News Update Real Estate
16 March 2020
The coronavirus has brought everyday life largely to a standstill. By order of the government, cinemas, museums, theatres, gyms, bars and restaurants will remain closed until 6 April at least, and further measures might follow shortly, with more drastic effects: it is very well possible that shops will also want to shut, or be ordered to.The impact on the operations of all these businesses is huge. Their turnover is suddenly non-existent, and their buffers - never very large in the retail sector - are rapidly running out. They can no longer pay their staff their full wages, if any at all, and will struggle to pay rent. Many of the businesses are at risk of bankruptcy, and the financial stakes and other interests of lessors and investors are also high.
We have been asked numerous questions about the potential consequences of the coronavirus for lessors and lessees. Lessees want to know whether they are still obliged to keep their businesses open in the property in these circumstances. Another question is whether lessees have to pay the full rent if they shut down, voluntarily or at the government’s orders, or can they claim a reduction in rent, or perhaps even damages?
Obligation to operate the businessLeases often contain a clause under which the lessee is obliged to operate its business. If the lessee does not fulfil that obligation, in some situations the lessor might have grounds to terminate the lease, or instead to demand fulfilment and seek payment of contractual penalties. If the lessee is forced to shut down the business by order of the government, the lessor cannot reasonably demand that the lessee fulfil the contractual obligation to operate the business. This is force majeure, and as a result the lessee will not be required to pay any penalties.
Matters are not quite so straightforward if the lessee decides to close shop voluntarily in connection with the coronavirus. This does not constitute “real” force majeure, although the lessee might be able to argue unforeseen circumstances: this is not a decision that most lessees will make lightly, but to protect the health of the staff and/or if lack of available staff leaves the lessee with no other option. However, the lessor might have a strong interest in requiring the lessee to continue the operations, for example with a view to safety or to prevent deserted streets and empty shopping centres.
RentThe next question is what shutting down the business in the property in connection with the coronavirus means in terms of the rent. Unfortunately, the answer is not straightforward. Essentially, by law lessees may claim a reduction in rent in the event of a defect, where the reduction is proportionate to the diminished enjoyment owing to the defect. In simple terms, a defect arises if the lessee’s enjoyment under the lease is diminished as a result of the condition or a feature of the property, or another circumstance that is not attributable to the lessee. However, diminished enjoyment under the lease as a result of an actual disruption by a third party does not constitute a defect. If the lessee shuts down the business in the property, this means that the lease provides no enjoyment whatsoever. Besides the fact that many leases derogate (at least in part) from the statutory arrangement outlined above, the question arises of whether this does in fact constitute a defect. That appears not to be the case, at least if it was the lessee’s own decision. However, even if the lessee is required to close shop by order of the government, the lessor might adopt the position that this qualifies as an actual disruption by a third party. Additionally, case law indicates that, although the concept of a “defect” is generally construed in a broad sense, is does not cover everything: some external factors that adversely impact the lessee’s operations are considered to be business risks. A familiar example of this is where a shopping centre attracts fewer shoppers than projected. Since the lessor cannot do anything about the consequences of the coronavirus, it is possible that they will be placed in the same category. At the same time, given the extraordinary circumstances, it might be unacceptable by standards of reasonableness and fairness for lessors to demand full payment of the rent from their lessees.
Moreover, given the unique situation, it is not surprising that leases do not contain any arrangements for it, nor has any case law been handed down to govern this issue. Nevertheless, established case law has long held that the principles of reasonableness and fairness also extend to lessor-lessee relationships, and it is logical therefore to find an appropriate solution based on those principles. Our advice is that both parties should communicate clearly.