COVID-19 has devastated lives and livelihoods, severely impacting economic relationships throughout society. Commercial tenancies are one such severely impacted area.
In order to protect public health, many businesses have closed their doors. Employees have lost their workplaces, often their jobs, and many people have been deprived of their valued public spaces. The widespread and ongoing shutdown has also put property owners in a tough spot — significantly reducing income but not reducing obligations to pay lenders, taxes, utilities and other costs.
Precise numbers are hard to come by, but reasonable industry estimates indicate a more than 8-percent decrease in rental payment rates across retail tenants nationally, with smaller tenants performing considerably worse than larger chains. A recent industry report estimates that 85 percent of independent restaurants will close as the result of COVID-19 (absent government assistance).1 Closer to home, the amount of space available for sublease in downtown Portland jumped by 36 percent as tenants have attempted to vacate office and retail space.2
The impact of COVID-19 extends well beyond landlords and tenants. Commercial tenancies support most aspects of our cultural life and social existence — from music venues and art studios to restaurants and bars, leased commercial property provides the spaces in which we gather. They also support our essential needs and labor force — from medical provider offices, childcare centers and grocery stores to warehouse and supply chain distribution centers and beyond.
While some tenants were starting to recover before the latest “freeze” in social activities took effect in late November, continuing public health restrictions will have long-term — and in some instances, permanent — effects. And many tenants have survived this long only by delaying payment of rent and other debts that remain due.
Landlords are facing their own challenges, falling behind on loan payments and seeing demand for their property change in ways that were unforeseeable at the start of 2020 — all of which are being exacerbated by new restrictions. This leaves a number of difficult decisions for both sides to the lease: renew or terminate, pay or withhold, remain or vacate.
None are easy choices, and each comes with a host of additional issues.
The Current Landscape
Virtually all commercial leases require the payment of rent (sometimes a fixed amount, sometimes a percentage of sales, and sometimes both), and many require the payment of some share of taxes and other common expenses. But since mid-March 2020, significant numbers of commercial tenants have missed one or more rent payments. In addition, vacancy rates are up, as are tenant inducements like tenant improvement allowances and free-rent periods.
On April 1, 2020, Gov. Kate Brown issued Executive Order 20-13 (EO 20-13), which provided a temporary moratorium on residential and commercial evictions for nonpayment of rent caused by the pandemic.3 The Legislature replaced EO 20-13 with House Bill 4213, which allowed tenants to defer paying rent accruing through Sept. 30, 2020, and granted a grace period for the repayment of back rent until March 31, 2021.4
Brown has since extended the protected non-payment period for residential (but not commercial) tenancies until Dec. 31, 2020.5 The Legislature enacted similar relief from loan payments for property owners under HB 4204 (as extended by EO 20-37).6 We have seen firsthand that Oregon landlords and tenants are reacting rationally, often working together to maintain their relationships and survive the current crisis. Many landlords voluntarily deferred or abated rent in the early days of the pandemic, and numerous tenants continued paying all or some of the rent due. Even when availing themselves of the available rent deferrals, some tenants have worked with landlords to develop payment plans that fit the needs (if not necessarily the desires) of both parties.
Complicating Factors
Additionally, the impact of the pandemic is not limited to rent deferrals, particularly for large, multi-tenant properties. Landlords must navigate complex lease provisions, with little control over the events that affect them.
For example, large retail tenants often require a co-tenancy clause in their leases, obligating the landlord to lease to certain other tenants or types of tenants in order to maximize the desired foot traffic at a certain location. Similarly, a multi-tenant retail lease may contain a continuous operations clause, requiring other tenants to remain open.
The remedy for violations of these types of lease provisions is often significantly reduced rent for an extended period, or even lease termination. If a required co-tenant goes out of business or is forced to close because of a shutdown order (think movie theaters, indoor dining or buffets), the reduced rent provision could kick in.
In addition, the landlord’s lender will generally have approval rights for rent concessions and other lease amendments that may restrict a landlord’s ability to grant specific tenant requests for assistance.
Anticipating the Unknown
Because of rapidly changing governmental action and legislation, planning for the future can feel daunting, and forward-looking contractual provisions can be tricky.7
Landlords understandably wish to limit rent concessions to those tenants in genuine need, both to preserve the landlord’s ability to meet its own financial obligations and to ensure that limited resources are not going to tenants whose businesses have remained stable. Accordingly, many landlords require copies of a tenant’s financial statements prior to granting rent relief.
Such financial statements can also help a landlord identify tenants likely to fail even with significant assistance, and plan appropriately. Tenants, understandably, may be reluctant to provide this information if not required to do so under the lease.
Landlords often also request that tenants pursue all other relief options, including business interruption insurance and CARES Act benefits8 — and some have helped tenants apply for those protections. Addressing presently available government assistance during lease negotiations is fairly straightforward; more difficult, though, is addressing the impact that future government action might have on a commercial tenancy. Landlords have tried to account for this uncertainty by trading rent concessions for a promise to pass through any future rent assistance and/or waiver of the benefit of future eviction moratoriums and the like. The enforceability of this type of contract provision has yet to be tested in the Oregon courts.
Anticipating the Known
Despite best efforts and intentions, the reality is that we remain in a precarious situation. Tenants will undoubtedly seek bankruptcy protection, bringing a new set of considerations into play. Under Section 365 of the Bankruptcy Code, which covers commercial leases, tenants have two basic options: assumption or rejection.9 Any commercial lease not affirmatively assumed or rejected within the time allowed will be automatically deemed rejected.10
If the tenant assumes the lease under Section 365(b), then it must cure the default or provide adequate assurance of prompt cure; compensate the landlord for any actual pecuniary loss resulting from the default or provide adequate assurance of prompt compensation; and provide adequate assurance of future performance under the lease. However, if the landlord has deferred or abated rent before the tenant files for bankruptcy protection, then the tenant is not in default for nonpayment of such rent, and the unpaid deferred (or abated) rent is not recoverable if the tenant assumes the lease.11
This means that if the landlord has deferred or abated rent, then the tenant need not pay the deferred rent as a prerequisite to continuing under the lease. Accordingly, where bankruptcy is likely, a landlord may be better off declaring a default and allowing the unpaid rent to accrue than it would be working out a payment plan.12 Because HB 4213 treats the unpaid debt as statutorily deferred, it is an open issue as to whether such statutorily deferred rent needs to be repaid upon assumption, even though the landlord did not voluntarily defer the unpaid rent.
One recent case that deserves consideration is In re Hitz Restaurant Group, No. BR 20 B 05012, 2020 WL 2924523 (Bankr. N.D. Ill. June 3, 2020). There, the bankruptcy court reduced the tenant’s rent obligation based on the force majeure provisions in the lease. While the decision turned in part on the specific language of the lease and the landlord’s conduct, it does highlight the difficulty in enforcing lease terms during these trying times. Other cases have addressed extraordinary rent relief claims because of COVID-19 and government shutdown orders.13
If the landlord is the party that declares bankruptcy, it generally has the same right to assume or reject an unexpired commercial lease; however, the tenant has heightened protection under the Bankruptcy Code. Essentially, Section 365(h) provides the tenant with two options: either treat the lease as terminated, or retain possession and use of the property (including any applicable renewals or extensions). If the tenant chooses the latter, the lease terms must remain the same. However, the landlord will no longer be obligated to provide any services required under the lease. Instead, the tenant may offset any damage resulting from such nonperformance against rent that comes due.
Collaboration is Key
More than any other event since the Great Recession, the COVID-19 pandemic has highlighted how all our fates are intertwined. The resiliency and survival of Oregon’s vibrant business community depends on continued flexibility, creativity and collaboration among landlords, tenants and government.
This legal update is originally from the Oregon State Bar Bulletin.
1 See tinyurl.com/RestaurantClosures.
2 See tinyurl.com/TollOnPortland.
3 Under Chief Justice Order 20-06, issued by Chief Justice Martha L. Walters, eviction proceedings (Forcible Entry and Detainer or “FED”) were effectively suspended during the emergency period and, in any event, local circuit courts were not allowing FED actions to proceed. This was extended by subsequent orders. While FED actions are now moving forward, they are limited to nonpayment defaults and payment defaults that occurred after Sept. 30, 2020.
4 HB 4213 Section 5(7) allows the landlord to offer an alternative payment plan for payment of the nonpayment balance (rent, late charges, utility charges and service fees). However, the default is that the tenant need only pay the unpaid balance by March 31 in the absence of an alternative arrangement. HB 4213 Section 5(4). The landlord cannot take any action to terminate the lease for nonpayment of rent during the emergency period (April 1-Sept. 30). HB 4213 Section 5(2).
6 However, property owners have not been relieved of their obligation to timely pay property taxes, nor have they been given relief from paying utility bills as they have come due. Further, even though tenants may not be paying rent, landlords are still required to fulfill their maintenance obligations and care for common areas, or face potential defaults themselves under their leases.
7 Gov. Kate Brown issued Executive Order 20-65 on Nov. 17, limiting restaurants to takeout only and reducing the capacity of DECEMBER 2020 • OREGON STATE BAR BULLETIN 33 retail and grocery stores. This has put the future of many restaurants, bars and local retailers in further limbo, just as there might be hope going into the traditionally high volume shopping season.
8 Under the CARES Act Paycheck Protection Program, tenants may use PPP funds to cover rent payments due under leases in effect before Feb. 15, 2020.
9 The tenant’s decision is ultimately subject to bankruptcy court approval, after notice and hearing, via application of the typical “business judgment” standard. See In re Pomona Valley Med. Grp., Inc., 476 F.3d 665, 670 (9th Cir. 2007).
10 Under Section 365(d)(4), the tenant has until the earlier of plan confirmation or 120 days from the petition date to affirmatively assume or reject its commercial leases, subject to one 90-day extension upon a showing of good cause. In Chapter 7, the applicable period is 60 days, but that may also be extended for cause. 11 U.S.C. § 365(d)(1). Any additional extensions require the consent of the counterparty to the lease.
11 Deferred rent is typically due on a future date or in accordance with future payment terms, while abated rent typically need not ever be repaid. However, in some instances, abated rent is merely deferred indefinitely but may become due upon the event of a future default. It is an open question as to how the bankruptcy court would treat abated rent that became due as result of the bankruptcy filing. (Often, a tenant’s bankruptcy filing is an event of default under the lease.)
12 Unpaid deferred rent will likely be treated as unsecured debt in the bankruptcy estate, rather than a rent default that needs to be cured under Section 365(b) as a prerequisite to assumption. However, the court may treat deferred pre-petition rent as a post-petition administrative priority claim, though there is a split of authority as to how a deferred rent claim meshes with other provisions of sections of the Bankruptcy Code. This will need to be considered when advising a landlord as to whether to defer rent and how.
13 See In re Modell’s Sporting Goods, Inc., Case No. 20-14179 (Bankr. D.N.J., Mar. 23, 2020) and In re Pier 1 Imports, 615 B.R. 196 (ED Vir.).