Blog Details

COMMERCIAL LANDLORDS AND TENANTS FACING PROBLEMS DUE TO COVID-19 AND EVALUATE THEIR OPTIONS AND WORK OUT SOLUTIONS

Author - Advocate Rashi Suri (Managing Partner), Pradyun Chakravarty (Associate)

The Covid-19 pandemic is leaving businesses highly vulnerable, the challenges are particularly magnified due to complications from lockdowns, travel restrictions and quarantines of employees, customers or contractors for the fragile MSME sector as well as big corporates including those that operate its businesses our of rented premises.. As a result, commercial tenants throughout the country are temporarily closing, curtailing operations and suffering sharply declining revenues. For them the pandemic may especially pose an existential threat to continuity of business and payment of rentals in a real sense. 

Due to this unprecedented challenge which has heightened the volatility of business operations commercial landlords and tenants are now at the cusp of facing a number of critical issues, both in the short-term and in the near future. There are various assessments that both a landlord and a tenant should be doing right now, such as:

Qs. How will the parties address closing of tenant’s business or the problems of reduction in workforce and persisting revenue losses affecting its ability to operate, pay rent for leased space? 

Qs. What should be the appropriate response by a landlord if and when a tenant defaults or requests for rent relief?

Qs. How does the above affect a landlord’s own responsibilities of paying real estate taxes, maintenance costs and debts, if any, on the property?

KEY ISSUES INVOLVED

I. CONTRACTUAL TERMS & OTHER SAFEGUARDS

Understanding Force Majeure clauses in corporate leases 

• Generally, these clauses are designed to excuse or suspend a party’s obligation to pay rentals during the continuance of force majeure event. As per the Ministry of Finance, Government of India’s Office Memorandum dated February 19, 2020, it has been stated that Covid-19 should be considered as a case of natural calamity under force majeure clauses of the contracts. Therefore, a business entity should check whether there is a mention of natural calamity as a triggering event in their contracts. 
  
  
• The concept of force majeure will extend and also include man-made circumstances such as government policy and action. Therefore, the order of the central government and state governments to effect a national or a territorial lockdown to limit the spread of Covid-19 would certainly qualify as a force majeure event.
  
  
• Although, Force majeure clauses allow for an affected part to get out of performing certain obligations in the event of unforeseen events, but most leases generally don’t contain force majeure provisions which allows parties to take refuge in case of an exigency. Alternatively, if tenants are prevented from occupying their premises, they may seek the help of doctrine of frustration which is provided under Section 56 of the Indian Contract Act, 1872 to see if that can help get them out of their lease obligations.
  
  
• In case the contract or lease agreement contains a force majeure clause, then the language of such provisions, which may vary from contract to contract, would have to be reviewed thoroughly. In all likelihood contracts or leases with such clauses will often require the affected party claiming a force majeure event to mandatorily comply with some other additional obligations as well, like giving prompt notice of the event (within a definite time period) or the delaying factors (specific incidences and occurrences) or detailed documentation regarding the damages that is suffered due to the particular force majeure event for which indemnity is being claimed.
  
  
• An affected party should have clarity about the terms of the contract that governs cancellation, repudiation and breach of the contract or any other similar terms which requires the affected party to mitigate its damages or delays incurred as a result of the force majeure event. 
  
  
• In case where leases do not have provisions related to force majeure then the language of such contracts would have to analyzed which will depends upon a technical interpretation based on:
  
  
  • The nature and context of the business’ particular contract; 
  • The wordings in relevant provisions; and
  • The general terms of the contract, including the governing law.
    
    
• Notice to the Lessor: Whether or not a notice is required to be sent under a lease depends on the specific terms and provisions of it. It is nonetheless recommended that an affected party should draft and as soon as it gains knowledge of the force majeure event send a notice letter to the other party which includes: 
  
  
  • The scope of the outbreak, the corollary government interventions and its impact on the business’s function and ability to meet contractual obligations, along with citations or references to relevant government circulars and notification; 
    
    
  • A formal Notice, that the business intends to modify its performance of the contract and payment of rentals under the force majeure clause; 
    
    
  • A statement that the business’s exercise of its rights under the force majeure clause should not be interpreted as a breach, repudiation, or cancellation of the contract.
    
    
  • It is imperative that the business duly notifies the other party regarding the inability to pay rentals on account of the force majeure event and such notices, letters or correspondences with the other party along with any internal documentation should be kept and maintained in a safe custody which can be admitted as evidence in the event a suit seeking damages for breach of the contract is instituted by the other party in future. 
    
    
  • Similarly, such notice and letters with the supporting documentation should be drafted by a lawyer who is well versed and has appropriate experience both with force majeure events and associated litigation. Sometimes deferral or suspension of payment of maintenance charges during the force majeure event may be specifically requested for in the said notice notifying the force majeure. 
    
    
• “Keep-open” clauses in commercial leases: The tenant’s in the retail sector having keep-open clauses in their leases should consider the impact of closing their outlets due to governmental law, policy or action. Keep-open clauses may trigger conflicts between the landlords and tenants. 
  
  
• Other Critical Lease Terms: Some of the other provisions of a lease that should be reviewed are those relating to a tenant’s 
  
  
  • Operating and compliance with legal requirements; 
  • Co-tenancy; 
  • Frustration of contract, 
  • Early termination, 
  • Surrender or recapture of rights; 
  • How to meet deadlines 
  • Renewal options; 
  • Defaults and remedies; 
  • Security deposits and other collaterals. 
    
    
• Effect on Tenant’s Business: As soon as practicable the parties must review the impact of Covid-19 to assess the tenant’s operations and financial ability to pay rent and comply with its other contractual obligations. The Tenants need to specifically consider their business viability options such as:
   
  • Closing underperforming locations, 
  • Consolidating operations, 
  • Limiting expenses, 
  • Maintaining operating funds and reserves. 
    
    
• Health and safety: After assessing the risks to the health of employees or customers and what effective protective and preventive measures are to be undertaken, in most cases, it would be for the tenant to consider the threats to the health and safety of its employees. Therefore, the tenants should ensure that they have access to good health and safety advice. It will be their duty to consult employees about the risks at work and the adequacy of current preventive and protective measures. Nonetheless, governments would primarily dictate the best approach to comply with health and safety obligations which will have to be followed by the tenants and their employees.
  
  
• Risk Mitigating factors 
  
  
  • Insurance: It may be unlikely that most tenants would have business interruption insurances that may cover this kind of scenario i.e. the impact of an epidemic, is although available in the insurance market, but not commonly bought. Government of India has termed coronavirus a “notified disaster” therefore fulfilling the formal requirements of many insurance policies. The businesses which had insured themselves under this interruption cover can now claim under it.
    
    
  • Government Relief Policies: It would be prudent for the landlords and tenants to determine whether they are eligible for loans, grants or any other benefits which are available to both large and small businesses for working capital, rent and mortgage payments and other qualified purposes under the central or state laws.

II. RIGHTS AND DUTIES OF A TENANT 

• Withholding of rent: Most leases don’t allow the tenant to withhold rent regardless of the circumstances. In such situations, it would be prudent to communicate the concern with the lessor/landlord before such a decision is taken, in order to avoid future disputes.
  
  
  • Further, the issue of whether or not rent is payable by the lessee due to a force majeure can be found in Section 108(e) of the Transfer of Property Act. In considering the scope of the applicability of the Transfer of Property Act, the Supreme Court in Raja Dhruv Dev Chand v. Raja Harmohinder Singh held that, “Where the property leased is not destroyed or substantially and permanently unfit, the lessee cannot avoid the lease because he does not or is unable to use the land for purposes for which it is let to him.”  
    
    
  • There are currently no Act or ordinance in India preventing eviction a business tenant due to non-payment of rent.
    
    
• Tenant’s short to medium term Business Plan: It is necessary to ascertain whether the tenant intends to close in the short-term or continue to operate and if at all then at what capacity. Tenants will need to discuss with landlords their plans, however uncertain, to stay in business, capabilities to operate remotely, wind down certain parts of their business or resume operations as governmental closure orders and restrictions begin to lift and business improves over time. Landlords will need to evaluate tenants’ plans and ability to continue to operate and resume paying rent in the near and long-term.

III. RIGHTS AND DUTIES OF A LANDLORD

• Landlord duties and ability to recover costs of enhanced cleaning and regulatory compliance: Commercial landlords are responsible for common area maintenance and therefore have to provide more frequent and thorough cleansing of those common area, particularly frequently touched surfaces (e.g. door handles, elevator buttons and toilets), although, there is no legal obligation on them, yet, to provide such services for preventing the spread of Covid-19. But in any case providing these extra cleaning services will have cost implications, and commercial landlords should check the relevant service-charge provisions in their leases to ensure such costs are recoverable.
  
  
• Landlord’s Ability to Recover Leased Space: Commercial landlords will also need to assess their own ability to find a suitable tenant for replacement, if the negotiations fail or if the landlord opts to repossess the leased premises. Re-letting the commercial property may be difficult in the short-term. It is also to be considered how quickly a landlord can be able to evict a defaulting tenant if the tenant does not voluntarily vacate the premises. 
  
  
  • Many courts are already closed or have limited operations. Likewise, many states have also issued moratoriums prohibiting residential and commercial evictions and foreclosures. Consequently, in the short-term it may be impossible for many commercial landlords to start evictions or obtain writs to repossess space.
    
    
• Seeking certain information relating to the tenant’s financial condition like: 
  
  
  • Recent profit and loss statements; 
  • Financial statements and tax returns; 
  • Credit status of the business with its lenders and suppliers, 
  • Vendors and customers etc.

IV. REVIEW BY LEGAL COUNSELS

• It would be convenient for the affected party or a business to use their legal counsels who can carefully review the contracts for:
  
  
  • The relevant force majeure provision;
  • Any notice provisions that may be needed to be provided to the opposite parties under the contract; 
  • Any terms governing cancellation, repudiation, or breach of the contract; 
  • Any requirements that a party should submit evidence or information along with a notice of reliance on the force majeure clause, etc.
    
    
• In addition to the above, the legal counsel can also help with clearly ascertaining and advising its clients whether the non-payment of rentals, non-performance of obligations is primarily caused  due to the spread of virus itself or is due to the resulting government action to limit impact and contain the spread of the virus (government action meaning: lockdowns, limitations and curb on transportation, quarantines, closures of establishments and premises etc.) or it was a case of continuing breaches and defaults on the part of the other party which only conveniently got labelled as ‘non-performance due to force majeure event’ which need to be examined and replied on the basis of facts and circumstances in reach case. A through and holistic legal examination of each case is therefore imperative before any written correspondences are exchanged between the Parties.

V. ACTIONABLE MEASURES 

• For businesses at risk from Covid-19, the following steps could be beneficial:
  • Be up to date with latest Indian government’s guidelines and notifications;
  • Reviewing any obligations in leases, construction contracts and other real estate contracts;
  • Insert epidemic wording into any new real estate contracts;
  • Prepare IT systems for potential additional remote-access usage and capacity enhancement.
    
    
• For businesses entering into new contracts:
  • Thoroughly reviewing obligations in the lease, construction and other real estate contracts
  • Inserting a clause w.r.t an epidemic outbreak in new contracts
  • Tenants in the retail segments should check their leases to ascertain their responsibilities and liabilities in case they cannot operate their businesses from the premises.
  • Taking business interruption insurance to cover the loss of income.

If you have questions related to your lease work outs or any other leasing matters, please contact us on info@upscalelegal.com