Is it Time to Go? Considerations for Terminating Your Lease
This article is based upon Practice Notes covering general and COVID-related lease termination considerations, just a few of the more than 70,000 resources available in Practical Law.
Negotiating a termination agreement
A lease-termination dispute may very well end up in court, but an attempt at negotiation can be a positive first step. Most commercial leases contain language — such as a default clause — that outlines the tenant’s responsibilities and explains what will happen if the tenant defaults on the lease or otherwise violates the rules of the agreement. This language is meant as a deterrent, but when negotiating a termination agreement, keep in mind that landlords are primarily interested in how they are going to get paid, so there may be more room for compromise than the contract language suggests.
The most common exit strategies to explore are sub-leasing or a lease buyout.
If the contract itself doesn’t give tenants permission to sub-lease the space to another tenant, landlords may still be open to the idea, especially if the tenant helps the landlord find a replacement tenant. Under a sub-lease arrangement, the new tenant would pay the rent for the duration of the lease, though the outgoing tenant may have to pay for the time the space was vacant if the handoff to the new tenant cannot happen immediately.
Negotiating for a lease buyout involves persuading the landlord to buy out the remaining portion of the lease for less than they would have otherwise received, but more than they would get if the matter went to court. As with a sub-leasing, a landlord is much more likely to consider a buyout if another reliable tenant is lined up and ready to move in, although that could be a tall order in the COVID-19 business environment.
Taking the matter to court: Litigation
Negotiation is the preferred path to resolve a lease dispute, but litigation is sometimes the best — and only — option for businesses that cannot meet their lease obligations and have no other recourse.
Arguing force majeure
Though every business situation is different, the main legal argument in most cases where a business has shut down and vacated its space due to COVID-19 is a variation on the idea that government-mandated stay-at-home orders and business closures (of bars, restaurants, gyms, movie theaters, etc.) are grounds for triggering a contract’s “force majeure” clause.
The trick with force majeure clauses is that courts tend toward extremely narrow interpretations of real estate contract language, so the argument can be an uphill climb if “acts of government” or “pandemics” or “public health crises” are not specifically stated in the contract. In order to consider a force majeure claim, many courts also require defendants to demonstrate a strong causal connection between the alleged force majeure event and the litigant’s inability to meet their contractual obligations.
However, if the tenant’s contract does happen to have an applicable force majeure clause and it can be proven that COVID-19 restrictions caused the business to close, courts around the country have been generous in granting tenants the right to cancel their contract.
Frustration of purpose and impracticability
If the force majeure language in a contract lacks the necessary specificity, then common-law defenses for “frustration of purpose,” “impracticality,” or “impossibility” may be invoked instead of, or in addition to, a force majeure claim.
Frustration of purpose can be argued if the purpose for which the business entered the lease is “substantially frustrated,” such as a restaurant that can only serve takeout during the pandemic, or a gym that can only offer workout classes online. In such cases, a related claim of “temporary impracticability” may also apply. But such arguments, even if successful, don’t usually result in rent obligations being discharged — just reduced or delayed.
During the pandemic, frustration of purpose could conceivably be married with an “impossibility of performance” defense as well; however, proving absolute impossibility about COVID-19 is itself extremely difficult. That’s because courts tend to regard pandemics and other public health crises as events that are unlikely but are somewhat foreseeable and should therefore be included in a contract. If not, and if there is any conceivable way a business can continue to generate revenue, the chances of an impossibility defense succeeding are improbable at best.
Business interruption insurance
Businesses that carry Business Interruption Insurance may also understandably believe that their policy should cover any losses due to COVID-19 or relieve them of their rent obligations. Unfortunately for tenants, the courts so far have largely sided with insurance companies on these matters — again, unless the language in the contract specifically includes pandemics or government-mandated actions beyond the tenant’s control.
If all other arguments have been exhausted and a landlord simply insists on enforcing the terms of the contract, declaring bankruptcy may be a business’s best option, for several reasons.
First, bankruptcy under Chapter 11 allows tenants to reject their lease, which automatically triggers a cap on the amount of money the landlord can legally recoup from the tenant. If a tenant goes through with bankruptcy, the suit itself can provide some measure of economic protection.
For litigators, a bankruptcy filing can also be used as a negotiating tool. In general, landlords do not want to go to court, so a bankruptcy filing can sometimes be used to bring landlords back to the negotiating table. There, the cap triggered by the lease rejection can be used as leverage, or simply serve as a starting point for further negotiation.
For general counsel, terminating a business’s commercial lease can quickly escalate into a major matter. Commercial real estate law is complex, and the uninitiated can potentially stumble onto landmines. Furthermore, most landlords, property managers, and commercial real estate brokers (and their lawyers) are much more familiar with the legal system than are their business tenants, so adequate representation on the business side is a must. Consulting or partnering with an experienced local real estate attorney can go a long way toward ensuring that clients receive the best possible representation.