This article appeared in Commercial Leasing Law & Strategy, your monthly source for practical, must-have information on the business and legal aspects of commercial leases.

Under the current circumstances, with most businesses required to be closed, the question arises as to what a commercial tenant's obligations are under the lease for its premises, most particularly with respect to rent. Can the tenant be relieved of, or does it have a defense to, the obligation to continue to pay rent? The short answer is possibly yes, but the situation is unprecedented and the answer may have to be determined in litigation.

Force Majeure

With respect to the specific language in leases, the terms force majeure and "Acts of God" appear frequently in articles, newsletters and other publications as more and more businesses are looking for ways to freeze performance under their lease or perhaps terminate the lease altogether. A force majeure clause, which typically includes a reference to "Acts of God," is one that permits a party to a contract to be relieved from performing under that contract during a time when, due to some event outside of its reasonable control, the party's ability to perform is impeded, hindered or prevented. Generally speaking, the event must be one that can be neither anticipated nor controlled that may arise from acts of nature (e.g., floods, hurricanes) or of people (e.g., riots, strikes, war). There is a high bar for the invocation of a force majeure clause and whether or not it will apply will depend on the exact language of the lease and the law of the jurisdiction set forth in the lease. In the context of a commercial lease, if the lease contains a force majeure clause that specifically relieves performance in the event of a pandemic or similar event, a tenant may be permitted to close and stop paying rent. However, force majeure clauses often can be a frustrating dead end because: 1) courts apply them very strictly; 2) lease language frequently applies force majeure only to more limited circumstances such as delays in construction; 3) very few leases actually reference pandemics; and 4) many leases specifically do not permit force majeure to forgive payment of rent. If the lease in question originated with a landlord with multiple properties and a strong landlord lease, there is a good chance the force majeure clause will specifically not forgive the payment of rent. That landlord will expect the tenant to insure against that risk. In any event, if there is any chance of making a claim for rent relief under the force majeure clause, the tenant should examine the lease for landlord default provisions or the notice clause to be certain that appropriate notice of tenant's position is sent to the landlord. Otherwise there is a risk of tenant's rights being waived.

Insurance Considerations

It is additionally essential that the tenant review its insurance provisions to determine if there is any coverage for interruption of business or rent insurance. Some leases require business interruption or rent insurance for the landlord's protection. Tenant can make that claim to its carrier.

Potential Common Law Remedies

In many jurisdictions, case law or common law provides a stronger argument than any language in a lease for relief, including possibly permitting a tenant to close its business and/or stop paying rent. Two relevant doctrines related to this concept found in case law are: 1) impracticability or impossibility of performance; and 2) frustration of purpose.

Impracticability or Impossibility of Performance

The Restatement (Second) of Contracts states the basic rule of impracticability as follows:

Where, after a contract is made, a party's performance is made impracticable without his fault by the occurrence of an event the nonoccurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary.

Restatement (Second) of Contracts §261 (1981); §20:11.Impracticability, 28A N.Y. Prac., Contract Law §20:11.

Thus, a party may be excused from its performance obligation on the ground of impracticability if an unforeseen event beyond the party's control impacts its ability to perform. The party asserting that its performance is impracticable must not have caused the unforeseen event, and the event must alter the essential nature of the parties' agreement. The doctrine applies where the agreed performance has been made impracticable by the occurrence of a contingency, the nonoccurrence of which was a basic assumption of the contract at the time it was made. Performance must be made impracticable because of circumstances unforeseeable at the time of contracting, for the doctrine may not be applied where the party claiming impracticability may be deemed to have assumed the risk that a foreseeable occurrence would impact its ability to perform.

"The distinction between difficulty which does not discharge contract obligations and impracticability which does is whether the unanticipated circumstance has made a performance of the promise vitally different from what was reasonably to be expected." Consumers Power Co. v. Nuclear Fuel Servs., Inc., 509 F. Supp. 201, 210 (W.D.N.Y. 1981).

In New York, this concept is governed by the similar concept of impossibility of performance. This is generally confined to the destruction of the means of performance by act of God, or prohibition of the performance by applicable law. See, 407 E. 61st Garage, Inc. v. Savoy Fifth Ave. Corp., 23 N.Y.2d 275, 281 (1968); §20:3.Impossibility — Basic considerations, 28A N.Y. Prac., Contract Law §20:3. But where the purpose and means of the contract have been destroyed, such as in a lease where the stated activity is no longer possible, then "at common law if the interest of the lessee in demised premises has been destroyed by act of God or the public enemy so as to render the subject matter of the lease incapable of beneficial enjoyment by the tenant, the rent should be abated." Schantz v. Am. Auto Supply Co., 178 Misc. 909, 912–13, 36 N.Y.S.2d 747, 750 (Sup. Ct. 1942).

This standard for impossibility is more stringent than the standard of commercial impracticability in the Uniform Commercial Code. Impracticability permits excuse even though performance may still be possible if a supervening contingency has changed the nature of the bargain between the parties. See, Restatement (Second) of Contracts 11 Intro. Note (1981). The law of impossibility applies only where performance cannot be rendered. For impossibility to be a viable defense, performance must be objectively impossible. See, §20:3.Impossibility — Basic considerations, 28A N.Y. Prac., Contract Law §20:3. Thus, where impossibility or difficulty of performance is occasioned only by financial difficulty or economic hardship, even to the extent of insolvency or bankruptcy, performance of a contract is not excused. See, id.

As relevant here, impracticability and impossibility can both lead to the discharge of the obligation to perform if that performance were impacted by subsequent governmental action or court order. See, Restatement (Second) of Contracts §264 (1981) ("If the performance of a duty is made impracticable by having to comply with a domestic or foreign governmental regulation or order, that regulation or order is an event the non-occurrence of which was a basic assumption on which the contract was made."); §20:11.Impracticability, 28A N.Y. Prac., Contract Law §20:11; Bush v. Protravel Int'l, Inc., 192 Misc. 2d 743, 750, 746 N.Y.S.2d 790, 795 (Civ. Ct. 2002) ("Precedent is plentiful that contract performance is excused when unforeseeable government action makes such performance objectively impossible.") The regulation or order must directly affect a party's performance in such a way that it is impracticable for him both to comply with the regulation or order and to perform. See Restatement (Second) of Contracts §264 (1981). While the doctrine of impossibility may provide a defense where unforeseen government action prevents the performance of the contract, it is critical that this intervening governmental activity be unforeseeable to excuse performance of the contract. If the governmental action were foreseeable, a party may not be able to invoke the defense of impossibility.

In the context of a lease, if customers are legally restricted from visiting a business location due to unforeseen circumstances (i.e., pandemic lockdown), a court may find that: 1) the parties assumed that such an event would not occur in making the contract; 2) the event was unforeseeable; and 3) as a result of the event the contract cannot be performed. Specifically, as in the case of the recent orders by the Governors of New York, California and Illinois, if a business is prohibited from operating, which prevents it from operating according to the terms of its lease, then the party may be excused from performance. In the case of a tenant, this equates to being excused from paying rent if the circumstances were unforeseeable. The businesses that were targeted in the original Governor's Orders in New York, all non-essential business activities, certainly fall into this category. They have been mandated to close their doors. If a governmental order renders performance impracticable or impossible, a tenant may argue that their obligations to perform under the contract are excused because the state government prevents them from opening and operating, and it was wholly unforeseeable that a global pandemic would occur which in turn would cause state governments to order all non-essential businesses to close.

Another issue to be alert to is the remedy that may be granted in the event of inability to perform because of governmental action. Termination of the contract is mentioned in some cases. If we assume that the tenant does not want to terminate its lease but merely obtain rent relief, then the manner in which the tenant exercises its rights and expresses its position will have to be very careful and precise.

Frustration of Purpose

Frustration of purpose arises when both parties can perform but, as a result of unforeseeable events, performance by one party would no longer give the other what induced the other party to make the bargain in the first place. See, Restatement (Second) of Contracts §265 (1981) ("Where, after a contract is made, a party's principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or the circumstances indicate the contrary."); §20:18.Frustration of purpose, 28A N.Y. Prac., Contract Law §20:18. The doctrine offers a defense against enforcement when the reasons for performing the contract have ceased to exist due to an unforeseeable event which destroyed the reasons for performing the contract. See, id. Frustration of purpose excuses performance when "a virtually cataclysmic, wholly unforeseeable event" renders the contract valueless to one party or has destroyed the underlying reason for performing the contract. See, id. See also, United States v. Gen. Douglas MacArthur Senior Vill., Inc., 508 F.2d 377, 381 (2d Cir. 1974). This doctrine applies to all contracts including leases. See, 119 Fifth Ave., Inc. v. Taiyo Trading Co., 190 Misc. 123, 127, 73 N.Y.S.2d 774, 778 (Sup. Ct. 1947), aff'd sub nom. 119 Fifth Ave. v. Taiyo Trading Co., 275 A.D. 695, 87 N.Y.S.2d 430 (App. Div. 1949).

"Impossibility" and "frustration of purpose" refer to two distinct doctrines in contract law. The Second Circuit has explained the distinction as follows:

[I]mpossibility may be equated with an inability to perform as promised due to intervening events, such as an act of state or destruction of the subject matter of the contract. … Frustration of purpose, on the other hand, focuses on events which materially affect the consideration received by one party for his performance. Both parties can perform but, as a result of the unforeseeable events, performance by party X would no longer give party Y what induced him to make the bargain in the first place. Thus frustrated, Y may rescind the contract.

Gen. Douglas MacArthur Senior Vill., Inc., 508 F.2d at 381.

The promisor can be relieved of its obligations when the parties contacted based upon the assumption of facts, neither party reasonably could have been expected to guard against the non-occurrence of the assumed facts, and the facts turned out differently than what the parties had assumed. The frustrated purpose must have been so completely the basis of the contract that, as both parties understood, without it, the transaction would have made little sense. See, §20:18.Frustration of purpose, 28A N.Y. Prac., Contract Law §20:18. The fact that the occurrence of an event has made performance more onerous does not mean that a frustration of purpose has occurred. The frustrated party not only has a defense to a claim of breach but also can seek to rescind the contract.

Frustration is no defense where the contract did not provide safeguards for a reasonably foreseeable intervening event. A determination of frustration of purpose seems to largely turn on the foreseeability of the event. Arguably, there is a question of fact as to whether a public health emergency like the one we are facing is the type of situation that should have been contemplated by the parties at the time of the lease. However, insofar as frustration of purpose requires a "virtually cataclysmic, wholly unforeseeable event" which destroys the underlying reason for performing, it is hard to imagine a situation that would ever meet that description if the present Coronavirus outbreak does not. If found to be unforeseeable, this may be sufficient under the frustration of purpose doctrine to permit the tenant to close and stop paying rent.

It is significant to note that, in a situation like the present one, where impracticability/impossibility of performance or frustration of purpose will only be temporary (albeit for a currently undeterminable time), it will undoubtedly be removed at some point. When the circumstances giving rise to the impracticability or frustration cease to exist, he must then perform. He is usually expected to perform in full and is entitled to an appropriate extension of time for performance. See, Restatement (Second) of Contracts §269 (1981) ("Impracticability of performance or frustration of purpose that is only temporary suspends the obligor's duty to perform while the impracticability or frustration exists but does not discharge his duty or prevent it from arising unless his performance after the cessation of the impracticability or frustration would be materially more burdensome than had there been no impracticability or frustration.") In some cases, however, delay will make performance materially more burdensome than had there been no impracticability or frustration, and when it appears that this will be so, a duty may be discharged and not merely suspended. See, id. In applying the standard of materiality, a court will consider whether the delay has seriously upset the allocation of risks under the agreement of the parties. See, id. See also, Scanlan v. Devon Sys., Inc., No. 89 CIV 1634 LMM, 2000 WL 218389, at 2 (S.D.N.Y. Feb. 24, 2000) (while impossibility suspends performance, it does not excuse it when the impossibility is removed.)

Additional Considerations

Assuming for a moment that applicable law does not permit the tenant to close its business and/or stop paying rent, many businesses will make the practical decision to do just that anyway. What repercussions may follow from that will likely be determined by the applicable terms in the lease and will be subject to state/county/local municipality mandates, some of which may be subsequently brought to bear on these situations. Many jurisdictions have already announced moratoriums on commercial evictions. For example, New York has ordered all but essential actions in its court system to cease for 90 days. So even if a tenant's position is unclear, a tenant could make the economic decision to stop paying rent and know that, while the landlord may send them a default notice, there is no legal action that can be taken against them, including an eviction proceeding, for at least 90 days. However, the tenant should be careful to evaluate notices to determine if they create irreversible consequences, such as termination.

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Terrence M. Dunn, a member of this newsletter's Board of Editors, is a founding partner of Einbinder & Dunn, in charge of the firm's business, real estate, trusts & estates and fashion law practices.