Dealing with Defaults: Commercial Lease Issues in and out of Bankruptcy

By: Jeffrey Lynne April 28, 2020 6:41 am

Time to read: 5 Minutes

The first of the month – rent is due…right? The Coronavirus has prompted some of the largest tenants, including Nordstrom and Barnes & Noble, to request rent relief or simply announce they were not going to pay rent. The Coronavirus has prompted many landlords and tenants to review their leases for options. Considerations include among other things: rent concessions, force majeure clauses, and outcomes in bankruptcy.

Rent Concessions and Out-of-Court Workouts

Whether by necessity (due to limited Court activity or eviction moratoriums) or a desire to collaborate on a solution, landlords and tenants are engaging in discussions outside of court to address rent payments due during a reduction in operations during the Coronavirus. According to media reports some tenants are requesting rent relief through the summer and others through the year. Below are some of the potential issues that would be discussed as part of an addendum, revised lease, or forbearance document:

• Rent Relief – are rent payments forgiven (entirely or in-part)? Or will they be pushed to a later date to be paid as a balloon or spread out over several months? Do any of these provisions require the landlord’s lender to consent under applicable loan documents?
• Reduction in Leased Space – remote work and economic realities of the business may make it more prudent to reduce the footprint of the leased space to allow for rents which can be afforded going forward.
• Personal Guaranty – some landlords may desire enhance their position by requesting that a business owner who did not previously provide a personal guaranty provide one in exchange for rent deferral. Is the guaranty for the entire debt or only the portion deferred? Does the guaranty lapse?
• Collateral – are the payment obligations secured in any manner?

Force Majeure and Other Defenses to Performance

Many leases include standard provisions that generally do not become an issue in litigation under normal circumstances. Force majeure clauses are one of those that clauses. Generally, the clause identifies specific events which excuse performance, such as acts of God, war, or labor disputes to name a few. Whether the coronavirus, pandemics generally, or the related government orders leading to closures or operation limitations trigger force majeure provisions is a subject of discussion and litigation. Under Florida law, determining whether performance is excused for force majeure depends on:

• The Specific language in the lease.
• Whether the event was unforeseeable.
• Whether the event was outside of the party’s control.
  Other common law defenses of impracticability, impossibility, and frustration of purpose will likely be raised and litigated to determine whether rent payments are required

Bankruptcy: Lease Issues and Recent Court Decisions

When a business files for Ch. 11 it generally receives breathing room from its past due debts through the automatic stay which pauses most collection activities. In a Ch. 11 case, businesses have the option to assume or reject leases as part of their reorganization efforts. Typically, the continuation of operations depends upon maintaining some physical presence and lease negotiations begin promptly to determine whether the lease will be assumed. One of the key provisions of the Bankruptcy Code, Section 365(d) requires, absent Court Order, the debtor in bankruptcy to timely pay rent rent and perform other obligations until the lease is assumed or rejected.

Recently, tenants in bankruptcy, including Modell’s Sporting Goods and Pier 1, have received Court Orders that allow them to defer rent payments during the closures. Recently, the Hair Cuttery’s parent company filed bankruptcy to request similar relief. Generally, bankruptcy courts are scheduling status conferences to evaluate the level of closures in the future given the revision of government orders on the issue. In Pier 1, the bankruptcy extended the period deferred rent through May at a recent hearing over substantial landlord opposition with continued monitoring to occur. In order to assume these leases and continue as a going concern the past due will have to be paid. These disputes are likely to playout across the country and will undoubtedly be watched by landlords and tenants alike as they evaluate options.

Final Thoughts

Crisis or not, it is a good idea to review lease documents from time to time. In many cases, certain lease provisions have not been revised years from tenant to tenant or lease to renewal. Fresh eyes and new experiences can guide landlords and tenants in future lease negotiations and lead to provisions that better understand the relationship.

Dialogue between landlords and tenants during this time will prove vital to both parties’ continued operations, litigation prospects, and whether bankruptcy is necessary.