In the wake of government orders closing businesses, the often-overlooked condemnation clause in real estate leases may be important. Typically, a condemnation clause permits a landlord or a tenant to either terminate the lease or abate the rent in the event of a government "taking" of the leased property. This alert examines how government orders can trigger the condemnation clause in a lease and impact the relationship between a landlord and a tenant.
The first issue that landlords and tenants should investigate is whether the government action amounts to a "taking," and thus triggers the condemnation clause. At the outset, landlords and tenants should look carefully at the triggering language in the clause. If the clause is triggered by “eminent domain,” then it probably only applies if the government physically appropriates the leased premises, e.g., by using the premises as an emergency medical center. By contrast, if the clause is triggered by a “taking” or “condemnation,” then the clause may apply either in the event of a physical appropriation or through interference with a tenant's business operations, by way of executive or emergency order, or regulation. In the latter situation (business interference), whether a taking has occurred and triggered a condemnation clause requires looking at three factors. First, the government's action must have a severe economic impact on the premises. Courts ordinarily require a showing that the affected tenant is basically shut down. Second, the action must affect the tenant's "reasonable investment-backed expectations." Longstanding tenants could likely satisfy this criterion, because they could not have expected a pandemic to prevent the operation of business. On the other hand, tenants who signed leases very recently, when the potential severity of COVID-19 was better known, may find it more difficult to argue that the government action was unexpected. The third factor is the "character of the government action," meaning that the government action must be intended to benefit the public as a whole as opposed to facilitating a particular public or private project. Action in response to COVID-19 likely meets this factor. In summary, both government-mandated business shutdowns and physical appropriations may amount to a taking and trigger the condemnation clause in a lease.
The second issue that landlords and tenants should investigate is what the condemnation clause specifically says can happen if it is triggered. Some clauses provide for termination. Some clauses merely provide for rent abatement. Some clauses require that the taking last for a certain period of time before the clause is triggered. Some require notice within a certain period of time after the event that constitutes a taking. Some impose repair obligations during or after a taking. This is not an exhaustive list and each lease is unique, so landlords and tenants should inspect their condemnation clauses carefully.
One caveat (beyond the scope of this alert): There is a separate question, potentially complicated, as to whether a landlord or a tenant can recover compensation from the government in the event of a taking, as opposed to a remedy against the other party to a lease.
As government actions severely impact businesses, landlords and tenants need to be aware that such actions can constitute a taking and trigger the often-overlooked condemnation clause in a lease. Landlords and tenants should review their specific condemnation clauses to determine whether the clause has been triggered and, if so, what relief is available.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.