Federal Court: New York City COVID-19 Guaranty Law Unconstitutional

On March 31, 2023, U.S. District Judge Ronnie Abrams of the Southern District of New York issued her highly anticipated ruling in the latest iteration of Melendez et al v. The City of New York, et al.  Judge Abrams granted Plaintiffs’ motion for summary judgment and found that  New York City’s “Guaranty Law,” a COVID-19 enactment that rendered certain personal guaranties of commercial leases unenforceable, was itself unenforceable because it violated the Contract Clause of the US Constitution (read the decision here). The closely watched decision comes five months after the U.S. Court of Appeals for the Second Circuit reversed Judge Abrams’ dismissal of Plaintiffs’ Contract Clause challenges to the Guaranty Law, and remanded the case for further development of the record concerning the reasonableness and appropriateness of the law.¹

Below, we introduce the Guaranty Law, then provide an overview of the issues and holdings in (i) Judge Abrams’ decision on Defendants’ motion to dismiss (Melendez I), (ii) the Second Circuit’s reversal of Judge Abrams’ dismissal of the Contract Clause challenge (Melendez Appeal) , and (iii) Judge Abrams’ recent ruling on remand (Melendez II).

The Guaranty Law (NYC Administrative Code § 22-1005)

March 2020 marked a pivotal turning point in the pandemic across the world, the United States, and New York. With nearly 100 reported cases of COVID-19, Governor Andrew Cuomo declared a state of emergency on March 7, 2020; on March 11, the WHO declared COVID-19 a pandemic; and on March 13, President Trump declared a national emergency. Two weeks later, Congress would pass the largest stimulus in history, the $2.2 trillion CARES act.

The “Guaranty Law” was part of New York City’s local pandemic response. Announced April 21, 2020, and signed into law by Mayor DeBlasio on May 26, 2020, it was included in a “COVID-19 relief package that aim[ed] to protect tenants, help small businesses survive, and find creative ways to address the public health crisis brought on by the virus.” Introducing the legislation, primary sponsor District 2 Council Member Carlina Rivera stated the provisions will:

 “… ensure city business owners don't face the loss of their businesses and personal financial ruin or bankruptcy as a result of this state of emergency.” [Hearing Transcript - Stated Meeting 4-22-20. New York City Council, April 22, 2020, pp. 51]

The Guaranty Law rendered unenforceable guaranty provisions for certain tenant obligations (such as rent) in rental agreements for real property within New York City if:  (1) the guaranty was given by a natural person (i.e., a non-corporate entity) other than the tenant; (2) the tenant was (a) required to cease serving patrons food or beverage for on-premises consumption or to cease operation under executive order number 202.3 issued by the governor on March 16, 2020; (b) a non-essential retail establishment subject to in-person limitations under guidance issued by the New York state department of economic development pursuant to executive order number 202.6 issued by the governor on March 18, 2020; or (c) required to close to members of the public under executive order number 202.7 issued by the governor on March 19, 2020; and (3) the obligation arose between March 7, 2020 and (as extended by later legislation²) June 30, 2021.

Melendez I, 503 F. Supp. 3d 13 (S.D.N.Y 2020)

On July 22, 2020, a group of plaintiff landlords filed suit against the City of New York claiming the Guaranty Law violated the Contracts Clause of the United States Constitution. 

Defendants moved to dismiss the Contracts Clause challenge for failure to state a claim pursuant to Fed. R. Civ. P. 12(b)(6).  In ruling on that motion, the District Court applied the Second Circuit’s three-part test and assessed whether (1) the contractual impairment was substantial and, if so, (2) the law advanced a legitimate public purpose, and if such purpose was demonstrated,  (3) the law used reasonable and necessary means to accomplish its purpose. Melendez I, 503 F. Supp. 3d at 32 citing Sullivan, 959 F.3d 54, 64 (2d Cir. 2020).

On the first prong, the District Court held that the contractual impairment was substantial (as it was permanent), but on the second prong found that the law advanced a legitimate public purpose.  Id. at 33 citing Sanitation, 107 F.3d 985, 993 (2d Cir. 1997).  As to the third prong, the Court found the law was a reasonable and necessary means to accomplish that legitimate public purpose. First, the District Court was satisfied that “a real emergency exist[ed]” in the City due to the pandemic. Id. at 34.  In assessing “reasonableness,” the District Court gave strong deference to the legislature’s role in crafting reasonable policy noting the “Second Circuit is extremely deferential to the decisions of policymakers seeking to advance a legitimate public interest.” Id. at 33.  The court acknowledged the legislature appeared to make a policy decision to effectively shift a financial burden from small business owners to their landlords, but  the Court stated “it is not the role of this Court…to opine on the wisdom of the policy decision at issue here.” Id. at 35. The Court was satisfied that the means to accomplish the law’s purpose was appropriately tailored because it applied only to guarantors who were natural persons (as opposite to a legal entity), only to tenants affected by three Gubernatorial executive orders, only to debts within a specific window of time, and left open other legal means to pursue the obligations owed. Such means cited by the court included recovering unpaid rent directly from the tenant or evicting non-paying tenants. Id. at 35-36.  In countering concern over the reasonableness of permanently extinguishing the debt, the Court pointed to caselaw where the deprivation of contracted benefits was deemed reasonable if it was temporally limited. The District Court found that the Guaranty Law was temporally limited in so far as it applied only to obligations accrued within a limited window (i.e. March 7, 2020 – June 30, 2021).

Based on these factors, Judge Abrams found that the Guaranty Law passed muster under the Contracts Clause and dismissed Plaintiffs’ complaint.

Melendez Appeal, 16 F.4th 992 (2d Cir. 2021)

Plaintiffs appealed the dismissal of their Contracts Clause challenge to the U.S. Court of Appeals for the Second Circuit.  Using the same three-part Sullivan test as the District Court, the Second Circuit agreed that the law substantially impaired plaintiffs’ contract and that it served a significant and legitimate public purpose. However, based on the record before it, the appeals court disagreed that the law was an appropriate and reasonable means to advance that significant public purpose. Melendez Appeal, 16 F.4th at 1016.  The Second Circuit identified five concerns and remanded to the District Court so those concerns could be addressed.

First, the Second Circuit was concerned that the Guaranty Law was not truly temporary.  Even though it applied only to obligations that accrued within a limited window (i.e. March 7, 2020 – June 30, 2021), those obligations were rendered permanently unenforceable.  According to the Second Circuit, the fact that the obligations were rendered “forever unenforceable” “weigh[ed] heavily against” a reasonableness determination at the pleadings stage.  Id. at 1038.

Second, guarantors received full relief from their obligations even if they took no action to further the Laws purpose  “to help shuttered small businesses survive the pandemic so they can reopen…ensuring functioning neighborhoods throughout the City.” Id. at 1040. The Court noted the City must have made three assumptions enacting the Law: shuttered small businesses are usually owned by the individuals guaranteeing their leases, such owner-guarantors would be financially ruined if required to pay their obligations, and that such business owners would likely not re-open their businesses after the pandemic. However, because “the law does not condition the relief it affords on guarantors owning shuttered businesses, or even if they do, on their ever reopening those businesses,” the court could not find a sufficient link in the record to conclude the law “is an appropriate means to serve this public purpose.” Id. at 1041.  In other words, guarantors who did not own a shuttered small business, were not owner-guarantors, or even if they were, but had no intention of reopening, would receive relief under the law.  

Third, the “allocation of the full economic burden of the Guaranty Law to landlords” and “not at City expense…or…the public that benefits from functioning neighborhoods” concerned the Second Circuit. It noted “reasonableness and appropriateness concerns are raised by a legislative decision to provide financial relief to certain persons not through public funds but by destroying the contract expectations of other persons.”  Id. at 1042.

Fourth, the relief afforded by the Guaranty Law was not conditioned on need. The Court noted that other contemporary pandemic relief measures at the state and federal level, such as the CARES Act, were conditioned on need or hardship. Id. at 1043. Furthermore, the record lacked a reason why such a condition was not included and lacked evidence to support an inference that “landlords are better positioned financially than guarantors to absorb the economic blows of the pandemic.” Id. at 1044. The Court held that absent such evidence, at the pleading stage, “the Guaranty Law cannot be deemed reasonable and appropriate to its public purpose as a matter of law.” Id. at 1045.

Fifth, the Guaranty Law provided no means of compensation for damages or losses landlords would incur as a result of guarantees being unenforceable. The court noted the failure of the Guaranty Law to condition its relief on “some compensation for, or mitigation of, tax, and other obligations the landlord…is required to satisfy, is a further reason to question the reasonableness and appropriateness” of the law. Id. at 1046.

Based on these five concerns, the Second Circuit remanded to the District Court for further development of the record.

Melendez II, No. 20-CV-5301 (RA), 2023 WL 2746183 (S.D.N.Y 2023)

Following further proceedings on remand, Plaintiffs moved for summary judgment on the Contracts Clause claim.  The District Court followed the Second Circuit’s roadmap to evaluate the facts relating to each of the Court of Appeals’ five enumerated concerns. 

(1) The Guaranty Law is not a “temporary” impairment of contract

To analyze this first concern, the Melendez II Court followed Supreme Court precedent, highlighted by the Second Circuit, that the temporary or limited duration of a contract impairment is a critical factor in determining its reasonableness. The Guaranty Law, though temporally limited in so far as it covered obligations that accrued within a limited window (i.e., March 7, 2020 – June 30, 2021), “permanently and entirely extinguished [the accrued obligations].” Looking to the record, the Court found the City was aware the law was permanent, not temporary. Melendez II, at *10. Therefore, the Court concluded that although it only applied to a temporary period, the Guaranty Law was not a temporary impairment.

 (2) The record does not support an assumption upon which the Guaranty Law was based

The Melendez II Court  found that one of the three assumptions made by the City when it enacted the Guaranty Law was not supported by the record.  The Court held that there was insufficient evidence for the City’s first assumption that “shuttered small businesses are usually owned by the individuals guaranteeing their leases.” Given that the law “permanently eviscerated a crucial provision negotiated into commercial leases contracts”, the lack of evidence for this critical assumption, coupled with the “myriad ways in which the City could have fashioned a more targeted law to address its stated purpose,”  led the Court to ”weigh this concern in favor of finding the Guaranty Law violates the Contract Clause.” Id. at *12-13.

(3) The burden of the Guaranty Law was placed exclusively upon landlords

The Second Circuit was concerned with the allocation of the burden being “transferred…to the ‘few shoulders’ of commercial landlords.” On remand, the City made two arguments and the court rejected both. First, the City claimed the relief to guarantors provided through the Guaranty Law “balanced the burden felt by tenants, guarantors and landlords.” It argued, in error as the Court pointed out, that relief funds available through city agencies were available to landlords but not to small business owners. Melendez II, at *13-14. Second, the City argued that the Guaranty Law “encouraged [l]andlords to negotiate and renegotiate leases with their tenants for the benefit of the economy as a whole.” The Court rejected that argument, noting there would be no incentive for tenants/guarantors to negotiate because the Guaranty Law renders accrued obligations permanently unenforceable; and further, even if the parties did come to the table, because the guaranty provision was suspended, landlords were in a weakened bargaining position, and “would have been forced to make unilateral concessions.” Id. at *14.

(4) The City did not condition the application of the Guaranty Law on need

On remand, the City did not add to the record any “evidence of a need analysis, or any investigative or empirical process.” Id. at *15. Rather, it relied on prior testimony from small business owners about the urgent need for relief.  The Melendez II Court turned this back on the City and held that this testimony proved that small business owners were capable of demonstrating their need on a case-by-case basis. The Court also rejected the City’s argument that the Guaranty Law was inherently “reason[ably] tailored” simply by virtue of being limited to natural person guarantors.

(5) The Guaranty Law does not compensate landlords for unpaid rent

Finally, the Melendez II Court found that the Guaranty Law did not compensate landlords, including by affording them relief of their own, such as a break on real estate taxes.  Among the facts the Court relied was evidence from one plaintiff that he was unable to recover rent in excess of $100,000, had to use $35,000 from another business account to pay taxes, and took out an SBA pandemic relief loan at 4-5% interest. The Court concluded that the City failed to provide evidence that a lack of compensation to landlords was a reasonable and appropriate means of advancing the purpose of the Guaranty Law. Id. at *16.

Based on these five factors, Judge Abrams found that the Guaranty Law did not pass muster under the Contracts Clause and held that the law is invalid.

Conclusion

Melendez has been a hotly-contested and closely followed case.  There may yet be more turns, including a possible return to the Second Circuit.  In the meantime, landlords, tenants, and guarantors should carefully evaluate their options, whether that means litigation, negotiation, or waiting to see what happens next in the Courts.  We encourage you to consult with your Seyfarth counsel to discuss your options in light of this most recent decision.

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1. The Second Circuit affirmed Judge Abrams’ dismissal of Plaintiffs’ challenges to the two other laws at issue in the original case, the Residential and Commercial Harassment Laws

2. Local Law 98-2020 and Local Law 50-2021 (extended protections to March 31 and June 30, 2021, respectively)