UPDATE: On April 16th the Federal Government announced tentative rent relief for small and medium-sized businesses. More details to follow.
You get the dreaded call. Your tenant can’t pay rent. Or you’re a commercial tenant forced to close shop and your landlord calls looking for this month’s cheque. What do you do?
Landlords and tenants alike are facing these all-too-common scenarios amidst the Covid-19 pandemic. While the Government has provided limited assistance to residential landlords, these protections do not extend to commercial tenancies which remain, at their core, a strictly contractual relationship.
Commercial Lease Basics
The commercial lease governs the rights and obligations of the landlord and tenant. The first step in a distressed lease scenario is to carefully read your lease or have experienced legal counsel review it for you.
There’s No Free Lunch:
Unsurprisingly, provisions for payment for rent tend to contain the most stringent language in any commercial lease. The tenant is almost always required to pay rent as and when due without any deferral or abatement.
It is still unclear if the doctrine of frustration plays a role in rent defaults as a result of the Covid-19 pandemic. Frustration allows an agreement to be set aside if it can no longer be performed due to unforeseen circumstances or if such circumstances undermine the very foundation of the contract. No relevant case law holds this crisis or a pandemic of this nature as a basis for a successful claim of frustration. Time will tell whether this doctrine can offer any relief in commercial tenancy proceedings once courts reopen.
Force Majeure Maybe
Force Majeure clauses, also known as the “Act of God” provision, operate to excuse or suspend performance of a party’s obligation due to unforeseen circumstances which render performance unfeasible. Review your force majeure provision carefully to determine whether any reference has been made towards public health emergencies, pandemics or similar analogous scenarios. Even where there is specific reference to a pandemic, it would be highly unusual for a Landlord to agree to a Force Majeure clause that excuses or absolves late payment of rent. Force Majeure provisions typically exclude the tenant’s inability to pay rent from constituting a triggering event entitling a tenant to rely on the clause.
Insurance Interrupted
Tenants should review insurance policies for any “business interruption” coverage. Typically this coverage will only compensate the tenant for loss of business income occurring during the period that the underlying premises is being restored on account of physical damage having been sustained. While the Insurance Bureau of Canada’s website has stated that traditional business interruption insurance policies do not offer coverage due to Covid-19, a close review of your insurance policy is worthwhile.
Practical Solutions for a Pandemic: A Bird in the Hand
Without a silver bullet or government bailout for the unique challenges of Covid-19, practical solutions and workouts are likely the most viable approach for both landlords and tenants for distressed leases. Landlords and Tenants are best served by communicating early and often, by getting creative in structuring solutions and by having an experienced lawyer prepare and finalize all documentation.
Lease Workouts: Deferral, Abatement and Beyond
While landlords typically have no obligation to abate or defer rent, enforcing against a defaulting tenant during a pandemic may not be the best business strategy (unless the Landlord wanted to end that particular tenancy).
The reality is that commercial landlords will be hard-pressed to find replacement tenants. There is significant risk terminating a lease without a reasonable prospect of a replacement tenant for an unknown period of time. New tenancies carry cost, risk, and start up time. Terminating a tenant who could have rebounded in the near future could be short-sighted to longer term business plans, co-tenancy provisions or tenant mix in a given asset.
Landlords should consider practical solutions as an alternative to lease enforcement, including the following rent relief strategies:
- Deferral. Rent is not forgiven, but merely delayed and either amortized into later lease payments or structured in a way to allow repayment at a later date without prejudicing the landlord’s right to collect such amounts later. While this option gives the landlord certainty that rent still remaining owing, it can create a death spiral where a tenant is unable to catch up.
- Abatement. Rent is waived or suspended for a period of time on terms and conditions agreeable to the landlord. If a tenant would be burdened by deferred rent to the point they fail, a temporary abatement coupled with other tools may be the most realistic option. Of course, this will impact a landlord’s cash flow in the short term and may not be appetizing to lenders or other stakeholders.
- Control Letters. If the landlord hoped to recapture part of the space or claw back any special provisions, rights exclusives or restrictive covenants or other perks under the lease, now would be a good time to negotiate a quid pro quo on rent and a claw back.
- Landlords can actively empower the tenant to sublet their space, even by engaging the Landlord’s broker at the expense of the tenant or helping by reaching out to prior tenant inquiries.
- Default Then Chill. Landlords can issue default notices on rent in accordance with the Lease, then wait to take action while the pandemic plays out. A no waiver clause in the lease means the landlord doesn’t have to take action on every default while still retaining its rights.
Any lease workouts or rent relief arrangements should be set out in a carefully worded agreement prepared by an experienced lease lawyer. Landlords should check with their lender before agreeing to any deferral or abatement to ensure that their financing terms do not require lender consent.
Practical Asks; What Have You Done For Me Lately
Landlords want to see tenants making reasonable efforts to obtain such assistance as a sign of good faith or even require such attempts as a pre-condition before considering rental abatement or deferral. Landlords should request and Tenants should offer the following:
- Copies of the insurance policies, including business interruption coverage, required to be carried under the Lease.
- 2019 and year-to-date 2020 financial statements for the location, including gross sales on a monthly basis, and (b) ongoing monthly sales reports beginning with March, 2020.
- A summary of the effects of the COVID-19 crisis, and related governmental orders, on business operations in the leased premises.
- A summary of actions being taken by the tenant (or the business operator) to maintain continuity of operations and to mitigate damages resulting from the crisis (for example, curbside and take-out operations, delivery services, or online ordering), and (if applicable) by franchisors and investors to assist the operator (for example, financial and/or administrative support).
- Suggestions for ways that the owner can assist with ongoing operations (for example, temporary signage assuring customers that stores are open, designation of common areas for curbside pickup).
Security Deposit: Kicking the Can Down the Road
A Landlord can typically apply any security deposit it currently holds, to compensate for its loss of rental income, then demand a top up. This strategy may only delay the inevitable domino effect of late rent. But it can buy the parties some time if a cash strapped tenant is waiting on a new loan or government relief which is evolving daily.
The Bottom Line: It’s Deal Making Time
Landlords and tenants are both struggling amidst the current Covid-19 pandemic. The options available to either party will largely be determined by the lease agreement governing their respective rights and obligations to and from one another. As of now, negotiations and workouts are likely the best course for both landlords and tenants, especially considering the closure of courts having eliminated more traditional remedies such as litigation, or orders for possession.
We can help by reviewing your lease documentation, negotiating and documenting workouts or rent relief agreements and looking at your options. Our experienced team of lease solicitors and litigators can assist you in assessing your rights and obligations and working towards a solution.
For assistance with your lease problem please contact:
Tony R. Anderson
tanderson@owenbird.com
(604) 691-7528