The pandemic has changed our world in many ways. Commercial tenancies are not immune from its effects and both commercial landlords and commercial tenants are now wrestling with its consequences.
In the COVID era, perhaps more than ever before affected commercial tenants may be at increased risk of losing their leased premises due to plummeting market conditions in many business areas brought about by the pandemic. Restaurant businesses are prime, although non-exclusive, examples. As there is no legal moratorium on commercial evictions, these days countless commercial tenancies end through eviction or the tenant’s voluntary surrender of the property to the landlord. Commercial landlords, on the other hand, understandably have tax and carrying expense obligations, often including mortgages, and they too must act to protect their investments.
While eviction is a serious enough consequence, the pain inflicted on a commercial tenant that had just lost its space may extend well beyond eviction. The landlord can then also sue for unpaid back rent as well as accelerated future rent If there was any appreciable term left on the lease. The situation is even direr for principals of the commercial tenant who may have personally guaranteed all lease obligations to the landlord. In such cases, both the commercial tenant, typically a corporation or limited liability company, as well as the personal guarantor of the tenant’s lease obligations will be named in the lawsuit as co-defendants. Any judgment recovered by the landlord is likely to be against both defendants, who are jointly and severally liable for the judgment debt. A judgment entered in state court eventually becomes a lien on all real property owned by either defendant.
In the face of such significant exposure, tenants and their personal guarantors faced with the prospect of a lawsuit eviction have several avenues of potential action and defense. First, when faced with the possibility of defending a lawsuit for unpaid rent, they should carefully examine their written leases to determine if “impossibility of performance”, “impracticability of performance”, “Act of God”, “natural disaster” or other similar language may afford them a viable defense due to the pandemic. Depending on the jurisdiction the premises are located, some of these clauses may provide solid defenses. California, for example, is a good example of a jurisdiction that interprets “impossibility of performance” very liberally, to equate essentially to “impracticability”. Nevertheless, few, if any, landlord-drafted leased contain such clauses in favor of the commercial tenant. In fact, most lease agreements, especially those that had not been negotiated with the tenant’s active participation through an attorney, are all too often totally protective of the landlord’s interests to the detriment of the tenant.
As touched upon above, assuming the lease itself does not provide a commercial tenant a contractual defense to an action to recover all unpaid rent due under the lease, including future accelerated rent, the commercial tenant may not only be evicted but may also face the possibility of having to defend an action by the landlord to recover the entire balance of the unpaid rent through the end of the lease term. This is because, on default, most leases contain an acceleration clause, pursuant to which all remaining future rent becomes immediately due and payable. Inasmuch as the end of the term could be years from the date on which the tenant vacates the premises, the tenant may well face the dire prospect of being saddled with a judgment for hundreds of thousands of dollars or even millions.
By way of an example, let us assume the lease is for a ten-year term. The tenant was forced out of business by the pandemic during the first year, and nine years are left on the lease. The yearly rent is $100,000.00. In its action to collect unpaid rent, the Landlord may demand a whopping $900,000.00, plus attorney’s fees and court costs, typically permitted under the lease. The situation becomes even graver for the tenant’s principal if he or she personally guaranteed the rent obligation unconditionally, as is quite often the case.
In residential lease cases, the law has always been that the landlord has a duty to mitigate its damages. In other words, the landlord may not simply sue to recover the monetary equivalent of the entire balance of unpaid rent through the end of the lease term. Instead, the Landlord was always deemed to have an affirmative obligation to mitigate or lessen, its damages by exercising all reasonable efforts to re-lease the premises. The former tenant would only be responsible to the landlord for the difference in any rent proceeds between the sums called for in the original lease, and the presumably lesser amounts received from the new tenant.
The issue of whether commercial tenancies are subject to the same mitigation of damage rule has been answered affirmatively in Fanarjian v. Moskowitz, 237 N.J. Super. 395 (App. Div. 1989). As such, in New Jersey:
…Reason and logic, as well as public policy, support the extension of the mitigation of damage requirements to commercial lease settings. Such policy considerations include denying the injured party the opportunity to sit idly by and exacerbate damages; discouraging economic and physical waste; and society’s interest in encouraging that vacant property to be put to practical use as soon as possible.
To protect their own interests, commercial landlords therefore assiduously exert all reasonable efforts to re-lease the vacated premises. Engaging one or more commercial brokers and ensuring the space is advertised appropriately at a reasonable, current market price will go a long way to satisfying the landlord’s legal duty to mitigate damages.
Occasionally, there may be language in the commercial lease agreement that parallels the mitigation of damages rule implied by law. In such cases, that language may be dispositive of the issues and should be carefully studied and exploited to the client’s advantage.
Because freedom of contract permits the parties to deviate from obligation the law otherwise implies, so long as the deviation is not deemed unconscionable or in violation of public policy, Landlords too can, and often do, try to minimize the mitigation rule, in their favor.
Another option that must be always considered is strategic and timely negotiation with the landlord. On a case-by-case basis, settlement of difficult cases may prove advantageous to all parties involved in the transaction. The advice of an experienced commercial litigator should prove invaluable in such cases as well for commercial landlords and commercial tenants alike.