Two Critical Factors Are Emerging in Apparently Conflicting New York Decisions on Commercial Tenants’ Lease Liability During the COVID Pandemic …

Two Critical Factors Are Emerging in Apparently Conflicting New York Decisions on Commercial Tenants’ Lease Liability During the COVID Pandemic:  The Importance of Specific Lease Terms and the Importance of Tenants’ Alternate or Partial Use of Space During Government Restrictions

From the Desk of Cassandra Porsch …

The litigation between commercial tenants and landlords over tenant obligations to pay rent during COVID shutdowns and restrictions continues unabated.  Three recent decisions involving retail commercial tenants add to the landscape of case law illuminating the rights and obligations of the parties in the COVID pandemic context.  An emerging trend may be gleaned from the three cases discussed here:  (i) tenant claims for relief may have traction if they are not burdened by a specific adverse lease clause and are seeking relief for a period when they were totally deprived of the use of their space; while (ii) various specific lease clauses protecting the landlord in situations generally like this pandemic or partial use of leased premises may be an obstacle for tenants with that problematic baggage.

In one recent case, the Kings County Supreme Court found that a Brooklyn baby shop was excused from paying its rent arrears due to the doctrine of impossibility of performance.  In 267 Development LLC v. Brooklyn Babies and Toddlers, LLC, et al., No. 510160/2020 (Sup. Ct. Kings Co.), the Court found that the government shut down of non-essential businesses rendered the lease objectively impossible ― the subject of the lease was “destroyed.”  The Court analogized the situation to an impossibility of performance case arising out of the September 11, 2001 terror attacks, where a travel contract was deemed to be rendered impossible due to travel shutdowns.

Notably, unlike the facts in the two other cases discussed here, there was no mention of any sort of ongoing partial use of the leased premises such as curbside pick-up or shopping by appointment.  Accordingly, it may have been easier for the Court to find that the subject matter of the lease agreement was “destroyed,” one of the elements in conducting an impossibility of performance analysis, than it would be where some use persisted.

This case represents a significant win and an expansion of the tenant arsenal in this sphere of litigation.

In The Gap, Inc. v. Ponte Gadea New York LLC, 20-cv-4541 (S.D.N.Y.), the Gap and its landlord cross-moved for summary judgment against one another, with the Gap trying to vitiate its lease and the landlord trying to enforce it.  The Gap had operated a Gap and Banana Republic store on the corner of 59th and Lexington Avenue for many years.  The Gap argued that the pandemic had deprived it of the benefit of the bargain to which it was entitled under the lease: a location in the center of a heavily foot-trafficked business district just above the intersection of several subway lines.  With the pandemic, shut down orders, and then only a small fraction of Manhattan office workers and tourists returning once restrictions were relaxed, Gap argued that the lease should be deemed terminated as of March 2020 when the government first shut down non-essential businesses.  During the state’s phased re-opening, the Gap did not re-open those two stores to shopping, despite re-opening other nearby stores.

The Gap tried several approaches to abandon its lease, none of which were successful with the Court.  First, the Gap argued that the pandemic constituted a “casualty,” which would mitigate its lease obligations while the landlord was required to remediate the casualty conditions.  The Court rejected this argument because the relevant term of the lease was titled “Fire or other casualty,” and the section “described in detail restoration obligations in the event of a casualty, making it clear that it referred to singular incidents having a physical impact on the premises, such as a fire.”  The Court noted that there was no way the landlord could do “restoration work that would eliminate the pandemic of alter government restrictions on operations.”

The Gap also argued that it should be excused from its lease obligations under the now-familiar doctrines of frustration of purpose and impossibility of performance.  The Court rejected the frustration of purpose argument because it required that the purpose of the lease be “completely” frustrated, not simply that the transaction was not as profitable for the affected party or even that the party would sustain a loss.  The Court also noted that, contrary to the Gap’s arguments that it could no longer use its premises during the shut down and then restricted reopening, it did use the stores to offer curbside pick up as well as for online order fulfillment.

Similarly, the Court denied relief on the doctrine of impossibility of performance on which 267 Development was decided for a tenant.  The Court held that this doctrine requires a lack of foreseeability of the circumstances causing the impossibility.  The Court then noted that lease contained a force majeure provision which specifically foresaw and allocated the risk that government measures taken in conjunction with a public emergency could affect performance.  Finally, the Court found that the Gap was not entitled to lease rescission for failure of consideration, remarking that the retailer did continue to receive value under the lease — space to house its merchandise and process online fulfillment and in-store pickup — so it could not be said that it was receiving no value for its rent.

On the luxury end of the retail spectrum, Valentino made similar arguments in a complaint seeking declaratory relief in an attempt to be released from the terms of its lease for a prime location on 5th Avenue, for which it was paying approximately $19 million per year in rent.  In Valentino USA Inc. v. 693 Fifth Owner LLC, No. 652605/2020 (Sup Ct. N.Y. Co.), Valentino sought relief from its lease on familiar grounds of impossibility of performance, frustration of purpose and failure of consideration.  In a short decision, the Court dismissed the complaint based upon documentary evidence and failure to state a claim.

This Court found that the specific language of the lease between the parties foreclosed Valentino’s arguments because it contained a provision specifically stating that cataclysmic events or restrictive governmental laws or regulations would not excuse the payment of rent.  Perhaps recognizing the limitations of its more traditional arguments in light of this very restrictive lease provision, Valentino also tried a more novel argument of constructive eviction.

The doctrine of constructive eviction excuses a tenant from its lease where the landlord has caused a disturbance rendering the premises uninhabitable and unsuitable for the purposes for which they were leased.  Here, the Court found this doctrine inapplicable because there was no wrongful act by the landlord (as opposed to a pandemic and government restrictions) depriving Valentino of the beneficial enjoyment or actual possession of the premises.  Further, a tenant arguing constructive eviction must plead that they actually vacated the premises.  While Valentino ultimately did vacate, the Court noted that it continued to operate by curbside retail and by appointment for several months beforehand.

These two cases indicate that both the Gap and Valentino may have been disadvantaged in their arguments due to restrictive lease terms, and were also hamstrung in attempting to seek total rent relief when they did utilize the premises in at least some manner.

Overall, it appears that the ability of a commercial tenant to obtain rent relief for COVID-related shutdowns or restrictions may come down to the presence or absence of (i) a specific lease term that at least comes close to speaking directly to the pandemic scenario and (ii) the tenant’s ability to use the leased premises in any way during the relevant time periods.  Tenants seeking rent relief should consult with an experienced commercial litigator to evaluate their circumstances.

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