In a recent post, I discussed the effect of COVID-19 on real estate closings. Another topic affecting the real estate industry is whether coronavirus will excuse tenants from paying rent. While tenants of all sorts may experience difficulty paying rent in light of current economic challenges, commercial leases present an especially complex legal issue. In the commercial context, a tenant may find itself not only short of cash, but expressly prohibited from operating its business as intended.
Legal concepts that are important in evaluating whether a commercial tenant might be excused from its lease obligations include “force majeure” and the doctrines of “impossibility” and “frustration of purpose.” Each of these concepts has been examined by North Carolina courts in the context of landlord-tenant disputes.
Force Majeure
Leases sometimes include force majeure provisions that expressly address the parties’ obligations in the event of an “act of God” or other catastrophe. If a lease contains such a provision, its wording will be critical. For example, in a 2018 case before the N.C. Business Court, a law school lost its license to operate and argued that it should be excused from performing its obligations as a tenant. (South College Street, LLC v. Charlotte School of Law, LLC, 2018 NCBC 80.) While the lease contained a force majeure provision that excused performance based on “inability or delays in obtaining governmental permits,” the provision expressly stated that it only applied to duties “other than the payment of any monetary sums due hereunder” – a detail on which the court relied in finding that the tenant breached the lease by failing to pay rent. Obviously, if the parties to a lease clearly agree in writing that unexpected catastrophes will not excuse the payment of rent, a tenant will be severely constrained in arguing otherwise.
Impossibility & Frustration of Purpose
The doctrines of impossibility and frustration of purpose are also important – particularly when a lease does not contain a force majeure provision that squarely addresses the crisis at hand. These legal concepts were examined in the N.C. Court of Appeals case of WRI/Raleigh, L.P. v. Shaikh, 183 N.C. App. 249 (2007). There, a tenant in a shopping center learned, after signing a lease to operate a restaurant, that applicable city ordinances required a much larger “grease trap” than what the premises contained — and that, based on the layout of the premises, a new grease trap system would likely experience repeated clogging. The court found that the tenant breached the lease after he did not open his business and returned the keys to the landlord. The doctrine of impossibility applies where “the subject matter of the contract is destroyed” or it is otherwise literally impossible to adhere to a contract. The court noted that, where the premises still existed and a new tenant was in fact actually operating a restaurant in the space, the doctrine of impossibility was inapplicable. The court also discussed the similar doctrine of frustration of purpose, which applies where performance under a contract is possible, but an event which was not reasonably foreseeable makes the contract of virtually no value. The jury in the case decided that the predicament could have been reasonably foreseen.
Other Guidance from N.C. Courts
Other North Carolina landlord-tenant cases provide further guidance on these doctrines:
- In Taylor v. Gibbs, 268 N.C. 363 (1966), the N.C. Supreme Court held that a tobacco farm tenant breached its lease by failing to pay the full rent. While the tenant argued that unanticipated “acreage-poundage” regulations limited his yield, the lease was enforced as written, despite any “unforeseen and unexpected eventuality.”
- In Knowles v. Carolina Coach Co., 41 N.C. App. 709 (1979), the Court of Appeals held that a tenant breached its lease by failing to pay rent. The tenant rented a bus station from Carolina Coach to operate a ticket agency for carriers including Carolina Coach. When Carolina Coach suspended operations because of a labor strike, the ticket agency was still required to pay rent. The court noted that fluctuation of traffic levels in the station was a normal business risk that should not have been “beyond the imaginations of the contracting parties” and could have been specifically addressed in the lease.
- In Tucker v. Charter Medical Corp., 60 N.C. App. 665 (1983), the Court of Appeals likewise found that frustration of purpose did not apply. There, a tenant leased premises to build a hospital. Although the city denied approval for a certain hospital building, the court held that the building could have been built if the tenant had not requested a rezoning – and, in any event, the lease did not restrict use of the premises to a hospital.
- In Crabtree Valley Investment Group, LLC v. Steak & Ale of N. Carolina, Inc., 169 N.C. App. 825 (2005), a tenant was evicted for failure to pay rent during a period of time in which the tenant was awaiting receipt of a W-9 tax form from the landlord. The tenant argued that a force majeure provision excused performance based on events beyond the tenant’s control. The court stated that receipt of the W-9 was not legally required for the tenant to pay the rent and that receiving the W-9 prior to payment was merely the tenant’s internal policy.
- In the Charlotte School of Law case, the Business Court also rejected an argument of frustration of purpose – not only because the parties had agreed on how to allocate risks in their force majeure provision, but because the tenant had other options for using the premises. Specifically, the lease allowed the premises to be used for purposes other than a school – and it generally allowed the tenant to assign the lease or to sublease to another party.
Looking Forward
At the current moment, North Carolina civil courts are essentially frozen, and litigation over non-payment of rent is temporarily hindered. However, once courts are again operational, litigation over unpaid rent may be abundant. Whether landlords will, as a business decision, want to evict mass numbers of tenants in a shaky economy will have to be seen. However, issues about force majeure, impossibility and frustration of purpose will certainly arise. Disputes may turn on the particular language of a lease provision – or on facts such as whether a “stay at home” order totally outlawed a particular business from operating or merely made it more difficult to generate revenue.
Landlords and tenants who expect a dispute should review their leases carefully, with the assistance of an experienced lawyer. Landlords should also review their standard lease forms now with an outlook to the future. While current disputes may turn on the language of leases that were signed years ago, the COVID-19 crisis is a reminder that catastrophes will happen again. When they do, it will be beneficial to have planned ahead.
About the Author
Elliot has practiced law for over 20 years and is a member of the Federal, North Carolina and Forsyth County bar associations. He is an experienced litigator with major case experience in state and federal courts and in private arbitrations. Elliot has a broad range of experience with real estate disputes in contexts ranging from shopping centers to affordable housing complexes.