Top Five COVID-19 Impacted Office Lease Provisions
The COVID-19 pandemic has forced changes on us at a rate that is unprecedented in our lifetimes. Social distancing is the new normal, along with other government-imposed requirements governing conduct and physical upgrades for public and private spaces to help mitigate spread of the virus. With the recent surge in COVID-19 cases across the country, it is now apparent that these effects will continue to be with us far longer than most people imagined, and commercial office space owners have had to respond accordingly.
While the impacts of COVID-19 have been particularly devastating on the retail sector, principally due to mandatory closures of a variety of retail operations, restaurants, health clubs and the like, office space has also been impacted, and many office building tenants are looking to their landlords for rent abatement and other forms of rent relief. As a result, office building landlords and tenants have been examining their respective rights and obligations under their existing lease provisions. Though the full impact of COVID-19 (and resulting governmental requirements) on office landlords and tenants is not known yet, it is worthwhile to review some key office lease provisions in an effort to minimize negative and unforeseen impacts. The following are some of these typical commercial office lease form provisions that landlords may want to revisit in light of COVID-19.
Operating expenses are the costs incurred by a landlord for the operation, management, maintenance and repair of a commercial office building, which tenants typically reimburse through the payment of additional rent. Since many landlords have incurred, or are anticipating incurring, substantial costs in implementing operational and physical upgrades (including capital improvements) at their buildings in order to comply with governmental requirements and public health and safety recommendations due to COVID-19, those landlords will want to be able to include those costs in operating expenses if possible. However, office leases typically place restrictions on what can be included in operating expenses, especially when it comes to capital improvements. Although many office leases provide landlords with rights to pass through the cost of capital improvements if made to comply with new laws or to reduce other operating expenses, those rights might not be broad enough to encompass COVID-19-related capital improvement costs. Landlords may want to consider adding an express right to include in operating expenses all of the costs (including capital expenditures) that the landlord incurs in connection with the safety and/or security of the building, including any operational and physical modifications made to implement public health and safety recommendations or other best practice protocols.
Many office leases use a “base year” structure where tenants only pay those operating expenses that are in excess of the operating expenses that are incurred in, typically, the calendar year in which the lease commences. Since most leases place all operating expenses into a single, combined pool of expenses, one common concern of landlords is that in any given year after the base year, increases in some costs (such as, for example, insurance or utilities) that would otherwise be payable by the tenants could be offset by decreases in other costs, especially decreases attributable to one-time costs incurred only in the base year or otherwise not recurring every year after the base year. In such a case, a tenant may underpay its fair share of the increases in the operating expenses that were actually incurred in years following the base year. If significant one-time costs (including for capital improvements and operational protocols) are made or anticipated for a base year for operational and physical modifications in response to the pandemic, then to reduce the impact of potentially inflated base year operating expenses, landlords should consider endeavoring to exclude one-time or non-recurring costs incurred in the base year from the calculation of base year operating expenses. Specifically, landlords may want to expressly exclude from the base year all one-time costs, including capital expenditures, incurred in connection with the safety or security of the building, including any operational and physical modifications made to implement public health and safety recommendations and best practice protocols.
Force majeure is a concept that many people have become familiar with over the last few months. Prior to COVID-19, the concept of force majeure was often viewed as a “boilerplate” provision that did not receive much, if any, scrutiny during lease negotiations. With many tenants now looking to the force majeure provisions of the lease, among other provisions, as potential grounds to excuse their obligation to pay rent due to COVID-19 impacts, landlords have been pressed to revisit their force majeure provision to see if they may be construed to potentially excuse delays in performance caused by COVID-19 interruptions, including excusing the payment of rent by the tenant. While it will be rare for pre-COVID‑19 force majeure provisions to specifically address viral pandemics, some might refer to “governmental actions”, or “other causes beyond the reasonable control of the party obligated to perform”, and either of these definitions could arguably be applied to the current COVID-19 situation to excuse performance by either a landlord or a tenant. However, since courts tend to construe force majeure provisions narrowly, landlords may want to add a specific reference to epidemics and pandemics, including delays resulting from related government-mandated shutdowns, closures, and shelter-in-place orders. And although most commercial lease force majeure provisions will not excuse a tenant’s obligation to pay rent, revising force majeure provisions to address these events still will be of particular value for landlords in connection with their non-monetary lease obligations, including leases that have landlord construction and/or delivery obligations that have been delayed by COVID-19 events.
Typical Office Lease Rent Abatement Provisions
Most office leases contain provisions that permit a tenant to abate some or all of its rent obligations in the event of certain specified events, most often relating to casualty/destruction and condemnation, and less often relating a landlord’s failure to provide specified services or access to a tenant’s premises. In response to the pandemic, tenants have been looking at these lease provisions to see if they might also provide some form of rent relief. Landlords should review these provisions in their lease forms to ensure they do not inadvertently provide a tenant with an abatement right due to COVID-19.
One provision that a tenant might view as potentially providing rent abatement is the casualty provision typically found in office leases. Casualty provisions usually only apply where the physical structure of a premises has been damaged, but a tenant might argue that COVID-19 contamination constitutes physical damage, or that the closure of the premises or building constitutes a casualty. In order to avoid this interpretation, landlords may want to expressly provide that a “casualty” requires damage to the physical structure of the premises and/or building, and to provide that the mere closure of the premises and/or building does not result in a “casualty”.
Another such provision is the condemnation/eminent domain provision typically found in office leases. Landlords may want to expressly state that “condemnation” does not include a closure of the premises or building in order to comply with governmental orders or public health and safety recommendations.
Finally, some leases allow a tenant to abate rent in the event the tenant cannot use some or all of its premises due to a failure by the landlord to provide some required service or access to the premises. Most of these provisions only allow rent abatement if the lack of service or access is due to the fault of the landlord, and many office buildings remain open even if tenants are not in occupancy, in part, to help avoid an interpretation that the landlord is not providing services or access. However, since some of these provisions are drafted broadly, landlords should review them to be sure that they are not triggered by governmentally required shutdowns or actions taken by a landlord in implementing operational and physical upgrades at its building to address public health and safety recommendations.
Rules and Regulations
Commercial office leases generally contain a list of rules and regulations affecting day-to-day operations and procedures. Most office leases will allow the landlord to make reasonable modification to those rules and regulations. Landlords should consider implementing rules and regulations intended to limit the spread of COVID-19, and to supplement and/or reinforce any physical and operational modifications made, or that landlords may make in the future, to the building in order to comply with governmental requirements and any applicable public health and safety recommendations and best practices protocols.
Please keep an eye out for future articles addressing other office lease provisions impacted by COVID-19 and related governmental requirements and orders. In the meantime, if you have any questions about implementing the changes referenced above to your lease form, or any other questions relating to office leasing and operations in this COVID-19 era, please contact us.