Meyer Last, a partner with Fried, Frank, Harris, Shriver & Jacobson, and Bonnie Hochman Rothell, a partner with  Morris, Manning & Martin/courtesy photos

With the COVID-19 pandemic dealing crushing blows to retailers, restaurants and other businesses and their commercial real estate landlords, attorneys warn that skipping rent or mortgage payments could lead to other legal complications beyond the obvious.

More and more retailers and restaurants, as well as other businesses, have skipped payments to malls and office buildings recently as  COVID-19 shelter-in-place orders shut down operations. Cheesecake Factory and Urban Outfitters are among the large chains that announced they did not pay the April rent during shutdown orders, according to news reports. 

Commercial property researchers at Green Street Advisors said owners of 30,000 strip malls in the U.S. have been paid only between 30% and 50% of April rent, according to the Financial Times. 

Many commercial property landlords are aware of their tenants' difficulties and are being flexible with distressed occupants, the attorneys said. But many cash-strapped tenants are also accepting the risks of not paying the rent, one real estate attorney said.

Fried, Frank, Harris, Shriver & Jacobson real estate partner Meyer Last, who is based in New York and represents commercial real estate owners and lessees, said on Wednesday, "The vast majority of retail tenants are not paying rent. Banks and pharmacies and a few very well-financed retailers are paying rent. But three-quarters of retail tenants are not. In the office world, it is reversed. About three-quarters of tenants are paying rent and a small percentage are not.

"The two worlds are very different," he continued. "For the most part, neither office tenants nor retail tenants have the right under their lease to not pay rent. Most tenants under these circumstances have to pay their rent. The retailers are engaged in self-preservation, which right now means cash preservation. They don't have the cash to pay those rents." 

Bonnie Hochman Rothell, a partner and chairwoman of the litigation practice at Morris, Manning & Martin in Washington, D.C., said in-house counsel for commercial real estate tenants should be mindful that tenants who withhold rent could face several repercussions beyond the obvious ones. 

She said, for example, if they are getting funding under the CARES Act, the COVID-19 federal relief package, "if they are a small business that receives a PPP [Paycheck Protection Program] loan, it can be excused if they use the money to pay rent. The value of the stimulus is to enable that," she said. But "if they take the loan and then don't pay rent, it could prevent them from having the loan forgiven down the road."

"If establishments get the loan, they should be able to pay the rent in the short term and have time to work something more amicable out with their landlord," she said. "And they could end up with claims against them from their business investors and business owners if they don't have the proper consents." 

Hochman Rothell said businesses might be better off negotiating a reduced rent for the entire year rather than not paying any rent in the short term. The business could be leaving its lease guarantors exposed if it forgoes paying rent, and the commercial landlord could go after the guarantor on the lease, which could be one of the business' owners, particularly in small businesses. "There could be an unintentional exposure if the guarantor gets sued by the landlord," she said.

But Last said that's a risk some distressed businesses are willing to take. "Yes, there can be consequences to not making a rent payment or a mortgage payment. In nearly all the cases I am dealing with the factors that are pushing people to not make the payments generally override the other consequences," he said.

And he said, "Generally speaking, retail and office, we, for the most part, have been counseling our clients not to send default notices to their tenants who don't pay rent because they know tenants are not in a position to do anything different. People have been avoiding creating situations that make it difficult to crawl out of."

Considerations for landlords and their own mortgages

Hochman Rothell said in-house counsel for commercial real estate landlords who have their own mortgages to pay also should be cautious about requesting relief for mortgage payments so as not to seemingly admit they're unable to pay their debts. 

Other investors and loans could be affected by that type of admission, she said. She warned  that "such an admission may enable a contract counterparty to terminate the agreement or remove a manager or general partner from their managerial and oversight positions—with potential loss of economic rights, such as a promoted interest, incident to such removal."

"You want to make sure that in seeking forbearance you are not making an admission that might adversely affect a guarantor or joint venture's rights or trigger an exit remedy," she said. "A small to midsize company with a joint venture agreement with a subordinate loan, you might need to make sure that you are not triggering something." 

Asking for forbearance in one loan might trigger a default on a subordinate loan, for instance, she said. 

"You have to look at the entire deal structure to make sure that solving one problem does not create another, such as creating a secondary default, or trigger an investor's exit rights if the entity doesn't maintain its obligations in a timely manner," Hochman Rothell said. "Rental and mortgage forbearances can't be looked at in a vacuum. Look at all the documentation to make sure you are not causing a problem on some other end of your deal." 

Another reason that the entire corporate structure and loan documents have to be examined is to make sure that the proper consents are obtained, such as investor or board consent. "You have to make sure that you have the appropriate consents to take action," she said.

"All in all there are two takeaways: Know your deal structure and corporate documents and know your rental agreement, so you know the facts of your particular case, and negotiate rather than take matters in your own hands," Hochman Rothell said. "Nine times out of 10 you will be better off with a long-term perspective in mind rather than a short-term, not thought-through approach."