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Law360 (October 29, 2020, 4:09 PM EDT) --
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| Marc Hamroff |
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| Danielle Marlow |
These cases highlight a number of central issues raised by the COVID-19 pandemic and its impact, such as (1) who must bear the risk of the catastrophic cost of the pandemic; (2) how parties and courts will interpret leases and other contracts with regard to these issues; (3) whether there are any discernible trends in the courts in their handling of COVID-19 issues; and (4) how parties can prepare for such contingencies going forward.
A number of recent high-profile cases highlight these questions and how they are being handled.
In the case of The Gap Inc. v. 44-45 Broadway Leasing Co. LLC, The Gap and Old Navy brought a lawsuit to enjoin the termination of their lease in Times Square for failing to pay rent because of the pandemic's devastating impact on retail commerce in New York City. On July 21, New York Supreme Court Justice Debra James granted the requested injunction, but as a condition of such relief, required The Gap and Old Navy to post a bond for 90% of the monthly rent — thus affording The Gap and Old Navy with limited, temporary economic relief.
In Victoria's Secret Stores LLC v. Herald Square Owner LLC, filed on June 8, Victoria's Secret claimed that the lease for its premier Herald Square location — for which it paid $937,734 per month in rent — should be declared unenforceable based upon the legal doctrines of frustration of purpose and impossibility of performance because of the government-mandated shut downs and the drastic reduction in foot traffic in Manhattan.
The landlord moved for summary judgment on the ground that the subject lease specifically addressed contingencies such COVID-19, and in such cases, performance would not be excused.
Specifically, Article 26 of the lease, titled "Inability to Perform," provided that if landlord is unable to fulfill its obligations as a result of "laws, government preemption in connection with a national emergency or by reason of any rule, order or regulation by any federal, state or municipal authority" tenant's performance was not excused.
How the court — specifically presiding Justice Andrew Borrok — rules on this issue will be instructive to parties going forward, particular regarding the issue of the interpretation of lease provisions that arguably govern the COVID-19 pandemic.
In Club Monaco U.S. LLC v. BSD Broadway Propco LLC, on Sept. 24, tenant Club Monaco sought an order (1) enjoining its landlord BSD Broadway Propco from terminating its SoHo lease based upon its failure to pay late fees; and (2) declaring the lease unenforceable as a result of the COVID-19 pandemic and the related government-mandated shutdowns. As with Victoria's Secret, Club Monaco claimed that the COVID-19 pandemic frustrated the purpose of its SoHo lease (with an annual rent of almost $5 million) and rendered performance impossible.
The New York Supreme Court, New York County, granted Club Monaco's request for a preliminary injunction enjoining termination of the lease, but conditioned upon Club Monaco posting a bond for $576,505.75 — the full amount of the rent due.
Most recently, on Oct. 9, Hugo Boss Retail LLC filed an action, Hugo Boss Retail LLC v. A/R Retail LLC, seeking rescission of its lease for space in the Time Warner Center with a rent of $692,026.07 a month, and a declaration that the lease is unenforceable in light of the COVID-19 pandemic and related government shut downs. The store could not reopen until Sept. 9, and going forward, capacity has been limited to 50%.
Hugo Boss argued that the purpose of the lease had been unforeseeably frustrated and performance has been rendered impossible. Hugo Boss also sought a rent abatement based upon Section 15.1(d) of the lease, which provides for such an abatement "if the Premises are completely or partially damaged by fire or other hazard." Hugo Boss claims that COVID-19 constitutes such a hazard. This case is in the early stages and it will be instructive to see how it plays out.
Key Takeaways
Going forward, tenants and borrowers will likely be making impossibility, impracticability, force majeure, impossibility of performance and similar arguments more frequently in light of the impacts of COVID-19.
As demonstrated by the cases discussed above and the many others being filed, these defenses have increasingly come into the spotlight in the wake of the COVID-19 pandemic, and this is particularly the case with commercial leases in the New York area.
As argued by the tenant parties in the cases highlighted above, fundamental assumptions of such leases were that (1) New York's position as a hub of retail and other business would continue; (2) the premier position of locations such as Herald Square, Time Square and Columbus Circle would continue; and (3) businesses would be permitted to operate at 100% capacity — not 50% capacity or less as is the case pursuant to the limitations imposed during the pandemic.
But from the landlord's perspective, built into the leases is a mutual allocation of risk — for example, the tenants assume the risk that the locations in question may become less desirable during the term of the lease, but the landlords assume the risk that the locations may become more desirable and valuable — yet the landlord is bound by a lease on set terms which does not allow an increase in rent.
How courts address the impossibility, impracticability, force majeure and similar defenses will likely be influenced by what the court views as a foreseeable risk covered by the contract, as compared to a risk that is beyond what the parties did or could have reasonably contemplated in negotiating the lease or other contract at issue.
To understand the strengths and weaknesses of each side's arguments, it is paramount to analyze the relevant agreements to determine whether events, such as a pandemic and related government-ordered shutdowns, were either contemplated in the governing agreements, or the relevant provisions are broad enough that the pandemic could fall within the language of the agreement — and which party under the governing agreements is required to bear such risk.
The language of the governing lease or other agreement is always the first place the court and parties must look to in determining who bears the risk. As argued by the landlord in the Victoria's Secret case, if the lease specifically addresses certain contingencies, then the lease governs performance will not be excused.
As many, if not most leases and other contracts do not expressly address pandemics, this will lead to parties needing to be being creative in their interpretation of leases and other contracts.
For example, Hugo Boss' argument that the rent abatement provision applicable in the case of "fire or other hazard" includes the COVID-19 pandemic is an example of such an argument. Particularly in an environment where so many parties have been devastated by the effects of COVID-19, such arguments are likely to find some traction.
Increasingly, courts will be forced to grapple with these issues, and it will be important to observe the trends of specific judges and the bench more generally. To date, a discernible pattern has yet to be established either by specific judges or the judiciary more broadly. The courts have been all over the spectrum on their handling of lease and other contract disputes in the wake of COVID-19.
And for the most part, courts are not viewing the pandemic as a get-out-of-jail-free card for tenants. For example, as discussed above, the courts in The Gap and Club Monaco cases did enjoin the landlords from terminating the leases in question, but conditioned those injunctions on the tenants posting a bond in the amount of 90% (in the case of The Gap) or 100% (in the case of Club Monaco) of the rent due — demonstrating some, but limited sympathy for the plight of pandemic-stricken tenants.
On the other side of the spectrum in the related area of Uniform Commercial Code Article 9 foreclosures, in Shelbourne BRF LLC v. SR 677 Bway LLC, on Aug. 3, Justice Jennifer G. Schecter completely enjoined a lender from conducting an Article 9 sale of the collateral securing the subject loan, despite the borrower's default, in light of the view that bids for the collateral would likely be depressed due to the pandemic.
As the court held: "Severe turmoil in the real estate market due to the pandemic makes the notion of a sale resulting in payment of fair market value highly uncertain."[1]
It is thus clear there will be vast differences in how individual courts handle these issues, and this will inevitably play into parties' calculations in determining how to handle COVID-19 lease and other contract disputes, including parties' decisions regarding whether or not to pursue litigation.
Going forward, in drafting leases and other agreements, it will be critical to expressly address future events, such as a pandemic and related government shutdowns, and specifically state who bears the risk of same.
It goes without saying that going forward, leases and other contracts can and should expressly address potential future pandemics or other historic events mandating shutdowns and other measures with severe, if not catastrophic economic results.
Before the pandemic, the term "force majeure" was not near as widely known or recognized as it now is and must be. Parties should take a Murphy's Law outlook in drafting agreements to foresee and address as many future crises as possible.
Marc L. Hamroff is the managing partner and chair of the firm's financial services practice at Moritt Hock & Hamroff LLP.
Danielle J. Marlow is a partner at the firm.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
[1] See Decision and Order dated August 3, 2020 in Shelbourne BRF LLC et al. v. SR 677 Bway LLC.
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