We anticipate a busy year for real estate litigation as disruption resulting from the first year of the pandemic continues and recovery from the pandemic begins in earnest. COVID-19 has served to accelerate trends already in progress, such as the rise of e-commerce and the decline of brick and mortar retail stores. The pandemic also has served to push over the edge certain residential and commercial developments and properties who were struggling before the pandemic.
Still an Ever-Shifting Landscape
Legislatively-imposed moratoriums on foreclosures and evictions are set to expire. Forbearance agreements negotiated earlier in the pandemic and government sponsored financial assistance, such as the PPP program, likely served as temporary solutions that simply deferred parties' inability to meet their financial obligations. Once these temporary solutions no longer are available or no longer provide adequate protection, the disruptive effect of the pandemic will have increasingly significant impact on real estate, particularly in the retail and hospitality sectors, and will likely result in an uptick in the already increased number of lawsuits. We anticipate commercial landlord-tenant litigation to remain robust in 2021.
Prior government shutdown orders and ongoing capacity restrictions continue to impact landlords and tenants of retail and office properties. This has spawned a cottage industry of litigation in both state and federal courts throughout the country.
In the retail industry, our experience has been that tenants, including traditional and big-box retailer tenants and quick serve restaurants, generally contend that because they were forced to close their doors to the public due to the spate of government shutdown orders that swept across the country they were unable to conduct ordinary operations. Accordingly, they have argued that they are relieved of their contractual obligations to pay the full amount of rent due during the impacted period by various contractual and equitable doctrines. Some tenants have even attempted to use such doctrines as a springboard to seek reformation or rescission of leases. We have seen that landlords typically respond that temporary periods of closure and negative economic impacts in the wake of COVID-19 are insufficient to relieve tenants' obligation to pay rent in general and under lease terms, particularly force majeure clauses, which typically contain carve-outs for monetary obligations.
These tensions have forced parties, and courts, to scour previously little-regarded lease provisions and revisit old common law excusability doctrines. Courts, and parties, typically first turn to the lease's force majeure clause, which is where contracting parties typically address rights and remedies for foreseeable events that could prevent, or render impossible, or delay a party's performance. Because force majeure clauses in commercial leases frequently contain carve-outs for monetary obligations, thereby still obligating tenants to pay rent, landlords rely on these clauses to defend against tenants' efforts to avoid rent obligations, particularly where government orders or restrictions are identified as events of force majeure.
This has forced tenants to try to distinguish their particular force majeure clause, or turn to other contractual defenses, such as co-tenancy (if they were shut down, other anchors may have been as well, thereby triggering a co-tenancy failure), casualty, and covenants of quiet enjoyment. In addition to contractual defenses, tenants have also resorted to a cadre of excusability defenses, including frustration of purpose, impracticability, and impossibility.
While the contours of excusability defenses and the impact of lease force majeure clauses are still developing in the real estate litigation context, preliminary results of court rulings have tended to skew in favor of landlords. There is also a vibrant argument that is emerging in developing case law regarding the availability of excusability defenses when the lease at issue contains a force majeure clause. Some courts decline to apply excusability defenses, noting that the parties contracted to incorporate those defenses as they saw fit in the force majeure clause, and other courts agree to proceed through the contractual and equitable defenses alike. In this regard, force majeure clauses are technically limited to the doctrine of impossibility, namely where a party is prevented or unable to perform, as opposed to the doctrine of frustration of purpose, where an intervening event has, either temporarily or entirely, frustrated the purpose of the lease, even though a party can still perform (i.e., the tenant is not prevented from paying rent). Some courts have adeptly noted that distinction, while others have blurred the doctrines together.
There have been, however, some notable pro-tenant rulings. For example, a recent Massachusetts trial court ruled that a commercial tenant was excused from paying rent while indoor operations were barred by government order during the Spring of 2020. Addressing the interplay between the common law doctrines of frustration of purpose and impossibility on a commercial tenant's obligation to pay rent during periods of shutdown where the lease's force majeure clause identified government restrictions and contained the typical carve out for monetary obligations, the court noted that the force majeure clause invoked the doctrine of impossibility. It distinguished that doctrine from "frustration of purpose [which] is a different issue, arises under different circumstances, and was not addressed by the force majeure provision." Similarly, in a New Jersey case, we represented the retail tenant who defeated to the landlord's motion for summary judgment on the ground that the tenant was permitted to present its defense of frustration of purpose as excusing its obligation to pay rent during the government shutdown.
In the office lease context, our experience has been that the excusability doctrines are finding much less success when courts look at the specific purpose of a space. For example, in a New York case, we represented the landlord of office space, who won summary judgment on its action to recover unpaid rent, against a tenant which asserted defenses of impossibility and frustration of purpose. As for the impossibility defense, the court explained that the tenant's business was not shut down by COVID-19-related government orders. The court's ruling is consistent with the prevailing view that mere economic hardship does not excuse a tenant's rent obligations. The court limited its holding to office leases, noting that this was not a case "where a tenant rented a unique space for a specific purpose that can no longer serve that function." In essence, courts are examining the use provisions of leases and the specific impact of government shutdowns and restrictions on particular uses, rather than issuing blanket relief for tenants.
Whether a cohesive body of case law develops regarding excusability defenses and the impact of lease force majeure clauses, or whether the results will continue to vary state by state and court by court is unclear, but it will dramatically impact the outcome of these disputes. Of course, this uncertainty could result in landlords and tenants being more willing to compromise, such as in the form of lease amendments or modification agreements, in order to control their own destiny and to implement business strategies, while avoiding unpredictable and unwanted results in court. This is a trend that we are already witnessing.
Insurance Coverage Litigation
Although we have not seen the anticipated tsunami of insurance coverage disputes relating to the pandemic, there is a growing body of decisions on whether COVID-19- related business income losses constitute compensable losses under business interruption or "casualty" coverage provisions. The results thus far skew strongly in favor of carriers where policies contain exclusions for losses arising from the presence of virus, bacterial or other microorganisms or which limit coverage to situations including "direct physical loss or damage to real property," with most courts requiring actual physical loss or damage rather than loss of access to or use of premises (due to government shutdowns or restrictions), to constitute a compensable loss.
Foreclosures and Bankruptcy Litigation
In addition to the well-publicized impact of COVID-19 shutdowns and the economic downturn on retail and office leasing, and on real estate financing for such properties, the hospitality industry has been particularly hard hit. There likely will be an increased number of mortgage foreclosures and UCC foreclosures on affected hotel properties, as well as guaranty litigation, hotel franchise disputes and possibly lender liability claims arising from actions taken by parties during the pandemic to defer or forbear from enforcement of remedies. In June 2020, a New York State court evaluated what constituted a commercially reasonable UCC foreclosure sale during the pandemic and enjoined a lender from proceeding with a UCC sale of the upscale, landmarked Mark Hotel where the sale was not "crafted in a way to accommodate New York City's stay at home orders and other local mandates in response to COVID 19." The court was persuaded by plaintiff's argument that "what is reasonable during normal business times, may not be reasonable during the pandemic." It is notable that the court did not rule that all foreclosure sales held during the pandemic are unreasonable, but rather, directed the lender to craft a commercially reasonable sale plan, considering COVID-19 conditions.
In addition, shopping mall failures likely will accelerate, with loan foreclosures on mall properties and lease disputes ranging from going-dark litigation, actions to recover rent on vacated spaces, and co-tenancy failures by mall owners, generating other shopping mall lease disputes. This would lead to more bankruptcy filings and work-out related disputes.
There have been several bankruptcy court rulings dealing with these precise issues and tackling the same contractual and equitable arguments pervading retail and office landlord-tenant litigation generally, again with varying outcomes. For example, an Illinois bankruptcy court excused the debtor-restaurant's obligation to pay full rent during the government shutdown where the lease's force majeure clause identified government orders as an event of force majeure but, unlike most commercial leases, did not contain a carve out for monetary obligations. Since the restaurant was able to use 25% of its premises for take-out orders, the court ultimately concluded that the "Debtor's obligation to pay rent is reduced in proportion to its reduced ability to generate revenue due to the [governor's] executive order," such that the debtor-restaurant was required to pay 25% of its monthly rental obligation. Relatedly, a Texas bankruptcy court rejected the debtor-restaurant's invocation of common law excusability defenses where several of its leases' force majeure clauses identified government orders as an event of force majeure and contained the usual carve-out for monetary obligations.
Property Management and Ownership Concerns
We anticipate litigation involving claims against commercial and residential property owners and managers arising from actions taken or not taken relating to COVID-19 such as potential claims relating to inadequate measures taken to protect against COVID-19 or improper restrictions or obligations imposed relating to COVID-19. Similar claims are anticipated in the context of cooperative and condominium governance disputes.
In addition, the disruption likely will lead to increased real estate partnership disputes, partition actions, as well as general commercial litigation involving real estate ownership entities and properties.
Development and Construction Project
There likely will also be increased litigation in the context of ongoing development projects. We have already seen litigation involving real estate purchase and sale agreements. As a basis for an attempt to nullify an agreement, some parties are pointing to the economic and business impacts resulting from COVID-19 as changing the fundamental purpose of an underlying agreement.
Construction-related litigation involving claims arising from project delays and project overruns will continue, and there likely will be an increase in mechanic's lien litigation. Resolution of these disputes will involve application of the same common law excusability doctrines and contractual force majeure clauses that impact landlord-tenant litigation as well as delay damages provisions unique to construction contracts.
New Areas of Potential Liability
Public real estate companies could face claims arising from inaccurate or incomplete disclosures regarding the impact of COVID-19 on their operations and values. In addition, in a trend that we have begun to see, some states are enacting legislation mandating gender diversity on corporate boards, obligating them to comply with board gender diversity disclosure requirements established by the legislation. Failure to do so could expose them to liability, including for disclosures that contain material misstatements or omissions. In addition, a company could face shareholder derivative suits alleging breach of fiduciary duties as a result of decisions made concerning board diversity or the lack thereof, or potential harm to their brand.
Conclusion-Optimism and Opportunity
Seyfarth's 2021 Real Estate Market Sentiment Survey indicates an overwhelming 85% of respondents' believe that 2021 will be a year of opportunity for their real estate companies, as they navigate the fallout from the 2020 recession and adapt to new market demands. If history is our guide, disruption in the real estate market coupled with companies' optimism about new opportunities will result in increased real estate litigation.
Originally Published 31 March, 2021
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