Impact of the COVID-19 crisis on commercial leases: important clauses for parties to consider
As the world undergoes this unprecedented crisis, the ability of many companies to meet their contractual obligations is being compromised. The crisis is having a significant impact on the global economy and the real estate sector won’t be spared. Moreover, the impact of the crisis on tenants and landlords is likely to linger and worsen with the passage of time.
While every lease contract is unique, and its interpretation depends on the clauses it contains, the COVID-19 crisis will certainly require landlords and tenants to be creative and flexible in order to ensure business continuity. Therefore, it is important for all parties to review the terms of their commercial leases and implement the best strategy to get through this crisis, while respecting the rights and obligations arising from these contractual agreements.
In this respect, it is crucial for parties to quickly establish a dialogue regarding their respective obligations during and after the crisis. The goal is to prevent adverse outcomes, such as a cascade of retail business closures and a surge in vacancy rates in retail centres and commercial buildings.
Here are some important clauses to consider when analyzing a lease in times of crisis:
1. The force majeure clause
Commercial leases generally include a force majeure clause. This clause often contains a list of events that may or may not constitute force majeure, as well as the consequences of such events on the rights and obligations of the parties. Before invoking this clause, it is imperative to review it closely, as it may vary from one lease to another.
For the crisis arising from COVID-19 to constitute force majeure, the party invoking it must demonstrate that it was unable to avoid the consequences, even by acting with prudence and diligence. It is not always possible to meet this test. It is also important to note that force majeure clauses do not necessarily release tenants from all their obligations, such as paying rent.
Only an analysis of the particular circumstances of each case will make it possible to determine the impact of this clause.
2. Operating costs clause
If the force majeure clause expressly requires the payment of rent, or if COVID-19 does not qualify as force majeure, the parties to a lease could potentially turn to the operating cost clause to determine their rights and obligations, and adjust rent payments, where applicable.
This clause usually stipulates that tenants must pay additional rent, over and above the base rent, to cover the cost of building maintenance, operation and repairs. Generally speaking, the amount payable is based on the landlord’s actual expenses, plus administration fees, and it is usually divided up according to the area occupied by each tenant of the building. This clause may be used to ease the financial pressure on tenants in the context of the pandemic without impacting landlords’ obligations to their creditors. Within limits set out in the clause, a landlord may decide to postpone work that was initially planned or minimize other expenses chargeable to tenants, in light of the slowdown in activities. Government measures permitting the deferral of tax, mortgage and electricity payments may also influence the amount of additional rent payable during the pandemic.
At the end of the landlord’s fiscal year, any invoicing for rent adjustments provided for in the lease must be detailed and precise, particularly for the months of the pandemic.
3. Continuous operation clause
In addition to the payment of rent, a key obligation in many commercial leases is the continuous operation clause. Often found in retail centre leases, this clause generally stipulates that the tenant must operate the premises on a continuous basis, according to the schedule established by the landlord. Failure to do so could result in termination, damages or injunctive relief.
Tenants must comply with the applicable legislative framework, including government directives to close all businesses deemed “non-essential“. This situation is bound to have an impact on the implementation of continuous operation clauses.
For businesses with limited cash flow, the impact of this clause will be felt when the government gives non-essential business the green light. If, after the crisis, a tenant is financially unable to operate its business on a full and continuous basis as required by the landlord, this could constitute a violation of the lease.
4. Property tax clause
The importance of this clause is often underestimated, especially from a financial point of view. It is clear that the current crisis will have an impact on property values. However, it will take some time before we know the extent of the impact of COVID-19 on the real estate market in the province.
It will be important for both owners and tenants to check the property tax clause and consider the possibility of requesting a review of the value placed on the municipal assessment roll for the property — and potentially disputing it.
5. Default and termination clause
A default clause generally lists the events of default provided for in the lease as well as the steps to be taken in order to have the lease terminated.
Once again, the content of this clause may vary from one lease to another. Before taking legal action, parties must carefully analyze this clause to ensure compliance with their obligations under the lease.
In addition, some leases may contain a right of termination clause that allows a lease to be terminated automatically, without the need for legal action. In the absence of such a provision, the party wishing to terminate a lease must pursue the appropriate legal remedy after having applied the default mechanism provided for in the lease.
6. Insurance clause and related insurance policy
Many commercial leases contain clauses requiring the tenant to buy business interruption insurance. It is important to review any insurance policy in place to determine what coverage it can provide, if any.