Landlords Fear Tenant Wins In Lease Disputes May Snowball

By Andrew McIntyre
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Law360 (December 23, 2020, 3:32 PM EST) -- As commercial landlords and tenants continue to try to work out their COVID-19-related disputes regarding payment of rent, landlords are growing increasingly anxious about the potential for broad implications of court rulings while tenants may be gaining traction with co-tenancy arguments.

Experts say the bar remains high for tenants to win court battles over leases that have landlord-favorable language, which is often the case, but landlords may also be more inclined to forge agreements out of court fearing a ripple effect across hundreds of their leases if a court were to side with a tenant.

Those and other considerations are weighing on landlords as they assess how to handle situations of tenants not paying rent amid increasing pressure from their lenders to take action.

Landlords Are Concerned About A Court Ripple Effect

While a single dispute between a tenant and landlord may not appear to have broad reach, experts say landlords are concerned that if a judge rules in a tenant's favor on a particular point in a lease agreement, other of the landlord's tenants across the country may then seek relief as a result.

"Now, [landlords have] recognized that this is a pervasive issue for them. And not just for one tenant. For multiple tenants," said Perrie Weiner, partner in charge in Los Angeles at Baker McKenzie and chair of the firm's lease litigation and restructuring group. "There are concerns about provisions of their lease becoming invalided by a court."

Landlords that have hundreds of retail tenants across the country often use fairly boilerplate language in their leases, so the concern is that a tenant-friendly court ruling in a dispute with one tenant could have cascading effects across hundreds of leases nationwide. That, experts say, is a reason for landlords not to go to court.

Weiner said landlords, in turn, have been more willing to negotiate a certain amount of rent forgiveness or rent abatement.

Of course some landlords will want to keep the tenant at the property, particularly if a reduced rent agreement can be reached. Evicting the tenant is risky, because it would likely be tricky to line up a new rent-paying tenant amid the pandemic, so landlords face a challenging calculus.

But as far as large players go, those that have a roster of tenants across the country may be less inclined to go to court, fearing a ripple effect.

"The larger the landlord, the bigger the issue," Weiner said.

Co-Tenancy Argument Could Have Legs For Tenants

As tenants consult with their lawyers about possible strategies in court, many are looking at co-tenancy provisions, and experts say tenants in malls in particular may find a viable argument on the co-tenancy point.

While the four corners of the lease may not provide an out for not paying rent, experts say tenants may be able to make the argument that they don't need to pay rent if a co-tenancy portion of the lease is not fulfilled.

Co-tenancy provisions are designed to help a tenant have some sort of a guarantee of the amount of foot traffic going by the store by requiring other stores to remain open. Mall owners routinely juggle hundreds of such provisions, but the forced closure of many malls and stores may trigger co-tenancy agreements, and could give tenants an argument as to why they are not required to pay rent.

"If every other store [in a mall] is shut down, that provides a defense," Weiner said.

Edmund Pittman, a partner at McGuireWoods LLP, said as an example, some leases allow for shopping center tenants to not pay rent if the shopping center is not open.

And just as landlords may be wary to go to court fearing the ripple effect, owners also aren't thrilled at the idea of evicting their tenant, since the prospect of finding a new tenant is not great at present. Parties may negotiate on the co-tenancy issue as well, rather than head to court.

"In the next few months, what I think we're going to see is a push by both tenants and landlords to work things out short of litigation, if they can," said Jeremy Cohen, a partner at Seyfarth Shaw LLP.

There's Concern Judges May Read Outside The Four Corners Of The Lease

Aside from the potential for unfavorable rulings leading to further suits, there's the also the question of how exactly judges will approach the disputes.

Although many landlords feel confident they'd win disputes based on a strict reading of the lease, one question is whether judges will look beyond the lease in their interpretation and ruling, given the unprecedented nature of the pandemic.

"What if a judge starts to be a little proactive and says, 'landlord, you are collecting all the rent but the tenant can't use the space. That doesn't seem fair,'" said Matthew Lynch, a partner at Nixon Peabody LLP. "It gets a little tricky. It will be interesting to see how the next two months go."

What makes the situation complex is that normally rent payment disputes come about due to some action on the part of the tenant or landlord. But in the case of COVID-19, that's not the case.

"That's why the situation is so unusual," Lynch said. "Usually the landlord or tenant did something wrong. In this case, neither party did something wrong, but the tenant still needs a remedy."

Weiner said he expects courts to be "sympathetic to what tenants are facing."

And while Lynch said he doesn't necessarily expect to see that sort of reasoning from judges, he also said he wouldn't be shocked if it happened.

"From the landlord's perspective, what scares the landlords a little bit hasn't played out yet. What are courts going to do? Courts have very broad powers. They should just enforce the lease, but what's happened in the last nine to 10 months is unprecedented," Lynch said.

A Flood Of Litigation Is Expected

Despite the court concerns landlords have, lawyers say many will file suits against their tenants in the coming few months, and experts expect also to see more tenants sue to get out of their leases.

On the one hand, many landlords simply believe they have winning arguments, and have not had luck reaching agreements out of court.

"Unless there is a specific provision in the force majeure clause that mentions a pandemic or government order, odds are a court is not going to view COVID-19 as a force majeure condition," said Cohen, who recently helped an office landlord plaintiff win a dispute in 1140 Broadway LLC v. Bold Food LLC et al, in the Supreme Court of the State of New York, New York County.

The judge in that dispute found that aspects of Common Law such as frustration of purpose and impossibility did not let the tenant off the hook for months of missed rent payment earlier in 2020.

But landlords also have their lenders to be concerned with, and many landlords will file suits feeling pressure from lenders. The suits go both ways, with tenants also filing to get out of leases.

"We already know there is a significant percent of tenants that are paying no rent … In the next three to six months you're going to see an explosion of litigation in this area," Weiner said. "There will be a breaking point. Tenants will need to sue preemptively to get out of their lease or the landlord will have to sue to satisfy their lender."

And as time goes on, landlords are also getting impatient, experts say.

"This is just the tip of the iceberg," Weiner said. "It's going to peak over next two to three months. More and more tenants are preemptively filing claims for declaratory relief. … We've yet to see it run its course in the commercial real estate realm."

Indeed, while parties are still seeking out-of-court solutions, many will find court is the only viable option.

"If you can't work it out, it leaves you with two options: live with it or litigate it," Lynch said.

--Editing by Amy Rowe.

Correction: An earlier version of this story misstated the name of a case. The error has been corrected. 

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