COVID and the Real Estate Market
Houston — March 20, 2020 As the novel coronavirus (“COVID-19”) continues its rapid spread throughout the world, the real estate industry is not immune. Below is some brief insight into the impact we’re seeing COVID-19 have on real estate.
Force Majeure
The effects of COVID-19 are beginning to be felt in the real estate industry and the term “force majeure” is on the tip of everyone’s tongue. The force majeure clause allows a party to a contract to get out of certain obligations due to unforeseen events. In order for a purchaser or tenant to seek the benefits of the force majeure clause, a contract must first contain one. Depending on how a contract’s force majeure provision has been drafted, COVID-19 may or may not be an event that provides a defense to performance under the contract. For new contracts and leases, it is advisable to specifically reference COVID-19 or pandemics in the force majeure provision in anticipation of delays in performance.
Delayed Closings
Federally mandated quarantines are preventing clients from timely reaching the closing table or from providing the opposite party with contract deliverables. In addition, purchasers may be questioning whether they can still obtain financing in the current market environment. As a result of the foregoing, amendments to extend feasibility periods and closing dates may be necessary.
Property Management
As we adjust to social distancing and elbow bumps, owners and property managers will be tasked with enacting and enforcing new policies and guidelines that are in alignment with the new government directives being issued to stem the spread of COVID-19. As such policies and procedures are put into place, owners and managers must consider the implications of employment laws and the terms of current leases. Owners and managers should also consider how they will respond in the event of exposure within the building, being mindful of lease confidentiality provisions and individual privacy.
Construction Delays
The inability to timely complete construction due to labor and supply shortages may excuse performance under a contract. The longer the COVID-19 outbreak lasts, the more strain we are likely to see put on our construction industry, which will ultimately result in fewer developments and build-outs being completed in accordance with their current contractual timelines. Even if a contract does not contain a force majeure provision, there are several principles that may be applied to avoid the contract’s requirements when performance is made impracticable. Under this doctrine of commercial impracticability (also referred to as the doctrine as “frustration of purpose” or “impossibility of performance”), the performance of obligations under a contract is excused when a party’s performance is made impracticable, without its fault, by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made.
MAC Clauses
COVID-19 will also have purchasers reviewing their contracts for a material adverse change (MAC) provision. In the same vein as force majeure, MAC clauses may be utilized by a purchaser to avoid closing on a transaction. MAC clauses generally are expressed either as (1) a closing condition that enables a purchaser in a purchase and sale agreement to terminate the contract if there is some MAC between the trigger date (typically the date of signing of the agreement or expiration of the due diligence period) and the closing date, or (2) a seller representation that as of the closing date no such MAC has occurred between the trigger date and closing date. Whether COVID-19 and its effects fall into the definition of a material adverse change is likely to be a hotly debated topic and potentially litigated.
Insurance
Tenants forced to shut down their business during the COVID-19 outbreak should review their commercial lease and its insurance requirements. Owners and tenants of restaurant spaces should pay close attention to their lease’s insurance coverage requirements. Policy-holders should review all existing insurance policies and work with their insurance broker or claims consultant to determine if coverage is available. In the event that a tenant does have applicable insurance coverage, delays in collecting funds should be expected based upon anticipated increases in time for processing claims. Most business interruptions policies exclude viruses as a coverage triggering event and are likely to require that the loss of business income stem from physical damage to the property. There are other policies on the market (e.g. policies covering loss caused by a notifiable infectious disease) which may help; however, it will depend on whether a landlord has taken out such a policy and the scope of its terms (including any exclusions).
Rent Implications
As owners seek to ensure the cleanliness of their buildings, they may seek to pass through such costs to tenants. The terms of the lease should be reviewed as the language of each lease differs and the specific terms will determine whether such additional landlord expenses can be charged back to a tenant. While some leases may include a hard cap on the amount of expenses that a tenant is responsible for, other may have a “reasonableness” qualification. Tenants whose businesses have been shuttered may seek to withhold rent payments; however, most leases will not permit suspensions of rent due to the loss of revenue. However, a tenant may be entitled to suspend its rent if it cannot access the leased premises or the landlord is not complying with all laws to ensure the premises is safe and in compliance with any new COVID-19 legislation.
For more information please contact Jack Turano.
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