Covid-19: The Impact on Commercial Lease Agreements

The economic fallout from the COVID-19 pandemic is forcing commercial landlords and tenants to confront a host of difficult business decisions and legal questions concerning their relationship. This articles addresses some of the key contractual provisions and legal doctrines that landlords and tenants should consider as they assess their options. It concludes by encouraging the parties to engage in constructive dialogue, either directly or through their Legal Practitioners, when appropriate.

During the lockdown, Commercial Landlords currently have little ability to pursue claims against defaulting Commercial tenants. The Minister of Justice has published regulations, in terms of which all non-essential court functions have been suspended for the duration of the National Lockdown. In the case of breach, Landlords may serve demands, in accordance with the provisions of their leases, but Landlords would be precluded, at this stage, from approaching the courts to launch proceedings.

To protect the retail property sector on 24 March 2020, the SA government gazetted special regulations titled Covid-19 Block Exemption for the Retail Property Sector, 2020, affording an opportunity to landlords to work together with their competitors and to enter into discussion with their tenants to ensure the survival of retail tenants during and after this national disaster. This is usually not permitted as s4 and s5 of the Competition Act, 89 of 1998 (‘the Act’), which usually prohibits what can be seen as collusion or price-fixing between groups of competitors as well as suppliers and customers.  However, the regulations exempt a category of agreements or practices between designated retail tenants and retail property landlords from the application of sections 4 and 5 of the Act.  

The Regulations call for payment holidays, rental discounts, limitations on evictions and the adjustment of lease agreements. The regulations however merely allow for the discussion to take place and do not impose any obligations on landlords It is important to note that the regulations are only applicable to the retail sector, pending potential government intervention for the inclusion of alternative sectors and industries.

For purposes of this article we will merely discuss the impact of commercial leases which are not subject to the Consumer Protection Act (CPA), which does NOT apply to all lease agreements (or rental agreements). It is important to distinguish between the two situations, and the CPA has a major influence on the lease and changes the legal position between the landlord and tenant significantly.

Generally, The CPA will apply to all leases, except for instances where the lease is concluded between a landlord and a tenant which is a juristic entity (such as a company, trust, partnership or association) and where such tenant (at date of transaction) has an annual turnover or asset value which equals or exceeds R 2 million, or where the landlord is not leasing the property in the ordinary course of business.

Where the CPA is not applicable to a lease agreement, the provisions of the termination clause in the agreement must be followed in instances where tenants would like to terminate the lease agreement.

Commercial Tenants seeking to permanently or temporarily excuse their performance may wish to consider the remedies of Force Majeur or Supervening Impossiblity of Performance.

Force majeure is the legal mechanism which may be relied upon by contracting parties who are under a legal obligation to carry out specific performance, but are unable to carry out such specific performance pursuant to an exceptional event or circumstance which is beyond the control of those parties bearing a legal obligation.

There are certain conditions that must be fulfilled in order for a force majeure to trigger the type of impossibility that extinguishes a party’s contractual obligations. These are:

1.  The impossibility must be objectively impossible;

2.  It must be absolute as opposed to probable;

3.  It must be absolute as opposed to relative, in other words if it relates to something that can in general be done, but the one party seeking to escape liability cannot personally perform, such party remains liable in contract);

4.  The impossibility must be unavoidable by a reasonable person;

5.  It must not be the fault of either party;

6.  The mere fact that a disaster or event was foreseeable, does not necessarily mean that it ought to have been foreseeable or that it is avoidable by a reasonable person.

Not all contracts have force majeure clauses and in such instances, under South African law, an affected party would look to rely on the common law doctrine of supervening impossibility. As a general rule, supervening impossibility will relieve a contracting party of liability for non-performance if such impossibility is not reasonably foreseen by the parties at the time they entered into the contract (despite it being within the bounds of human foresight) and provided that the affected party did not contribute to the circumstances giving rise to the impossibility of performance.

COVID-19 has the potential of preventing parties to commercial agreements from performing their obligations as provisioned in commercial agreements which could trigger default events and lead to substantial losses being suffered as a result of the non-performance.

In commercial agreements where force majeure is provided for, parties to such commercial agreements would need to consider the manner in which force majeure has been defined in order to determine if such a definition can be interpreted in a wide manner to include COVID-19 and excuse specific performance.

When included in a commercial lease, generally, a force majeure clause contains four parts: the identification of who is excluded from performance (landlord, tenant, or both); a list of events that qualify; the obligations of the party that is impacted; and remedies for the other party.

Nearly every force majeure clause is drafted not to apply to a party’s monetary obligations. This means that if an unforeseen event occurs and a contracting party is unable to make a payment, then the affected party may not invoke force majeure as a reason for its non-payment.

For a landlord, this means that the tenant must continue paying rent and, if the Landlord has obligations requiring it to make payments to it’s tenant (i.e., a tenant improvement allowance), then the force majeure clause would not shield the Landlord from having to make that payment.

Whether a force majeure clause will apply to COVID-19 depends heavily on the specific terms of the clause. A force majeure clause might refer expressly to pandemic, epidemic or disease or, instead, to events similar to ones caused by COVID-19, such as a declaration of a national or regional emergency, strikes and riots, or government actions.  

In the absence of a Force Majeur clause, the contracting parties may still invoke the common law remedy of supervening impossibility of performance.  The party wishing to invoke supervening impossibility has the onus of proving that the performance is objectively impossible and that the impossibility cannot be avoided by a reasonable person.

Therefore the  provisions of the contract are paramount. The force majeure clause will typically define the scope of the remedy available to the party and prescribe the steps to be taken to trigger the clause, for example, obligations to notify and mitigate. The contract may contain additional obligations which could also impact the operation of the clause, for example, obligations to adhere to ‘good industry practice’, or to put in place business continuity or disaster recovery plans and so forth.

Whether parties may rely on force majeur or supervening impossibility of performance, is not clear cut and remains open to interpretation.  Over the coming months and years, court across the world will confront the question of whether particular force majeure clauses in commercial leases apply to COVID-19. This will provide some guidance for commercial parties, though we expect that these decisions will turn on the precise terms of a given lease (and, thus, how the parties agreed to allocate the risk of business interruptions) and facts underlying the non-performance at issue.

Parties are therefore encouraged, as far as possible, to comply with the terms of their respective lease agreements.  The withholding of payment and/or the unilateral reduction in rental payments could constitute a breach of the agreement, which would entitle a Landlord to terminate a commercial lease agreement and/or to launch an action for damages and specific performance.  The damages claim may include a claim for the full balance of the rental owing for the remaining term.  The cancellation of the agreement would in turn furthermore lead to potential exposures for any parties which may have bound themselves as guarantors and/or sureties in respect of the lease agreements.

In Conclusion:

Parties Commercial Landlords and tenants should firstly attempt to engage each other to try to adopt a practicable and reasonable solution.  It is important to remember that very few entities and individuals will remain unaffected by the pandemic, and therefore, it would be worthwhile reaching a compromise and as far as possible, to comply with the terms of any agreement.  

Both parties should be mindful of the impact on the liquidity of both entities, and that it would serve in both parties interests’ to attempt to reach an agreement, and consider alternative methods which could alleviate the financial burden that both parties could potentially experience in the event of tenants and/or Landlords being left with no alternatives but to consider Business Rescue Proceedings and/or Liquidation proceedings.

However, should either party wish to rely on remedies afforded to them in terms of the agreement, or the common law, it is imperative to follow the procedure in the contract and to engage with your Legal Practitioner without any delays, to ensure compliance with the agreement.