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By: Stuart Lieberman Esq. and Brittany Debord, Esq.
Covid-19 has caused a business shutdown and our national and local economies have all but come to a complete halt. New Jersey and New York have been hit particularly hard by the virus, with both states mandating the suspension of many business operations. The business freeze will no doubt be around for an extended period. At the time of this article’s writing, this freeze is relatively new. However, the longer this lasts, the more strain will placed on commercial tenants and landlords alike.
Without question, there will be an increasing number of commercial tenants who simply cannot pay their rent because their business has disappeared. The trickle down effect of the Covid-19 crisis will become apparent as tenants default, and landlords in turn feel the adverse affects of the business shutdown. Even with government loans and grants on the horizon, lease default will be inevitable for some. In this article, we will explore this process as well as potential defenses that may be raised.
In New Jersey, commercial real estate evictions take place in the Special Civil Part of the Superior Court. As of the date of this writing, the Supreme Court of New Jersey has suspended the landlord/tenant court calendar of the Special Civil Part through April 26, 2020 in light of the Covid-19 crisis. Time will tell whether the court extends the suspension of its calendars in order to continue protecting judiciary staff and the public from exposure.
The process is usually straight forward and governed by statute. Specifically, N.J.S.A. 2A:18-53 provides that tenants may be removed in the following non-exhaustive list of scenarios:
The landlord is required to submit written notice to the tenant in advance in the above scenarios, except when the tenant defaults in payment of rent. Prior to the entry of final judgment, the tenant has the power to discontinue the proceedings by paying the clerk of the court the rent claimed to be in default, together with the accrued cost of proceedings. Once a final judgment against the tenant is entered, the landlord must apply for a warrant of removal within 30 days of the judgment. An officer of the court will then evict the tenant.
Unlike residential defaults, which are often perceived as following a judicial process that favors the tenant, commercial leases lack that veneer. A commercial lease is perceived by the courts as being an arm’s-length transaction, thus requiring both parties to fully perform. The primary tenant responsibility is to pay rent. And the failure often results in a prompt removal of the tenant.
Covid-19 creates some unusual issues for both tenants and landlords. Here, tenants are less likely to default in rent payment because their business is failing in the “traditional” sense. Rather, due to the effects of an unforeseen pandemic and government-mandated shutdown of business activity, revenue generation is now completely impossible for some businesses, and nearly impossible for many more. For example, many retail operations have been completely shut down by operation of law and have little prospects of securing business through other means, such as online sales or phone orders. For them, revenue production may be fairly characterized as being impossible during this difficult time.
For restaurant operations, while take-out orders are still permitted at the time this article is written, many restaurants are not maintaining necessary revenue production. Customers are concerned about spending income at this time of uncertainly, and many are concerned that the virus might remain on take-out food packaging materials or otherwise be spread during the delivery process. We are told that the takeout option is helpful, but not necessarily a real substitute for in restaurant sales, which means that the restaurant business, and many many others, will soon come up short when rental payments become due.
Whether a landlord rushes to court to commence eviction proceedings is a question that no doubt will vary from landlord to landlord and from situation to situation. It will depend on the financial health of the landlord, on the prospect of other replacement tenants becoming available upon a successful eviction, and perhaps on the prospects of the tenant regaining financial health after this emergency passes.
A tenant who was weak going into the crisis may not be perceived by a landlord as possessing the same post crisis potential as one who entered into it with a strong footing. Inevitably for some, the decision to proceed in court will be selected. However, landlords must consider the unique economic crisis at hand, and the difficulty of finding a new tenant in this climate.
For default of rent payment due to the Covid-19 crisis, a landlord’s claim will be straightforward. Failure to pay rent results in eviction and other remedies by lease and the above-stated law. Leases usually have default language requiring notice of a default, time to cure, and the right to take possession if the tenant has not left the premises. Most leases provide that these remedies are in addition to others provided at law.
In New Jersey, commercial landlords have a duty to mitigate damages upon a tenant default. Generally, this means that a landlord must make a good faith effort to find a new tenant to lessen the losses incurred from the former tenant’s default and nonpayment of rent. The possibility of mitigation may be particularly difficult during the Covid-19 crisis. Commercial landlords in New York, however, have no mitigation duty. For some commercial landlords in New York, this will make the decision to evict easier.
Overall, the landlord’s path forward is routine and predictable. We would also anticipate landlords seeking to recover attorneys’ fees and costs, which are typically provided as a remedy in contemporary New Jersey Commercial leases. Furthermore, we would anticipate that a landlord would seek as damages the balance of the rental for the remainder of the lease term.
We do not know if judicial demeanors and dispositions might change with respect to commercial tenant evictions. One might imagine that Courts will be inclined to view these commercial lease defaults in a different, more sympathetic view, than standard default cases. After all, this has nothing to do with normal business operations and everything to do with an unforeseen global pandemic outside of anyone’s control. That being said, judicial demeanor cannot be known in advance.
There may be legislative measures that make commercial evictions more difficult. For example, on March 16, Chief Administrative Judge Lawrence Marks for the State of New York published a memo suspending both residential and commercial evictions and pending eviction orders. In New Jersey, Governor Phil Murphy signed Executive Order No. 106 barring eviction and foreclosure proceedings for residential property only. New Jersey has yet to address the hardships facing commercial tenancies.
Many leases contain a “force majeure” clause, which allows the tenant to default on their contractual obligations in the event of unforeseen calamities and causes beyond the defaulting party’s control. The clause might list the events triggering tenant forgiveness, such as an “act of God”, acts of war or terrorism, or government condemnation. Going forward, we may very well see “pandemic” frequently added to these lists. Depending on the terms of the lease, a tenant might successfully use this clause as a defense, considering Covid-19 can almost objectively be characterized as an unforeseen calamity.
Government-mandated business closure may also trigger this defense, particularly if the lease clause explicitly lists government orders/interference as a force majeure. However, the lease may also limit the force majeure clause by excluding the obligations that are forgiven under this term, particularly payment of rent. Tenants may also need to follow notice requirements, if such terms exist in the lease, to give their landlord advance notice of the impending default and invocation of force majeure.
When reviewing a lease’s force majeure clause, keep in mind that generally, the clause is narrowly construed and will only apply when the intervening event is specifically listed therein. See Hess Corp. v. ENI Petroleum US, LLC, 435 N.J. Super. 39, 47-48 (App. Div. 2014). However, when the force majeure clause is broad or vague, a tenant affected by an unspecified event like Covid-19 may have a stronger argument.
In Facto v. Pantagis, a defendant wedding venue successfully invoked the force majeure clause, barring plaintiffs’ breach of contract claim. 390 N.J. Super. 227, 233-234 (App. Div. 2007). The venue was unable to deliver on the contracted-upon wedding reception when an area-wide blackout occurred, far beyond defendant’s control. Id. at 233 (“These are precisely the kind of circumstances under which the parties agreed, by inclusion of the force majeure clause, that the [defendant] would be excused from performance.”) A black-out may prove to be an apt analogy to Covid-19, which is similarly area-wide, unforeseen, and out of a commercial tenant’s control.
A tenant may also seek relief from default in rent payment by invoking two related doctrines: impossibility of performance and frustration of purpose. These concepts apply to contractual obligations that cannot be met due to the occurrence of a supervening event. The event would be an unforeseen and extraordinary circumstance.
Under the the doctrine of impossibility, such an event would make the performance of the contractual obligation impossible. With respect to Covid-19, a tenant may argue that the government-mandated business shutdown has eliminated revenue, thus rendering rental payment impossible.
Under the doctrine of frustration of purpose, the unforeseen and extraordinary event would alter the relationship of the parties and the benefits for which they bargained, thus destroying the purpose of the contract. In other words, if the extraordinary circumstance was present prior to the execution of the contract, the parties would have never entered into the agreement in the first place.
A historic example is found in the California case, 20th Century Lites, Inc. v. Goodman, 64 Cal. App. 2d Supp. 938 (1944), wherein the lessee, leasing neon signs, was relieved of its duty to pay the lessor after the the United States emergency war measure of August 1942 ordered cessation of all outside lighting at night.
In the more recent New Jersey case of JB Pool Management, LLC v. Four Seasons at Smithville Homeowners Ass’n, Inc., the doctrine of frustration of purpose was successfully invoked to relieve defendant homeowners’ association of its obligations to pay for a pool services contract, which provided lifeguards and maintenance services. 431 N.J. Super. 233, 248-251 (App. Div. 2013). During the contract term, a mold infestation of the pool facilities prompted government officials to order the pool to be closed. Id. at 236.
Elimination of the use of a pool clearly frustrated the purpose of a pool services contract. A similar argument might be made with regard to a pandemic and associated business freeze, where functional elimination of a business frustrates the purpose of a lease for a premises on which to conduct said business.
Finally, most commercial leases require compliance with all applicable state and federal laws. For many business suffering from the business freeze, it is impossible to abide by this provision and operate the premises as envisioned by the lease. Furthermore, contracts with an illegal purpose are unenforceable where the contract cannot be fulfilled without the illegal transaction occurring. These legal concepts may strengthen a tenant’s defense to defaulting on the lease and/or payment.
The Covid-19 pandemic poses novel issues for commercial landlords and tenants alike. The law will have to compete with a human sense of sympathy within the judiciary, and time will tell which legal argument will succeed over policy and moral reasoning. Unfortunately, one of the few certainties during this turbulent time is that there will be defaults, and parties to a commercial lease will require legal recourse in the months ahead.
About the Authors
***Both authors are attorneys in Princeton’s Lieberman Blecher & Sinkevich, P.C. The firm represents commercial clients in real estate, land use and environmental matters.
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