By Aaron Goodman

Law360 (April 21, 2021, 5:53 PM EDT) --

Aaron Goodman

A body of pandemic-era law has started to emerge in courts across the country — in particular as to the application of common law contract defenses — addressing the nuances at play under the unique circumstances of the COVID-19 pandemic, including doctrines little known outside of law school.

While New York courts have been fast out of the gate, issuing many of the first rulings in what are surely hundreds — if not thousands — of pending pandemic-era disputes between commercial tenants and their landlords, judicial sentiment that at first favored landlords is now trending in favor of tenants.

On April 7, in a critical win for commercial tenants rejecting several of the most common commercial landlord arguments, the U.S. District Court for the Eastern District of Michigan upheld temporary frustration as a valid defense to a commercial tenant's failure to pay as a result of government-mandated closures in an effort to curb the spread of the coronavirus.

The court in Bay City Realty LLC v. Mattress Firm Inc. looked to the specific use permitted under the lease, an often very specific and restrictive provision included in most commercial leases, which in the case of Mattress Firm was the retail sale of bedding products with any other permitted secondary uses of the space for storage and offices predicated on its primary use for retail sales.

As a result, the court found that the primary and secondary retail purposes of the lease were frustrated by the governor's closure orders, as the leased space was essentially converted to storage units for business equipment during the shutdown. Consequently, the court reasoned that the purpose of the lease — the retail sale of bedding products — was substantially frustrated during the shutdown.

Those are the magic words. Landlords everywhere continue to pound the table — arguing that frustration of purpose cannot and does not apply in the context of commercial leases and government shutdowns — because the defense requires that the entirety of the purpose of the lease to have been frustrated. But that is a narrow and incorrect reading of the doctrine, which also applies where the impact to the purpose of the lease is substantial.

The court analogized the restriction and frustration of Mattress Firm's ability to operate its retail mattress business during COVID-19 closures to the prohibition of a winery tenant, which was prohibited from using leased property as a winery and alcohol business during prohibition.[1]

In so doing, the court also upheld the argument that a contract may be temporarily frustrated, which provides for relief from the contract during that time frame.

Having determined that the Mattress Firm lease was, at least, temporarily frustrated, the court then asked whether, (1) the purpose of the lease was frustrated by an unforeseeable event, (2) not assumed by the tenant and (3) not due to the tenant's conduct. The court answered yes to all three questions.

The court quickly disposed of any notion that the government-ordered closures were in any way foreseeable by the parties, holding that the pandemic and shutdown orders were not reasonably foreseeable at the time the lease was signed in 2013. Rather, the real question at issue was whether Mattress Firm had assumed the risk of the shutdown orders in the lease.

Indeed, for the frustration doctrine to apply, the risk of the frustrated purpose must not be assumed by either party in the contract itself; or, rather, not by the party asserting frustration as a defense.

In arguing this point, Mattress Firm's landlord pointed to the specific language of the lease stating:

Lessee, at its sole cost and expense, shall comply with all laws, statutes, ordinances, rules, regulations and orders of any governmental authority having jurisdiction concerning environmental, health or safety matters.

Although this language on its face seemingly favored the landlord's argument, the court determined that in the greater context of the lease, this provision did not require Mattress Firm to comply with all health and safety regulations, but rather all health and safety regulations relating to hazardous materials.

As such, the express language of the lease did not allocate the risk of a government shutdown due to a viral pandemic to either the landlord or tenant. Nor was the tenant's conduct at issue, since Mattress Firm had nothing to do with the necessity of the closure orders.

In granting Mattress Firm's motion for summary judgment and denying the landlord's cross-motion, the court held that Mattress Firm was excused from the payment of all rent, interest and fees for the period during which it was shut down because of the governor's orders.

However, the court stopped short of relieving Mattress Firm of its remaining obligations under the lease, explaining that under these facts temporary frustration of purpose was not grounds for canceling the contract.

The Mattress Firm decision is important, in the context of evolving pandemic law, because it strikes a balance between a strict reading of the contract and the defenses a tenant may have under the circumstances of COVID-19 closure orders.

Many courts have summarily dismissed tenants' frustration arguments, finding that a temporary closure, even if complete, is not substantial or that closure constitutes only a change in economic circumstance that is both foreseeable and cannot serve as the basis for the frustration defense.

In contrast, the court in Mattress Firm thoughtfully walks through the purpose of the lease, the permitted use of the premises, the foreseeability of the pandemic, and the assumption of risk under the lease.

As a result, Mattress Firm provides a framework and step-by-step process instructive to both tenants raising pandemic-era defenses and courts hearing these cases.

Unlike many early decisions that are conclusory and lack any real analysis, the court's decision in Mattress Firm, to reject the landlord's broad reading of the lease to disallow the tenant's defenses, is well supported by analysis of pertinent local and national cases.

This well-reasoned decision is likely to stand up well and gain traction over time. In comparison, many of the summary decisions issued in places like New York will almost certainly be the subject of appellate review, which could overturn an entire tranche of landlord-favorable cases.

Even so, summary decisions are unlikely to be particularly persuasive outside of the issuing court's jurisdiction, where Mattress Firm is likely to be cited as precedent going forward.

The court's holding in Mattress Firm joins other recent and notable pandemic-era landlord/tenant cases favorable to tenants, including 267 Development LLC v. Brooklyn Babies & Toddlers LLC, in the New York Supreme Court, King's County, and UMNV 205-207 Newbury LLC v. Caffé Nero Americas Inc. in the Commonwealth of Massachusetts Superior Court, Suffolk County.

In Brooklyn Babies, the court addressed cross-motions for summary judgment addressing, in part, the tenant's argument that rent was excused due to impossibility, argued by the tenant alongside frustration of purpose. The tenant, one of many businesses forced to close pursuant to Gov. Andrew Cuomo's executive orders, argued that performance under its lease was made objectively impossible.

The court found "that performance under the subject lease was made impossible." The court reasoned that the "shutdown of [tenant's] business ha[d] precluded it from performing its contractual obligations," and the "government shutdown was unforeseeable and could not have been built into the contract."

As such, the court granted the tenant's motion and denied the landlord's, ruling that the landlord's action against the tenant was barred by the doctrine of impossibility.

The court's reasoning in Brooklyn Babies more closely resembles frustration of purpose than impossibility, or perhaps impracticability, but the point is that one or more of those defenses should apply under the circumstances.

Critically, this decision goes against a number of decisions issued by other New York state judges, leading back to the conclusion that appellate review is practically inevitable.

In fact, each state judge appears to be taking a slightly different approach to these landlord/tenant cases, some favoring tenants, some completely rejecting any lease defense, and others favoring landlords but leaving the door open for tenants to prevail under the right set of facts.

In Caffé Nero, the tenant had leased the premises for the sole purpose of operating a Caffé Nero-themed café.

When Massachusetts barred restaurants from allowing on-premises consumption of food or beverages in March 2020, Caffé Nero closed its café and stopped paying rent. The landlord terminated its lease immediately and brought an eviction action, following which Caffé Nero vacated the space. The landlord then sued Caffé Nero for unpaid rent.

The Massachusetts Superior Court granted Caffé Nero's motion for summary judgement, finding that payment of rent was excused due to frustration of purpose, for the period of time when indoor and outdoor dining were both prohibited and for any other time restaurants were closed by government order.

The court reasoned that where "government action bars the only permitted or possible use of the leased property, and there is no evidence that the lessor voluntarily assumed that risk, then 'the use of the leased property intended by the parties is frustrated.'"

This decision, together with Mattress Firm, Brooklyn Babies and other such cases, reveals that there is an element of equity in the court's rulings, which seeks to parse where to place the pandemic burden.

The greater weight of the judiciary has yet to make its mark on what is sure to become a historical body of law flowing from this unprecedented time. But for those landlords who were feeling good as the early rulings were issued in summary landlord/tenant proceedings and continued to use heavy-handed collection tactics, it may be a good time to start rethinking and reassessing the true exposure to their real estate portfolio.

More specifically, there is a growing trend among state and federal courts that suggests commercial tenants may be able to successfully argue that government shutdowns excuse their obligation to pay rent.

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Aaron Goodman is of counsel at Baker McKenzie.

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] Industrial Development & Land Co. v. Goldschmidt , (Cal. Ct. App. 1922).

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