With the onset of the global pandemic, questions related to lease clauses involving force majeure—literally, “superior force” but often interpreted as “acts of God”—loom in retail real estate: Does the pandemic qualify as a force majeure event? If so, are tenants justified in declining to pay rent? What protection do these clauses provide to landlords?
David Goodman, a Principal at Equity Retail Brokers, sat down with Bart I. Mellits, Chair of the Real Estate Department at national law firm Ballard Spahr, to explore this territory. The Philadelphia attorney is a 35-year veteran of real estate law and one of the country’s foremost authorities on force majeure and related legal defenses. Having represented big-box retailers and national REITs alike, Mellits understands perspectives on both sides of the negotiating table.
DAVID GOODMAN: Bart, maybe we could start with a quick overview of force majeure itself.
BART MELLITS: It’s basically a clause in the back of the lease. Force majeure is one of those boilerplate clauses that should never be ignored, but sometimes is. Traditionally, few have spent much time on it. The intent of force majeure is to allocate the risk of nonperformance based on some unforeseen act – something beyond the party’s control.
GOODMAN: And are we talking about a universal legal principle here?
MELLITS: Force majeure is purely contractual. It’s not something that would get implied. To be sure, there are some common-law defenses related to the performance of lease obligations, but there’s no general rule as to what force majeure is. So if a tenant or landlord asks you about one of these clauses, you’ve got to see what that clause says. It could be very different from somebody else’s, and that could be dispositive of the issue.
What we’re really talking about here is the world of contract-interpretation. Typically, where there’s an exclusion related to performance, contracts will be very narrowly construed.
GOODMAN: And that speaks to whether a pandemic qualifies—it’s all about how the contract is construed.
MELLITS: Yes. If the clause says something like, ‘Force majeure consists of government action, hurricanes, riots, pandemics, strikes, materials shortages,’ etc., then the situation is clear. But most of the clauses that we have seen in the wake of Covid-19 never mention pandemics, although that is not unheard of.
A key consideration is the presence or absence of a phrase like, ‘A force majeure event shall include, but shall not be limited to, the following events…’ Most clauses combine a list of specific events with such a catchall phrase. Even if the catchall is broadly worded, interpretation may still be required: Some courts have said that events not specifically listed need to be like those that are spelled out in the lease. A tornado, for example, is like a hurricane. A pandemic may not be similar enough.
GOODMAN: What are some of the pre-pandemic force majeure-related issues that were commonplace?
MELLITS: Right now, we’re hearing a lot about whether force majeure is an outlet for rent relief on behalf of tenants, but pre-pandemic, force majeure was cited by owners and developers regarding their delivery obligations. You can see how these clauses can cut both ways.
Let’s say a landlord who is building out a space for a tenant misses the delivery date due to the city dragging its feet on the permits. Big-box retailers tend to bring the hammer down in such situations. If the force majeure clause lists such permitting delays as an exclusion, the landlord could avoid hundreds of thousands of dollars in liquidated damages, penalties and rent relief.
GOODMAN: And what about tenants citing this clause as a basis for rent relief or deferrals?
MELLITS: Yes, tenants are now themselves citing acts of the government—the lockdown orders—as a reason not to pay the rent. But I’d say that something on the order of 90 or 95 percent of force majeure clauses in modern leases have a line such as ‘Nothing in this clause shall relieve the tenant of its obligation to pay rent.’
GOODMAN: Yes. We’ve seen this in leases.
MELLITS: The tenant could have a great force majeure clause—one that specifically cites pandemics. That doesn’t mean the tenant lacks the money to pay rent. A major fast food chain might have a $1 billion line of credit. The force majeure event hasn’t stopped that tenant from performing its obligations by authorizing a wire transfer or writing a check, even if stores are temporarily closed.
GOODMAN: In those cases where the obligation to pay rent is so clearly stipulated, what’s the basis for tenants to make these force majeure rent-relief requests?
MELLITS: We’ve been talking about a strict reading of the lease and specific lease clauses. An important question to ask is, ‘What’s the judge going to say?’ And this is where litigation comes in. I am a transactional lawyer; I’ve never been a litigator. I don’t know what the judge is going to do. I do know that litigation is expensive and stressful for all involved. Mostly, you should try to avoid it, but it is another tool in your negotiating tool box, for both landlords and tenants.
GOODMAN: I see.
MELLITS: The clause could say ‘thou shalt pay rent no matter what.’ But once you get into litigation, the judge could want to help that tenant, especially a small business. Let’s face it, this isn’t the 2008 financial crisis. With this pandemic, none of these businesses did anything wrong. Forcing them to endure further hardship may not feel right to the judge. In litigation, sometimes you get results that don’t really match what’s in the document, not to mention the costs involved. That’s why we’re seeing so many landlords show a willingness to negotiate, even when, technically, they do have the upper hand.
GOODMAN: Right. Many landlords are being cooperative. They might defer rent and give the tenant 12 or 18 months to pay it back; or defer rent for three months but then add 90 days to the lease; or take back some unfavorable lease clauses as part of that negotiation. I’m involved in a deal where a national big box tenant, which is not paying rent right now, says it will give up its do-not-build right and allow the landlord to make a deal for part of the parking lot.
MELLITS: I will say that each side can exploit the situation, too. Some landlords may see this as an opportunity to get rid of underperforming tenants. We have seen some of the big-box retailers come on really strong with landlords in terms of refusing to pay rent.
GOODMAN: And what about those five or 10 percent of cases where the force majeure clause does not stipulate that the tenant must continue to pay?
MELLITS: That can level the playing field a bit. Now the landlord can’t merely point to the wording of the lease as their first line of defense as to why the tenant must continue to pay the rent. It’s always best to have it spelled out in the lease.
GOODMAN: As we speak, lockdowns are still in place in Pennsylvania, New Jersey, Delaware, Connecticut, Kentucky and Michigan, along with Puerto Rico and Washington, D.C. That seems like a pretty clear force majeure situation: You’re a nonessential business, and the state has ordered you to close. Does it take force majeure off the table if you’re partially open, with severe occupancy restrictions, as with restaurants or theaters in states like Georgia or Texas?
MELLITS: I’ll give you a lawyerly answer. On the one hand, if a force majeure event has merely made it harder for you to perform, there is legal precedent to suggest that this may not be enough to qualify as force majeure. On the other hand, the concept of a partial force majeure, while weaker, could have merit. If you think about owning a restaurant that usually serves 100 dine-in guests, but the state says you can have no more than 20, how are you supposed to make money?
GOODMAN: So it’s case-by-case. You also mentioned other potential defenses, over and above force majeure.
MELLITS: Let’s say a tenant has agreed to a bad force majeure clause, one that stipulates that the tenant must continue to pay rent despite any force majeure event. There are two common-law defenses that the tenant could rely on. These are fundamental rubrics of contract law that you study in law school.
The first is called ‘frustration of purpose’: If you agree to sing at a concert hall that burns down before the performance, the principal purpose of that contract has been voided. Likewise, a retailer could argue that the principal purpose of the contract—occupancy in the space—has been frustrated by the pandemic and subsequent lockdowns.
Another principle is called ‘impossibility’ or sometimes ‘impracticability.’ This defense relates specifically to an inability to perform. A construction contractor could agree to build a steel building within a certain period of time, but then steel suddenly becomes completely unavailable in a way that is indisputable. When the contract was signed, there was a basic assumption of an intact steel market. That market is gone.
GOODMAN: And these defenses come up frequently?
MELLITS: Not as frequently as force majeure. Relying on these defenses can be difficult. They are fact-intensive and hinge on common law. In addition, courts in some jurisdictions have said that if you have a force majeure clause in the lease, then that’s the spot where the parties dealt with this issue, so claims of impossibility or frustration of purpose may be superseded. Nevertheless, these are legitimate defenses. In litigation, in particular, you may see them used as part of a ‘shotgun’ approach involving multiple strategies by the tenant’s attorney.
GOODMAN: Bart, this has really been enlightening. Thanks so much for the time. Anything else you’d like to add?
MELLITS: Just that what’s happening with business-interruption insurance is another important area to track. Initially, there were those who thought insurance companies would cover the costs—including rent—of interruptions caused by the pandemic. In fact, after the first SARS pandemic, many, many insurers included specific exclusions for pandemics in these policies. Insurance companies are also arguing that business-interruption insurance is about physical damage to the property—things like fires and floods. Universally, insurers have been rejecting business-interruption claims related to Covid-19.
Legislatures around the country are now weighing whether to force insurers to pay these claims. In Pennsylvania, two different bills are in play. Insurers are saying, ‘Hey government, how can you rewrite our contracts?’ They’re also arguing that the costs involved—I’ve seen estimates of up to $340 billion a month—would wipe out the insurance industry as we know it.
GOODMAN: Definitely important for both the landlords and tenants we represent. Maybe we can chat again when there’s more clarity on that issue. Thanks again, Bart.
MELLITS: Thanks, David. It was a pleasure.