What happens to your business if the governor shuts down your operation because of a national pandemic?
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Today, we need to talk about commercial leases. This is a very interesting topic, especially in a situation where the governor of your state may have decided to just close all the businesses and send everybody home. Now, whether this is legal for them to do or not, and it’s really not the subject of this podcast, it does put a lot of us in a very strange situation. Of course, those of us with a computer can just go home and work from home on many things we do. It’s the service workers. It’s the construction guys. It’s really anybody that works outside that suddenly can’t have a livelihood. This is why we’ve seen the unemployment claims go through the roof. But what happens to your local delicatessen or your retail store? What happens to the beauty shop, the barber shop the gas station, how do they actually operate? Some of these as you know are called essential businesses, and they get to operate. In some jurisdictions, gun stores are essential, liquor stores are essential. Certainly gas stations and grocery stores are essential. But what happens to, for example, a department store? How about a menswear store? How about a store that sells pet food? Are your pets essential? These questions are tough.
So let’s take a look at a commercial lease situation. Say we have a mall, it doesn’t have to be a giant mall, it could be a little strip mall, it could be just a store on a on a parcel somewhere, and the business owner rents the location. So the business owner gets possession through a document called a lease. Sometimes commercial leases can be 50 to 60 pages long. Sometimes commercial leases for a particular store, in a strip mall or a larger mall, might be subject to a master lease that governs everybody in the mall. Sometimes there are conditions, covenants, restrictions, you know our old friend, the CC&R’s that govern activities in the mall. We will assume there are a couple of things going on, we will assume that the person that has title to the underlying dirt has a loan that they took from a bank to purchase that dirt to buy the mall. And they have taken the mall and split it up into however many store spaces that are rented through a commercial lease to a small business. Maybe it’s a tire shop, maybe it’s a dairy queen, oh, let’s go. What could it be? You just drive by any business, it could be that business. So let’s take a look at the interlocking relationships here. And then let’s drill down to a couple of things to be careful about.
The first thing we need to recognize is that the bank that loans the money to the person that owns the dirt, to buy it, to buy that real property, they are going to want to be able to step in and take control if the landlord has problems with the tenants. Or if the landlord doesn’t do a very good management job, that lender’s gonna want to step in, take the landlord and set them off to the side, maybe they go into bankruptcy, maybe they got some real problems over there. But the lender can step in and collect the rents from all the lessees, you know all the small businesses, they can collect those rents. They can exercise rights to evict people, you know, just tell them to get out. In other words, they will take the place of the landlord in case of an emergency, an emergency being defined as something like insolvency or bankruptcy. Or are catastrophic failure of a person. Well, say they died of Coronavirus? It could be something that dramatic.
Here’s another part of the relationship, the person buying the dirt is going to be the landlord. And they’re going to have a commercial lease with the lessee, or the small business, taking possession of that interest in real property that’s allocated to them. And there’ll be a certain size space, and there might be tenant improvements. And some of these leases get rather rather long. But there are a couple of things to watch out for. And let’s just go right to what’s going on today. If the governor of the State of Washington or the governor of the State of Idaho, or the governor of some state says, using the police power, that we’re going to shut down all the businesses in the state and everybody has to stay home, and you can only go out to get gas and groceries and you have to wear a mask, and all this sorts of stuff, then suddenly, these businesses are closed, they’re done. They cannot operate, they cannot open their doors. In fact, it’s against the law for them to do so. So now they can’t actually pay the rent. The store owner is is high and dry. Oh my gosh, how are they supposed to pay the landlord?
Now, some store owners have a bank of cash, they’re good savers. They’re good managers, they’ve got the cash. And they take a look at the governors restriction. And they say, well, you know, maybe for two to three, maybe four, maybe five, six months, I can continue to pay the rent, maintain control and possession in the space, not be in a default or a breach of contract situation with my rent. So I’m good. But other store owners say, I don’t have the money. I am dependent on foot traffic to give me the money to pay the rent, I can’t pay the rent. So they go to the landlord and they say, look, I can’t pay the rent, I’m in trouble. And the landlord has to be faced with the question of whether he’s going to evict the store or not. Or whether maybe a one- or two-month layover is something the landlord can do. Everybody’s looking at the state government and saying, what kind of plans do they have to reopen the economy? And what kind of risk is it for me to accept this situation where my store owner can’t pay me? And therefore I can’t maybe pay my loan. You see it all kind of dominoes.
There’s a couple of provisions in some commercial leases that we need to watch out for. One is obviously what’s called the force majeure situation. Force majeure is French. And it basically means a supervening event. That is to say, something happened in the world that neither the landlord nor the lessee, the renter, can do anything about. And a pandemic, it turns out, is likely one of them. Usually a force majeure, or they call these acts of God, are fire, earthquake, volcano, this type of thing. This pandemic probably fits into that category. Except, remember, it’s not the pandemic that caused the store to close. It was the state government’s action telling the store owner to close the store that closed the store.
So is this a state interference with a private contract that’s barred by the U.S. Constitution? Is this a taking of the renter’s contract and property because they can’t even open their doors? Sounds like some kind of a regulatory taking at least. We really don’t know the answer to these questions. All we know is the contract says that if you don’t pay your lease payment on a monthly basis on time, you’re in breach of contract and I can evict you. But look, nobody wants to go around evicting everybody, especially for a supervening event. Sometimes the force majeure section will say, this is unavoidable. And if it happens, there will be a tolling or a span of time within which, during this supervening event, the rent will not come due. The rent was due on the first of April. They couldn’t pay because of the pandemic and the governor’s order. And so the obligation to pay the rent to the landlord is now delayed until the pandemic is over, or the governor lifts the order or whatever constitutes the supervening event, the force majeure. So this is a tolling prospect. And, you know, that doesn’t mean they don’t have to pay the rent. It just means they don’t have to pay it now. You will have to pay it later.
And the question is, say this situation goes on for three months. And the governor lifts the order and all the stores open and everybody’s happy. Does that mean they owe four months of rent the next month? Or is the landlord able to enter into an agreement with the tenant that says, look, we know you owe us four month’s rent, but that’s a pretty heavy lift, and we know you just opened your store. So why don’t we play it this way. You pay me the next month’s rent, plus a week of rent. And then we’ll do that for as many weeks as it takes for you, as you know, as many months as it takes for you to catch up, which would be three months, four weeks a month, that would be twelve. So that’d be a whole year before the landlord gets paid. And that’s probably not functional. How about you give me a month-and-a-half of rent, then it only takes me six months to catch up, and might not be viable either. So there may be an arrangement that can be had with that. So let’s put that aside. We’ll call that a forbearance on the part of the landlord.
Now let’s look at a little bit different situation. Now, the tenant comes to the landlord and says, I don’t think I should have to pay anything during this time. In fact, let’s take a rent holiday. I’ll sit at home and watch cartoons. You sit on the beach in Maui, and you have your day. Well,no maybe not Maui. No, no, no, you go sit in your house and watch cartoons. And we’ll just each do nothing. And I won’t pay you rent, and you won’t collect rent. And we’ll just call it good until it’s over. And then when it’s over, I’ll start paying you again. And sometimes the landlord just has to say, well, that’s not gonna work for me. If you don’t want to have a forbearance agreement, you just want me to give up the rent? Well, no, I can’t do that unless you vacate the space and give me possession. Because frankly, as long as you have possession of my premises, you owe the rent, which is very fair, it’s according to contract. Very straightforward.
So let’s take these two situations, various tenants will read various force majeure provisions differently, and they’ll come up with their separate ideas about how they think they think things ought to go. But let’s take a look at how the landlord is bound. Because remember, the lender back there that lent the landlord the money to take title to the dirt to own the shopping center. Now, there may be provisions in there. And one thing we see frequently is a document called assignment of rents, or assignment of leases. Now, here’s a situation where the landlord in order to buy the property has the bank telling them, in order for us to lend you these millions of dollars to buy the property, you have to assign all of your rents to us, that we just that we own them, we control them, and we’ll let you manage them. You can collect the rents, you can do this, that and the other but and then they throw in a provision. And sometimes they say, you can’t amend those leases, unless you tell us and get our prior written approval. You can’t enter into a forbearance agreement without telling us without our prior written approval, there are all these provisions like that. And the question is, how do you handle those? And so if you have a problem with your commercial lease, and your lessee comes to you and says, Hey, I can’t pay the rent, there’s a pandemic or, more specifically, I can’t pay the rent because there’s a pandemic and because of the pandemic, the governor shut down my business, I can’t pay you, then the landlord not only should be reading the lease, but should also be reading any underlying loan documents to make sure there isn’t some sort of a transfer of an interest that might trigger acceleration in the loan documents, bringing all those millions of dollars due from the landlord to the lender, just because they wanted to amend this little lease over here for the for the pet store. Okay, these are these are relatively dangerous provisions. Most of them differ. Attorneys write these documents, and they say you should speak to your audience. Well, unfortunately, attorneys are always talking to other attorneys. With these documents, they are dense, they are way too long. The sentences make an ordinary person’s hair burst into flames and make you on a run and jump in the lake. And frankly, it’s just not proper, they should be written in a way that an ordinary lessee running a pet store and an ordinary landlord who’s just really trying to make some money on all these stores they have, should be able to read and understand these documents. Unfortunately, that is not always the case. And so you need to call makkar law or your local trusted contract attorney who can handle these complexities and understand that they are out there waiting to bite you if you’re not careful.
So that’s that’s our talk on commercial leases. Today, we hope you don’t have any force majeure events, and we hope you have nothing but sunny days ahead. Thanks for listening.
This episode is sponsored by Timely Contract. Buying real estate is the most complex and important financial transaction most people’s lives. It’s estimated that over 60% of American wealth resides in the family home. For small- to medium-sized businesses, a commercial building may be the biggest asset on the company’s balance sheet. With so much on the line, don’t make a mistake on the buy. Know what you’re buying before you sign. If you have signed, find out exactly what you’ve signed.