The impact of COVID-19 on the commercial real estate industry is unprecedented. We have been asked a broad range of questions as a result of the pandemic, some of which include:
What if a tenant cannot pay rent?
Many landlords and tenants are seeking counsel about what happens if a commercial tenant cannot pay rent. Some considerations include:
- Landlords may ask tenants to seek relief under the CARES Act and use the proceeds to pay rent. Particularly where a Tenant has a number of employees (and a Landlord may not), the Paycheck Protection Program may be a source of funds for rental payments, which can be eligible for loan forgiveness. See helpful links below:
- Landlords and tenants may be able to access the Economic Injury Disaster Loan Program or other programs under the CARES Act as sources of funds for rent or income in lieu of rental receipts.
- Even our own Oklahoma City is progressive in developing an assistance program when other resources may not be available. See the Oklahoma City Small Business Continuity Program for COVID-19 emergency relief.
- Economic stimulus programs are new and evolving, and vigilance is necessary to stay abreast of potential programs, rules and requirements.
- Alternatively, landlords and tenants may consider short-term rental reductions, abatements, or deferrals and any such agreements should be put in writing. Prior to consummating any amendments to leases, landlords should review their loan documents to determine whether lender consent is required for such amendments. (see below for “transfer” issues).
- Resorting to litigation over unpaid rent by a landlord at this time may be a slow process as many courts are closed, there will likely be a backlog and Courts may be sympathetic to tenants given the situation.
Are commercial transactions being closed?
- Many commercial purchase and sale transactions have reached a screeching halt, with buyers terminating agreements and lenders having underwriting concerns. Often buyers are terminating during an inspection period where they are entitled to a return of earnest money. In instances where an inspection period is not available or has expired, buyers are looking for conditions precedent to closing, such as a material adverse change, which would excuse performance. Otherwise, on a unilateral termination, buyers may face a loss of earnest money or trigger a default under the agreement.
- For some transactions that appear to be moving forward, there remains uncertainty as to whether the County recording offices will be open at the time of closing for the filing of deeds, loan instruments, and other closing documents. Accordingly, parties should consult with their title companies and underwriters in order to determine if and how the title company will facilitate a closing in the event of a shutdown of the recording office. Also paramount will be issues relating to “gap coverage” as a result of potential delays between closing and recording documents, as well as use of online remote notaries and other logistics for closings.
- Most purchase and sale agreements contemplate a specific list of closing deliveries for each party, together with a “catch-all” requiring such other documents as are reasonably requested by the other party and/or title company. In light of the uncertainties regarding whether a recording office will be open or shut-down on the closing date, title companies may require new, additional indemnities and covenants from the parties at closing in order to achieve closing, which documents may prohibit, for instance, a seller (whom still may appear in the real estate records as the fee owner) from executing any other conveyances concerning the property. Parties should consider expanding the “catch-all” clause accordingly.
- For transactions that are teetering, sellers and buyers should consider agreeing to extend the inspection period or the time to close to let the pandemic subside prior to any such closing. Any such extensions should be in writing.
- In lieu of closing or extending, buyers may move to the sidelines, waiting for values to decline and proceeding after the pandemic is resolved.
How are lenders and borrowers handling the consequences of the pandemic?
- Bank regulators have provided guidance encouraging financial institutions to cooperate with customers dealing with the adverse economic effects of COVID-19.
- For borrowers unable to make debt service, we are seeing short-term accommodations, such as interest only or reduced payments for 3 months, with full payments continuing after that time.
- Should the pandemic prove to have more long-term effects, we would expect to see forbearance agreements, workouts and bankruptcies. Time will tell whether these more drastic measures will be necessary. If so, the tax consequences of these arrangements should not be ignored.
- Prior to exploring any of these options, it is prudent to thoroughly review all loan documents, with emphasis on restrictions on transfer, default, notice and cure and force majeure provisions.
- For non-recourse loans, documents should be thoroughly reviewed so as not to inadvertently trigger recourse liability. For example some non-recourse loans have “bad boy” carve-outs which trigger full or partial recourse liability to borrowers and guarantors where a borrower (i) admits in writing the inability to pay its debts as they come due; or (ii) makes a “transfer” which is not permitted by the loan documents. A “transfer” is often broadly defined as including making amendments to lease agreements without the lender’s consent. Accordingly, borrowers should exercise caution in taking actions to renegotiate loan documents or compromise lease obligations, which in certain circumstances, could trigger recourse liability.
Are Force Majeure clauses available to delay or terminate performance obligations?
- Force Majeure clauses are contractual clauses that extend or in some instances terminate performance obligations when “acts of god” or other named events prevent or delay a party’s ability to perform their obligations. Force Majeure clauses appear in many, but not all, types of real estate contracts and such clauses are limited to the exact language, which may not be standard from agreement-to-agreement and in most cases don’t appear broad enough to include the current pandemic situation. For example, Force Majeure clauses are typically not in short-term agreements such as purchase and sale agreements, but may be included in loan agreements, leases, construction agreements and the like.
- Each Force Majeure clause should be carefully reviewed to determine whether it applies in this situation and if so, whether any notices need to be given to the parties under the agreement.
- Use of Force Majeure clauses in the future should be considered, with expressly including references to epidemics, pandemics or other health related crises beyond the control of the parties.
What else should be considered in light of the pandemic?
- Business interruption insurance policies should be reviewed to determine whether there may be coverage.
- For property management, responsibility should be evaluated to identify whether there are special duties to maintain health and cleanliness.
For more information on how the COVID-19 pandemic may affect your business, please contact:
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