When Commercial Tenants Refuse to Pay the Rent

a partner a Quinn Emmanuel. How bad is the situation from what you're hearing from your clients. Well, for retail clients, it's pretty severe. They have no foot traffic obviously, their stores are shuttered, and they are looking to the question of whether they can get complete relief or some relief from their landlords or if necessary, from the government or other sources. Tell us what usually happens when a commercial tenant can't make the rent? What did the landlord and

tenant usually do? Well. Leases are frequently written to be pretty protective of landlords, so the landlords have a variety of means to get the rent paid. Sometimes it can be drawing down on a letter of credit for example, and It can also include eviction of the tenant for failure to pay, and it can happen pretty quickly in the event of a non payment of rent. And here what we've got is a situation where the tenants may have some pretty unusual and potentially strong excuses under the

law for paying or for forbearing. How often do landlords negotiate with tenants in commercial situations and commercial leases when tenants aren't able to pay the rent, Well, it depends on the size of the lease and the term. So what we've seen here recently is it was publicized so I could say it. Taubman has been telling all of its tenants that they expect them to pay because they're going to have to pay their lenders and pay utility

bills and so forth, and hold them to it. In other circumstances where you've got a dominant tenant that makes a building otherwise not commercially viable and that tenant camp pay, than I would very much expect that the landlord would try to work with them. The circumstance here is unprecedented because it potentially impacts not every tenant, but of a vast majority of tenants. When you look up and down Fifth Avenue and Madison Avenue, and all the closed stores,

all the vacant office buildings throughout the city. Its situation no one's ever seen before. Wendy's is deferring rent payments on properties least to franchises by half over three months. Can other businesses afford to take that kind of a hit? Is that a solution for some businesses but not others? It may have to be. I mean, people can only pay what they can pay, and the law can step in, and some circumstances legal doctrines, I should say and try

to help folks out. So if your cash flow is interrupted, then it may be that doctrines like temporary and practicability make it impossible for you to continue to pay on down the stream. So if you're relying on a tenant paying you to pay your lender, for example, that may be a circumstance that excuses your payment or at least gives you some basis for a forbearance. What other legal

concepts might come into play here? A variety of different legal concepts that apply to circumstances when a contract unexpectedly can't be performed or is extraordinarily difficult to perform. So impossibility is the extreme where you can't perform the contract at all. The example is where an opera house burns to the ground and the opera singer can't perform. Impracticability is short of that. It's one where in theory you

could because you can always in theory pay money. It's not impossible, but you don't have the money to pay because the way that the contract is structured, it's coming from a particular source. Courts can be sympathetic to that, particularly if it's a temporary situation. The other one that comes into play here as a broad legal doctrine is called frustration of purpose, which is where you engage in a contract for a particular purpose so that everyone understands

and you can no longer achieve that purpose. So the idea is, you know, you're renting Masison Square garden to put on a concert and can no longer occupy the garden because of government regulations. Well, the entire purpose of the contract can't be fulfilled. So those are the legal doctrines that can step in quite apart from particular clauses and leases. Is this a time when courts might be more sympathetic to tenants rather than landlords. It's a great question, June.

The courts are very accustomed to seeing commercial lease disputes, and it's the landlords. They're typically repeat players, so they have their game well owns and and leases that are crafted to protect them. Here, I do think courts are going to be unusually sympathetic. The courts themselves are really under tremendous strains, So in New York, courts are closed for everything except what's deemed essential business, and they're handling

cases on a remote basis. So I think you've got a circumstance where courts are going to be quite sympathetic to tenants, particularly if what the tenant is looking for some kind of temporary relief until the crisis abates, at least into some degree. Another question I have is if there are, you know, mass defaults on commercial leases, how much can the courts do during these times? Might overwhelm the courts at a time, and they're not really doing much.

I think you're absolutely right. What you've got courts really with judges not showing up, with lawyers not appearing, they're doing what they can to try to handle essential disputes,

and I think, um they will expect parties to be patient. Certainly, if what I read in the Wall Street Journal a couple of days ago is that half of small businesses in the US haven't paid their rent uh made their mortgage payments for April, I think that problem accelerates into May, because which you've got is people who are paying now to avoid what are sometimes pretty draconian penalties in their leases. Um. But they're just not going to be able to continue

doing that, And the courts can't handle that kind of volume. Uh. And and there are going to in in uh, in New York, in California. Uh, they've both either authorized local governments to do it or or indicated that they're not going to proceed with commercial evictions in the short run. UM. Looking at that on like a three month basis, That may continue, And certainly you can't expect courts to handle thousands of cases on anything like an expedity basis. There's

so many unknowns here. But even if landlords succeed in evicting someone, how do they get tenants in this environment? It's a great question. Uh. Look, that's that's a commercial question. They're going to have to be thinking about what do they replace it with um, you know, sort of at some point they may turn from being landlord's demanding rent to being partners trying to figure out the best way to restructure a difficult situation. And it's often better to

get some rent then to get none. Governor Cuomo has said that tenants can't be evicted for the next few months. Does that apply at all to commercial tenants or is that just residential tenants? Now? Uh, my understanding is that uh, commercial tenant evictions have been paused. It doesn't mean that that they have gotten governmental real leaf in terms of um actually paying their rent um. But I think courts

are minderstanding. Executive orders of courts are not going to be uh conducting commercial evictions over the next ninety days, and so those disputes will just continue to brew. Um So in some instances, because as I mentioned, their penalties and leases, tenants may continue to pay as long as

they can under a reservation of rights. We're seeing some of that um in others like the cheesecake factory and H and M examples that you gave, Uh, they're not They're not gonna pay, and they're going to take their chances and see what happens, but I don't think any of those will result in immediate term evictions. Is there any relief from the federal government or the state government

for example the Cares Act? Is there any relief there? Well, I understand that there's three fifty billion dollars that has been devoted to small business loans. Obviously they're a lot of devils and those details. Um, but uh, I don't I don't know that it's directed specifically towards um towards payment of rent, but I think that's the The idea is it's to keep small businesses afloat so they can

pay their rents. And some landlords are taking the view that well, you know, you can either look to the government for help that you can't afford the rent, or you can look to business interruption insurance, which is a source of recovery for some businesses if if they're fortunate enough to have it. Um. But you know, we expect that our rents do because we have our own obligations.

So uh if that's um. You know. What I've also read is that only something like a quarter of landlords or banks are offering any kind of rent reduction or deferral to the small businesses that can't pay. That's a pretty big looming collision. You know, half the half the businesses aren't paying, and only um you know half of those involve landlords who are willing to compromise with them. Uh. Then then there's gonna end up being quite a lot of disputes. What kinds of calls are you getting from

your clients? Sure, so we're we're talking to uh, you know, commercial tenants. UH. So we're talking to you know, I won't have old any client names. We're talking to household uh, you know name retailers. We're talking to um, fortune five type companies, you know, large employers that have a need for massive office space. UM. Candidly, we also talked to uh landlords, we talked to reachs, we talked to um uh commercial brokers, UM, you know, across the landscape of

what they can do. UH. And you know, these are uh frequently very tailored situations. UH. And it depends, you know, how much their cash flow is hit it and how much their business is hit, and whether there's any degree to which the property can be salvaged or put to other use during this time period. So it's a it's a case by case circumstance. Um. But we're seeing it as a problem from every direction. Lenders, uh, you know, the actual commercial landlords, and of course the tenants whose

businesses are completely disrupted by this. You have this reverberating effect or cascading effect. So the landlords are any of them already coming up against problems because they can't pay their loans. Well, I can't say I have seen that quite yet. They've talked about it as a potential problem, um. And you know, the large commercial landlords may be well capitalized. A lot of buildings are structured in a way where

they're held in special purpose vehicles. So it's sort of a self contained economic unit which relies on uh, you know, relies on rent to be paid. Uh. That's going to be funding in turn, what the commitments are to the lenders, what the commitments are too if there's a master lease on the property on the ground lease owner, what the commitments are for utilities, for taxes and so and so forth.

So there may be circumstances where, despite the health of the uh commercial landlord, that the particular property has business risk associated with it, and that all depends on um, how tight the economics are of that property, and and you know, how long this crisis goes on for buildings makes you know, certainly survive. I'm on for two or three. Uh, you know, at some point the building is you know,

the building economics itself may not survive. How do you handle this when you don't know how long this could take? I mean, every day it seems like they're any another week and their month onto how long will be you know shuttered, which means that business activity is low or nil. Yeah, no, it's it's an impossible situation because you know, one has a crystal ball in terms of how long this crisis

is going to keep everyone sheltering in place. So it seems like the markets are you know, frankly paying more attention to the daily press conferences of Governor Cuomo than almost anything else because they're trying to get a handle on how long we're gonna we're gonna live like this, um you know, all hermited to ourselves and our homes, and and they're being you know, no commerce on a lot of sectors of the economy, at least none remotely

like what we're used to. So that's you know, that's almost impossible for folks to predict and you know, it's a circumstance where I don't know, frankly, either landlords and tenants are going to be working with each other, um, and working with lenders to try to come up with short term resolutions or there there's gonna be a lot

of brewing disputes. And where push is going to come shove is you know, where you've got the tenants who absolutely don't have the ability to pay, Um, we'll just stop paying and um, you know, and then the dominoes fall from there. When can landlords claim their property has been effectively taken by the government? You know, there is this concept that's embedded in the system endment of the Constitution of a taking by the government. The government cannot

take your property without giving you just compensation. So the classic example of eminent domain, they decide that they're going to uh condemn your house since they were building a high way that's needed for public use, and then they have to pay you the market value of your house. So what happens if you have uh some government restriction that diminishes the value of your property but doesn't quite destroy it, or that temporarily makes it unavailable. There are

concepts in some jurisdictions of regulatory takings. So the idea of the government puts a constraint on your property that greatly diminishes its value or its use, and those have both, you know, potential effect of making claims against the government in certain circumstances. I would think this would be a difficult one, since this is you know, the government exercising its police power, or it can be ones that trigger

rights under the lease. So casualty clauses under leases have language frequently that allows for non payment of rent in the event the property is uh to froid. Uh. Some of them have much more broad language that includes the properties impaired or that the property has restricted use by a virtue of a government regulation. Uh. And in those circumstances, that may well be a basis for tenants to not have to pay, at least on a temporary basis. Thanks Andrew.

That's Andrew Rossman, a partner at Quinn Emmanuel. Thanks for listening to the Bloomberg Law Podcast. You can subscribe and listen to the show on Apple Podcasts, SoundCloud and on Bloomberg dot com slash podcast. I'm June Brasso. This is Bloomberg ye