How to Respond to Rent and Loan Payment Obligations in Light of COVID-19

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How to Respond to Rent and Loan Payment Obligations

in Light of COVID-19

As the beginning of April inches closer and the uncertainty of how long shelter at home orders will remain in effect, businesses around the country are uncertain as to what lays ahead.

Public health authorities suggest it will be many more weeks, possibly months, before the emergency is lifted.

Many nonessential businesses cannot work remotely or, if they can, their production has slowed. For many that can operate and remain open, demand is significantly lower. Either way, most businesses are generating less revenue but still have many of the same monthly expenses. Everyone is evaluating cash flow and ways to economically weather this storm. In short, your contractual counterparty is facing the same issues as you.

Landlords and tenants as well as lenders and borrowers are no different. Tenants and borrowers who cannot meet their financial obligations are already reaching out to their counterparties, asking for financial relief. But, landlords and lenders, who also have their own financial obligations to meet, are suffering from the same economic fallout and many cannot shoulder their own economic burden, certainly not long-term. So, what can these parties do? While there is no one size fits all answer and every situation is unique, below we have provided some matters to consider and general steps to take in California.

Considerations for Landlords and Tenants

1. Determine your contractual rights and obligations. A review of the lease is the first place both landlords and tenants should start. The lease provides the contractual rights and obligations of each party and forms the framework for what may be done. Every lease contains its own unique set of issues for the parties to consider. The most talked about form of potential tenant relief is whether a force majeure provision in the lease may relieve the tenant of its rent payment obligation. But, the mere inclusion of a force majeure provision may not entitle tenants to such relief. There is the threshold question of whether COVID-19 events constitute a force majeure event under the terms of the lease. Some force majeure provisions contain express carve-outs for obligations that are not tolled or excused due to force majeure events (e.g., the obligation to pay rent or other monetary obligations). We discussed force majeure and other potential contractual rights in more detail in our contractual enforceability article last week, which we encourage you to read. Beyond a force majeure provision, landlords and tenants should also consider the other provisions in the lease to determine how shelter-in-place orders may affect other rights and obligations and claims and remedies that may be asserted.

2. Determine any time restrictions or notice requirements. The landlord and tenant should be sure to comply with any express notice requirements or time restrictions in the lease that may be required to enforce or preserve certain rights, remedies, and defenses, including force majeure. Additionally, many local authorities have issued ordinances that, under certain circumstances, limit a landlord’s right to evict a residential and/or commercial tenant for nonpayment of rent for a period of time and, in some circumstances, expressly provide that the failure to pay is not a default. However, some of these ordinances contain specified times by which a tenant must undertake specific actions to invoke this non-eviction protection. Any time and notice requirements that may affect a party’s strategic goals should be followed.

3. Evaluate your economic situation. While most businesses have been affected economically, not all parties have been affected to the same degree. Institutional landlords or national tenants may be able to comply with the terms of the lease – at least for a period of time – whereas smaller mom and pop operations may be at risk of going out of business if monetary obligations are not met. On the other hand, some large non-essential retail tenants are being hit harder than others that may be permitted to remain open by the shelter-at-home restrictions. Before reaching out to your counterparty consider your economic situation and what you really can and cannot do economically. Landlords may request and many of the local eviction protection ordinances require a tenant to demonstrate the inability to pay rent due to COVID-19 related issues. Therefore, a tenant that can pay rent or a portion of it likely will need to continue to do so or a landlord may be able to exercise its usual rights and remedies.

4. Negotiate a lease amendment. If a tenant has taken the above steps and requested rent relief from its landlord, the landlord must undertake the same analysis set forth above to determine both how it can proceed legally and what it is willing to do from a public perception and business relationship point of view. The relief, if any, agreed upon does not necessarily need to be an all or nothing proposition. Meeting somewhere in the middle may be negotiable, and we have seen numerous and creative rent relief structures negotiated between landlords and tenants. If some type of rent concession is agreed upon, the parties also need to consider whether, when, and how the rent should be paid and how to enforce that obligation. Parties should memorialize any agreed upon rent relief in a formal lease amendment. Parties may also want to consider including a confidentiality provision in any lease amendment, or even entering into a non-disclosure agreement prior to negotiating relief, with the goal of keeping discussions and agreements solely between the landlord and tenant.

Considerations for Lenders and Borrowers

1. Determine your rights and obligations. Not surprisingly, lenders and borrowers should also start by reviewing their rights and obligations under their loan documents and whether there are any contractual rights or restrictions that may apply in this situation. This includes any guaranties that may have been given and the rights and obligations under them. Most construction loans allow for certain delays on account of force majeure so such force majeure provisions should be analyzed to determine if the current situation can be deemed to qualify. Similarly, make sure you comply with any time or notice requirements set forth in the loan documents to trigger any contractual right or obligation.  

2. Consider the implications of foreclosure. As of the time of this writing, we are not aware of any prohibition on lenders enforcing their rights and remedies in the event of a failure to pay debt service by the borrower. But there are strong suggestions from various sources, including from industry organizations and in various local ordinances, that lenders should hold off. Many jurisdictions still are considering certain restrictions on foreclosures arising from non-payment, which may at some point impact the parties’ rights and obligations and almost certainly will require that a borrower demonstrate financial inability to meet monetary obligations due to COVID-19. For certain borrowers, Freddie Mac and Fannie Mae announced relief for borrowers impacted by COVID-19, including relief to multi-family apartment owners but only in exchange for an agreement not to evict financially impacted tenants. Lenders should consider how they will be perceived publicly based on the positions they take and the potential long-term effect.

3. Consider any milestones. Some loan agreements (e.g., with respect to construction loans) require that the borrower adhere to a construction schedule; failure to do so constitutes a breach. Further, the breach on account of such failure to complete construction in accordance with the approved schedule may also trigger a cessation in the disbursement of loan draws to a borrower, including draws to pay debt service and operating expenses, which leads to other defaults. Borrowers should determine what those milestones are and what steps can be taken to meet them.

4. Negotiate a loan modification or forbearance. Giving consideration to a borrower’s financial situation and its relationship with its lender and the type of lender (e.g., a CMBS lender needs to be treated very differently than a portfolio lender), a borrower may want to consider requesting a loan modification to extend certain milestones. Borrowers should be very careful when making requests to their lenders, such as any statements regarding a borrower’s ability to pay its obligations and debts, as certain disclosures could trigger full recourse liability under their respective loan documents. If the borrower simply fails to meet its obligations under the loan documents, the lender must determine whether to agree to a forbearance agreement, and whether it would be better than the time and expense to undertake a foreclosure process and make demand under the applicable guaranties. For example, has the borrower historically met its obligations, is it likely that the borrower will be able to resume loan payments after the forbearance period is over and is the loan adequately secured. Notably, Governor Newsom recently announced that many financial institutions in California have agreed to offer mortgage payment forbearances up to 90 days and to forgo commencing any new foreclosure sales for 60 days for homeowners, both subject to certain conditions being met. But, negotiated loan modifications and forbearance agreements can be structured in a variety of ways, including adjustments to or temporary suspensions of payments of interest and/or principal, a temporary reduction in the interest rate, or longer periods to complete construction and stabilize the project. Anything that is negotiated between the lender and the borrower that modifies the loan documents should be documented in writing and consented to by any guarantors.

The suggestions above are not exhaustive. Your contract, individual facts and circumstances, and the national, state and local laws must all be evaluated and considered for each of these situations. New laws are being passed regularly that affect the rights and obligations of these contractual relationships. You are encouraged to seek legal counsel whenever necessary.

Most importantly, remember we are all in this together.

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