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Impracticable Cloak: COVID-19 defenses to commercial lease enforcement

“Where, after a contract is made, a party’s performance is made impracticable without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his duty to render that performance is discharged, unless the language or the circumstances indicate the contrary.” Restatement (Second) of Contracts, § 261 (1981).

In simpler times, law students around the country would know these words – the 1981 formulation of the “doctrine of impracticability” – as nothing more than a final exam topic, intellectually intriguing but rarely applicable in everyday practice. Johnny agrees to ship a container for Lisa, when pirates seize control and render shipping too dangerous, does Johnny have to brave the waters to deliver the goods? Never mind that the everyday Johnnies of the world rarely own international shipping companies, let alone plan trade routes through pirate-infested waters. By its very nature, the doctrine of impracticability is meant to apply to situations so far outside of normal cognition that even the most creative paper-tiger-chasing attorney would miss them – and commercial contracts are littered with an ever-increasing chroma of pages-on-pages of boilerplate fluff that seem to envision every potential scenario under the sun.

But if 2020 showed us anything, it’s that there are always more scenarios under the sun. 2020 was the ephemeral manifestation of that that one final exam hypothetical that not even your professor thought would ever happen.

In Virginia, lease enforcement is routed through a unique process known as the summons for unlawful detainer – a streamlined, juryless, discovery-free proceeding to both decide the right of ownership and appropriate rent within the span of a single hearing. For personal real estate leases, Virginia has issued a series of emergency orders staying evictions and passed additional protections under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. But commercial tenancies have not enjoyed the same protections. Unquestionably, businesses have been hit hard during the pandemic. Stay-at-home orders, fear of enclosed spaces, and loss of disposable income have caused many consumers to avoid retail and restaurant establishments, often crippling those businesses. With fewer shoppers stopping by retail locations, commercial tenants face lower revenues and may fall behind on rental payments. Missed rental payments means commercial landlords don’t hit anticipated revenue targets and risk defaulting to creditors. With no emergency order to prevent eviction or defer payments in place, it makes economic sense for commercial landlords to replace nonviable tenants in struggling retail or in-person dining establishments with more pandemic-friendly businesses (such as tenants more focused on fast, high volume take-out). And the summons for unlawful detainer offers a streamlined way of doing so.

This may seem uncharitable to certain commercial tenants. After all, COVID-19 isn’t their fault; why should they bear the brunt of the expense for the economic downturn that resulted? Commercial tenants have leaned heavily on two defense strategies in the face of pandemic-fueled economic hardship – (1) the lease force majeure clause, and (2) the doctrine of impracticability.

The first thing to recognize is that a commercial lease is not just about setting forth the location the tenant will occupy, how much money the tenant will pay for that space, and who is responsible for the water bill – it’s also about allocating various risks between two parties. This may include deciding what happens if a pipe bursts, who pays for the legal bill if a third-party wanders onto the property and files a law suit after being injured, what happens when the government seizes the underlying land, and so on.

Typically, commercial leases will contain a “force majeure” clause, which is a fancy French term for superior (or powerful outside) force. A force majeure clause will state that, if any of a broad range of enumerated events occurs (typically including catastrophic weather events, wars, terrorism, restrictive new laws, and so on), the parties are excused from performing actions that would be rendered impossible by the occurrence of that event.

Some commercial tenants have attempted to get out of rent payments or other lease obligations by invoking the force majeure clause in their leases. However, these arguments typically fail for three reasons. First, many force majeure clauses fail to explicitly address or encompass the occurrence of a pandemic that causes people not to shop – and in the realm of contract enforcement, courts are loathe to read provisions to apply to a broader range of scenarios (especially when other, concrete examples are given within the clause). Second, most force majeure clauses require the event to prevent the underlying property itself from operating, rather than incidentally causing limited foot traffic. To be fair, in certain localities that outright banned various commercial spaces from opening, there may be a decent argument that the law or order passed to close the commercial space is a force majeure event (assuming governmental action is included in the clause). However, third, most force majeure clauses include a provision saying that the obligation to pay rent is not excused even if a force majeure event occurs.

Close, but no cigar. So what’s next? Enter the doctrine of impracticability (note: not impractical, but impracticable), which applies to excuse contractual performance when certain unforeseeable events cause a party to be unable to perform its obligations without extreme and unreasonable difficulty, expense, injury, or loss to one of the parties. The doctrine has been explicitly adopted by Virginia courts as a legitimate and total defense to contract enforcement.

The concepts of force majeure and impracticability are often closely connected, as they both deal with rare events occurring outside of the control of either party – “acts of God,” so to speak. However, there is a key distinction. Force majeure is governed by contract, the terms of which are set forth and agreed upon by the parties, and impracticability is an equitable doctrine, meaning the court reads into what would be fair under the circumstances – even if it’s not expressly codified in some written agreement between the parties. As such, force majeure applies to events that were explicitly contemplated by the parties at the time of contract and explicitly assigns what should happen if those events should occur. On the other hand, impracticability, by definition, only applies to events “the non-occurrence of which was a basic assumption on which the contract was made,” in other words, events that were not explicitly addressed by contract.

There’s a good argument that COVID-19 qualifies as an event that was so far outside the realm of foreseeability that the parties would assume it would not occur. Does that mean that commercial tenants have a silver bullet to get out of rental payments since March? Not so fast – the doctrine of impracticability is nuanced and limited, and there are three key counterarguments against applying it to missed rental payments from the downturn in business caused by COVID-19:

First, impracticability typically only applies to limit further harm / market inefficiency from being caused by the performance itself, and discharges the “duty to render that performance.” In our aforementioned pirate example, performing under the contract would force the performing party to put himself and others at substantial risk of physical harm. But COVID-19 has not prevented the physical transfer of rental money; although the CDC may recommend against meeting with your banker face-to-face, commercial leases would almost certainly allow for mailing a check or wire transfer. As such, typically, “market shifts or financial inability do not usually effect discharge under the rule,” since the transfer of money from one party to another does not cause aggregate harm (unless the physical movement of money itself is impracticable, e.g. if payment under the contract specifically required ferrying briefcases of gold bullion through the now-pirate-infested waters). Restatement (Second) of Contracts, § 261 cmt. b.

There are some exceptions in which transfer of money is itself made impracticable, but they tend to involve some great market distortion (such as vastly increased costs) that would occur “well beyond the normal range.” Restatement (Second) of Contracts, § 261 cmt. d. For example, if a party had contracted to procure some rare spice from a third party, and there was a freak wildfire that destroyed the vast majority of that spice, driving market prices freakishly high, then forcing a party to purchase large amounts of that spice at a 100x markup would cause catastrophic market inefficiencies, and would harm the purchasing party several orders of magnitude more than it would impact the receiving party. In the case of a tenant lease during Covid, the actual performance under the contract (occupation of the space and payment of rent) would not cause some massive systemic harm – the virus does not cause the rent to change (let alone “well outside of the normal range”) and, typically, a commercial lease does not include any obligation on the tenant to hit specific sales targets. The landlord is concerned only with receiving payment of rent. Impracticability does not apply to reapportion a set pool of money (the unpaid rent) between two parties.

Second, even if impracticability were construed to nullify contracts based on a “market collapse” theory (which would, if applied broadly, arguably undermine the entire framework of capitalism), most commercial lease arrangements would survive so long as some “alternative” means of performance is possible. Restatement (Second) of Contracts, § 261 cmt. f. For example, state restrictions on restaurants may have restricted indoor seating, but still allowed for take-out. Arguably, the responsibility should be on the tenant to demonstrate that alternative performance was tried and failed (since impracticability is an affirmative defense). However, some judges may place the responsibility on the landlord to start a dialogue with the tenant. Either way, landlords should work with tenants to come up with creative solutions for tenants, such as:

  • Permitting the use of additional outdoor space for outdoor seating
  • Modifying hours of service requirements
  • Marketing / making prospective customers aware that establishments are still open and under what conditions customers may still visit
  • Providing enhanced cleaning services, complementary masks, social distance marketing, etc. within common areas

Third, impracticability may temporarily suspend, but will not completely discharge, duties that are only temporarily frustrated. Restatement (Second) of Contracts, § 269 (1981). After the temporary setback ends, the contract remains in full force. Given the market recovery and vaccine rollout, it seems unlikely that a tenant could argue that the entire commercial retail industry is forever doomed. Therefore, at worst, tenants may have been able to argue for temporary suspension of rental payments (or reduction of late fees) during the worst of the pandemic.

One caveat: an argument could be made that certain ancillary obligations within a typical lease, such as a requirement that a certain number of workers be present or that the restaurant be open for table service during certain hours, could be waived if made illegal by government order. But these requirements tend to be tenant-restrictive, so even if impracticability waived those requirements, it would not also waive the tenant’s payment obligations.

If you have any questions about this article, please contact Matthias Kaseorg (mkaseorg@setlifflaw.com) at (804) 377-1273 or Steve Setliff (ssetliff@setlifflaw.com) at (804) 377-1261.

 

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