Reviewing New York’s Commercial Lease Defenses to Paying Rent
Few landlords and commercial tenants have been completely immune from the governmentally imposed economic shutdown and COVID-19’s wrath. Adam Leitman Baily and Dov Treiman discuss the three traditional theories under which commercial tenants can seek forgiveness of their rent.
By Adam Leitman Bailey and Dov Treiman | August 18, 2020
New York is in one of its worst depressions since the American Revolution. Few landlords and commercial tenants have been completely immune from the governmentally imposed economic shutdown and COVID-19’s wrath. Not including what may have been negotiated in a commercial lease, there are three traditional theories under which commercial tenants could seek to assert entitlement to forgiveness of their rent: frustration of purpose, impossibility of performance, and force majeure.
One of our partners recently participated in a lecture with two other judges where one of the judges announced that the courts would be kept very busy while these tenant weapons were litigated. That may be true but the reality from the past precedents since its first use in New York during World War II and recently, from the decisions coming down from the state supreme courts is that their ability to terminate a lease or vitiate the payment of rent will occur in very, very, few cases.
Frustration of Purpose
Formally defined, the doctrine of frustration of purpose applies when a change in circumstances makes one party’s performance virtually worthless to the other, thereby frustrating the purpose in making the contract. PPF Safeguard, LLC v. BCR Safeguard Holding, LLC, 85 A.D.3d 506 (1st Dept. 2011). What this means in real world terms is that regardless of fault, if circumstances arise in which there is (for at least one side) no purpose to the contract, that side’s performance is excused.
The elements of frustration of purpose require consideration of (1) whether the frustrated purpose is the basis of the contract, (2) whether the frustrating event was foreseeable, and (3) whether the frustration of purpose is substantial. Rockland Development Assocs. v. Richlou Auto Body, Inc., 173 A.D.2d 690 (2d Dept. 1991); Crown IT Services, Inc. v. Koval-Olsen, 11 A.D.3d 263 (1st Dept. 2004).
Frustration of purpose is “limited to instances where a virtually cataclysmic, wholly unforeseeable event renders the contract valueless to one party.” U.S. v. Gen. Douglas MacArthur Senior Village, Inc., 508 F.2d 377 (2d Cir. 1974). It is not enough that the transaction has become less profitable for the affected party or even that the affected party will sustain loss. Rockland Development, supra.
In Crown, supra, the court said that the doctrine is a narrow one and that “in order to invoke this defense the frustrated purpose must be so completely the basis of the contract that, as both parties understood, without it, the transaction would have made little sense.” PPF Safeguard, supra.
In Jack Kelly Partners LLC v. Zegelstein, 140 A.D.3d 79 (1st Dept. 2016), an owner and a tenant entered into a commercial lease agreement to use the rental space for general offices of an executive recruiting firm and so as not to violate the certificate of occupancy. However, the certificate of occupancy was for exclusive residential use. When the landlord refused to amend the certificate of occupancy, the court, finding frustration of purpose, allowed the tenant to terminate the lease.
In Mr. Ham, Inc. v. Perlbinder Holdings, LLC, 116 A.D.3d 577 (1st Dept. 2014), the lease provided that the premises were to be used for the preparation and retail sale of various food items and that the tenant would do the build out. The found that the owner’s unanticipated renovation of the premises, preventing the build out, deprived plaintiff of its consideration and frustrated the purpose of the contract, allowing rescission.
In Benderson Dev. Co. v. Commenco Corp., 44 A.D.2d 889 (4th Dept. 1974), a tenant leased premises to run a restaurant and could not do so until a sewer was constructed years later. The court allowed the tenant to rescind the contract based on frustration of purpose.
In none of these cases did the court address a situation where the duration of the frustrating event is expected to be considerably shorter than the expected duration of the lease. None of them consider the idea of forgiving some months of rent in the middle of the lease term when things are expected eventually to go back to normal. The “cataclysmic” standard of U.S. v. Gen. Douglas MacArthur Senior Village, Inc., supra, could therefore find that the temporary interruptions of the pandemic do not qualify for the rent forgiveness.
Recently, numerous cases have been filed in New York courts trying to terminate commercial leases or stop the payment of rent under this theory and one of the questions the courts will have to decide for the first time since these cases were first filed in New York during World War II is whether they can stand when the business is closed for a few months during a 10 or 20-year lease. I have named this theory temporary frustration of purpose. No court to date has allowed a tenant to stop paying rent based on these set of facts but the courts being closed for several months except for emergencies and the inability once the courts have been open to expedite or move a case through the system has limited the ability of practitioner’s to receive decisions.
Neither frustration of purpose nor impossibility of performance apply if the circumstances preventing the performance were foreseeable. Warner v. Kaplan, 71 A.D.3d 1, (1st Dept. 2009); Kel Kim Corp. v. Central Mkts., 70 N.Y.2d 900 (1987). One author, Dov Treiman, notes that it can be argued that COVID-19 was foreseeable since Ebola gave a comparatively mild rehearsal, showing what could happen. https://www.healthline.com/health-news/how-deadly-is-the-coronavirus-compared-to-past-outbreaks. Yet, others would argue that the ferocity of this pandemic sees its only parallel in the Spanish flu of a century ago and prior to that, only in the Bubonic Plague from centuries earlier and therefore no commercial lease could have been written in our lifetimes predicting this event.
In addition, COVID-19 and the governmental responses to it are distinct issues. Whether or not the virus itself was foreseeable, there can be frustration of purpose or impossibility of performance if the government’s response defied prediction. J.H. Labaree Co. v. Crossman et. al, 100 A.D. 499 (1st Dept. 1905).
In Kel Kim Corp. v. Central Mkts., 70 N.Y.2d 900 (1987), the parties were expected to see and predict the instability of the insurance industry and to make provision in their contract for the tenant’s inability to procure the required insurance.
Impossibility of Performance
The elements of impossibility of performance require a showing that (1) the event rendering the performance impossible was unforeseeable, (2) that said event destroyed the subject matter of the contract or the means of performance, and (3) it was the event that made performance objectively impossible. Kolodin v. Valenti, 115 A.D.3d 197, 200 (1st Dept. 2014); Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900 (1987).
The standards for unforeseeability are no different for impossibility of performance than they were for frustration of purpose.
Key to impossibility of performance is that a party should be excused from the performance required of it on a contract when it is objectively impossible to do the act the contract requires of the performer. The Reed Foundation, Inc. v. Franklyn D. Roosevelt Four Freedoms Park, LLC, 108 A.D.3d 1. Extreme difficulty of performance does not satisfy that condition, such as the nonpayment of money when one has no income. Even in an economy where no one is lending money, the cases conclusively presume that someone who needs money can always come up with it. 407 East 61st Garage, Inc. v. Savoy Fifth Ave. Corp., 23 N.Y.2d 275 (1968). However, the doctrine has no place when the other party has not actually required the performance. Walnut Place LLC v. Countrywide Home Loans, Inc., 96 A.D.3d 684 (1st Dept. 2012).
Where the law prohibits the performance, it is excused. (Labaree, supra). However, while the government has prohibited certain facilities from being open (thus excusing the landlord), it has not prohibited the tenants from continuing to pay their rent (thus not excusing the tenants). Crown Embroidery Works v. Gordon, 190 A.D. 472 (1st Dept. 1920). What the case law has not provided definitive guidance on is whether a business is truly shut down by governmental operation if the only part that is shut down is the face-to-face aspect of the business while the on-line presence thrives. See Crown Embroidery, supra.
In the element of impossibility of performance as above stated, “it was the event that made performance objectively impossible,” Kolodin, supra, is contained the idea that the catastrophe was the cause of the inability to perform. Kel Kim Corp. v. Central Markets, Inc., 70 N.Y.2d 900 (1987). Indeed, with many retail businesses, it will be a difficult matter of proof that their collapse was COVID-19 caused and not merely part of the ongoing shift to consumer preferred on-line shopping.
A decade after the 1918 flu, courts engaged the problem of causation, in Palsgraf v. Long Island Railroad Co., 248 N.Y. 339 (1928) where an exploding package on a railroad platform caused scales to fall on the plaintiff at some distance. The court found the cause and effect too attenuated to cast blame on the defendant.
While there is a direct cause and effect for a tattoo parlor ordered closed in response to the COVID-19 crisis, consider a negligence litigation law firm that occupies rented space, finding its income shut down by the closure not of their office space, but of the court system. This does not square with Palsgraf’s ideas of causation.
There is a line of authority that just because the disaster made the supplied party lacking a need for the product it undertook to buy, it was not excused from paying the full amount. See, Constellation Energy Services of New York, Inc. v. New Water Street Corp., 146 A.D.3d 557 (1st Dept. 2017). Thus, the law firm that did not need to use its office would not be excused from paying the rent.
Tenants seeking rent relief because of impossibility of performance will thus encounter barriers in causation, and objective impossibility.
Impossibility for Landlords and Tenants
The question of impossibility in light of COVID-19 reaches both ways in the landlord-tenant relationship, both as to the landlord’s inability to provide the space and the tenant’s inability to serve customers. Baron Leasing Corp. v. Raphael, 103 A.D.3d 763 (2d Dept. 2013) a case with a leased taxi medallion owned by a decedent, holds that governmental regulations prohibiting the use of the medallion excuse the owner from damages for requiring its nonuse. Thus, the owner is excused from damages arising from obedience to the law.
The other doctrines with which we have been dealing are common law in nature. MacArthur, supra. Force Majeure, however, is entirely contractual in nature. To establish an effective force majeure defense, these elements must be present: (1) The specific language used is a force majeure clause, (2) The event sought to excuse performance must fall within the scope of the clause, and (3) It is the event that renders performance actually impossible, rather than merely financially imprudent. Kel Kim, supra; Route 6 Outparcels, LLC v. Ruby Tuesday, Inc., 88 A.D.3d 1224 (3d Dept. 2011); Macalloy Corp. v. Metallurg, Inc., 284 A.D.2d 227 (1st Dept. 2001).
A contract may have a clause excusing performance of one of more of the contracting parties upon the occurrence of certain listed events. In the absence of such a clause, those events—typically storms, insurrections, earthquakes, and the like—do not excuse either party’s performance under the lease, unless they fall within the other doctrines discussed herein. General Electric Co. v. Metals Resources Group Ltd., 293 A.D.2d 417 (1st Dept. 2002).
What all these events have in common is that they are usually disastrous in nature, but since parties are free to contract as they will, Constellation Energy Services of New York, Inc. v. New Water Street Corp., 146 A.D.3d 557 (1st Dept. 2017) they could be something relatively benign in nature, such as a building becoming X% vacant or a party is unable to acquire the materials it needs. Route 6 Outparcels, LLC, 88 A.D.3d 1224.
However, force majeure clauses, as they actually appear in nearly all leases, where present, specify that a force majeure event does not excuse the payment of rent. Courts will not rewrite what the parties themselves have contracted. Vermont Teddy Bear Co. v. 538 Madison Realty Co., 1 NY3d 470 (2004) and give the tenant an excuse from paying rent when the lease specifies that these catastrophes are not an excuse from paying rent.
Often these clauses include language on the order of “or other similar.” Team Marketing USA Corp. v. Power Pact, LLC, 41 A.D.3d 939 (3d Dept. 2007). In order for an event to be “similar” to one listed, it has to be more particularly similar than also being a disaster. Reade v. Stoneybrook Realty, LLC, 63 A.D.3d 433 (1st Dept. 2009). While a volcano would likely be deemed similar to an earthquake, a pandemic is not similar to a labor strike. Kel Kim, supra.
As Team Marketing, supra, explained, “the precept of ejusdem generis as a construction guide is appropriate—that is, words constituting general language of excuse are not to be given the most expansive meaning possible, but are held to apply only to the same general kind or class as those specifically mentioned.” In Team Marketing the court declined to give the phrase “for any reason, including, without limitation” a reading that “any” meant “all” regardless of the types of disastrous events specifically listed.
It is not enough for the event to occur for it to excuse the performance. There must be a nexus between the event and the inability to perform. Phillips Puerto Rico Core, Inc. v. Tradax Petroleum Ltd., 782 F.2d 314, 319 (2d Cir. 1985) and the event in question must be beyond the control of the party seeking to have performance excused. Svenska v. Harris Corp., 3 F.3d 576, 580 (2d Cir. 1993); United Equities Co. v. First Nat. City Bank, 52 A.D. 2d 154 (1st Dept. 1976). This gives rise to the same questions about causation we discussed earlier.
Act of God
If the force majeure clause contains “act of God” language, the party may run into the issue of whether COVID-19 is an act of God. “Acts of God” are generally understood to include accidents caused by forces of nature. According to Black’s Law Dictionary, an “act of God” is “an overwhelming, unpreventable event caused exclusively by forces of nature, such as an earthquake, flood or tornado.” See Hernandez-Ortiz v. 2 Gold, LLC, 170 A.D.3d 465 (1st Dept. 2019); Chittur v. Briarcliff Woods Condominium Ass’n, Inc., 15 A.D. 3d 329 (2nd Dept. 2005); Merritt v. Earle, 29 N.Y. 115 (1864). The courts have also said that for a loss to be considered the result of an act of God, human activities cannot have contributed to the loss in any degree. See Moore v. Gottlieb, 46 A.D.3d 775 (2d Dept. 2007); Woodruff v. Oleite Corporation, 199 A.D. 772 (1st Dept. 1922). Since the loss of business upon which tenants seek to rely for rent relief is not based on the disease itself, but the governmental order to shut down, this could prove to be a problem for them.
While there have been some rulings in the Midwest (see, for example, In re Hitz Restaurant Group, 68 Bankr.Ct. Dec 22, 2020 WL 2924523) where commercial tenants have had a measure of success in seeking relief from their rent obligations, as to these three doctrines, and a lot of talk and threats and misunderstandings of the power of these three legal arsenal, application of them in accordance with New York’s understandings will make relief for tenants extremely difficult.
Adam Leitman Bailey is the founding partner of Adam Leitman Bailey, P.C. Dov Treiman is a partner at the firm. Allissa Kerr, a summer associate at the firm, assisted in the preparation of this article.