Posts

FAQs: Impact of Covid-19 On Commercial Real Estate

2020 Coronavirus Guidance header 2

By Phillips Murrah Directors Sally A. Hasenfratz and Bobby Dolatabadi, and the Real Estate Practice Group 

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:

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:

Portrait of Sally A. Hasenfratz

 

Sally A. Hasenfratz
Director
405.552.2431
EMAIL

 

 

Portrait of Bobby Dolatabadi

 

Bobby Dolatabadi
Director
405.606.4742
EMAIL

 

 


Keep up with our ongoing COVID-19 resources, guidance and updates at our RESOURCE CENTER.

facebook icon

Follow our coverage on FACEBOOK

Potential Legal Recourse for COVID-19 Losses

By Phillips Murrah Director, Clayton D. Ketter

The continuing uncertainty surrounding the COVID-19 global pandemic is causing significant disruption to business operations.  In addition, recent restrictions on operations is likely to further cause various businesses to lack the financial capabilities to meet ongoing obligations.  Such business may have various contractual and legal rights that may serve to ease their financial pain.  Several of these are analyzed below.

Clayton Ketter

Clayton D. Ketter is a Director and the Firm’s Litigation Practice Group Leader. Clay has extensive experience in financial restructurings and bankruptcy matters.

A. Business Interruption Insurance

The first place many businesses may look for relief when forced to temporarily close due to the COVID-19 pandemic and related government restrictions is a business interruption insurance policy.  Business interruption insurance generally compensates a business for lost income suffered in the event the business is forced to temporarily cease operations due to an unforeseen event such as a fire or natural disaster.  Some policies also provide coverage for issues with a business’s supply chain that are outside of the business’s control.

Every business interruption insurance policy will contain various exclusions from coverage.  After the SARS outbreak in 2003, it became common for insurance companies to seek to exclude from coverage losses sustained from communicable disease outbreaks, such as the current COVID-19 pandemic.  Such exclusions may prevent coverage in the current situation.

Many business interruption policies also require that covered losses be tied to physical damage to a business.  A typical example would be a business that was forced to close because its building was damaged by a fire or natural disaster.  A general slowdown in business related to a broad disaster is unlikely to meet this requirement, because there is no corresponding physical damage to the specific business.  Some policies also provide coverage when ingress or egress to a business is limited or prohibited by a governmental authority.  Those too, though, often require some specific physical damage to have been suffered.

However, the precise wording of the insurance policy, which will vary from policy to policy, is critical to determining coverage.  Even small variations in policy language can have large impacts, particularly in an unprecedented situation such as the one we are currently facing.  Thus, business owners should carefully review their specific policy and seek legal counsel for any potential issues.

B. Force Majeure Clauses

Another potential source of relief for specific contractual obligations is a contractual provision known as a force majeure clause.  The term force majeure covers a broad range of provisions that generally excuse a party’s performance under a contract when external events, such as an act of god, have rendered such performance impossible.  While there is no single standard force majeure clause and they can take many forms, a common example would be a provision providing:

In the event either party is unable to perform its obligations under the terms of this Contract because of acts of god or other causes reasonably beyond its control, such party shall not be liable for damages to the other for any damages resulting from such failure to perform or otherwise from such causes.

Specific clauses may explicitly set out circumstances that constitute a force majeure event, such as strikes, wars, and natural disasters.  It is also common for provisions to set out certain obligations that are not excused by a force majeure event.  For example, commercial real property leases often provide that a tenant’s obligation to pay rent is not excused by a force majeure event.

While force majeure clauses are common, most do not explicitly provide that a global pandemic will constitute a force majeure event.  Without a specific reference, parties seeking to invoke such a provision will have to rely on general terms such as act of god.  Such general terms are subject to differing interpretation by courts.  For instance, the Oklahoma Supreme Court has defined an act of god as “some inevitable accident that could not have been prevented by human care, skill and foresight, but which results exclusively from nature’s cause, such as lightning, tempest and flood.”  City of Purcell v. Subblefield, 139 P. 290 (Okla. 1914).  Whether a global pandemic such as COVID-19 would fit within that definition remains to be seen.

Another issue with the applicability of a force majeure clause is the extent that performance was affected.  Specific clauses will use a variety of standards to excuse performance, such as impracticability, impossibility, or illegality.  These differences will have a significant impact on whether a force majeure clause applies.  For example, restrictions on how businesses are permitted to operate in the current environment continue to evolve.  Those restrictions may make performance of a contractual obligation impracticable, but not necessarily impossible or illegal.  Thus, a business that has been statutorily restricted from operating would likely have a stronger argument that a force majeure clause applies than one whose operations have been impaired by the restrictions.

Ultimately, whether a party’s performance under a contract will be excused due to the COVID-19 pandemic is going to largely depend on the terms of the specific contract coupled with the facts of each party’s individual situation.  Thus, it is recommended that a contracting party carefully review the language of the contract at issue with a legal professional.

C. Governmental Taking

There may be other contractual provisions that could also provide relief.  For instance, it is common for commercial real property leases to excuse performance when the underlying property has been taken by condemnation or eminent domain.  An enterprising tenant could attempt to argue that governmental restrictions on the business’s operations constitute a condemnation because the tenant’s rights have been “taken” for the greater good of the public.  Such arguments appear to be completely untested.  However, as with the other issues raised herein, the ability to utilize such arguments is going to heavily depend on the specific terms of the agreement at issue.

D. Chapter 11 Bankruptcy

While the forced closure of a business may result in a general reduction in certain contingent expenses, fixed costs such as rent and loan payments are likely to continue.  Upon reopening, many business, despite being profitable, are likely to face liquidity issues due to the temporary cessation in income.  For such businesses, the first step should be to attempt to reach a consensual resolution whereby the outstanding obligations are restructured by agreement.  However, when an out of court workout cannot be reached, a bankruptcy under Chapter 11 may present a viable option.

Chapter 11 is designed to allow a debtor to restructure its debts so that it can repay creditors in an orderly manner.  Often, this involves extending the period for repayment.  For instance, a business that is facing a large amount of debts currently due, might be able through a Chapter 11 bankruptcy to repay those debts over time through a series of payments.  Thus, Chapter 11 may provide an otherwise profitable businesses that has incurred substantial debts as a result of the current crisis a path to continue operating and repay its debts in a structured manner.

E. Conclusion

Ultimately, a party’s rights and obligations will depend on the specific facts and circumstances at issue, including the language of the parties’ agreement.  To the extent a business is facing such issues due to the current pandemic and associated response, it is advisable to discuss the specific situation with a qualified legal professional.