Russian Federation: Coronavirus – What Should Parties In Lease Agreements Do

At both the federal and local levels, a number of regulations imposing restrictions on private business activities have been adopted in reaction to the spread of COVID-19 in Russia. Most of the measures adopted affect businesses' ability to operate their activities in indoors premises. The restrictions that have been imposed therefore have an effect on the relationship between landlord and tenant in lease agreements for commercial premises, and have a significant impact on the parties' ability to perform their obligations under such agreements.

These restrictions include, in particular:

• a suspension of "offline" activities for most businesses in the hospitality and entertainment sector (restaurants, cafes, movie theaters)
• restrictions on access to shopping and entertainment centers
• restrictions on people's freedom of movement, both domestically and internationally, which has inevitably affected occupancy rates in hotels and other temporary accommodation
• the prohibition for inhabitants to leave their homes except for strictly necessary errands (shopping for food and essential products, going to the pharmacy, seeking medical help, walking pets, taking out garbage), which hinders individuals from travelling to their workplace (including offices)

All regions and constituent entities of the Russian Federation are on high alert, and the list of restrictions applicable is approximately the same throughout the country, though there are variations in which organizations and businesses are affected, and whose activities are suspended.

As part of a series of measures taken by the state to support business during the crisis, the federal government has adopted a list of sectors of the economy that are most affected by the epidemic (the "List of Affected Industries"), which includes:

• air transport and airport infrastructure, road transport
• culture, recreation, and entertainment
• sports and other physical activities
• tourism agencies and other organizations offering services within tourism
• hospitality
• restaurants and catering
• organizations for further education and other non-governmental educational institutions
• conferences and exhibitions
• household services for consumers (repairs, laundry, dry-cleaning, hairdressing and beauty salons)
• dentists
• retail in non-food products¹ 

Clearly, the restrictions imposed have had a significant effect on all affected businesses without exception. In this alert, we will attempt to consider the various legal avenues open to parties in lease agreements, so that these may adapt their legal relations to the changing legal and economic reality.

What should tenants do

Review your lease agreement and consider regional restrictions

Lease agreements often include provisions that are significantly impacted by the restrictions described above. We would encourage you to check the following provisions of your lease agreement:

• force majeure: the contract may specifically regulate the consequences of a force majeure situation (for example, giving a right to repudiate the agreement)
• material change of circumstances: the agreement may itself restrict or expressly establish certain rights for the parties in the event of a material change of circumstances
• rights of the tenant: in lease agreements that we have drafted in the past, we have sometimes managed to include a right for the tenant not to pay rent if the premises cannot be used for their intended purpose
• termination of the agreement: the agreement may provide special grounds for its termination, including due to the impossibility to use the premises

Restrictions on commercial activities and support measures differ regionally. We would recommend that you check regional restrictions and support measures for the relevant business, or contact us for more detailed information for a specific region.

Stop paying?

Some tenants tend to unilaterally stop paying rent when force majeure circumstances occur. We would strongly recommend to take a balanced approach regarding such decisions. The tenant may be held liable for breach of payment obligations under a lease agreement even if they are in a difficult financial situation.

As a general rule, rent payments cannot be stopped due to a lack of funds without avoiding default and accruing fines and penalties as stipulated in the lease agreement or in the Civil Code of the Russian Federation (the "Civil Code"). Relief from this liability by invoking force majeure circumstances that have brought about an impossibility on the part of the tenant to fulfill its obligation to pay rent would be unlikely in most cases.

The tenant would have to prove that the lack of funds was caused by the restrictive measures adopted by the authorities, and that the tenant itself undertook all reasonable steps available to fulfill its obligations and to mitigate the consequences of force majeure circumstances (Article 401(3) of the Civil Code). For most businesses it would be arduous to meet such a burden of proof, and existing court practice in this regard favors the landlord's position.

In court practice, the general rule is that a lack of funds does not relieve the debtor from liability caused by defaulting on debt. However, the Supreme Court of Russian Federation has just published a Review² 

 (No. 1) of Selected Questions of Court Practice Related to the Application of Legislation and Measures to Counteract the Spread of the New Coronavirus Infection (COVID-19) in the Russian Federation. In this Review, the Court clarified that in our current situation, a party may be granted relief from liability after a default with basis in force majeure if the lack of funds was caused by the restrictive measures imposed by the authorities.

The Supreme Court has also clarified the additional facts that must be proven by the seeking relief from liability based on force majeure:

a) the presence and duration of the force majeure circumstances

b) the presence of a nexus of causality between the force majeure circumstances and the party's failure to perform or delay in performing its obligations

c) that the force majeure circumstances have appeared without the involvement of the party

d) that the party has in good faith taken all reasonable measures available to prevent or mitigate possible risks

If you find it economically necessary to suspend the rental payments, we would recommend you to notify your landlord without further delay to avoid liability for damages caused by late notification. In addition, it is highly advisable to promptly start gathering evidence for a potential dispute.

Apply for benefits if you are renting state-owned or municipal property

For small and medium businesses that rent federal property, the federal government has established a set of benefits that include³: 

• rent deferrals for the months of April to June 2020 until 31 December 2021
• relief from rent payments for April to June 2020 if the tenant conducts business activities covered by the List of Affected Industries, except for dental practice and non-food retail

In order to obtain rent deferrals or relief, the tenant should contact the Federal Property Management Agency and conclude an additional agreement to that effect.

Similar support measures have been enacted in certain regions for rented property belonging to state or municipal authorities. Local regulations should be checked in detail for the relevant region and municipality. Please contact us if you require more detailed information.

Claim a rent deferral

Federal law No. 98-FZ of 01 April 2020 ("Law 98-FZ") provides tenants a right to rent deferrals for 2020⁴ 

The following preconditions must be met:

• the tenant conducts activities covered by the List of Affected Industries
• a high-alert or emergency regime is established in the regions where leased property is located

As far as the rental market is concerned, there are no directly defined criteria in binding legislation to determine whether an entity's activities are covered by the List of Affected Industries. Neither in Law 98-FZ nor in Government Decree No. 439 of 03 April 2020 ("Government Decree No. 439"), is it determined whether the affected activities in question should be the entity's main field of activity, and/or whether these activities should be registered in the Unified State Register of Legal Entities (EGRUL)⁵. 

Rent deferral is granted on the following terms⁶:

• rent is deferred from the day the condition of high-alert or emergency situation has been introduced and until 01 October 2020
• deferred rent shall be paid no earlier than 01 January 2021 and no later than 01 January 2023 in equal installments no more than once a month
• the amount of rent to be deferred is 100% until the day when the condition of high-alert or emergency situation is lifted and from then onwards 50% of the rent until 01 October 2020
• funds due for the use of utilities or the costs of maintaining the leased property are not be deferred
• fines, use-of-money interests or other penalties are not be applied

To obtain a rent deferral, you should contact your landlord, who is under an obligation to conclude an additional agreement to that effect within 30 days.

Claim a rent reduction

Tenants have a number of different legal grounds under current legislation to claim rent reductions in the context of the COVID-19 epidemic, which are most efficient when used in combination:

• article 19(3) of Law No. 98-FZ allows any tenant to withhold rent payments in full or in part if it is unable to use the leased property during the condition of high-alert or emergency situation
• article 451 of Civil Code provides for agreements to be amended in court, including by reducing rent, if circumstances have materially changed since the conclusion of the contract. The coronavirus pandemic and related restrictions are likely to be a change deemed by the courts as material
• article 614(4) provides for the right of tenants to withhold rent if there is a significant deterioration in the conditions of use of the leased property due to circumstances not imputable to the tenant

The amount the rent reduction will depend on whether the tenant has only partially or completely lost the possibility to use premises in accordance with their intended purpose due to the adoption of restrictive measures in the relevant region. The request to be sent to the landlord should refer to applicable regional legislation that introduces the relevant restrictions on the use of the property and on the relevant activities performed.

Repudiate (terminate) the rental agreement

Repudiating (terminating) your rental agreement may also be a viable option in changed economic circumstances.

Article 451 of Civil Code mentioned above, besides providing for the forceful amendment of contracts, also provides for termination of the agreement if the balance of interest between the parties cannot be restored. Nevertheless, we would assume that the restrictive measures adopted, in view of their temporary character, would only give ground to terminate short-term rental agreements.

In addition, it is possible to terminate rental agreements by virtue of Article 620 of the Civil Code, if the property is in a condition unsuitable for use, which was caused by circumstances not imputable to the tenant.

Further grounds for termination may be regulated in your rental agreement.

What should landlords do

Review your lease agreement and consider regional restrictions

Landlords should also reconsider their lease agreement to decide a strategy in their interaction with tenants. We would encourage you to check the following provisions of your lease agreement:

• purpose of use: you should consider whether the leased property can be used in accordance with the purpose specified in the agreement. If no specific purpose of use is defined in the contract, then the landlord may avoid a significant reduction in the level of rent by insisting that the public-law restrictions applicable to the tenant's activities are a commercial risk to be borne by the tenant, as no particular purpose of use has been defined in advance
• the landlord's obligations as regards giving access to the premises, and guarantees and representations given by the landlord: if the agreement does not specifically provide for an obligation on the landlord to give access to the premises, this may be interpreted in the landlord's favor, as any access restrictions due to measures imposed by the authorities do not violate the landlord's obligation under the agreement
• force majeure: the contract may specifically regulate the consequences of a force majeure event (for example, giving a right to repudiate the agreement)
• material change of circumstances: the agreement may itself restrict or expressly establish certain rights for the parties in the event of a material change of circumstances
• termination: the agreement may provide special grounds for termination, including if it is impossible to use the premises

You should also consider which concrete restrictions on commercial activities are imposed on tenants at federal and regional level, was well as which support measures are in place both for tenants and landlords.

Evaluate the necessity to give tenants a rent deferral

1. Tenants whose activities are included in the List of Affected Industries

As indicated above, the main criterion to determine whether a tenant is eligible for rent deferral is whether that tenant's business activities are within a sector included in the List of Affected Industries.

If a tenant sends a request for rent deferral, and this tenant meets the criteria established in Law 98-FZ and Government decree No. 439 and carries out activities included in the List of Affected industries, the landlord must grant rent deferral and conclude an additional agreement to that effect with the tenant within thirty days. The landlord is otherwise likely to be forced to execute such an additional agreement on rent deferral by the courts as a result of a claim brought forward by the tenant.

The deferral should be granted even if the lease agreement expires or is terminated in 2020.

2. Other tenants

Rent deferrals may also be requested by tenants operating in a sector that is not included in the List of Affected Industries. Tenants operating in such industries nevertheless do not have a statutory right to demand a rent deferral by virtue of Law 98-FZ.

If such a request is received, the landlord is not under any obligation to grant the deferral. However, the tenant is entitled to file to the courts and request a deferral by invoking a significant change in circumstances under article 451 of the Russian civil code. If the court finds that a particular tenant has in the circumstances of the case been particularly affected by the situation and is entitled to a deferral, this may be awarded by the court. In this case, the conditions for deferrals ordered by the courts may well differ from those established in Government Decree No. 439.

Consider whether it is compulsory to give a rent reduction

Under article 19 of Law 98-FZ, the landlord is obliged to reduce the rent amount under the agreement if it is impossible for the tenant to use the property. The tenant may also demand a rent reduction based on articles 451 and 614 of the Russian civil code in specific cases regulated there.

Whether it is possible to use the property is to be determined based on the content of the lease agreement, and in particular of the provisions:

• regarding the landlord's obligation to provide access to the premises
• regarding the warranties and representations given by the landlord
• regarding the intended purpose (purpose of use) for the property

It is also necessary to assess the concrete impact of restrictive measures imposed by regional authorities on the tenant's activities, and consider whether, in view of the above, the premises indeed can be used in a manner compatible with the agreement.

Neither Law 98-FZ nor the Civil Code establish any formula to calculate an applicable reduction in rent or the amount of such reduction. The following issues should be considered for the purpose of determining the amount of the rent reduction:

• if access to the premises is hampered by the landlord, or the landlord has not restricted the access, but the tenant is not able to use the premises due to the restrictions adopted by the authorities
• if the tenant retains the possibility to partially use the property (for instance, restaurants in Moscow can only serve take-away and delivery dishes, while it is forbidden to serve clients inside)
• which permitted or intended use for the premises is stipulated in the agreement

If the landlord restricted or closed access to the premises to comply with requirements imposed by public authorities, and thereby violated its contractual obligation to give access to the premises, it is likely to be released from liability for this breach of contract by invoking force majeure. The tenant will in this case not be able to recover from the landlord any damages imputable to the restriction or closure of access to the premises.

The inability to use the premises due to restrictions adopted by regional governments may be considered a commercial risk to be borne by the tenant, and therefore imposing all negative consequences on the landlord would disrupt the balance of interest between the parties to the agreement.

Start negotiations with your bank to amend credit terms

Many objects of commercial real estate are mortgaged for credit from commercial banks. Parliament has nevertheless through recent legislation given various organizations a right to demand amendments in the terms of their loan agreements.

1. Pay attention to the borrower's obligations in loan agreements

Your loan agreement may contain the following provisions, which may be affected by the current situation:

• an obligation to maintain a particular rent level when renting out the property: it is clear that such a provision may need to be revised in light of the current situation
• an obligation on the borrower to agree to amendments in the lease agreement with the tenant, if such amendments affect specific parameters which were defined in advance in the loan agreement or otherwise defined by the creditor: even providing rent deferrals in accordance with law 98-FZ may be subject to prior approval by the bank
• an obligation to maintain a particular loan-to-value ratio: taking into account current changes in the economic situation, the market value of your property may well change

2. If you are a small or medium-sized business, apply for state benefits

Federal Law No. 106-FZ of 03 April 2020 ("Law 106-FZ") provides a possibility for borrowers to receive deferrals on loan instalments. Such deferrals are granted if both of the following conditions are satisfied:

• the borrower is a small- or medium-sized business
• the borrower carries out activities included in the List of Affected Industries

In credit relationships between lender and borrower, as is the case in rental relationships between landlord and tenant, there is no definition of the criteria applicable to determine whether an entity's business activities are covered by the List of Affected Industries. The applicable statutory rules do not require that the entity applying for loan installment deferrals must have the relevant type of affected activity as their main registered field of activity in the Unified State Register of Legal Entities.

Landlords that satisfy the criteria above may qualify for a six-month deferral on loan repayments, as established by Law 106-FZ.

If the bank grants such a deferral, the landlord is released from payment obligations for the debt both principal and interest for the entire grace period. The loan's duration and repayment period are then to be prolonged accordingly.

3. If you are not a small or medium-sized business

In this case, you will need to conduct negotiations with your bank in order to receive deferrals on loan installments or lower interest rates. Regrettably, the bank is not under any obligation to accept changes to the loan agreement.

As arguments in these negotiations, you may make reference to the following, as applicable to your situation:

• the impossibility to meet installment deadlines due to force majeure
• the presence in your building of a large number of tenants affected by the restrictive measures adopted to combat the COVID-19 pandemic
• the presence in your building of a large number of tenants to whom the landlord/borrower is under an obligation to give rent deferrals or reductions in rent

In all likelihood, invoking force majeure in negotiations with the bank will not have a significant effect, due to the approach to force majeure taken by the courts in judicial practice. However, given the approach adopted by the Supreme Court in its Review No. 1, which accepts the explanation above, landlord/borrower's position in negotiations with the bank is significantly strengthened. The landlord can now invoke the lack of funds caused by restrictive measures adopted by regional authorities as force majeure.

Apply for other state support measures to combat the crisis

1. Support measures include:

• tax benefits for corporate property tax on real estate, which during the relevant period is rented out to tenants granted rent deferrals
• tax benefits for private property tax on real estate, which during the relevant period is rented out to tenants granted rent deferrals
• tax benefits for land tax on real estate, which during the relevant period is rented out to tenants granted rent deferrals
• benefits for landlords who pay ground lease for the land on which real estate objects are rented out during the relevant period to tenants granted rent deferrals
• other support measures to reduce landlords' tax burden, and in particular: tax deferrals, setting up deferred installment plans for taxes due, and reductions in the rates of insurance premiums, as determined in federal law No. 102-FZ of 01 April 2020 and federal government decree No. 409 of 02 April 2020, and as previously pointed out by colleagues from our tax practice⁷

The concrete scope and conditions for tax benefits granted on corporate and personal property tax, land tax, and benefits for ground lease, will be decided by regional legislatures. The Federal Tax Service has nevertheless published recommendations⁸ 

 on the implementation of these benefits by constituent entities of the federation.

2. Who may count on support measures:

Real estate owners that have provided rent deferrals to tenants who carry out activities included in the List of Affected industries may count on the tax benefits and benefits for ground lease.

Footnotes