Covid-19: Impact on the obligations of commercial landlords and tenants.
By Evin McCarthy and Catriona Harte
25 March 2020
This briefing will examine, at a high level, some implications of the Covid-19 (coronavirus) pandemic upon the obligations of both commercial landlords and tenants in Ireland. We also comment on how best to document commercial agreements between parties to overcome short term cash-flow difficulties, avoiding unintended consequences.
Q. Can the Covid 19 Pandemic permit parties to suspend lease obligations/reduce or cease payment of rent/terminate leases?
Force Majeure clauses:
A force majeure clause excuses one party from fulfilling its contractual obligations under a contract following the occurrence of a certain specified event. Such an event is one beyond the reasonable control of that party and which has hindered or made impossible the performance of its obligations.
It would be very unusual to have a force majeure clause in a commercial lease, certainly in respect of the key obligations such as a payment of rent. That said, certain obligations may have carve-outs that are phrased in force majeure language. An example would be for landlord obligations to provide services. Leases will typically include clauses confirming that landlords are not liable for failure to provide services due to matters outside their reasonable control or procurement.
Parties should also consider whether the common law doctrine of frustration may apply in the particular circumstances. Frustration occurs where a supervening and unforeseeable event, outside the control of the parties, prevents a party performing its obligations under a contract.
In our view it is highly unlikely that the doctrine of frustration will permit parties to terminate a commercial lease. The test for frustration is extremely high and perhaps illustrative here the recent, much publicized decision in Canary Wharf Limited v EMA case, in which the UK High Court ruled that the tenant, a decentralised agency of the European Union, had not shown that its obligations under the commercial lease had been frustrated by Brexit. This case demonstrated that the frustration of performance must be permanent. It is hard to imagine that the Irish courts would find the coronavirus outbreak to constitute frustration in any but the most extenuating of circumstances e.g. if the entire period of a lease overlapped with the period of the coronavirus outbreak.
Q. What is the best approach to document short-term rent suspensions/abatements? What are the pitfalls?
Where landlords have agreed to support cash-starved tenants by means of rent suspensions/abatements, or other similar arrangements, it is critical that these are properly documented to avoid unintended consequences. Many such agreements, made in difficult trading environments in the financial crash, caused considerable collateral issues for the parties to the agreements and frequently resulted in litigation.
Some considerations for Rent Suspension/Rent Abatements:
- Impact on finance arrangements, the investment value of the property (and potential breach of LTV financial covenants).
Any such arrangements will need to have the consent of the landlord’s lender to avoid a landlord falling foul of property covenants and undertakings in the landlord’s finance agreements. This will also be important from the tenant’s perspective in that it is settled law that lenders are not bound by such arrangements where they did not specifically consent to them.
Furthermore, there were countless examples of well-intended but poorly-drafted rent suspensions/abatements agreements entered into at the time of the financial crisis. Those agreements, where ambiguous (e.g. not limited by time) and poorly drafted can have a material impact on the investment value of a property and therefore affect LTV covenants.
The parties may need to be creative and work collaboratively with the landlord’s lender in order to address potential value issues. For example, a tenant may consider waiving a future tenant break option in return for rent concessions. This may offset impact on the investment valuation, but professional valuation advices should be obtained to confirm this.
- Avoiding ambiguity in the rights and obligations of the respective parties.
A well-drafted rent suspension/abatement agreement is needed to provide certainty to the understanding of the agreement between the parties. There needs to be full consideration of the fundamental change in the nature of the covenant between the parties, for example:
Whether the rent is waived or merely deferred.
Whether the reduced/waived rent becomes immediately payable on breach of other tenant covenants.
The period that the suspension/abatement lasts. Is it automatically terminated or does it need to be terminated by the landlord giving notice?
Whether the term is extended by a period equivalent to the suspension/abatement.
Whether a call can be made on any tenant deposit to address rent shortfall (potentially without requirement to replenish until a future date).
What is the impact of the suspension/abatement on a future rent review? Is it to be discounted?
- Impact on guarantees.
It is a settled principle of Irish Law that the alteration in the terms of a principal contract that is unfavourable to the interest of a guarantor, without the consent of the guarantor, will discharge the guarantor of its obligations.
A reduction in rent simpliciter is unlikely to discharge a guarantor of its obligations under a lease. However, it may be that the consideration given (extension of lease term, waiver of tenant break etc.) would give rise to such a discharge. That being the case, it is best practice to have any guarantor join in a rent suspension/abatement agreement.
The key takeaways from this briefing should be that early engagement between landlords and tenants is key. Proactively negotiating these issues from the outset will be a far better strategy than trying to anticipate the courts response to a relatively unprecedented situation. Clearly, a balance will need to be struck between the competing rights of landlords and tenants but this will largely be done on a case-by-case basis, in accordance with the specific wording of each lease. Long-term thinking should apply and unilateral decisions without consultation should be avoided.
For more information on the content of this insight please contact:
Evin McCarthy, Partner | E. firstname.lastname@example.org | T. +353 1 6054204
Simon Lynch, Partner | E. email@example.com | T. +353 1 6054261
Margaret Ring, Partner | E. firstname.lastname@example.org | T. 353 21 4802743