The retail industry has experienced an unprecedented and immediate shift as a result of the economic fallout from COVID-19. One of the most apparent changes is evident when handling commercial retail leasing; read on to better understand what the new commercial standard will be on key retail leasing issues.
Definition of Force Majeure
Most often in commercial retail leasing, force majeure provisions only come into play in the initial build-out of the leased premises, or with respect to a casualty. The mandatory governmental closures brought a different aspect of what is or should be considered a force majeure event.
Should the definition of force majeure include or exclude pandemics?
If so, how do you define a pandemic?
Or, should the definition instead forgo a reference to pandemics all together and address a potential scenario only with respect to a mandatory governmental closure?
Force Majeure and Rental Abatement
Another pertinent issue highlighted by the pandemic is whether rental obligations should be abated due to a force majeure event. Historically, it was very rare that a force majeure event allowed for abatement of rental obligations. However, in the context of re-examining and potentially re-defining “force majeure”, especially considering mandatory governmental closures for many businesses in the retail sector, it begs the question: should there be an automatic rental abatement under these circumstances?
Modifications of Permitted Use/Exclusive
As particularly evidenced in the restaurant and food-service industry during the mandatory pandemic governmental closures, many establishments are operating in a limited or altogether different capacity. In some cases, this may directly cause a violation of an “exclusive use” which a landlord has previously granted another tenant in the same center.
For example, assume that Tenant A has an exclusive on carry-out liquor sales, but the local government suddenly permits all restaurants to sell liquor directly (with or without a carry-out license). This would likely trigger a rogue-tenant scenario, instead of a direct violation by the landlord. However, rogue-tenant clauses typically require the landlord to take some action to stop the rogue-tenant’s actions.
Depending on how long a governmental-mandated closure lasts, this could put the landlord in a position to either default on the lease with the tenant having the exclusive use, or to be forced to take action to shut down the rogue-tenant, potentially halting and likely severely hindering the business and solvency of that rogue-tenant.
Moving forward, landlords should strongly consider the impact of another (or different) wave of mandatory governmental closures and what flexibility they have when permitting certain limited operations for their tenants (possibly violating exclusives of other tenants), especially when negotiating future retail leases.
Tenants Failing to Comply with Governmental Orders
COVID-19 brought swift, broad, and sweeping closures in most sectors of the real estate and business market, but those closures were often not clearly or effectively communicated.
Are landlords required to notify and monitor the actions of their tenants to ensure that they comply with governmental orders?
Unique circumstances aside, most retail landlords won’t incur much liability risk for a tenant’s failure to act in a way that violates a governmental order. Generally, the tenant is at risk of incurring fines and/or a loss of its business license.
A retail landlord should heavily consider integrating additional rules and regulations for common areas of their buildings in compliance with such orders. Some suggestions may include: limiting the number of people permitted in an elevator at once, requiring face masks be worn by anyone in the common areas, and/or adding hand sanitizer dispensers throughout the common areas of the project.
What is a landlord’s ability to force its tenant to comply with new rules and regulations?
In an ideal situation, the existing lease provides a landlord the ability to modify rules and regulations from time to time. If that concept is not contained in the lease, a landlord should strongly consider adding this flexibility in its new leases going forward.
Continuous Use and Operations
Obviously, the issue of vacancy in shopping centers affects the optics of both sides of the business: for a landlord, it gives the appearance of struggle, and for tenants, it paints a less than savory shopping experience for customers. Often in retail leases, an event of default occurs when a tenant “goes dark” or fails to continuously operate in the leased premises.
As the initial wave of the pandemic’s economic fallout pervaded the retail industry, in-person retail business virtually came to a halt. As time went by, landlords feared an even greater loss in revenue stream from their retail projects. It raised the question: should penalties and/or an event of default be instituted by landlords because of a tenant’s closure (or severely reduced hours of operation) due to the pandemic or a mandatory governmental closure? Given these unique circumstances, even if the lease does not include that a properly defined force majeure event is an excuse to such closures, enforcing such a policy would be a hard argument for a landlord to make.
Security Deposit and Guarantees
The purpose of a security deposit and a guaranty of lease is to safeguard the landlord from bad acts of tenants as it relates to a tenant’s obligations under the lease. As evidenced throughout the mandatory governmental closures related to COVID-19, many tenants simply stopped (or were unable to continue) paying rent. Many leases permit the landlord to draw on a security deposit or trigger a guaranty upon a default. In these situations, a landlord may utilize the additional security provided by a security deposit or guaranty to support its cash flow in the event of a mandatory governmental closure.
Notice Provisions
Many notice provisions in leases are archaic, most notably with respect to disallowing electronic notices. However, the governmental closures and concern of transmission of COVID-19 necessitated the advancement of leasing protocols to evolve. Landlords and tenants should consider electronic transmission of notices being the new standard for transmitting notices, for the safety of both landlords and tenants (and their employees), and for efficiency of delivery the notice itself; mail and delivery services are not as reliable as they once were, and many tenants are not currently visiting the leased premises (as the standard was pre-COVID) on regular basis.
Co-Tenancy
While this concept is almost always specific to retail centers with big-box tenants (think Dick’s Sporting Goods, TJ Maxx, and Petco), co-tenants were hit hardest with regard to the mandatory governmental closures. Most often, other lessees in shopping centers that house big-box tenants contain a co-tenancy clause. To learn more about how this concept has been potentially impacted by COVID-19, click here.
While these shifts in the commercial retail leasing space may be frustrating, they are a harsh reality and one which can be navigated with the appropriate guidance and changes to future leases. Please let us know how we can help you audit your existing protocols and plan to avoid running into issues in the future.
If office leasing is also in your purview, click here for more information on changes in office leasing in the COVID-19/Post-COVID-19 world. For questions on this article, please contact info@rosenbergmartin.com.