COVID and your lease: Frustration of Purpose in Commercial Leasing

Friends and Clients:

If you are a landlord or a tenant, this information may prove interesting or useful in the midst of the COVID-19 pandemic.  This information is general in nature.  You should seek and receive advice specific to your situation before taking any action.  As a preliminary matter, there is not likely to be a definitive answer in the abstract or even as to a particular lease.  The most likely resolution will be a tenant asserting a defense to a landlord’s demand for rent, a negotiation and a settlement.  

We received many inquiries regarding the doctrine of force majeure and how it might impact a tenant’s obligation to pay rent.  This will usually depend heavily on the language of the lease in question.  We have reviewed several of our clients’ leases and reviewed California cases which interpret such provisions.  At the risk of oversimplifying it, as to the provisions we read, we found that a tenant might make a good faith argument for a finding of COVID-19 as a force majeure but that the landlord seemed to have the better position – at least better than under the next option . . .

The doctrine of frustration of purpose also applies.  It excuses performance where the purpose of the contract has been frustrated by something beyond the control of the parties and beyond the contemplation of the parties (and even where performance remains possible).  One key way that it is different from a force majeure analysis, is that frustration of purpose is not typically reduced to an express term of the lease agreement (and it need not be, anyway).  Instead, whether it applies will depend of the decision of judge or jury (or some combination of the two).  To expand slightly, if an event occurs, which was beyond the contemplation of the parties at the time they entered into the contract (here, a lease), and if such event frustrates the very purpose of the contract, then the agreement may be deemed to exist no longer.  One California case held that, absent an express agreement to the contrary, it cannot be assumed that the parties intended that one party would pay for something which has become worthless.  

With that in mind, some terms of the lease agreement will be important in determining whether a tenant could successfully assert the defense of frustration of purpose.  If the lease permits a specified use, and if that use is prohibited by orders of the government – like a nightclub or a gym – these facts will favor the tenant.  Favoring the landlord is the fact that the orders closing certain businesses may only last 2 months, which is but a fraction of most lease terms.  (This spins into the question of whether a tenant who can prove frustration of purpose is excused from the balance of the lease or simply the months which were lost to the pandemic.  For now, consider that one more topic of argument.)  Also favoring the landlord would be a provision in the lease which allows for subletting.  A landlord would argue that the tenant could have sublet the premises to a business which was not shut down.  That may sound preposterous – but, sadly, not all lawyers are deterred by what is preposterous.  

Notably, when the tenant’s use is merely reduced or minimized, the defense is less likely to prevail.  In other words, a restaurant suffer a dip in sales but because take-out orders are allowed, the frustration of purpose defense is not likely to prevail.  

Whether you are a tenant or a landlord, the information above coupled with specific advice from a lawyer, might help you during negotiations for a possible rent reduction.  We encourage an open dialogue between tenants and landlords.  In most cases, creativity and a shared desire to continue the relationship should yield a solution acceptable to both sides.

Good luck and feel free to reach out with any questions.