By Michael D. Brofman, Esq. & Michael J. Spithogiannis, Esq.
Email Michael Brofman
Email Michael Spithogiannis
The onset of the COVID-19 pandemic and government’s response was immediate and stunning, but few had time to fully consider and comprehend the long-term effects on their businesses. The rights and obligations of commercial tenants to pay rent amid the governmental restrictions, and whether an insured can recover for business interruption caused by the government’s response to the pandemic, are questions that clients are asking us to address. At present, there are no clear answers, but there are steps that should be taken to understand and address the issues.
In a typical commercial landlord and tenant relationship, courts look primarily, if not exclusively, to the parties’ lease to resolve any dispute. In the immediate future, many tenants and landlords will become familiar with the term, force majeure. In French, force majeure means superior force. In the legal sense, it contemplates an event that is neither anticipated nor controlled which prevents performance of an agreed-upon act. In general, force majeure includes acts of nature, such as earthquakes and hurricanes, and acts of people, such as riots, strikes, and wars. Although rarely at issue, many contracts include a force-majeure clause to allocate the risk of loss if performance becomes impossible or impracticable due to unforeseen and uncontrollable events.
A recent example illustrates the point. In response to the pandemic threat, the governor of Illinois issued an executive order directing restaurants to suspend food service for on-premises consumption. The executive order permitted and encouraged such businesses to sell food and beverages for off-premises consumption through delivery, drive-through and curbside pickup.
On June 2, 2020, the United States Bankruptcy Court, Northern District of Illinois, determined whether a restaurant operator was required to pay the full amount of agreed-upon rent while under the Illinois executive order. Predictably, the Bankruptcy Court first looked to the parties’ lease which contained the following force-majeure clause:
Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by . . . laws, governmental action or inaction, orders of government. . . . Lack of money shall not be grounds for Force Majeure.
Id. (emphasis added).
The Bankruptcy Court observed that a force-majeure clause will only excuse performance if the triggering event was the actual cause of non-performance. The court determined that the governor’s executive order constituted both governmental action and issuance of an order, which unquestionably hindered the ability of the tenant to pay its rent. The court observed, however, that the debtor-tenant could still operate by take-out, curbside pick-up, and delivery services. Consequently, the debtor-tenant was only partially excused from paying rent during the restrictive period, and the rent was only reduced in proportion to its reduced ability to generate revenue.
When a similar case is ultimately considered by a New York court, can we expect the same sort of analysis? Absent legislative intervention, the parties’ lease will likely control the outcome in New York as well. New York courts have often recognized that freedom of contract is a deeply-rooted public policy, and a right of constitutional dimension. Because force-majeure clauses excuse a party’s performance, or limit damages in cases where reasonable expectations and performance have been frustrated by circumstances beyond the parties’ control, New York courts generally apply them narrowly; relieving a party of its contractual obligations only under clear and unambiguous circumstances. Performance will, therefore, only be excused if the force-majeure clause specifically includes the event that actually prevents compliance.
In response to the COVID-19 crisis, New York Governor Andrew M. Cuomo issued a number of executive orders. Among them was Executive Order 202.3, issued March 16, 2020, which is similar to the one issued in Illinois. The likely scenario is that New York courts will look to commercial-tenants’ leases to determine whether the obligation to pay rent can be eliminated or reduced during periods when business operations were restricted. Each specific force-majeure clause will undoubtedly control how a New York court might determine rent-payment obligations in light of the Executive Order or other governmental action. It would behoove landlords and tenants alike to examine their leases carefully.
A corollary issue presented is whether business-interruption insurance provides coverage to either (or both) parties to a lease. One might expect that a source of relief amidst governmental restrictions arising from COVID-19 – particularly in the restaurant and retail business – would be business-interruption coverage bought and paid for under common all-risk commercial property insurance.
In a bi-partisan effort, 18 members of the United States House of Representatives wrote to insurance-industry trade groups urging them to recognize financial loss due to COVID-19 as part of business-interruption coverage. The response was uncompromising: “Standard commercial insurance policies offer coverage and protection against a wide range of risks and threats, and are vetted and approved by state regulators. Business interruption policies do not, and were not designed to, provide coverage against communicable diseases such as COVID-19.”
In light of the position taken by the insurance industry, on April 9, 2020, in one of the first lawsuits against insurance carriers, two restauranteurs commenced a federal class action lawsuit in the United States in the District Court, Southern District of Florida, asking the court to declare that the standard all-risk commercial property insurance policy provides coverage for business-income losses incurred because of measures taken by governmental authorities to restrict operations in light of COVID-19. The lawsuit is in its very early stages and will not likely be decided in the immediate future. We can expect the insurance industry to defend the case vigorously and resist payment of business-interruption claims in general. Moreover, as policy provisions often differ, class certification may be denied.
Like the force-majeure analysis in the case of commercial leases, the question of coverage will likely come down to the contract between insurer and insured – the insurance policy. Understanding what an insurance policy provides goes a long way to understanding the likelihood of success when a claim is made and formulating a strategy to pursue the claim once it is rejected.
Whether a tenant, landlord or insured business owner, knowing your rights will, at minimum, allow you to manage your expectations, negotiate from a position of strength and quite possibly obtain much needed relief. Getting counsel involved early to help in the analysis and provide guidance is a prudent and cost-effective measure in these highly uncertain times.
Weiss Zarett Brofman Sonnenklar & Levy, P.C. is a Long Island law firm providing a wide array of legal services to the members of the health care industry, including corporate and transactional matters, civil and administrative litigation, healthcare regulatory issues, bankruptcy and creditors’ rights, and commercial real estate transactions.
ATTORNEY ADVERTISING: PRIOR RESULTS DO NOT GUARANTEE FUTURE OUTCOMES