As the COVID-19 pandemic reaches the one year mark in the United States, the rollout of vaccinations is showing signs of lowering the rate of new cases and deaths. However, companies are still faced with government mandated prohibitions and occupancy limitations that can still result in detrimental impacts to business, especially retailers and restaurants. With only piecemeal governmental relief programs over the past year and a new COVID "rescue" bill only recently passed in Washington, many landlords and tenants--if still in business--find themselves in the same difficult position they were in last summer. Business operations remain negatively impacted, sales are sluggish, and available cash dwindles. Against the backdrop of Massachusetts' businesses continuing to feel the pain of the pandemic, this article will cover negotiation and litigation trends over the last six months and what can be expected as life slowly comes back to normal once vaccinations in the United States hit a critical mass.
Lease Modifications
After a short period of complete uncertainty in March and April 2020, a handful of landlords and tenants smartly negotiated modifications of their existing leases to establish new lease terms for the remainder of the calendar year and in some cases well beyond. Such lease modifications in the past six months have included the following:
- Rent Deferral - Deferral of rent payments for a short period (e.g. 1 to 3 months). The tenant would repay the deferred amount by spreading out smaller payments during the remainder of the lease term. Alternatively, the lease term would be extended for the same length as the rent deferment and the tenant would repay the deferred amount during the newly created extension period. This has been the most commonly agreed upon lease modification during the pandemic.
- Rent Abatement or Rent Reduction - Payment of reduced rent or a rent abatement for a short period. The reduced or abated rental amount would also be repaid by the tenant in the same manner as described for a rent deferment. However, landlords have not been too keen to permit full rent abatement unless there were special circumstances at play. For example, with numerous business closures, certain landlords have not been able to comply with a special requirement in some retail leases that a certain percentage of other tenants at a property be open and operating (known as a co-tenancy requirement)--a failure of such a requirement often results in a rent reduction for the tenant. Landlords with a potential co-tenancy issue have been much more willing to provide a short-term rent abatement or reduction in exchange for the tenant's waiver of the co-tenancy requirement.
- Percentage Rent (Retail Tenants Only) - Converting the monthly payment of standard rent payments for a retail tenant into monthly payments which are a percentage of a retail tenant's actual gross sales at the leased premises. While many retail tenants (especially restaurants) proposed this type of alternative rent when the pandemic began, landlords for the most part have rejected this modification. In particular, landlords have not wanted to deal with the administrative burden of reviewing gross sales records and calculating percentage rent.
- Reduction of Space - Reducing the space occupied by a tenant in exchange for lower rent. In certain situations (e.g., another tenant is considering space in a building) landlords have taken back a portion of an existing tenant's premises. The existing tenant can reduce its rental obligation while the landlord is then able to provide the total space required by a new tenant. For many landlords and tenants, this modification has been a "win-win" situation; however, it is not always an option because it relies on the landlord needing to recapture space to make room for another tenant.
Litigation Trends
It is no secret that many retailers have been unable to pay their full rental obligations (and some in no position to pay any rent). While some landlords and tenants have been able to reach agreement on one or more of the modifications described above, in many cases no resolution is reached. As a result, the court systems across the United States are filling up with rent payment disputes between landlords and tenants. The decisions in these cases have shaped how landlords and tenants negotiate rent modification agreements.
Most courts have so far found in favor of landlords which has led to some landlords being less incentivized to strike a deal with their struggling tenants. However, a recent February decision in the Massachusetts Superior Court found a judge bucking this trend by ruling in favor of a tenant operating as a café, sending a jolt through the commercial landlord-tenant community. In UMNV 205-207 Newbury, LLC v. Caffé Nero Americas Inc., the trial court excused the tenant café's obligation to pay rent during the period of Governor Charlie Baker's shutdown order, with the judge basing his decision on the application of an old legal doctrine known as "frustration of purpose". Under this doctrine, when a party's primary purpose under a contract is materially frustrated (through no fault of their own) by the occurrence of an unforeseeable event, then the party's obligations under the contract are discharged. While this case is only a lower court decision that could be overturned on appeal, it has served as a wake-up call for the Massachusetts real estate community. Other cases could be decided in a similar fashion as more landlord-tenant disputes work their way through the court system. Litigation will surely continue well after the pandemic is over and can change how parties approach lease modification discussions.
Conclusion
The commercial real estate industry in Massachusetts has experienced its fair share of twists and turns courtesy of the COVID-19 pandemic. Even with an end seemingly in sight, there is simply no way to predict when normalcy will return (and it will not be an overnight process). Open dialogue and cooperation is still the best path to negotiating a mutually beneficial solution to get through the pandemic and eventually return to business as usual. It is the one way for landlords and tenants to achieve a little bit of certainty amidst the unpredictability of the pandemic and the legal landscape still coming into focus.
Previously published in Greater Boston Chamber of Commerce.
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