COVID-19’s impact on the commercial leasing industry is now emerging, as some tenants request rent relief and landlords voice concerns over whether tenants will be paying rent in the coming months. How should landlords and tenants confront the challenges posed by this new reality? The following are some of the more salient issues currently facing landlords and tenants.
Moving forward on leases in the pipeline
Many leases and offers to lease are currently at various stages of negotiation. Landlords and tenants are now turning their mind to the status of and timelines in their leases, including:
- Construction schedules: There are concerns that construction activities may be delayed or otherwise impacted by the recent shutdown or disruptions to supply chains.
- Possession dates/fixturing periods/rent commencement dates: With possible delays in construction come concerns that landlords may be unable to deliver possession of premises to tenants by estimated possession dates. Similarly, tenants are concerned that they may be unable to commence construction of their leasehold improvements during their fixturing periods and prior to commencement of the term.
- Co-tenancies: Landlords and tenants may have negotiated co-tenancy clauses that are tied to tenants that may have already closed or will close in light of the government mandated shutdown.
- Force majeure: Force majeure clauses are likely being negotiated more than ever as tenants will likely be asking for specific language in their leases that contemplates a forced shutdown, pandemic and other similar circumstances as force majeure events.
- Compliance with laws: The mandated shutdown of non-essential businesses in Ontario has forced many tenants to cease operations from their premises.
The Ontario government has currently exempted a large segment of the construction industry and those companies that provide support, supplies, systems or services to this sector from the mandated shutdown. As a result, it is unclear whether landlords or tenants will experience any significant slowdown in construction activities as a result of COVID-19 or the government-mandated shutdown.
Thus far, we have continued to see significant efforts by landlords and tenants to continue to move lease transactions forward in anticipation of a return to business as usual in the near future. Nevertheless, ongoing lease negotiations are requiring due attention to the novel challenges presented by COVID-19.
Uncertainty around existing lease obligations
COVID-19 has also presented significant challenges in connection with existing lease obligations. Many tenants will likely be unsure about how COVID-19 or the government-mandated shutdown impacts their lease obligations. The more common questions arising from tenants are:
- Do I need to stay open for business given the circumstances?
- Do I need to pay rent when due if I am open for business?
- Do I need to pay rent if I close for business?
- Can I rely on the force majeure clause in my lease to withhold rent?
- If I close for business due to COVID-19, can I collect insurance proceeds to cover my losses?
Landlords are asking equally important questions, such as:
- What can I do if a tenant closes for business and has no grounds for doing so?
- A tenant has written a letter saying it plans on closing down and does not plan on paying rent for April. What can I do?
- Are there proactive steps that landlords can or should take to prevent a default by a tenant it anticipates will not pay rent in the coming months?
- If my tenant fails to pay rent, should I apply the tenant’s security deposit on account of the rent owing?
The starting point for answering most of these questions is to review the terms of the lease. For example, most leases will contain an operating covenant requiring tenants to remain open for business at all times. However, many leases will also contain a force majeure clause that would likely allow a tenant to cease operations in the event of a government-mandated shutdown or global pandemic. On the other hand, a force majeure clause may not allow a tenant to cease paying rent during a force majeure event.
In terms of insurance coverage, the coverage that would most likely be triggered in the present circumstances would be business interruption insurance. However, availability of business interruption insurance depends upon the stated exclusions in each policy and we are finding that a virus is a stated exclusion in many business interruption policies, and thus may not provide coverage for losses caused by COVID-19 (but may provide coverage for government-mandated shutdowns). One should carefully review the policy to see if any relief exists.
Keeping lines of communication open between landlords and tenants will be pivotal to moving forward with a successful recovery. Tenants should communicate challenges to landlords early in the process and not simply ignore their lease obligations. Similarly, landlords will have to remain open to discussing strategies to help tenants successfully overcome the challenges presented by these unprecedented times.
Kenneth Pimentel is an associate practicing with Aird & Berlis LLP’s real estate group.