Sapphire & Sage
COVID-19 Impact on Commercial Lease
COVID-19 IMPACTING COMMERCIAL LEASES
Amidst the devastating impact of Coronavirus in short (“COVID-19”) life is changing dramatically so is the ability of businesses to operate in their leased spaces. The Hon’ble Prime Minister of India had announced 21 days nationwide lockdown starting from 24th of March, 2020 Midnight. Though, the lockdown as of now is the only possible way to curb the spread of the virus which has severely infected 638,146 people worldwide as on 30.03.2020, it inter alia also has impacted the leasehold properties. This article aims to lay emphasis of its implication on commercial leases.
The World Health Organization (WHO) has declared COVID-19 a worldwide pandemic on 12th of March, 2020. The Department of Expenditure, Procurement Policy Division of Ministry of Finance vide Office Memorandum No. F. 18/4/2020-PPD dated 19th February, 2020 in reference to Para 9.7.7 of the “Manual of Procurement of Goods, 2017” clarified the outbreak COVID-19 as a “natural calamity” within the event of ‘Act of God’ and Force Majeure Clause may be invoked “wherever considered appropriate” in respect to disruption in the supply chain.
Lessee are seeking to avoid performance of contractual obligations during this lockdown in specific payment of lease rentals citing reasons of force majeure situation, unavailability of lease premises, impossibility of performance, unforeseeability, loss of business and revenue. Requests for waiver of rentals and common maintenance charges during this and extended period if any are on surge.
In contrast the Lessor are not agreeable for waiver or suspension of lease rentals for reasons of availability of premises, continued use and occupation by parking of goods, equipments and machineries of the lessee, non breach of terms by the lessor, temporary phase of inability of optimum commercial use does not fall within force majeure clause.
Under this scenario, it is crucial to understand whether COVID-19 being a “Force Majeure” event is utilized to bypass payment of lease rentals.
Force Majeure is a French term which means ‘superior forces’. The intent to describe the events under a Force Majeure clause (over which the party has no control) is to give protection to the party for its failure to perform a contractual obligation. However, protection to the parties would entirely depend on the factual analysis of contract, language of the Force Majeure Clause and its legal interpretation by the courts.
Foundation upon which the lease agreements are executed is the ‘right of enjoyment’ in lieu of which consideration is being paid by the lessee. Suspension of business operations due to a force majeure event per contra occupying the premises may not lead to waiver of lease rentals. Obviously, the burden of proof lies on the lessee to discharge its liability in terms of withholding of rental payments as even during a forced closure the payment of dues may become payable. Also, few contractual obligations entitle the landlords with right to terminate the lease arrangement beyond certain days as incorporated under the force majeure clause.
In a 2003 SARs epidemic-related case Li Ching Wing v Xuan Yi Xiong  1 HKLRD 754, a Hong Kong court rejected a tenant’s claim that a tenancy agreement was frustrated because the premises were aﬀected by an isolation order by the Department of Health due to the outbreak of SARS, which meant that it could not be inhabited for 10 days. The court held that a 10 day period was insigniﬁcant in view of the two-year duration of the lease, and that whilst SARS was arguably an unforeseeable event, it did not “signiﬁcantly change the nature of the outstanding contractual rights or obligations” of the parties in the case.
The Ministry of Finance in the Office Memorandum clarified that the Force Majeure Clause does not excuse a party’s non-performance entirely but only suspends it for the duration of a period. However, the memorandum cannot govern the lease commercials as it was issued with respect to disruptions in the supply chain thus invocation of force majeure clause will be indicated by the nature and construction of terms of the contract. In case the event falls within the provision by virtue of interpretation of the force majeure clause then the party may prevent or delay the performance of its obligations. In view of the present situation the lessee may be exempted from the performance in terms of expressions like “epidemic” or “pandemic” or “extraordinary events or circumstances beyond the reasonable control of the parties” and may cover “Act of God” in terms of commercial leases. It is essential for the party seeking force majeure to establish that COVID 19 qualifies in their force majeure clause. However, caution should be exercised in case of any exemption from invoking the force majeure provision. For example, few leases offer that lease rentals will be due despite a force majeure event not due to the default of the Lessor.
Section 56 of the Indian contract Act, 1872 provides impossibility of performance after execution of contract, may be invoked if the contract does not expressly provide a force majeure clause.
Energy Watchdog vs. Central Electricity Regulatory Commission & Ors is one of the leading Judgments wherein the Apex Court held in terms of Section 56 that:
“What was held was that the word “impossible” has not been used in the Section in the sense of physical or literal impossibility. The performance of an act may not be literally impossible but it may be impracticable and useless from the point of view of the object and purpose of the parties. If an untoward event or change of circumstance totally upsets the very foundation upon which the parties entered their agreement, it can be said that the promisor finds it impossible to do the act which he had promised to do. It was further held that where the Court finds that the contract itself either impliedly or expressly contains a term, according to which performance would stand discharged under certain circumstances, the dissolution of the contract would take place under the terms of the contract itself and such cases would be dealt with under Section 32 of the Act. If, however, frustration is to take place de hors the contract, it will be governed by Section 56.”
The party should be able to establish that non performance of the contract i.e. non- payment of lease rentals is not because of loss of business but due to the force majeure event.
Frustration of contract envisages impossibility of performance leading to avoidance of contract and can be categorized as discharge of contract. Therefore, establishing that an unexpected event is impacting the party’s ability to perform its obligation has frustrated the basis of contract. Proving frustration by the affected party would bring the contract to an end.
Under the present scenario, the present 21 days lockdown might not fall within force majeure event but extended government mandate shutdown for a longer period may constitute frustration of contract.
Seeking to bail out from COVID-19 impact by either reduction of rentals for a limited period of time or waiver in charges by the lessees at such instances, revenue of lesser would be at stake. It might also be difficult to defer the payments on part of the lessees as it would only build up their liability. There is no one-size fits all solution. The lessee should not pass on the burden to the lessor alone as they have other financial obligations of paying loan interest, property tax etc.
Few Property Owners, Developers, business occupiers have chosen for its specific partners complete waivers until the lockdown. However, this also seems to be a temporary aid for survival in the short run. During the existence of pandemic, the lessees would not be excused for dues pre or post COVID-19 crisis.
Under such conflicting circumstances, parties to the contract would be forced into Insolvency Proceedings for defaults in lease rentals but to our rescue, the Finance Minister Nirmala Sitharaman on 24th March 2020 in a press release declared that minimum threshold of default from 1 lakh is raised to 1 Crore for MSMEs with immediate effect.
While interpreting the disputes which would arise before various courts a holistic approach may be adopted so as to balance the interest of parties. Even otherwise, it is highly unlikely that Courts might interpret a lease contract incapable of performance leading to termination. In addition, tenant’s financial strength during the lockdown could also become an aspect for deciding waiver.
Depending on the rise of cases with lightening speed the Government of India may announce protective measures such as exemption from eviction during the crisis then the situation would be like that of a moratorium imposed against the landlords wherein, the rights of the landlord to evict the tenant shall stand suspended. However, in respect of commercial terms the termination would still be governed by analyzing the contract.
In addition, landlords will also have to be prudent in reasonably considering temporary mutual solutions to navigate through this crisis.
It would be advised in light of the pandemic crisis that Counterparties should choose to re- negotiate the contractual terms in respect of rental obligations. The negotiation would depend on the case to case basis ranging from reduction in rent, waiver and deferred payments with an extension in the lease terms.
An unprecedented time of COVID-19 is leading not only loss of human life but also disruption in contractual relationships. It is imperative for parties to seek protection through Force Majeure Clauses, assert non- performance by claiming impossibility, to consider possible measures for resolution of the dispute through means of negotiation in the best interest of the Parties for the sake of long term relationship.
Author: Shelly Gupta
(Senior Associate at Sapphire & Sage, Law Offices)