This is the sixth and final post in a series of blog posts on the topic of commercial leasing during these uncertain times. Throughout the summer this series has explored a number of commercial leasing related questions raised by both commercial landlords and commercial tenants.
Even before 2020, the world of commercial real estate was dominated by highly unique leasing arrangements, with no two lease agreements or arrangements looking identical. This year has only added to the individualized nature of commercial leasing arrangements and the need for both landlords and tenants to pay close attention to the terms of their existing and future lease agreements, to provide flexibility, long-term stability, and safety for their clients, employees and customers.
In previous posts, we addressed negotiations surrounding rent deferral and rent abatement as well as negotiations surrounding improvements to leased premises. Due to the increased need for additional safety precautions in all indoor spaces and concerns about the possible long-term financial impact of the pandemic, these have been two of the most frequently examined lease topics during the last six months. In this final post, we aim to identify other lease terms that landlords and tenants should examine closely as they review their existing leases, consider renewing an existing lease, or consider entering into a brand-new lease.
Lease Terms to Consider
- Force Majeure Clause: In light of COVID-19 and civil unrest, landlords and tenants are looking to the force majeure clauses of their leases to determine whether either party has a basis for non-performance. Force majeure clauses allow for delays in performance for various events outside of the parties’ control and may excuse performance for events such as riots, strikes, forces of nature and governmental actions or inaction. Nonperformance based on a pandemic may or may not be covered under the force majeure clause in a lease depending on the precise wording of such clause. Often, a force majeure clause will explicitly require the payment of rent during any period of force majeure but the explicit language of the force majeure clause should be reviewed carefully to confirm whether this is the case. Force majeure clauses are strictly and narrowly construed by the courts and will likely be given much greater scrutiny and be subject to more negotiation as landlords and tenants are navigating the uncertainties in our changing environment.
- Early Termination Provision: As we have discussed in this series previously, most businesses across the country and across the world have had to adjust occupancy limits in their places of business and/or have had to close their doors completely in order to deal with a rising number of COVID-19 cases in their areas. While in some places, the number of positive COVID-19 cases seems to be trending down, most states around the country expect positive cases to ebb and flow until there is a vaccine widely available. Accordingly, businesses may be forced to remain flexible, and to scale their operations back at times as a response to the pandemic. In order to remain financially stable, tenants in particular, may want to negotiate an early termination option in any new or renewed leases. This may come with a monetary fee but will likely leave a tenant in a better financial position long-term than they would have been had they been forced to remain in their leased space for the duration of their current lease term.
- Term of the Lease: Both landlords and tenants have suffered hardships in light of the pandemic and civil unrest in their communities. These hardships have resulted in some businesses closing their doors and not reopening. When negotiating a new lease or the renewal of an existing lease, tenants and landlords have had to weigh the costs and benefits in agreeing on the length of the initial term of the lease and any renewal terms. While the negotiation of a long-term lease may result in better rent terms for the tenant, many tenants moving forward will want to weigh the cost savings of reduced rent against the possible costs in the event the tenant is unable to fulfill its obligations under the lease due to the pandemic or civil unrest. These costs can be especially detrimental in situations where the tenant has personally guaranteed the terms of the lease, which is often the case with new businesses that do not yet have strong financials.
- Assignment and Subleasing Provision: Similarly, to consider the term of the lease, landlords and tenants may want to build flexible assignment and subleasing provisions into any leases. If the pandemic lasts as long as epidemiologists are anticipating, landlords may find themselves in a position where selling their commercial properties makes financial sense, and tenants may find themselves in a position where they do not need as much office or warehouse space and it may make sense to decrease costs by bringing in a subtenant or assigning the lease altogether.
- Casualty/Insurance Provisions: As a result of civil unrest some landlords and tenants have had situations where the leased premises have been damaged or destroyed. In these cases, both landlords and tenants have had to look to their lease provisions to determine both their responsibilities in connection with any rebuilding of the premises and the applicable insurance provisions of the Lease to determine what costs are covered and whether it is economically feasible to rebuild. Even in situations where buildings have not yet been damaged and losses have not yet been sustained as a result of COVID-19 and civil unrest, many landlords and tenants are evaluating the insurance provisions of their leases and their current policy coverages to make sure they are going to be adequately covered as we move into the future.
- Business Interruption Insurance: With many businesses having to close for indefinite periods of time due to government action or due to civil unrest, many tenants are carefully reviewing insurance policies for coverage. While business interruption insurance typically only covers interruption due to physical loss, there are differing definitions in insurance policies as to what constitutes a physical loss. In addition, while some policies may specially carve-out business interruption insurance for pandemics, some do not, and some policies may have endorsements specifically covering pandemics. Accordingly, it is important that such policies be reviewed and analyzed carefully to ensure that any claims for coverage are promptly submitted.
As we have discussed throughout this series, many landlords and tenants are reevaluating not only how they do business in uncertain times, but how they structure their leases in order to ensure that their properties and their businesses can remain economically feasible in the future.
Do you have further questions about commercial lease negotiations? Brandi Kerber, Victoria Dutcher, and members of Larkin Hoffman’s real estate team are available to answer your questions. You can reach Brandi at 951-896-1543 or bkerber@larkinhoffman.com and you can reach Victoria at 952-896-3305 or vdutcher@larkinhoffman.com.