How landlords and tenants are navigating lease negotiations during COVID-19

Jonathan Sopha, Turke & Strauss LLP; jonathans@turkestrauss.com; 414.238.2115

In the five or six weeks since coronavirus upended our world, the realities of how this health emergency will impact our lives and our livelihoods is slowly coming into focus. Stay at home, social distancing, remote learning and teleconferencing are now part of our daily lexicon, and acronyms like COVID, PPE and PPP are common vocabulary. We have seen an expansive – and at times muddled – financial response from our government in an attempt to pump trillions of dollars of liquidity into our economy. Local, state and federal leaders are providing varying messages to citizens and businesses. Information is coming from many directions, and we are tasked with sorting out practical advice from hyperbole.

How are tenants, landlords, lenders, brokers and governments managing disruptions? Like many things in our new COVID-19 business environment, there are many questions but few reliable answers. It is an understatement to say COVID-19 has caused disruption in the real estate leasing market. The first test of COVID-19’s impact on leases came April 1st as monthly rents came due, and some real estate sectors were hit harder than others. The vast majority of the resulting lease disputes are being resolved through negotiation, and that is likely to remain true during the pandemic. There are steps you can take, and opposing arguments to anticipate, that will improve your chances of reaching a negotiated resolution of a COVID-19 related lease dispute.

What Does the Lease Say?

The lease is a contract between a landlord and tenant and establishes the business and legal relationship. So, the first question to ask is, what does your lease say? This will help you understand your baseline rights and obligations. The most relevant Lease sections to review include:

  • Rent: Will failure to pay rent be an automatic default, or do other circumstances affect this obligation?
  • Business Insurance: A lease may include business risk or income loss coverage requirements which may apply to interruptions to business operations and lost income.
  • Maintenance: New public health protocols (cleaning, air quality, testing) may be required to maintain safe premises and common areas.
  • Operations: Building hours and access may be restricted due to public health, safety or security concerns.
  • Force Majeure: Disruptions outside the control of the parties may provide relief for certain responsibilities, although this provision often only applies to landlord obligations and typically does not relieve the duty to pay rent.
  • Quiet Enjoyment: The tenant expects to safely and peaceably enjoy the use of its premises without disturbance. Impacts from COVID-19 may affect this right.
  • Default / Termination: If a tenant defaults under certain lease provisions (most notably, failure to pay rent), a landlord could exercise its right to terminate the lease. This may be impacted by counterclaims from Tenant, or by COVID-19 governmental orders limiting legal actions against tenants.

Legal Concepts

You also should consider legal concepts that arise outside the specific language of your lease, including:

  • Warranty of Habitability: In the case of multi-family residential buildings, a tenant is generally guaranteed the right to live in safe and healthy conditions. Many jurisdictions codify this right by statute. Landlords will be well-served to adhere to federal (CDC), state (WI-DHS) and local safety guidelines to provide safe living environments.
  • Constructive Eviction: Similar to the warranty of habitability, a tenant could argue that a landlord’s failure to adhere to safety or health standards created a circumstance where the tenant was not able to safely occupy its premises.
  • Implied Covenant of Good Faith and Fair Dealing: Each party generally enjoys an expectation that the parties will bargain in good faith, and that neither party will attempt to frustrate the purposes of the lease agreement. In the case of COVID-19, courts may be especially suspicious of harsh and unfair negotiating tactics if unsettled negotiations result in litigation.

Preparing for Lease Negotiations

Reviewing the lease agreement is the most prudent first step of any lease dispute or negotiation, but understanding how to leverage the lease provisions during subsequent negotiations is also critical. Some sectors of the leasing industry are clearly in crisis response mode (week-to-week / month-to-month). As April rental data is collected and industry-wide surveys are compiled, we are beginning to understand what additional impacts may appear in May and June. Because long-term impacts remain fluid parties are focused on short-term solutions. Consider current market dynamics, and these additional factors, as you prepare to negotiate:

  • Relationship of Landlord and Tenant: The ability of the parties to freely communicate and connect on a personal level can impact success of negotiations.
  • Local vs. National Tenant: National tenants and landlords may have less flexibility to negotiate, and creative solutions may be limited in these cases.
  • Ownership Structure of Landlord: Syndicated, equity focused ownership groups are driven by different financial dynamics than owners with conventional mortgages or private financial backing. The financial structure of the landlord may impact availability of some negotiated solutions.
  • Financial Health & Viability of Tenant: Two tenants with similar business plans, operational practices and monthly financials may have vastly different abilities to absorb the shock of COVID-19 disruptions. Resilience and viability depend on a tenant’s relationships with lenders, access to capital and proven success in the marketplace. Businesses that are “late to the game” may not be in position to ride out the COVID-19 storm if they have not had time to build a customer base, establish business relationships and save operating capital.
  • Lender Consent: If a landlord has a mortgage, its lender may need to consent to any lease modifications.

Possible Negotiated Solutions

Armed with information about your specific lease provisions, legal concepts that might apply and what factors motivating the parties, you can work toward an appropriate solution. To avoid a later dispute, a prudent landlord will enter into a written agreement with tenants spelling out terms of any lease modifications or concessions and require all lease concession negotiations to be kept confidential. There is no “one size fits all” scenario for a commercial lease, and often a varied combination of these solutions will be utilized:

  • Rent Abatement: This would likely be a short-term concession, perhaps even day-to-day. A landlord may permit a tenant to only pay CAM (operating expenses) for a while. In the case of multi-family residential properties, some jurisdictions are considering laws to abate rent during the emergency period of COVID-19, and instruct landlords to seek compensation from governmental aid programs. Short term rent forgiveness could be exchanged for rent escalations later in the lease term.
  • Rent Deferment: Sometimes referred to as a “blend and extend,” this results in near-term rent being deferred to the end of the lease term, or amortized over a portion of the remaining term. Adjusted CAM payments could also be incorporated into a deferment strategy.
    Extension of Lease Term: The lease term could be extended for the length of the COVID-19 disruption.
  • Notices and Check-Ins: Communication is a key component of surviving a crisis, and landlords and tenants are requesting more dialogue, information and advance notice of lease issues.
  • Modification of Lease Covenants:
    • Tenant Requirements:
      • Restructured guarantees and financial assurances, including assurances for tenant financial solvency and sound business model. This could involve a tenant interview or lender-style due diligence.
      • Renegotiated financial terms and rental rates for landlord to capture value from the recent real estate boom.
      • Specialized insurance to pay for lost rent or business interruption.
      • Lease modifications may be conditioned on tenant applying for (and receiving) financial relief or an emergency loan.
    • Landlord Requirements:
      • Restrictions to landlord’s access to the premises for inspections, maintenance and showings.
      • Increased and deeper cleanings of common areas.
      • Provide safe rooms or health rooms for testing and staging for infected individuals.