Force majeure and Covid-19 in commercial leases – what to consider going forward

In basic terms, a force majeure clause can be described as a clause in an agreement that deals with occurrences that may take place that would excuse either one or both of the parties from performing in terms of that agreement.

When Government announced that South Africa would go under
lockdown in March, tenants, and landlords hurriedly reviewed the second last
page of their lease agreements for the possible exemption of paying full rental
(or rental at all) due to their businesses not being able to operate.

Considering Covid-19, Dean Wright, Partner at Schindlers
Attorneys does not believe that anyone fully contemplated these clauses in
context until three months ago.

These types of clauses in lease agreements were
especially important from a commercial property perspective but very few of
them sufficiently deal with what we are looking at now in terms of Covid-19
”.

The force majeure clause pre-Covid-19

According to Dean, it is important to understand where the
force majeure clause came from.

He says that there is a common law doctrine (which exists outside of a contract) that deals with scenarios in which the performance of a contract becomes impossible. What this contemplates is that when an unforeseen circumstance arises, not due to either party’s fault or, which renders one of these parties’ performance impossible, such party’s performance may be excused.  This occurrence would be called ‘supervening impossibility’ or ‘impossibility of performance’.

Over time parties started to regulate these types of occurrences and began inserting these types of clauses into written agreements which then, over time, evolved into what we know as the infamous ‘force majeure’ clause”.

In terms of the commercial property sector, the force
majeure clause applies to two specific parties: the landlord and the tenant.

Usually, commercial lease agreements have some type of a
force majeure clause in them but, they are normally drafted in a very vague,
all-encompassing manner i.e. if a particular instance occurs, then the parties
do not have to perform fully or, the agreement may even be terminated (either
by one party or mutually) on an amicable basis. 

A particularly good example is the destruction of a
property”
says Dean. “If a property is destroyed, logically the landlord
cannot perform its obligations (providing the tenant with occupation of such
property) and a lease agreement can no longer exist – that’s an event that
occurred and happened to no fault of either party
”.

The current landlord and tenant dynamic during Covid-19

On reviewing their lease agreements, Dean says that in his
experience, the most common disagreement between tenants and landlords were
that tenants believed it was ‘unfair’ to have to pay full rental in
circumstances where they were not able to operate under lockdown.

The landlords thought differently.

Landlords who did not have pressure and who weren’t exposed
to the banks, understood the situation and offered various mechanisms such as a
monthly rental reduction or a deferral of rental, but very few landlords gave a
complete payment holiday.

On the other hand, there were the minority of landlords who
were not in the financial position to do so and who could not afford to be as
accommodating and this Dean says, is where he has seen a lot of disputes.

Dean highlights that the issue of utilities was a big
sticking point too. Regardless of whether the tenant had access to the premises
or not, the landlord would have to incur the cost of the utility bills
irrespective.

In practice, it comes down to this ‘catch all’ force majeure
clause – what is the reason for being unable to operate or unable to occupy or,
not being able to access the premises? Is it the fact that it is an infectious
disease or is it because it has been declared a national state of disaster? Is
it the lockdown that has caused everyone not to be able to operate or, is it
the infectious disease itself?

Dean says that he has seen this most recently in the
insurance industry. Insurers are beginning to look at the triggers causing
business interruption and are asking whether it is the disease that has
interrupted the business or is it the national lockdown?

In the same thought pattern and, depending on the wording of
the clause, landlords are beginning to consider whether it is Covid-19 itself
or the national lockdown which has caused the force majeure event or, ‘impossibility
of performance’
?

Tenants disagree.

When people start getting creative about trying to apply a force majeure clause that is not specifically drafted for this situation, it becomes the chicken and the egg scenario.”

There was definitely a three-month honeymoon phase. Now
that we are coming out of lockdown and everything is easing up, we have seen a
lot more pressure from landlords on their tenants. A lot of them are no longer
willing to or able to give these reprieves or, accept less of a rental
.”

The force majeure clause and ‘impossibility of
performance
’ going forward

It all goes back to ‘what is the force majeure clause and
where does it stem from?’

The important key elements are that it must be an occurrence
or an event that could not be reasonably contemplated or foreseen by the
parties and caused by no fault of either party.

Dean says that going forward, parties are now acutely aware of Covid-19 and its affects and these are now ‘reasonably foreseeable’ so standard force majeure clauses and or arguments of ‘impossibility of performance’ will need to be relooked at.

When we are going into a lease agreement, you can bet
that both parties are going to know about Covid-19 and the potential of a
second or third wave with the possibility that companies will not be able to
work at their full capacity – it is no longer an unknown occurrence
.”

“What we have seen is that a lot of landlords and tenants
are now restructuring lease agreements by converting them to a variable model
based on turnover and income. The utilities etc. are the base line costs but a
lot of it (especially in the restaurant and retail industries) are looking at
these variable income models.”

However, you cannot suddenly start changing terms within a
lease agreement unilaterally.

Dean also warns tenants who have an existing agreement and
who are now trying to excuse their performance, in full or in part, by invoking
a force majeure clause (or any clause) which is not valid or caters properly
for this scenario, may in fact be considered a breach of agreement in the form
of repudiation.

In this instance, landlords can either enforce the terms and
conditions of the agreement or, they can cancel the agreement and claim
damages.

In commercial or retail leases for example, we are
talking about lease periods that are usually more than five years. Although
every landlord would like to claim the remainder of the full lease period after
the breach and cancellation, landlords must remember that they have a duty to mitigate
these damages by re-tenanting the space as quickly as possible. They simply
cannot just sit back and allow the space to remain vacant
.”

There’s no fixed set of rules but you’d have to prove
that you’ve tried to mitigate your losses and that you’ve tried to get another
tenant in. If you get another tenant in the next month, you have not really
suffered any damage – if it is the same rental. It’s a very fine line
.”

He advises that landlords prepare by including a specific
clause that deals with the effects of Covid-19 in their new leases going
forward or by way of an addendum to existing leases if the parties both wish to
regulate this. With everyone aware of the pandemic, landlords and tenants
cannot hide behind the former protection of this clause and it needs to be
regulated upfront. 

“We are suggesting an addendum to existing agreements that deal specifically with the change in the rental model as a result of Covid-19” he says. “Or, to deal specifically with what will happen with instances of Covid-19.”

“If it is a new agreement, the standard force majeure clause is probably not going to carry the weight that it should in relation to the effects of COVID-19 because everyone now understands that there is a very likely possibility that it may happen again. We suggest that you keep your standard force majeure clause as is but that parties include a specific clause to deal with the effects of Covid-19 and the parties’ obligations should those instances arise.”.

I don’t think we have seen the bulk of these fights as there has been a honeymoon phase. Everyone has been relatively understanding because we are all in the same boat but, as of the second easing of lockdown, people are starting to look to recover outstanding debts and are trying to put themselves back into a position pre-Covid-19” he concludes.

About Dean Wright

Dean joined Schindlers Attorneys as a Candidate Attorney in 2008. He was admitted as an Attorney of the High Court of South Africa in 2010 and he has been a Partner of Schindlers Attorneys since 2014.

He specialises in civil, commercial, and corporate litigation as well as property law, with a keen interest in representing sub-contractors in the South African Built Environment, particularly in relation to the JBCC Suite of Agreements.

Dean was also a co-facilitator for the Diploma in International Arbitration at the Royal Institute of Chartered Surveyors (RICS).

By Gemma-Louise Perrins.

Source: Propertywheel.co.za | https://propertywheel.co.za/2020/07/force-majeure-and-covid-19-in-commercial-leases-what-to-consider-going-forward/

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