The COVID-19 outbreak has impacted the real estate market, lowering stock market value and disrupting the functioning of the entire industry. More specifically, the spread of the virus is likely to delay commercial real estate deals across India due to travel restrictions and a lack of clarity on its impact on global economic growth. Amidst such a scenario, the concerns of commercial landlords and tenants are high.
The impact of COVID-19 for landlords and tenants in the commercial real estate segment is inevitable and significantly so. Majority of the businesses have already closed their office premises, owing to the 21-day (and now further extended) lockdown initiated by the Government to battle the rising cases of coronavirus in India. It is still not clear how the exit from the lock-down is going to be planned and implemented. It is understandable that in this situation, the businesses that have rented office spaces are finding it difficult to pay the rent and comply with other lease covenants.
There are reports of certain companies giving leeway to their tenants. For example, the Lodha Group is reportedly waiving rent for retail stores at its properties as the lockdown to counter the coronavirus outbreak has stalled business.
While the Government has been quick in providing reassurance to businesses and workers alike, the continuity of business plans remains uncertain. Affected retailers have already started communicating their inability to pay commercial rentals to the developers. Further, landlords, retailers, and corporates are expected to delay their decisions on new leasing of commercial spaces by at least a quarter. Startups, SMEs, and freelancers have reportedly started demanding full waiver of rentals, whereas some are even cancelling contracts while fighting for their survival.
Keep-open clause in commercial leases
Many commercial leases, especially for the retail segment have a “keep-open” clause, which is basically a clause creating an obligation upon the tenant to trade continuously throughout the duration of the lease. During the lock-down period Commercial tenants in the retail segment and who have “keep-open” clauses in their leases need to consider the impact of closing their outlets completely. Such “keep-open” clauses can trigger conflicts between the landlords and the tenants, subject to the provisions of the lease deed and the guidelines/ notification issued by the Government.
Force Majeure Clause in Lease Deeds
A Force Majeure clause is one which allows the parties to get out of certain obligations in case of unforeseen events, in relation to the lease deed. A sample force majeure clause may look like this:-
FORCE MAJEURE: The occurrence of any of the following events shall be referred to herein as “Force Majeure” and shall excuse the obligations of Landlord or Tenant as are rendered impossible or reasonably impracticable as a result of the event(s) in question to the effect such event continues to render performance impossible or reasonably impracticable: strikes, lockouts, or labor disputes; acts of God; inability to obtain labor, materials, or reasonable substitutes therefor; governmental restrictions, regulations, or controls; judicial orders; war, invasion, riot, or acts of terrorism; fire, flood, or earthquake; and other causes beyond the reasonable control of the party obligated to perform (excluding financial inability). Notwithstanding the foregoing, the occurrence of such events shall not excuse Tenant’s obligations to pay Rent. Landlord and Tenant shall use all commercially reasonable efforts to mitigate the consequences of any event of Force Majeure.
Further, whether a force majeure clause will apply to COVID-19 depends heavily on the specific terms of the clause. The above clause, for example, is likely to excuse lease obligations that cannot be performed due to closings ordered by the government, however, will not excuse the tenant’s obligations to pay the specifically identified rent obligations.
• Such clauses may also define what events constitute a force majeure, the causal nexus required between the event and the ability to perform, and what rights and remedies the nonperforming party has if a force majeure event occurs.
• A force majeure clause might refer expressly to pandemic, epidemic or disease or, even to events similar to ones caused by COVID-19, such as a declaration of a national or state emergency, labor stoppages, or government actions (which might include travel bans or executive orders mandating shelter in place).
• The provision may also specify what particular performance is excused and for how long.
• Further, a force majeure clause may require the parties to mitigate damages in these circumstances. Typically, the party seeking to enforce such a clause must demonstrate that it made reasonable efforts to exhaust alternatives to non-performance and provided agreed-upon notice to the other party.
If a Court were to interpret such a clause during a dispute, then it would largely look at the agreement between the parties vis-à-vis the wordings of the contract, as well as general principles of equity while deciding the dispute.
In such circumstances, it becomes imperative that due diligence is conducted by both parties to secure their interests in the lease deed for situations similar to those brought in by the Covid-19 pandemic.
Doctrine of Frustration for Lease Deeds
If the lease deed does not carry such a Force Majeure clause which allows the parties to terminate the contract, a commercial tenant may want to argue that COVID-19 has made performance of a lease impossible. Thus, where the tenant is prevented from occupying or using the premises, he may be tempted to seek remedial measures from the Doctrine of Frustration under Section 56 of the Indian Contract Act, 1872, which deals with acts that cannot be performed.
Under the Doctrine of Frustration as enshrined in Section 56, the promisor may seek to be relieved of any liability in case a supervening event renders performance of the contract impossible. The defense of impossibility applies when either the subject matter of the contract or the means of performance has been destroyed, and the impossibility must be produced by an unanticipated event that could not have been foreseen or guarded against in the contract. A tenant might argue that it can no longer perform its contractual duties in light of COVID-19 and the governmental actions taken in response to it. For instance, the imposition of a nation-wide lock-down by the Government has rendered the leased-out premises unfit for use and additionally, the collapsing of the economy has created financial pressure upon the tenant to pay rent.
However, interpretation of a lease agreement is governed primarily by the Transfer of Property Act, 1882, which is a special statue, and not on the Contract Act, which is a general statute. It is settled law that a special statute would prevail over a general statute.
There is a precedent in the Hon’ble Supreme Court’s decision in Raja Dhruv Dev Chand v. Raja Harmohinder Singh [AIR 1968 SC 1024] that “Where the property leased is not destroyed or substantially and permanently unfit, the lessee cannot avoid the lease because he does not or is unable to use the land for purposes for which it is let to him.” and that Section 108(e) of the Transfer of Property Act pertains to the issue of whether or not rent is payable by the lessee due to a force majeure. Section 108 (e) lays down that if a significant part of the property that has been leased is destroyed wholly or partly by fire, by flood, by war, by the violent acts of the mob or by any other means resulting in its inefficiency of being a benefit for the lessee.”
If the above principles are applied for dealing with COVID-19 realities, then it is unlikely that there would be any waiver of any rent, especially as the leased-out premises cannot be said to be ‘permanently unfit’.
Meanwhile, the likely stance taken by lessors would be that their obligation under all commercial leases is to provide possession to the lessee. In such a scenario, when the fitness to occupy the premises becomes impossible due to a temporary change in law or circumstance, due to no fault of the lessor, it would not disentitle the lessor from enjoying the proceeds of the lease. This view finds significant reinforcement from the fact that the premises continues to be in possession of the lessee along with the lessee’s furniture and fittings, and the lessor’s rights devolve by law upon the lessee, and there is no suspension of these rights. Further, there is obviously no change in “place of business” for commercial and legal purposes by the lessee during the present lockdown period.
If Lease Deed is not registered and not acted upon, or there is an Agreement to Lease
If the Lease Deed is neither registered nor acted upon, then the rule laid down in Sushila Devi & Anr. v. Hari Singh & Ors. [AIR 1971 SC 1756] would be applicable. In the said case, the Supreme Court of India held that the rule of frustration as embodied in Section 56 of the Contract Act applies only to a contract that is, an agreement to lease, and does not apply to leases, provided of course that all the criteria required thereunder are fulfilled. In this case, the Apex Court observed that the lease was to be for a period of three years and it could have been validly made only under a registered instrument. As it was not so registered, therefore, it was only an agreement to lease and not a lease. The Supreme Court held that such an agreement comes within the scope of S. 56 of the Indian Contract Act. The Supreme Court further went on to observe the following:-
• The impossibility contemplated by S. 56 is not confined to something which is not humanly possible.
• If the performance of a contract becomes impracticable or useless having regard to the object and purpose of the parties then it must be held that the performance of the contract became impossible.
• However, the supervening events should take away the very basis of the contract and it should be of such a character that it strikes at the root of the contract.
The supervening event which was claimed to render the agreement impossible in the present case was the partition of India and Pakistan in 1947 and the communal disturbances leading up to it. The lessor pleaded that she had done all that she was expected to do under the contract. According to her the lands sought to be leased were in the possession of the actual cultivators; she was not required to evict those cultivators and deliver physical possession to the respondents. She was only required to deliver the landlord’s possession of the lands proposed to be leased. According to her she had given to the respondents such possession as she could have given under the circumstances. She further pleaded that the doctrine of frustration is not applicable to leases. She also contended that under the contract she was entitled to forfeit the amount deposited as security.
The Supreme rejected the opinion of the High Court that the doctrine of frustration applies to leases and held that Section 56 applies only to a contract. Once a valid lease comes into existence the agreement to lease disappears and its place is taken by the lease. It becomes a completed conveyance under which the lessee gets an interest in the property. There is a clear distinction between a completed conveyance and an executory contract. The Supreme Court held that in view of the decision in Raja Dhruv Dev Chand (Supra), the view taken by some of the High Courts that Section 56 of the Contract Act applies to leases cannot be accepted as correct. In Sushila Devi, the agreement between the parties provided that the lease deed should be registered within 15 days from the date of the acceptance of the tender. For one reason or the other, the contemplated lease deed was neither executed nor registered. Therefore, there was no lease but only an agreement to lease, hence it comes within the scope of Section 56 of the Contract Act. Following this ratio, the Supreme Court held that the agreement had become impossible of performance.
It is yet to be seen whether such interpretation and judicial reasoning would be accorded to the COVID-19 situation, in light of the country and the entire world facing unprecedented financial crisis and sinking of the global economy, and there is no “destruction of the rented premises” as such. Moreover, in the present COVID-19 situation and amidst the lock-down, rented commercial premises can only be said to be ‘temporarily unfit’ and not permanently, which may also be factored in. Moreover, the commercial lessees are not opting for ‘alternate premises’ for their business continuity and many offices have either opted for limited operations or have shut down all operations till further notice. In such a situation, it would be interesting to see if Courts would interpret disputes on grounds of ‘equity’ or on a ‘case-to-case’ basis, rather than on a blanket rule for all.
Although the Ministry of Home Affairs, Government of India, has issued an advisory being No. 40-3/2020-DM-I(A) on March 29, 2020 with a prohibition to landlords to charge rent for a period of one month to labourers and migrant workers. However, no such advisory has yet been issued exempting businesses from paying rent on commercial leases.
What other Jurisdictions are doing
In Germany, there are reports of the legislation planning extensive regulations for the protection of tenants as part of a “Coronavirus emergency package”. Under these regulations, landlords will not be allowed to terminate the contracts with tenants who are unable to pay the whole or part of their rent in the period from April 01, 2020 to June 30, 2020 due to the impact of COVID-19.
For lease agreements also in times of a crisis, “pacta sunt servanda” generally applies, which means that the landlord continues to make the leased property available for use and the tenant must generally pay the rent without any reductions. The tenant is only entitled to reduce the rent if the rental use is significantly disturbed due to a defect of the leased property. The principle of disruption or loss of the basis of the transaction is not applicable if the realized risk was contractually assigned to one of the parties, as it is generally the case in many commercial leases: the landlord bears the risk of making the leased property available for undisturbed use and the tenant bears the risk of being able to run its business undisturbed in all other respects.
In France, the Emergency Act No. 2020-290 dated March 23, 2020 creates a state of health emergency allowing the government to take specific temporary measures by ordinance, i.e. without having to go through Parliament. At this stage, the state of health emergency has been declared for a period of two months as from March 24, 2020 but may be extended.
This Act allows the French government to pass legislation allowing the full deferral or staggering of the payment of rent, water, gas and electricity bills relating to professional and commercial premises and to waive financial penalties and suspensions, interruptions or reductions in supplies likely to be applied in the event of non-payment of invoices, for the benefit of microenterprises etc. whose activity is affected by the spread of the epidemic.
Further, through a series of 30 ordinances published since 26 March 2020, the French government has specified emergency measures that would be of interest to landlords and tenants, including:
The setting up of a solidarity fund to provide financial assistance to very small businesses
• The emergency fund aims to provide financial assistance to very small businesses, with 10 or less employees, an annual turnover below €1 million and a taxable profit below €60,000 during the previous financial year and not being controlled by a commercial company within the meaning of Article L. 233-3 of the French Commercial Code.
• This fund has a very limited duration of three months, which may be extended for a maximum of three months (i.e. a total of six months).
A specific scheme regarding payment of rents and utility supplies
• Landlords are barred from activating automatic termination clauses or to invoice penalties, late payment interest, or other financial penalties, or clauses providing for forfeiture or even to call upon third-party guarantees, due to non-payment of rents or service charges relating to professional or commercial premises due between March 12, 2020 and the expiry of a period of two months after the end of the state of health emergency.
This scheme is however solely available to very small businesses eligible to the solidarity fund.
A general scheme regarding payments under contracts , that would be available to tenants not eligible to the specific scheme.
• A party is barred from activating penalty payment, automatic termination clauses, penalty clauses or clauses providing for forfeiture against the other party that failed to comply with an undertaking that was due between 12 March 2020 and the expiry of a period of one month after the end of the state of health emergency. Such penalty payment or penalty clauses shall take effect and be enforceable as from the expiry of a period of one month after the end of that period if the debtor has not performed its obligation before that time.
• This general scheme can be applied to leases and would allow tenants to postpone payments without risk of forfeiture or penalty. However, landlords may still call upon third-party guarantees to cover any unpaid amounts.
The State of New York has instituted a 90-day moratorium (from March 16) on residential and commercial evictions. Landlords may serve rent demands, however, they cannot commence litigation against tenants, such as eviction proceedings. New York City has expressly warned that tenants are not excused from paying rent during the COVID-19 crisis, even if their revenues have declined precipitously. However, a bill that has been introduced in the New York State Senate, although not yet enacted, to “suspend rent payments and certain mortgage payments for certain residential tenants and small business commercial tenants for ninety days.” Other states, such as New Jersey, have also put certain other moratorium relief in place.
To cite an example by corollary, in the case Bush v. Protravel Int’l, Inc., 746 N.Y.S.2d 790, 795 (Civ. Ct., Richmond Cty. 2002), a New York Court found that there was a genuine issue of material fact about whether government restrictions imposed after the September 11, 2001 attacks made it impossible for a customer to cancel her contract on time. The court emphasized that “New York City was in the state of virtual lockdown with travel either forbidden altogether or severely restricted,” which may be analogous to the current COVID-19 situation.
In England, the Government announced that all commercial tenants in England and Wales will be protected from eviction under new emergency legislation to come into force, which is being touted as a relief for businesses facing quarterly rent bills. All non-essential commercial premises are also being asked to close.
Most standard leases in England require tenants to pay quarterly in advance on a specified day, failing which a landlord can forfeit the lease if the rent is not paid within a certain period, usually 14/21 days after the due date. The landlord does not need to give notice of its intention to do this; it can simply change the locks as soon as the period ends. Following the Government’s announcement, where rent is not paid on the due date, a landlord will no longer be able to forfeit. It would appear also that the moratorium applies to any other rent payment pattern such that any rent that is unpaid, whenever it fell due, will be caught.
The moratorium proposed currently will only last until June 30, 2020, but the Government has indicated this period could be extended. Importantly, the legislation will only suspend the landlord’s right to forfeit; it does not mean the rent is not payable. Therefore, based on the current proposal, a landlord’s right to forfeit will kick in again on July 01, 2020, so a tenant should be wary about complete waiver of rent.
In Australia, there is currently no legislation which relieves tenants from their rental obligations in the context of COVID-19. This is in stark contrast with its neighbour New Zealand, where after the Christchurch earthquake the Auckland District Law Society Form of Lease was amended and now allows an abatement for tenants affected by certain force majeure events, including an “epidemic”.
What happens after the lock-down period vis-à-vis leases?
As of now, no official relief has been declared by the Government for businesses on commercial lease. Even if a moratorium is announced, it is unlikely that payments will be waived altogether, and will most likely be suspended for a period subject to payment after the moratorium. Moreover, even after the lockdown, businesses will take time to recuperate from the cash-flow halt. The impact on corporate rental leases will be governed by how long the pandemic lasts and the duration of the lockdown period, as also on the nature of the business.
Prime Minister Narendra Modi on April 11, 2020 held a video conference with chief ministers of various states primarily to take their feedback on whether the 21-nation-wide lockdown be extended beyond April 14 till April 30 to control the spread of the COVID-19, which received a broad consensus. Pursuant to the video conference, many states and Union Territories have already announced the extension of the lockdown till April 30, including Mizoram, West Bengal, Punjab, Arunachal Pradesh, Puducherry, Odisha, Telengana, Maharashtra and Tamil Nadu.
Once courts become functional, there is a possibility of litigation initiated by landlords with regard to payment of rent with interests or by tenants for deduction from security deposits etc. However, landlords or lessors need to keep in mind that depending on the circumstances and the usefulness of the leased property, the tenant or lessee may opt to terminate the lease deed by giving notice as stipulated under the lease deed. In such an event, landlords may not get new tenants or even if they do, they may not get rent at the earlier rate. Moreover sometimes, the landlord may have expenses such as maintenance of the property, and the property may even lie vacant for several months.
Therefore, to ease the burden, landlords and tenants may be encouraged to communicate, understand each other’s problems and work together in these difficult times to find a resolution to the immediate impact on cash flow, which will affect both parties. This would largely depend on the landlord’s and tenant’s financial capacities and business continuity planning, considering both short term and long-term goals. There is no one-size fits all solution. Anything agreement between the parties should be formally documented to avoid any temporary concessions inadvertently becoming permanent variations to the lease deed.
Certain take-aways from the COVID-19 experience
Going forward, while entering into new lease agreements, parties (especially for businesses that are vulnerable to being affected by epidemics and pandemics) may consider to include the following:-
• Carefully review obligations in the lease, construction contracts, and other real estate contracts
• Insert a clause with respect to an epidemic outbreak in new contracts
• Insert a suitable clause accommodating a situation on what to do in case a tenant is unable to operate their businesses from the premises due to unforeseeable circumstances
• Ensure business interruption insurance to cover the loss of income
• Depending on the language of the lease agreements, landlords are likely to rely on letters of credit or offsetting against security deposits. Such a situation during a pandemic like situation should also be envisaged in the contract.
• If possible, insert provisions in the lease deed related to temporary adjustments in the rent under specific circumstances
• If possible, insert a provision in the contract clearly mentioning the mode of working of the organization, provision for losses, and meeting of operating expenses in the event of natural calamities and epidemics etc.