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By Ronald R. Rossi, Esq. and Gabriel Rodriguez, Esq.

April 20, 2020

It’s becoming increasingly clear that the COVID-19 pandemic is wreaking havoc on a great number of businesses and their employees, customers, vendors, and partners at local, national, and global levels. The spread of the virus and the resulting shelter-in-place orders and other restrictions imposed by local and state governments are affecting supply chains and disrupting the workforce, creating an unprecedented operating environment for businesses of all types.

This will not be the first time that external events have created troubled times demanding creative solutions. For example, in Ron’s 51 years of practicing real estate law, he experienced the early 1970s, when inflation running rampant and gasoline shortages caused market problems; the mid-1980s, when the prime interest rate climbed to 23% and home loans were at 19%; the stock market crash on Black Monday in 1987; the aftermath of the 9/11/2001 terrorist attacks; and the global financial crisis in 2008/2009. Today, it’s the COVID-19 global pandemic.

In this article, we’ll examine some of the legal issues our firm is encountering and working around due to the pandemic. A detailed legal brief will be provided to existing clients upon request. The issues facing a real estate law practice arise in two areas: leases and real property purchase contracts.

With respect to leases under our current circumstances, tenants are asking for rent abatement, rent reduction, and rent deferral. Various counties and cities, such as the County of Santa Clara, the County of San Francisco, and the City of Oakland, have enacted moratoriums on evictions in both residential and commercial situations, but many tenants are also claiming that they are entitled to rent relief based on the Doctrine of Impossibility of Performance and Commercial Frustration, among other legal theories.

One of the leading cases addressing these issues is Lloyd v. Murphy, decided by the California Supreme Court in 1944. The facts in that case were simple – a landlord leased property to a tenant in 1941 to sell cars. In 1942, the government restricted car sales because of World War II. Tenant/defendant repudiated the lease, and the landlord filed suit to determine whether the tenant’s obligations were terminated by the government’s restriction of car sales and, if not, whether the landlord could recover unpaid rent. The lease in question had a very use clause and restricted the tenant’s business operation to the sale of new automobiles, along with automobile repair and sale of petroleum products. The court went on to discuss the Doctrine of Commercial Frustration, which is akin to the Doctrine of Impossibility of Performance.

If either the Doctrine of Impossibility of Performance or the Doctrine of Commercial Frustration applies, the tenant would be discharged from the duty of paying rent. If there is a permanent impossibility or frustration of performance, the lease will end automatically. In Lloyd, the court noted that at the time the lease was executed, the National Defense Act had been executed by the President roughly one year before the parties entered into the lease. That Act authorized the President to allocate materials and mobilize industry for the purposes of national defense. The court held that these facts were commonly known, including the fact that the production of new automobiles would be curtailed due to the war effort, and, therefore, this consequence was foreseeable to the tenant. Therefore, the court held, this risk was assumed by the tenant.

On the other hand, there is case law that excuses performance when performance is prevented by operation of law. The Lloyd court stated that “the consequences of applying the Doctrine of Frustration to a leasehold involving less than total or near total destruction of the value of the lease premises would be undesirable.” Courts uniformly hold that a party (in this case a tenant) defending the failure to perform and repudiating the lease must prove first that the development was unforeseeable. (In this case, COVID-19 and the government’s response thereto demonstrate the lack of foreseeability of a statewide shelter-in-place order.) The Lloyd court further held that there must be no profitable use of the property possible due to the event (here, a pandemic) and the government’s response to that event. Courts will look to the provisions of the lease, however, to determine whether a tenant can either still profitably conduct a business on the premises or possibly sublet the premises to another tenant who can continue conducting business. In each case, all of these factors will be evaluated in order to determine impossibility or frustration of purpose.

Is there such a thing as temporary impossibility of performance? One case, out of New York, is very interesting in that regard. In Bush v. ProTravel International, Inc., a customer of a travel agent and tour guide claimed she could not physically cancel her contract in time because of the 9/11 catastrophe. The court found that at the time indicated, September 12-14, 2001, New York was in a state of a virtual lockdown, with travel essentially forbidden or restricted, and thus found that the customer’s inability to cancel the contract was excused because of unforeseeable government action that made her performance temporarily impossible. When a contract is temporarily impossible, the courts may order that performance is temporarily excused, but they will not find that it is permanently excused.

When can a tenant successfully claim impossibility of performance or commercial frustration? When can they suspend rent payments either permanently or temporarily based upon these legal theories? Since every situation will involve a different factual scenario, these questions can only be answered on a case-by-case basis.

On April 6, 2020, the leading publisher of commercial lease documents, AIR CRE, published an amendment to the lease entitled “Basic Rent Reduction / Deferral.” This amendment states that the landlord and tenant are negotiating rental deferral and/or rent reduction due to and because of the COVID-19 pandemic, and that is the only reason for the deferral or reduction. The amendment contains detailed provisions regarding what documents will be furnished, how long the deferral will last, and whether there will be total rent abatement or partial rent abatement.

This form contains some interesting recitals, however. Lessee must warrant to the Lessor that

  1. their business income has substantially declined due to the pandemic, including the effect of government-mandated closures,
  2. any financial statements or documents provided by Lessee to Lessor to substantiate the decline in Lessee’s business are true and correct, and
  3. such loss of business income is not covered by business interruption insurance (the form then provides a rent reduction option and a rent deferral option).

Many tenants at the local, state, and national level are requesting rent deferral and rent reduction, and many landlords are negotiating realistic solutions with their tenants in good faith. Smart businesspeople are attempting to work out these sorts of issues amongst themselves without having to resort to legal proceedings.

With regard to real estate purchase-and-sale transactions, we are seeing numerous cases involving contracts that the parties entered into prior to the statewide shelter-in-place order with close of escrow scheduled to occur after the shutdown took effect. Buyers have suffered job loss, salary reduction, and other displacement issues. Lenders have had problems getting appraisers out to appraise properties, and escrow companies have had to limit their services, as have most service providers. Delay in performance occurs as a result in some cases. RHRC partner Dave Hamerslough recently published an excellent article identifying and troubleshooting some of the issues now cropping up in residential real estate transactions due to the instability and anxieties caused by the spread of COVID-19. In a subsequent article, we will discuss the various forms recently created and published by the California Association of Realtors and other local realtor associations in an effort to address the many unexpected challenges presented by the pandemic.

Bottom line: all of these doctrines will require an analysis on a case-by-case basis. Whether you’re a tenant, landlord, buyer, seller, agent, or broker, this is one of those times when seeking advice from a qualified California real estate attorney before making any commitments is an especially prudent choice.