Business interruptions caused by the COVID-19 pandemic and the related government orders to shut down or limit operations has firms seeking answers about the effect on their contractual obligations, leases and rental agreements.
Some non-essential businesses forced to close to slow the spread of the coronavirus may not be able to fulfill production contracts or generate enough revenue to pay bills, including rent and lease payments. Even businesses still operating may experience such a reduction in sales that they have problems meeting financial obligations. Many business contracts include what is referred to as a force majeure clause that lays out the circumstances under which a party’s obligations might be excused because of events outside their control. The COVID-19 emergency will likely test the effectiveness of those clauses.
“In New York typically those clauses have been narrowly construed, meaning that courts really would like to see a specific reference to the event that’s triggering this exception to performance,” said Richard J. Marinaccio, a partner at Phillips Lytle LLP.
New York courts also don’t typically give general terms broad meaning. Phrases such as “including, but not limited to” or “other similar clauses beyond the control of the parties” will be limited to events that were specifically included in the agreement.
Unfortunately, many force majeure clauses have been loosely drafted, and don’t provide the protection parties might have expected.
“I’ve been interpreting a lot of these in the last 10 days and there’s very little consistency as to how they’re drafted,” Marinaccio said.
“From this day forward I’m sure that people will put a lot more thought into the force majeure clause, not only what the triggering events are, but what the effect of the triggering event is,” he said.
Although many businesses are being forced to close at least temporarily, some are continuing to operate and new business contracts are being negotiated.
“What I’m advising is not to rely on a force majeure clause for these short-term obligations because we are not really dealing with an unforeseen event. We know what we have here,” Marinaccio said.
“We know there’s a likelihood that performance is going to be impacted over the next few months, so what we’re doing is negotiating how performance could be affected and what type of leniency we’ll get in performance in these contracts,” Marinaccio said.
F.L. Gorman, co-leader of the real estate developers industry team at Harris Beach LLP, said it’s important to review your business interruption insurance. After the SARS outbreak in 2003 and the MERS outbreak about seven years ago, some insurance companies excluded viral pandemics from coverage.
Marinaccio said all businesses, landlords and tenants should start by reviewing their contracts and leases to understand their rights and obligations.
Attorneys fielding many questions about contracts and leases are telling clients to examine their leases and insurance policies to understand their respective duties and obligations in light of the pandemic.
Some tenants who can no longer stay afloat are expected to turn to New York state’s Real Property Law Section 227, which says a tenant can end a lease and surrender the property to the landlord when the building “is destroyed or so injured by the elements, or any other cause as to be untenantable, and unfit for occupancy” if there is no other agreement that would apply.
“Landlords should begin dialogues with their lenders to determine a reasonable path forward given the inevitable cash flow issues that will result from business difficulties faced by their tenants. Tenants should similarly keep landlords apprised of the state of affairs with respect to their businesses. Both parties should explore whether any government-sponsored disaster recovery resources might be available to mitigate cash flow shortages,” attorneys at Harris Beach PLLC wrote in a recent alert for small businesses.
Gorman said it’s best to try to work with your landlord or tenant to address cash flow problems during the crisis.
“I don’t think it’s going to be in anybody’s best interest to go to court. When you start litigating these issues it’s pretty easy to burn through money,” he said.
“Everything’s on hold now, but if you don’t work with somebody you’ll end up getting into litigation later. Is it not better to say, ‘OK I’ll give you 90 days rent relief and we’ll tack it on to the back of the lease,’ which I think is what you’re seeing a lot of people do,” Gorman said.
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