease.3 California courts may also permit unspecified force majeure triggers pursuant to a catch-all clause, but only if those events are not foreseeable at the time the contract was drafted.4
Given the tendency of courts to narrowly construe force majeure provisions and to ignore or limit catch-all clauses, tenants should include reference to pandemics in force majeure provisions going forward. Specifically include COVID-19 as a triggering event, but also include more generic events like “epidemic,” “global pandemic,” “outbreak of disease,” or “public health emergency.”
As mentioned above with respect to rental abatements triggered by COVID-19, be sure to include a ramp-up period in your force majeure clause. Your performance should be excused until it is feasible for you to resume operations, not merely until the triggering event has ended. You may need additional time to recall employees and re-stock supplies before you can perform your lease obligations.
Be on the look-out for other aspects of the force majeure provision that you can negotiate to work better for you. These include notice provisions, duties to mitigate, caps on the length of force majeure delay, and tolling provisions. For example, be sure that force majeure events toll the time period for your performance and do not simply excuse your failure to perform. If notice is required to formally trigger force majeure, make sure that the method of delivery is practical. Email is likely best in a situation where access to your office and overnight delivery services is limited.
Include an Operating Requirement in Co-Tenancy Provisions
If your lease contains co-tenancy provisions, make sure that they are structured properly. If you are counting on an anchor tenant to be in business or a shopping center to be active, make sure that your co-tenancy provision requires the specified tenants to be open and operating (and not merely under lease). Some co-tenancy provisions are structured so that they are satisfied when the specified tenants have entered into leases, but do not require those tenants to be operating. While knowing that surrounding spaces are leased is comforting to a tenant, the benefit of having other spaces leased is lost if the tenants in those spaces are not open and operating. A tenant may be excused from its own continuous operation covenant if a co-tenancy covenant is breached or may be entitled to rent relief. The tenant may even have the right to terminate its lease. In the current pandemic, many stores are closed, but remain leased. Unless a co-tenancy provision requires the specified tenants to be open, it will be of little benefit in this pandemic or future ones.
You should also examine the effect of force majeure on co-tenancy clauses. If your landlord can excuse or limit the effect of a co-tenancy clause due to force majeure, the clause will be of limited use to you. If your co-tenancy clause is subject to force majeure, consider limits on the period of time that force majeure can apply before your remedies begin, and consider preserving some remedies notwithstanding force majeure. You should, for example, be relieved of continuous operation covenants if the co-tenancy covenant is breached, even if that breach is excused due to force majeure.
Start Thinking About Reopening
On April 16th, the federal government issued guidelines for reopening commerce in the U.S., and a number of states have since followed suit. Most guidance suggests that the economy will open in phases and that new public health restrictions will be in place as businesses get back to work. Suffice it to say that when stores begin to reopen, business will not be the same as it was before the COVID-19 pandemic. In the early phases of reopening, the number of customers in a store or the number of diners in a restaurant will likely be severely limited, and retailers may need to reconfigure space or create physical barriers to ensure appropriate social distancing among customers and between customers and employees. Retailers may be required to reduce staffing levels or to re-assign duties to limit employee exposure to the coronavirus and may be required to take steps to protect customers from particularly vulnerable populations. Personal protective equipment is likely to be required for both customers and employees. Even in later phases of reopening, “retail-to-go” may become a permanent part of the retail landscape, where curb-side pick-up and other delivery options are prevalent. “Contact-less” payment systems may now become the norm -- e.g., payment by phone apps or contactless chips on credit cards.
Spend time considering what your business will look like in post-pandemic world. Consider what changes you might need in current leases or leases in progress to most efficiently operate in that new world. For example, you may need to rethink tenant improvement plans to reconfigure space to provide appropriate distancing. If you are a restaurant operator and you will now be serving fewer diners per square foot, consider whether the economic assumptions in your lease make sense. All retailers should consider how to best implement “retail-to-go”. Does your lease contain rules and regulations that restrict lines outside of your premises or otherwise seek to limit your use of the areas immediately outside of your premises? Do you have appropriate kiosk protection provisions to ensure that the areas in front of your premises remain clear?
Examine the common area provisions of your lease as well. Consider requiring your landlord to implement enhanced cleaning procedures and to provide hand sanitizer stations. Do restrooms in the common areas only provide cold water? Consider requiring hot water as well.
Consider issues like notification of positive coronavirus tests and mandatory temperature checks. Weigh the balance between privacy concerns and public safety. While it may be beneficial to receive notification from your landlord of positive test results from other tenants, consider whether you would be willing to submit to a requirement to notify landlords if your employees or customers have positive tests. Consider, also, the regulations being implemented by the states in which you are located. Some may require temperature checks and other screening procedures for your employees, or may require your employees to wear face masks. For example, the Texas Department of Health and Human Services recently issued guidelines for reopened retail services that include both suggestions.
Conclusion
We have spent just over a month living in the COVID-19 state of emergency. The situation is fluid and rapidly evolving and is being felt differently across the US. Some states are hard hit, some less so. Nevertheless, the impact is nearly universal and early lessons for leasing have begun to emerge. These lessons will be refined over time and new ones will emerge. The above is a snapshot of where we are now and highlights issues to consider as both federal and state governments issue guidelines for reopening and operating in a post-pandemic world.
1 Sarah Mervosh, Denise Lu and Vanessa Swales, See Which States and Cities Have Told Residents to Stay at Home, N.Y. Times, April 20, 2020, available at https://www.nytimes.com/interactive/2020/us/coronavirus-stay-at-home-order.html.
2 In re Cablevision Consumer Litig., 864 F. Supp. 2d 258, 264 (E.D.N.Y. 2012) (citing Reade v. Stoneybrook Realty, LLC, 63 A.D.3d 433, 882 N.Y.S.2d 8 (2009))
3 Kel Kim Corp. v. Cent. Markets, Inc., 70 N.Y.2d 900, 519 N.E.2d 295 (1987)
4 Watson Labs., Inc. v. Rhone-Poulenc Rorer, Inc., 178 F. Supp. 2d 1099 (C.D. Cal. 2001) and Free Range Content, Inc. v. Google Inc., No. 14-CV-02329-BLF, 2016 WL 2902332 (N.D. Cal. May 13, 2016)
