The Impact of COVID-19 on Commercial Real Estate
The Coronavirus and the State of Emergency
On March 10, 2020, the Michigan Department of Health and Human Services identified the first two presumptive cases of coronavirus, also known as COVID-19, in the State of Michigan. On March 16, 2020 Governor Whitmer signed Executive Order 2020-9 which closed restaurants, bars, cigar lounges, movie theaters, casinos, libraries, and gyms from the public. On March 23, 2020, Governor Whitmer signed Executive Order 2020-21 which imposed a temporary stay-at-home order for non-essential matters, which was later extended and expanded through Executive Orders 2020-42, 2020-59, 2020-70, 2020-77, and 2020-92, and is currently in effect for the majority of the State through at least May 28, 2020.
Moratorium on Certain Foreclosures and Evictions
In response to the coronavirus pandemic, Congress enacted the “Coronavirus Aid, Relief, and Economic Security Act,” also known as the CARES Act, which provides financial relief for many businesses and homeowners. Under the CARES Act, homeowners with government-backed mortgage, including Fannie Mae, Freddie Mac, FHA, VA, and USDA, may temporarily suspend mortgage payments if they are experiencing financial difficulties because of the coronavirus. Homeowners must contact their mortgage lenders to take advantage of this program and the forbearance period is up to 180 days, with the ability to request an extension of up to an additional 180 days. See 15 U.S.C. § 9056. The CARES Act also provides that “a servicer of a Federally backed mortgage loan may not initiate any judicial or non-judicial foreclosure process, move for a foreclosure judgment or order of sale, or execute a foreclosure-related eviction or foreclosure sale for not less than the 60-day period beginning on March 18, 2020.” See 15 U.S.C. § 9056. This program does not apply to commercial properties.
With respect to Michigan specifically, Governor Whitmer signed Executive Orders 2020-19, 2020-54, and 2020-85 which prevent residential landlords and land contract vendors (sellers) from evicting tenants and land contract vendees (purchasers) from residential properties and mobile homes unless the tenant/vendee: “poses a substantial risk to another person or an imminent and severe risk to property.” Under Executive Order 2020-54, tenants are not relieved of their obligation to pay rent, but landlords are temporarily prohibited from commencing eviction actions. The most recent Executive Order 2020-85 will remain in effect through June 11, 2019. Similarly, this moratorium does not apply to commercial properties.
Evictions During and After the Pandemic
In light of the fact that many businesses have been closed for several months, there have been devastating effects on the State’s economy and it is expected that there will be a large number of evictions once the stay at home order is lifted. There are several common provisions commonly included in commercial leases that impact the eviction process, including one-sided attorney fee provisions, waiver of jury trial provisions, waivers of affirmative defenses, mitigation of damages provisions, and certain requirements for security deposits. Prior to beginning an eviction action, the applicable lease agreement, and any amendments or addendums, must be carefully reviewed.
Under Michigan law, “A landlord is not permitted to forfeit a lease and reenter the premises upon breach of a covenant by the tenant absent a condition in the lease giving him such a right.” United Coin Meter Co v Lasala, 98 Mich App 238, 242; 296 NW2d 221 (1980). Although the provisions of a lease may give landlords certain additional or more limited rights, the Michigan Summary Proceedings Act gives landlords certain basic rights and remedies. After an eviction, a landlord may not necessarily have the right to recover future unpaid rent. The Michigan Supreme Court has held:
If the right to the occupancy of the land is terminated by the act of the landlord in evicting the tenant, the obligation to pay rent ceases. … It follows that an action by the landlord cannot be maintained for rent after eviction, but it does not necessarily follow that parties may not by their contracts obligate themselves in such a manner as that an action technically upon the covenant to pay rent may not survive the re-entry. There is nothing unlawful about such contracts, and the courts have quite uniformly enforced such provisions.
Stott Realty Co v United Amusement Co, 195 Mich 684, 690; 162 NW 283 (1917). Assuming the applicable lease agreement contains the required provisions allowing a landlord to recover post-eviction rent from the tenant, “The general measure of damages applied where an agreement to lease is breached by the prospective lessee is the excess of the agreed rent over the rental value of the property, or the rent plaintiff could obtain for the property through reasonable diligence.” Tel-Ex Plaza, Inc v Hardees Restaurants, Inc, 76 Mich App 131, 134; 255 NW2d 794 (1977). Moreover, “in Michigan, a lessor is obligated to mitigate damages.” Jefferson Dev Co v Heritage Cleaners, 109 Mich App 606, 612; 311 NW2d 426 (1981). See also Froling v Bischoff, 73 Mich App 496; 252 NW2d 832 (1977).
Options for Landlords
Just as landlords expect and rely on their tenants to pay rent on time, mortgage lenders are expecting and relying on landlords to continue making their monthly mortgage payments on time. The best advice for landlords at this time is to maintain communication with all interested parties. Landlords who have been impacted by the coronavirus should reach out to their tenants to get an understanding of who intends to pay rent. Commercial landlords should be proactive in evaluating the financial condition of each of their tenants for the next 3-6 months to ensure sufficient cash flow to meet all necessary operating expenses and debt servicing.
Landlords may want to consider negotiating deals with historically strong tenants that are struggling to pay rent at the moment. In certain cases, landlords may consider a short-term reduction in rent in exchange for an extended lease term and/or additional guarantors. Before making any deals, landlords should request and review financial documents and business plans from these tenants to adequately assess each tenant’s financial condition and ability to survive the pandemic. Landlords should also require regular financial reporting from these tenants to quickly determine if a tenant is at risk of defaulting. Any agreement that is reached with a tenant will also need to be in writing and signed by both parties, as this is a standard provision in virtually every lease agreement.
If a landlord has tenants that have already permanently closed, one option to consider is negotiating a “cash for keys” deal or another type of agreement to regain immediate possession of the property without incurring legal fees. This is particularly beneficial if a tenant and any guarantors have filed for bankruptcy and/or may be uncollectible. A tenant’s security deposit can be an important negotiating chip in ensuring that a landlord obtains quick possession to the premises, as well as ensuring that the property is not damaged and can be quickly leased. These agreements should also be in the form of written lease termination and release agreements and must be carefully reviewed. In certain cases, the landlord may be required by its mortgage lender to obtain the lender’s consent prior to any lease being modified.
If no agreement can be reached with a tenant who has defaulted, landlords should be prepared to take immediate legal action to recover the premises. Landlords should begin organizing and compiling all necessary documents, including copies of all signed leases, addendums, amendments, personal guarantees, security agreements, and records/ledgers of all payments. Although there is currently no moratorium on commercial evictions, many courts are currently closed and/or only hearing emergency matters for the time being. If a tenant is causing damage to a property, this may rise to the level of an emergency which could potentially warrant immediate legal action.
Once a landlord has spoken to its tenants and can anticipate future rents for at least the next few months, landlords should consider reaching out to their mortgage lenders. If a landlord seeks a forbearance or loan modification agreement, many lenders require additional security and/or guarantees. In certain cases, lenders may seek other assets as collateral and/or additional personal guarantors. The importance of negotiating a personal guaranty cannot be understated and having a positive relationship with your lenders to discuss possible forbearance requests and/or loan modifications could make the difference between retaining a property and losing it.
In certain extreme circumstances, if a landlord is already underwater on a property and there is no personal guaranty, or a limited guaranty which has expired, walking away from an investment, and giving a deed in lieu of foreclosure may be an option worth considering. A landlord should be sure to negotiate a release of any personal liability in such a transaction.
Finally, landlords and property managers who operate properties with heavily trafficked common areas should ensure that proactive measures are taken to either close or limit the use of non-essential common areas and/or ensuring sure that proper cleaning and sanitation is being performed. Landlords and management companies should be careful to ensure compliance with all applicable laws, ordinances, and executive/administrative orders relating to the pandemic as there could be potential liability related to improper cleaning/sanitation or a violation of an applicable law/regulation if someone becomes infected with the virus. These claims would likely be brought as negligence or breach of contract claims, and may not be covered by insurance.
Options for Tenants
Tenants who are struggling as a result of the coronavirus are also encouraged to reach out to their landlords and try to work out a deal. Tenants could offer to sign a longer lease in exchange for a short term reduction in rent or a short term rent forbearance agreement. Although not ideal, a tenant may consider offering a partial or extended personal guaranty, or other form of security, in exchange for obtaining a temporary rent forbearance or reduction. Tenants should also keep in mind that a landlord can only renegotiate rents to a certain point before a property becomes a negative cash-flow asset. In addition, landlords may not be able to unilaterally modify lease agreements without obtaining the lender’s consent.
Many landlords and tenants have already sought assistance from the Small Business Administration’s Paycheck Protection Program and Economic Injury Disaster Loan and Loan Advance. Unfortunately, the funds available for both of these programs were exhausted almost immediately before many business owners were able to obtain relief. For businesses that are suffering due to the pandemic, one additional option to consider is any potential insurance coverage. Since tenants and landlords are almost always required to carry insurance for the property, in certain cases, insurance may include coverage for “business interruption” which could potentially be triggered by the COVID-19 pandemic. Any insurance policy being carried by a tenant or a landlord that has been impacted by the coronavirus should be reviewed to determine if coverage may exist. It may also be worth considering putting an insurance carrier on notice of a potential claim in the event that legislation is passed that requires coverage.
If a tenant cannot reach an agreement with its landlord, and the tenant wants to remain in business, there are various legal arguments that could be raised as a result of the pandemic. One of the most anticipated arguments is expected to be force majeure, which is a provision included in many contracts that excuses a party’s performance as a result of causes beyond such party’s control. Another potential legal argument could be the doctrine of frustration of purpose which is when, “a change in circumstances makes one party’s performance virtually worthless to the other, frustrating his purpose in making the contract.” City of Flint v Chrisdom Props, Ltd, 283 Mich App 494, 499; 770 NW2d 888 (2009). Arguments such as impossibility and impracticability could be used when “the promised performance was at the making of the contract, or thereafter became, impracticable owing to some extreme or unreasonable difficulty, expense, injury, or loss involved, rather than that it is scientifically or actually impossible.” Although the viability of these arguments due to the coronavirus are currently untested, it is likely that there will be a large volume of litigation concerning these doctrines once the courts re-open.
Finally, it is also important to carefully review the lease terms to determine if a defense could be raised based on the landlord’s first or prior material breach of the lease. Depending on how certain provisions are drafted, such as those guaranteeing tenants the right of quiet enjoyment to the leased premises, and those strictly defining the permitted uses of the leased premises, tenants could potentially make arguments that their performance under the lease (i.e., payment) is excused due to the landlord’s prior material breach.
Regardless of whether you are a landlord or a tenant, communication is key. Since almost everyone is going to be struggling during this time, keeping constant communication, and working cooperatively gives all parties the best chance of staying in business. There are various options for landlords and tenants to discuss and negotiate, but the specifics of each lease agreement and mortgage loan agreement must be reviewed in order to ensure that all agreements are appropriately entered into. If you are a lender, a landlord, or a tenant and would like to discuss your options for any legal issues related to commercial real estate, please feel free to reach out to Hirzel Law, PLC for a free consultation.
Brandan A. Hallaq is an attorney with Hirzel Law, PLC where he dedicates the majority of his practice to representing condominium associations and homeowners associations. He litigates cases involving construction defects, contract disputes, shareholder/member disputes, quiet title actions to determine interests in property, enforcement of restrictive covenants, real estate foreclosure actions, and bankruptcy matters representing creditors. He also has experience preparing documents for business and real estate transactions including purchase agreements, franchise agreements, loan/financing documents and commercial and residential leases and mortgages. In each year from 2018 through 2020, he has been recognized as a Rising Star in the area of real estate law by Super Lawyers Magazine, a designation that is given to no more than 2.5% of the attorneys in the State of Michigan each year. Mr. Hallaq obtained his Juris Doctor degree, cum laude, from Wayne State University Law School where he served as an editor on the Wayne Law Review. He can be reached at (248) 478-1800 or at [email protected].