COVID-19: How to handle contractual distress in lease agreements?
COVID-19 pandemic has generated unprecedented legislative measures and harsh economic consequences amongst which the work from home obligation, closing down of certain public spaces etc. implemented under the Decree no. 195/2020 for the emergency state in Romania and subsequent implementing norms (the „Emergency Measures”).
In the midst of this storm, what happens with the ongoing lease agreements (industrial platforms, HORECA facilities, shopping malls etc.) where the tenants are either prevented by the Emergency Measures or disengaged by the mere loss of business as a consequence thereof to use the rented premises? Who bears the contractual risk, what the landlords and the tenants should do about it?
STEP 1 – Check out the law
The law offers several tools to a party in the lease agreement for justifying the failure to fulfil its contractual obligations, to obtain a readjustment of the contract, or to exit from it. Basically, in the COVID-19 current difficult circumstances, the tenants’ interests would be to either suspend / terminate the leases, or obtain better terms, while the landlords’ interests would be to maintain the status quo.
The Romanian law regulates the following main relevant tools serving such purpose: (i) fortuitous impossibility of performance; and (ii) hardship.
A. Fortuitous impossibility of performance
1. What does it mean?
According to the law, this refers to force majeure, fortuitous event or „other events with the same effects” (for example, an emergency or other specific situation to which the special legislation recognizes the same effects).
The force majeure is an external, unpredictable, and absolutely invincible and unavoidable event. The fortuitous event is an event which cannot be foreseen nor prevented by the person which would be liable in the absence of such event. Therefore, the force majeure is general and absolute, while the fortuitous event is particular and relative to the person whose liability is at stake.
The analysis whether the COVID-19 pandemic might be considered force majeure or fortuitous event in relation to a lease agreement is to be done on a case by case basis, taking into account the particular circumstances (for instance, the extent to which the obligation to work from home is applicable to a certain tenant, the extent to which the Emergency Measures prevent a landlord to keep the leased premises operational, or whether other Emergency Measures directly apply to the tenant / landlord, or impact them indirectly etc.).
2. When can it be activated?
According to the law, one party can validly claim the benefit of a fortuitous impossibility of performance only if such party is not itself in a default imputable to it and has not been served by the other party a default notice in this respect.
Also, the law requires the party affected by force majeure to notify the event within a reasonable term under the sanction of compensations due to the other party for damages as result of failure to do so.
3.What are the consequences?
The obligation is suspended when the impossibility of performance is temporary or is deemed extinguished if the impossibility is definitive. COVID-19 being a temporary situation, its potential effect would likely be suspension, not the extinguishing of the subject obligation.
But what about the contract itself? The law provides that in case of total and definitive impossibility to perform a material obligation, the contract is automatically terminated, while in case of a temporary impossibility, the creditor may choose to suspend the performance of its own obligations, or to terminate the contract. Thus, if the landlord would claim force majeure as regards its obligation to make available the rented premises, the tenant could, in principle, use this option right.
4.Does it apply to all obligations/contracts?
In principle yes; however, according to the law, the fortuitous impossibility of performance does not apply to obligations having as object fungible goods (on the general assumption that such goods could always be procured, in principle).
As such, the tenants as debtors of monetary (payment) obligations, cannot, in principle, claim fortuitous impossibility of performance with respect to their obligation to pay rent, but landlords could do so with respect to their obligation to procure the availability of the rented premises for tenants’ use. Likewise, the courts’ practice so far was to reject the qualification of financial blockage as an event of force majeure.
However, the tenants of premises which would have to be closed down according to the Emergency Measures (or which are closed down by the landlords, preventively, anyway) could claim suspension of their obligations to pay the rent based on the exception of non-performance. Exception of non-performance means that a party is allowed to willingly not perform its obligations if and to the extent the corresponding (interdependent) obligations of the other party towards it are not performed either (whatever the reasons of such non-performance, as the law does not make any such distinction).
But the tenants should not be able to claim the same remedy in case the leased premises remain available for use because, for example, the Emergency Measures do not forbid them to use such premises, but only restrict activities therein, (this seems to be currently the case for restaurants that can still operate on the basis of home delivery orders).
Again, a case by case assessment must be made.
Nonetheless, in the event the tenants may not claim a fortuitous impossibility of performance, they might still be able to claim the benefit of hardship.
1. What does it mean?
Hardship represents an exceptional change of circumstances during the performance of a contract that tilts the balance of contractual obligations unreasonably too much in favor of one party and, in this situation, the law provides for a possibility of readjustment of the contractual terms.
2. What prior conditions are required?
The hardship remedy works only if the following prior conditions are met: (i) the change of circumstances occurs after the conclusion of the contract and were not (and could not have been) reasonably foreseen at the conclusion of the contract; and (ii) the affected party did not assume (and it cannot be reasonably considered that it has assumed) the risk of such change of circumstances and has made endeavors within a reasonable term to negotiate in good faith the adjustment of the contract.
3. What are the consequences?
If these conditions are met, the court can decide: (i) the adjustment of the contract in an equitable manner; or (ii) termination of the contract under the conditions established by the court. In case of a lease agreement and considering the temporary nature of the COVID-19 pandemic, it is likely the court would prefer solution (i) over (ii).
It is also likely the hardship would be easier to be successfully claimed by tenants compared to other remedies because the restrictions on their activity brought by both by the Emergency Measures and by the economic crisis ensuing from COVID-19 pandemic seem to meet the hardship criteria on a general, prima facie level (as long as we are referring to lease contracts signed before the outburst of the crisis and which do not contain waivers of the hardship benefit).
Obviously, yet again a case by case assessment should be made.
STEP 2 – Check out the contract
Having in mind the above legal background, the parties need to check the contractual clauses in the lease agreements regarding force majeure, other situations when the non-performance would be justified, or hardship situation (for instance, rent/costs indexation clauses).
The contract could provide, for instance, procedural steps such as (i) prior notice and other formal requirements (type, form of notice, etc.); or (ii) possible requirement of prior negotiation endeavors /formalities etc.
Also, the contract may provide for specific risks allocation rules and consequences of the force majeure, hardship or similar adverse events (for example, rules for financial compensation, rent adjustment, obligation to offer alternative solutions, an easier way out of the contract etc.).
To the extent not violating any mandatory laws, these contractual clauses take precedence on the legal provisions, as they represent the „law of the parties”.
STEP 3 – Follow the applicable procedural steps
These contractual steps, if any, must be strictly followed. If the contract is silent, the steps in the law are to be followed (please see Step 1, point A.2 above).
Failure to do so entails the risk that a court of law denies the benefit of force majeure or similar legal remedies, even if the case at hand would qualify as such on its merits.
COVID-19 pandemic opens up to tenants a few legal windows for renegotiating or suspending (but unlikely terminating) the lease agreements, while it also offers landlords some defenses to block such course of action.
The Emergency Measures (especially if the pandemic escalates) might adopt a pro-tenants approach on the ground that their businesses are deeply affected (for instance, by using the tool of the emergency status certificates to be issued under the Decree no. 195/2020, as further regulated by existing or future subsequent legislation). However, the authorities in charge need also to consider the difficult situation of the landlords which income sources could be depleted.
Landlords and tenants need to carefully analyze each lease agreement in the light of the applicable legislation described above and particular circumstances related to both COVID-19 impact and the respective lease, in order to take an informed decision and preserve their rights.
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