Contract agreements are an important part of any business’ operations. Commercial real estate (CRE) lease agreements provide building owners with a security net to ensure that their space will continue to be occupied at a certain rate and price for the duration of the contract. Normally, commercial leasing agreements are extremely difficult, if not impossible, to break out of—short of one of the parties declaring bankruptcy.
However, the recent coronavirus outbreak, which was declared a public health emergency by the US Secretary of Health and Human Services (HHS) on January 31, 2020—and was later declared a national emergency by President Donald Trump—may have far-reaching impacts for commercial real estate contracts that would have been unimaginable just a year ago.
Why? Because of something known as “force majeure.” What is force majeure? How does it relate to commercial real estate leases? And, who stands to benefit or lose from the potential impacts of this contract clause?
What is Force Majeure?
Force majeure is a French term that translates to “superior force” in English. It’s the commonly-used term for a contract clause that indemnifies contract participants against breach of contract penalties in light of “acts of God.”
What’s an act of God? It’s any unforeseen circumstance that is beyond the control of either party in a contract that would prevent said party from being able to complete their contractual obligations. The key parts of force majeure include:
Unpredictable. The event must be reasonably unexpected or impossible to predict.
Uncontrollable. The event must be beyond the control of either party to cause or influence.
Impact. The event must materially affect the party’s ability to perform its obligations.
Normally, general market events would not trigger a force majeure clause. However, there is a risk that the national emergency posed by the coronavirus outbreak could be used to trigger such clauses. Why? Because, as noted by explanatory sites like Contract Standards, “acts of state or governmental action prohibiting or impeding any party from performing its respective obligations under the contract” can be considered part of force majeure.
A Forbes article discussing the recent shutdown of NHL and NBA sports events cited force majeure clauses in team and player contracts as a concern: “Both leagues have force majeure language in their collective bargaining agreements that would allow owners to withhold a percentage of player’s paychecks upon the occurrence of a ‘force majeure event.’” Furthermore, the Forbes article also reported that “many companies who advertise in sports are using force majeure as a way to claw back any money that was originally to be spent on ads during sporting events.”
How Do Force Majeure and Coronavirus Relate to Real Estate Leases?
Force majeure clauses are often considered a piece of legal boilerplate for commercial real estate contracts—something that gets thrown in without much scrutiny or thought. However, with the coronavirus outbreak and the unrest accompanying it, there may be room for some renters to ask for a release from their CRE contract agreements under their contract’s force majeure clauses. The risk of these leasing contract breaks could put some landlords against the proverbial wall.
Why would the outbreak allow for a force majeure clause to be enforced? Aside from the virus’ heavy impact on the global economy, which has sources such as The New York Times stating that “there is little doubt that the nation is headed into a recession,” governmental responses to the threat of COVID-19 could also trigger a force majeure clause.
For example, in some states (like Maryland) government officials are enforcing the closure of “nonessential” businesses as a means of limiting the virus’ spread by encouraging workers and customers alike to stay home. If a business cannot operate remotely, then it cannot continue to make money—and may thus be unable to complete its contractual obligations per their commercial real estate leasing agreements due to circumstances outside of its control.
This, in turn, may be grounds for leasing contract breaks based on force majeure clauses that may exist in these contracts.
Who Stands to Benefit from the Force Majeure Situation?
The mere threat of a force majeure clause being incited could put a lot of negotiating power into the hands of commercial real estate renters. Many landlords don’t want to risk having unexpected vacancies in their CRE portfolios, which the leasing contract breaks that force majeure clauses would enable could create. This creates an incentive for landlords to offer advantageous clauses in their lease agreements.
However, the presence or absence of a force majeure clause in a contract may not even matter if a company that is leasing space goes out of business because they cannot keep up with their leasing costs, employee pay, and other financial burdens because of a crisis-induced recession. With this in mind, many landlords may prove to be more amenable to contract renegotiations to help their current occupants remain solvent during this trying time.
Some sources (like Forbes) note that, once the pandemic has passed, there may be “constructive impact for what was already a robust real estate market if interest rates remain low and the return to normalcy [takes] only a few months.” In such a scenario, real estate investors with lots of liquid capital to invest could make significant gains. However, if recovery is slow, it could leave a shortage of potential clients for commercial office space, which would make it a buyer’s/renter’s market.
We’ll have to wait and see what the impacts of the coronavirus outbreak are in the coming months. However, the team here at iOptimize hope that the threat of the virus passes quickly, and that people are able to remain safe and healthy during this crisis.
Have questions about how COVID-19 might affect your real estate portfolio? Reach out to the team at iOptimize Realty to discuss your needs.