COVID-19 Issues For Commercial Landlords and Tenants

TRANSCRIPT

My name’s Edward Robson, I’m the managing shareholder of Robson and Robson PC. Robson and Robson PC is a business law firm that’s located outside of Philadelphia, Pennsylvania. We represent businesses and their owners in a variety of matters, including commercial litigation, employment, commercial leasing and mergers and acquisitions. The topic of our video podcast today is going to be commercial leasing. And let me give you a quick background on what we’re doing here.

 

Since we’re all working from home during the pandemic, we’re taking the opportunity to film a series of informal video podcasts to share with our clients, potential clients and friends of the firm, how we think about various issues. Some of the issues are coronavirus related and pandemic related. Others aren’t, and you take them for what they’re worth and hopefully they’re helpful to you.

 

So what we’re going to focus on today is how we might approach representing a tenant who is in the unfortunate situation of not being able to pay rent or is considering not paying rent to maintain some liquidity in their business during the coronavirus pandemic. And none of this is surprising. It seems like almost every day in The Wall Street Journal or in the major news networks, you hear about businesses, in particular in the retail sector, making the conscious decision to simply not pay rent. And in a sense, using a landlord as an involuntary lender, I’ll say we’ve received a number of inquiries from tenants and I’ve represented tenants dealing with their landlords. A number of our landlord clients have had to deal with non paying tenants and tenants requesting rent abatements and a variety of other accommodations.

 

So none of this should be surprising, but we want to walk through how we think about these issues from a tenant’s point of view. So at the risk of stating the obvious. Let me start by saying not paying your rent is a big deal. I think that there’s certainly some information floating around or there’s a trend or there’s a notion that not paying your rent during the pandemic is not a big deal, that there’s going to be some force majeure or impossibility or because there’s a disruption of business, hey, we just don’t have to pay our rent and we’re going to be able to skate and when we start paying our rent again in six months, when the virus has subsided and business is back to normal, everything’s going to be fine.

 

That is a very, very risky way to view dealing with a landlord. If you are not paying your rent, you are in default under your lease. And when you are in default under the lease, a landlord can take all of the remedies that the lease says. And most commercial leases provide for the acceleration of rent, which means that if you miss a rent payment, you will be on the hook not only for that payment, but also for all future payments, even those that haven’t accrued yet. And if you have a lease that is of significant term five, ten, twenty years, the amount of future rent that you might owe can be substantial.

 

You can have hundreds of thousands of dollars in rent liability from missing a payment. The problem is even more serious if you are personally guaranteeing a lease. For some of our smaller and even our mid-sized clients, a landlord will insist on personal guarantees from the owners or the partners of the business. And so if one of those businesses defaults, the landlord can certainly seek to recover the unpaid rent from the business, but also from individuals who have personally guaranteed the lease.

 

So all this is to say that if you’re faced with a liquidity issue, if you’re considering not paying your rent, you should take that quite seriously. You know, the consequences can be significant. Currently – and I should say, this video is being recorded on May 5th, 2020 – courts are not accepting or processing evictions, commercial or residential. And so if you default by not paying, the landlord does not currently have a way to evict you and remove you from the property. That being said, courts will reopen, evictions will be processed and ultimately the landlord will be able to remove you from the space.

 

So, you know, there is some reprieve there. But it is most certainly temporary and that reprieve is from eviction only. And it’s not going to have anything to do with monetary liability associated with defaulting on your rent.

 

So a tenant who’s come to us considering defaulting or considering not paying their rent, the very first thing we ask him is. Have you gotten your PPP money? PPP money is a payroll protection program. These are the loans for small businesses, small businesses in this context means five hundred or less employees. And are you aware that you can spend your PPP money on rent payments? The way the program works and I should say you can spend the money on the payments, on rent payments and still have it forgiven. So the way the program works is there are a limited category of permitted expenses. The primary one is payroll. But you’re also permitted to spend PPP money on rent, mortgage interest and certain other financing obligations.

 

The catch is that the program is really intended primarily to keep people employed and to funnel money toward wages. So if you’re going to spend money, spend your PPP money paying rent, you have to keep in mind that 75% of your loan proceeds must go toward payroll. So at most you can only spend 25% of your PPP money toward rent and still have it forgiven. Now, in some circumstances, it may make sense to get your PPP money, but basically, you know, have your employees on unemployment anyway. That strategy would prevent the loan forgiveness feature of the payroll protection program money, but would free up loan proceeds to pay your rent.

 

Well you say, well, why would you do that? Well, depending on your circumstance, depending on the wages of your employees, you may be better off putting them on unemployment. They may make more money on unemployment. Now, you would lose the loan forgiveness feature of the PPP. And so, you know, it no longer becomes free money from the government. But what it does become is a 1% loan with six months deferral on interest. And so if you were to use those proceeds to pay your rent, you would have some very favorable financing terms. That might leave you in a better spot than actually defaulting on your rent. I want to be very cautious here, though, in, you know, on this point, how to use that PPP money in the most advantageous way really requires some careful analysis.

 

I mean, you really need to break out spreadsheets with employee wages and retirement contributions and everything else. So you need to be very careful about that. But the salient point is that PPP money or a portion of it can be used to pay rent. And you can still have the forgiveness feature of the loan. So just keep that in mind as you sort of work through whether defaulting on a lease or whether or not paying the landlord makes much sense. So if you’ve already considered your PPP money and you don’t think that’s going to work, the next step is to talk to your landlord, to make an inquiry of your landlord as to whether it can offer you any kind of rent abatement or any other kind of accommodation.

 

And when you do this, you have to be a little bit careful because you want to make an inquiry and nothing more. And by that I mean you should inquire as to whether the landlord can offer you anything, but stop short of indicating that you can’t pay. And the reason that we say that is because of a concept known as anticipatory breach or anticipatory repudiation of a contract. And the concept here is basically that when a party, you know, definitively says that it cannot or will not perform an obligation under a contract, in this case a tenant’s obligation to pay rent, then that in and of itself is a breach. And we’ll give the other party the right to exercise whatever remedies it has under the lease. So in making that initial inquiry to the landlord, we don’t like to see tenants saying that they’re not going to pay because all of a sudden that in effect triggers a breach and the landlord can be off to the races with their remedies.

 

So that initial communication ought to be an inquiry and really, really nothing more. So when the landlord receives your inquiry looking for an accommodation or receives a tenant worrying, looking for an accommodation there’s a couple of options. So the first option and when we’re representing landlords, this is what we suggest that they do is to push the tenant to see whether they can pay, or require them to admit that they can’t pay. In other words, the landlord may want to establish that the tenant is in breach or force the tenant into saying that it intends to breach the contract because it can’t pay. Why would the landlord do that? Because once there is a default or there is an intention, a stated intention by the tenant that it’s going to default. The landlord has a little bit more of a lever because it has all its remedies under the lease. And so many landlords won’t start negotiating any kind of abatement or any kind of modification until there’s a clear indication that the tenant is in default. And so if you’re the tenant and you have a landlord that’s pushing you to do that, you have a decision to make as to whether you want to admit to that default or not.

 

Other landlords won’t force you into admitting a default before they discuss an accommodation. And that’s the idea, I mean, that’s sort of the friendlier approach. Landlords are offering accommodations, at least many of them are. Not all of them, but many of them are. And those accommodations typically take one of a few forms. One common way to accommodate a tenant is through a rent abatement. In other words, giving the tenant a break on rent for a period of a month or more and then providing a schedule for the tenant to repay that abated rent over time, sometimes with interest, sometimes without.

 

Another strategy is to extend the lease, extend the term of the lease, and some landlords like this, particularly if the tenant is a good tenant overall because the landlord will typically get to collect a higher rent at the end of the term. After all of the rent escalations have taken effect. So, you know, all things being equal, the rent you’re paying per square foot at the end of the term is likely more than the rent you would be paying during an abated period of nonpayment or during an abatement. You may be asking, you know, why would a landlord agree to any kind of accommodation with a tenant? You say, well, you know, the low hanging fruit answer to that is, well, they don’t have a choice. They’re worried about putting a tenant in default.

 

And, you know, this is just what they have to do otherwise, their properties are going to be vacant and they’re nowhere. There’s certainly an element of that. And that’s a very legitimate concern of landlords. That’s a real problem. But another thing to consider is that landlords have various expenses to pay throughout the year; taxes, operating expenses associated with their building, some of which may or may not be passed on to tenants. And those expenses are not evenly spread out throughout the year. And so some landlords, depending on the timing of their expenses, may be able to offer rent abatements with very little effect on their year end bottom line. I mean, by timing the tax payments that are due, by timing the debt service payments, by timing operating expense payments, they may be able to shift the timing of rent they collect without too much skin off their back.

 

So depending on the landlord, they may be willing and frankly able to make an accommodation without too much effort. One additional strategy that I wanted to touch on was the idea of a lease termination. And obviously, if you’re somebody or if you’re a tenant that wants to stay in the property, a lease termination is not going to be a helpful concept. But if you are a tenant that was already considering restructuring their operations to give up space, or now that your team and your workforce has been working at home, you may find that that’s quite effective and really that there may not be as much of a need for the expense of traditional office space.

 

And so one approach is to go to the landlord and propose a lease termination, which is exactly what it sounds like. It’s an agreement between a tenant and a landlord to end the lease early. A lease termination is typically accompanied with a lease termination fee, which again is exactly what it sounds like. It’s a fee that the tenant pays to the landlord for the privilege of getting out of their obligation to pay rent over the remainder of the term.

 

What’s interesting is in the midst of the coronavirus crisis, a landlord may be much more willing to accept a lump sum termination fee. In normal times, a landlord may be unwilling to accept a termination fee that’s anything less than accelerated rent payments or accelerated rent payments discounted to present value. But the need for immediate liquidity now may make that a much more attractive option to a landlord and provide a tenant who is looking to gauge some space or give up some space, a real opportunity to do so.

 

Finally, if you’re not able to resolve it with the landlord or you’re not able to get an accommodation, the case may ultimately end up in litigation. And if you do find yourself in litigation, there are some legal defenses that may be available because of the pandemic. You may have heard of some of these before. This is the idea of forced majore or frustration of purpose or impossibility of performance. Those defenses have not been heavily litigated yet in this context. And so, you know, what we’re gonna see over the next few years is those issues are going to be litigated in courts, are going to have to make decisions as to whether, you know, the pandemic counts as a force majeure event under the common law, whether it makes performance of a commercial lease impossible or impractical. And, you know, we’re going to develop an interesting body of case law in the next few years around those issues.

 

I think that ultimately and this is what I’d like to leave you with. Ultimately, landlords and tenants are going to have to figure out a way to allocate the damage that the pandemic has caused, allocate that damage between them and that allocation can be achieved in the form of negotiation. Whether that negotiations are rent abatement, whether it’s an extension of term or it can be achieved through litigation and, you know, parties can use litigation as a way to pressure the other side into coming to a resolution and that that process is going to play out over countless leases, countless court cases and countless private negotiations.

 

How it turns out in any particular case is going to depend on the credit worthiness of the landlord. I should say the credit worthiness of the tenant, the landlords, the landlord’s obligations, including their debt service obligations and a number of other factors. But that’s I think what we’re going to see play out over and over again. So with that, let me thank you for tuning in here. I appreciate you taking the time. I hope that you got something out of this. If you have any questions, if you have a commercial leasing issue or if you have any suggestions for a future video podcast like this, please feel free to give me an email. It’s erobson@robsonlaw.com. Thanks.

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