Commercial Lease Obligations in the Time of COVID 19

As of March 25, 2020, all non-essential businesses, including all
restaurants, bars, entertainment and recreational facilities, in Washington
State (with few exceptions) have been ordered to close for at least two weeks
in an effort to slow the spread of COVID-19 (the Novel Coronavirus). This order
will likely be extended for additional time if the spread of COVID-19 does not
slow down significantly. The impact of this closure, and the coronavirus
pandemic in general, is being felt throughout the State.

If you operate a business that has been forced to close or lease property to
such a business, what does this mean for you? If you can no longer operate
your business at this time, do you still have to perform under the terms of your
lease agreement? If you are the tenant, do you still have to pay rent during this
time? If you are a landlord, can you still collect rent from a tenant who has
been forced to close? Understanding the terms of your lease agreement, as
well as the doctrines of “frustration of purpose” and “impossibility of
performance,” are vital to understanding your obligations and rights as either
landlord or tenant.

Force Majeure

Lease agreements may contain a provision which would excuse or delay
the performance of certain lease obligations during the time when certain
businesses are unable to operate. For example, many lease agreements
include a “force majeure” clause. This type of clause often excuses or defers
performance required under the lease agreement in the event there are
circumstances beyond the parties’ control, such as fire, flood, war, or other
acts of God. Courts typically construe force majeure clauses narrowly, and the
party seeking to assert the force majeure clause will typically have the burden
of showing that the clause applies.

Whether the coronavirus pandemic and the resulting restrictions constitute
a “force majeure” and what, if any, obligations may be excused because of it,
are dependent on the language of the lease agreement itself. For example,
some lease agreements expressly state that the rental obligations required
under the lease agreement will not be excused or delayed even in the event of
an act of God or other force majeure. The interpretation and applicability of
force majeure clauses is very likely to be the subject of many court cases in
the future as people dispute their rights and obligations under various contracts
during the coronavirus pandemic.

We suggest you review your lease agreement carefully to see if there are
any force majeure provisions that may apply. If you have any questions, please
contact your attorney right away so your attorney can assist you with your
review. Some lease agreements require prompt notice of any force majeure
event be provided to the landlord before any obligations are excused or
delayed, so, if you are a tenant, the quicker you act, the better.

Frustration of Purpose

If there is no force majeure clause in your lease agreement, or if it does not
apply to the coronavirus pandemic, certain lease obligations may still be
excused during this time under the doctrine of frustration of purpose. This
doctrine is described as follows: “Where, after a contract is made, a party’s
principal purpose is substantially frustrated without [that party’s] fault by the
occurrence of an event the non-occurrence of which was a basic assumption
on which the contract is made, [the frustrated party’s] remaining duties to
render performance are discharged, unless the language or the circumstances
indicate the contrary.”

Washington courts have established three requirements for discharge of
the frustrated party’s duty:

• First the principal purpose of the party must be frustrated.
• Second, the frustration must be substantial. If a transaction has become
  less profitable, that is insufficient to show substantial frustration.
• Third, the nonoccurrence of the frustrating event must have been a basic
  underlying assumption of the contract.

In one case, the Washington Supreme Court released a tenant from its
obligations under a mineral lease where the tenant was unable to obtain the
permits necessary for mining. There, the court noted:

Where the assumed possibility of a desired object or effect to be attained
by either party to a contract forms the basis on which both parties enter into it,
and this object or effect is or surely will be frustrated, a promisor who is without
fault in causing the frustration, and who is harmed thereby, is discharged from
the duty of performing his promise unless a contrary intention appears.

The court will consider whether the parties contemplated the risk of the
frustration and provided for that contingency in the lease agreement, thereby
allocating the risk to one side or the other. If the risk was allocated to one of
the parties by the language of the lease agreement, then the court will not
apply the doctrine of frustration of purpose.

To determine whether the doctrine of frustration of purpose applies, the
lease agreement as a whole must be considered. A court will examine the
description of the permitted uses in the lease agreement. The more restrictive
the permitted use is, the more likely a court would find that the purpose of the
lease is frustrated. For example, in the mining case, the only permitted use of
the premises was for a mining operation. The court relied on this permitted use
to find that the principal purpose of the lease was the mining operation, which
could not be conducted without the mining permits.

To the contrary, in a prohibition-era case, the Washington Supreme Court
found that a tenant was not released from its obligations under a lease
agreement where the permitted use was permissive and not restrictive. In that
case, the lease agreement stated that the tenant “may during the life of this
lease carry on and conduct a retail saloon business.” The court interpreted that
provision to allow, but not require, the tenant to operate a saloon. Thus, when
the city in which the premises was located prohibited the sale of liquor, it did
not render the lease agreement unenforceable.

So, if your lease agreement only allows for the leased premises to be used
for a restaurant, bar, or entertainment or recreational facility, or for another
non-essential business and for no other purpose, then it is more likely that a
court would find that specific use was the “purpose” of the lease agreement,
and thus that the purpose is frustrated.

Impossibility of Performance

Similar to frustration of purpose, the doctrine of “impossibility of
performance” can also excuse a party’s performance of its obligations under a
lease agreement. This doctrine encompasses both strict impossibility and
impracticability due to extreme and unforeseeable difficulty, expense, injury or
loss. Under this doctrine, Washington courts have held that the “mere fact that
a contract’s performance becomes more difficult or expensive than originally
anticipated, does not justify setting it aside.” Under the relevant cases, one
common reason for alleging impossibility of performance is a government
passing a law or decree that makes performance under the contract illegal.

As with the doctrine of frustration of purpose, the courts will consider
whether the intervening event was foreseeable and whether the parties
allocated the risk of the event happening to one of the parties in the language
of the lease agreement. If the parties should have foreseen the risk (such as
where the parties should have foreseen the risk that the government would
make performance under the lease agreement illegal), then the courts might
find that the tenant assumed the risk and might not release the tenant from its
obligations.

The duration of the government-ordered shut downs may also have an
impact on the extent to which a court might find lease obligations excused
under either doctrine. The longer the shut down lasts, the greater the chance
that a court would find either frustration of purpose or impossibility of
performance applies.

Can a tenant stop paying rent because its business is shut down?

Whether performance of lease obligations (including the obligation to pay
rent) will be suspended or excused during this time of unprecedented
government-ordered shut downs is largely dependent on the specific language
of the lease agreement and the circumstances under which it was entered. If
the lease agreement was entered into after the initial coronavirus cases were
reported in China, the court may find that the pandemic and resulting
government shut down and declaration of a state of emergency was more
likely to have been foreseeable. If a lease agreement was entered into years
ago, however, it is less likely that the court would find this situation
foreseeable.

Whether you are in the role of landlord or tenant, the interpretation of
existing lease agreements will likely be a critical issue for your business. If you
are a tenant, we do not recommend you stop paying rent or vacate the
premises without first discussing your lease obligations with an attorney and
possibly with your landlord. Please contact Karr Tuttle Campbell if we can
assist you with questions about your lease obligations.

This Client Alert was prepared by Jacque St. Romain.
Please feel free to contact her with any questions.
Karr Tuttle Campbell | 206-223-1313 | www.karrtuttle.com

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