In the initial months of the COVID-19 pandemic, many saw retail closures and strict social distancing guidelines as merely a storm to be weathered, rather than a long-term shift in the climate of retail. Now, five months after Governor Pritzker issued his first order closing all non-essential businesses, the impacts of COVID-19 are further reaching than some had anticipated.
Facing a potential long-term shift in retail, tenants have attempted to escape their contractual payment obligations by relying on force majeure provisions, co-tenancy covenants, and the common law doctrines of impossibility and frustration of purpose. This article will outline practical responses to those arguments and highlight key lease provisions and areas of common law that landlords can use in tenant disputes.
First things first: Reserve your rights
Once a tenant fails to pay rent, the landlord first must send all applicable notices and reserve its rights under the lease. Every lease defines failure to pay rent as a breach of the lease. But whether that breach ripens into a default depends on the particular lease’s terms. Many leases require the landlord to provide the tenant with written notice of failure to pay and offer an opportunity for the tenant to cure the breach.
The first time a tenant fails to pay the full amount of rent when it is due, a landlord should evaluate the terms of the retail lease and send any required written notice to the tenant with a demand for payment. A written demand for rent does not bind the landlord to a particular path toward resolution; rather, it provides the landlord the option to exercise one of its many remedies under the lease and the law.
If the tenant does not respond to the demand with full payment, the landlord often has several potential remedies under the lease. One common option is to terminate the tenant’s right to possession of the premises by suing to evict the tenant and recover damages for past due rent. Typically, this option does not terminate the lease, and the tenant will remain liable for monthly rent for the remainder of the lease term. But this option ultimately leaves the landlord with possession of the premises and all of the various duties and liabilities that accompany possession.
Another option is to terminate both the tenant’s right to possession of the property and the lease itself. In this case, the tenant is liable for rent accumulated prior to termination of the lease but it does not have a continuing obligation to pay rent. This option benefits the landlord when the retail market is booming, and the landlord can relet the premises at a higher rent rate.
A third option could be to forgo termination of possession and termination of the lease and proceed with a lawsuit for past due rent. This option may require the landlord to file multiple suits throughout the term for past due rent, but it also leaves the duties and liabilities associated with possession of the premises with the tenant.
It is important that landlords consult the language of the particular lease because not all of these options may be available under its terms.
Arguments raised by tenants under the lease, and possible landlord responses
The tenant may respond to an action brought by the landlord to enforce the terms of the lease with affirmative defenses or counterclaims against the landlord. In some Illinois state and federal courts, tenants have invoked force majeure and co-tenancy clauses in an attempt to shed rental obligations.
Force majeure clauses
Responding to the changing retail landscape and plummeting retail sales, certain tenants have proactively relied on force majeure clauses to avoid rental obligations under the lease. Force majeure clauses can excuse performance of obligations under the lease during the pendency of certain enumerated acts beyond the control of the landlord and tenant, including tornadoes, hurricanes and other acts of God. Significantly, some force majeure clauses also can excuse performance where government laws or mandates prohibit performance under the lease. In the wake of Governor Pritzker’s orders requiring closure of non-essential businesses, many retailers and restaurants have attempted to rely on such orders to excuse payment of rent under the lease.
Critically for landlords, force majeure clauses often expressly do not excuse performance of monetary obligations under the lease—in other words, rent remains due and payable. And courts may be willing to apply the clause to excuse or reduce rent payments, even where a lease could be read to require rent payments in the face of a force majeure event.
Recently, in In re Hitz Restaurant Group, 20 B 05012, a case currently pending in the U.S. Bankruptcy Court for the Northern District of Illinois, the court issued an opinion partially relieving a tenant from its post-petition rent obligations pursuant to a force majeure clause. The tenant in In Re Hitz argued that the force majeure clause was triggered by Governor Pritzker’s March 16 order which temporarily suspended service for businesses that offered food or beverages for on-premises consumption.
In that case, the force majeure clause read as follows:
“Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by … laws, governmental action or inaction, orders of government. … Lack of money shall not be grounds for Force Majeure.”
The court reasoned that Governor Pritzker’s order triggered the force majeure clause because it was a governmental action that hindered the tenant’s ability to perform by temporarily prohibiting on-premises food consumption. The court held that the Governor’s order was the proximate cause of the tenant’s inability to pay rent because it prevented the tenant from operating normally. But the court also reasoned that, because tenant could offer delivery services during the temporary prohibition of on-premises food consumption, the rent could not be abated entirely, so the court reduced the rent so that it was proportional to the tenant’s reduced sales.
Although In re Hitz is not controlling in Illinois courts, it does provide insight into how force majeure clauses might be interpreted by courts facing similar issues. Ultimately, sparse force majeure case law in Illinois will require courts to look to the language of the lease and the law related to contract interpretation when determining whether a force majeure clause can excuse monetary obligations. Landlords and their counsel therefore should carefully review their leases to determine whether a force majeure clause can be applied to payment of rent.
Some tenants have disputed rental obligations by reference to a lease’s co-tenancy clause, which can be triggered when occupancy of a particular retail complex drops below a designated level, or if certain anchor tenants vacate. These clauses reflect an understanding, documented in that lease, that the success of the retail complex is tied to the amount of foot traffic generated by having multiple, proximate stores. Once the clause is triggered, tenants may be entitled to pay reduced rent (usually a percentage of sales) until the shopping center’s tenant population recovers.
Certain tenants have argued that co-tenancy clauses were tripped by Governor Pritzker’s order closing non-essential retail businesses. While some co-tenancy clauses merely require the other retail spaces to be occupied, other clauses require the spaces to be both occupied and open for business. This issue becomes further nuanced during periods when retail stores are allowed to operate exclusively through curbside pickup or online orders. As referenced in the above discussion of In re Hitz, the court may take into consideration online or delivery services available to retail stores and restaurants when evaluating the duty to pay rent under the lease.
Concepts from the common law: Impossibility and frustration of purpose
Finally, some tenants have reached outside their leases’ language to the doctrines of impossibility and frustration of purpose in an attempt to avoid or abate rental obligations. The common law doctrine of impossibility excuses performance of a contract when performance is rendered impossible, either because the subject matter of the contract is destroyed or by operation of law. To the extent such impossibility is only temporary, the doctrine only temporarily suspends the contractual obligation. Notably, government regulations and orders can trigger the doctrine of impossibility.
The common law doctrine of frustration of purpose extends the doctrine of impossibility, to excuse performance when the purpose of the contract is frustrated, rather than rendered impossible; think of it as “impossibility light.” The doctrine allows for rescission of the contract if the frustrating event was not reasonably foreseeable and if it has destroyed the value of the contract. Some tenants have argued that government regulations prohibiting the operation of retail spaces frustrate the purpose of the retail lease, rendering it of little to no value to the tenant.
Recently, in the case of The Gap Inc. et al. v. Brookfield Properties Retail Inc. et al., 2020-CH-04984, currently pending in the Circuit Court of Cook County, retail tenants argued that the doctrine of impossibility excused rent obligations under their leases. In that case, various retail tenants filed a complaint against their landlords seeking a declaration that they did not have to pay rent during the time they were forced to suspend retail operations and demanding reimbursement for rent paid during that time. Additionally, the tenants seek judicial rescission, cancellation and termination of their leases as the purposes of those leases have been frustrated. The Gap Inc. could be the first in a long line of cases in Illinois where tenants rely on the doctrines of impossibility and frustration of purpose to avoid rent obligations.
In such disputes, landlords might point to the clear language of the lease requiring rental payments. Landlords may also elucidate certain general principles of the impossibility and frustration of purpose doctrines, namely that even severe economic hardship does not excuse performance of monetary obligations. Because the law recognizes value in the certainty of commercial contracts, proving impossibility is a heavy lift under Illinois law, and to avoid a contract by arguing frustration of purpose is no cake walk, either.
Ultimately, outcomes in tenant claims for rent abatement depend largely on the language in the lease. Landlords should carefully review their leases when deciding how to respond to tenant disputes. If the language of the lease is not favorable or unclear, other strong arguments can be found in general principles of contract law. Good advice from experienced counsel can be especially valuable.
About the authors
Todd Gale practices litigation at Dykema Gossett PLLC in Chicago. For more than 30 years, he has represented clients in complex commercial litigation, and represents a number of landlords in tenant disputes related to commercial, retail and restaurant space
Katie Welch is a litigation associate in Dykema’s Chicago office and member of the firm’s financial industry group and commercial mortgage-backed securities special servicer group. She specializes in the representation of banks, credit unions and special servicers in loan enforcement litigation and commercial foreclosure actions.