COVID-19 Moratoriums, Commercial Leases and Unpaid Rent | Creative Lawyering Solutions
Updated: Nov 17, 2020
IMPORTANT NOTE: This article is authored primarily with the City (and County) of Los Angeles eviction moratorium laws (applicable during the COVID-19 pandemic of 2020-2021) in mind. It may have application to moratoriums in other jurisdictions as well, but was penned with an eye towards the commercial real estate situation in the greater Los Angeles metropolitan area and through the lens of a commercial real property landlord.
The year is 2020. You are a commercial property landlord.
Commencing early March of this year, you found yourself in the grip of an unprecedented pandemic caused by the COVID-19 virus. Until then, things were good. No, they were great. The US economy was roaring, your property was providing you with an excellent, seemingly effortless income stream that you had become accustomed to. Income that you relied upon for your livelihood. Perhaps your owned several commercial buildings, including a strip mall, a high end retail center, and a stand alone single-tenant office building. You had never had any serious issues. Tenants generally paid on time, respected you and abided by the terms of their leases, particularly your national anchor tenants: the pride of your mini empire. Now, almost overnight, the world was turned upside down.
On March 4, 2020, the Governor of California announced a formal state of emergency arising from the quickly spreading and deadly virus, now arrived on US shores. Within a couple of weeks, multiple counties and cities throughout the state (indeed the nation) issued lockdown orders and emergency tenant protection laws. And for good cause. Without expedited and unprecedented legal protections the entire US economy would almost certainly collapse in a catastrophic failure.
In the City of Los Angeles, for instance, Ordinance Nos. 186585 (effective March 31) and 186606 (effective May 12) (collectively, "City Ordinance") came to the rescue of both residential and commercial tenants. The primary purpose and effect of these laws is to prohibit evictions arising from failure of residential and commercial tenants to pay rent as a consequence of the economic impact of the pandemic. Under the City Ordinance, rent continues to accrue, but be deferred for later payment. In the case of commercial tenancies, the City Ordinance allows the tenant to defer accruing rent until three months after the Mayor of Los Angeles declares an end to the COVID-19 emergency (at which point all accrued, unpaid rent shall immediately become due in payable -- and failure to pay may, only thereafter, result in pay or quit notice and related eviction proceedings). As of this writing, on November 13, 2020, it remains entirely unclear when the Mayor of the city intends to lift the emergency and it is not reasonably likely to occur any sooner than April 2021, when vaccines are expected to be both approved by the FDA and made widely available to consumers.
ASIDE: To make matters worse, the County of Los Angeles recently enacted its own overlay moratorium ("County Moratorium") which applies to both residential and commercial tenants in any LA County location, including the City of Los Angeles. Under this set of rules, commercial tenants with nine or fewer employees will have up to 12 months following the end of the moratorium period to repay any past due payments. Commercial tenants with ten, but less than one hundred, employees will have up to six months following the end of the moratorium to pay back any past due rent in equal payments. Since these rules provide even greater tenant protections than the City Ordinance, the County moratorium will control on the timing of repayment of deferred rent issue, thereby effectively increasing the post-moratorium repayment period to either six or twelve months (versus the City Ordinance's three month period).
For illustrative purposes, assuming the moratorium is called off on April 1, 2021, the landlord's commercial tenant is owed deferred rent of $100,000 and his or her commercial tenant six employees, this is what the landlord is up against:
Under the applicable city and county laws, the landlord cannot take any coercive or unilateral action to seek rent payments until at least April 1. This includes pressuring, locking out, shutting off utilities, serving a pay or quit notice, filing an unlawful detainer action, etc. Any such prohibited activities will not only give rise to an affirmative defense in favor of the tenant, it may also give rise to affirmative claims by the tenant against the landlord.
Even then, for commercial tenants, you would need to allow for expiration of an additional twelve months: through April 1, 2022. Only then, if the landlord still have not been brought current on the entire $100,000 in back COVID-19 deferred rents, could he serve a three day notice to pay or quit, after which he could file an unlawful detainer action to evict the commercial tenant.
Once a UD action is filed (in 2022), the backlog for trials on such action is likely to be substantial given that there are many thousands of landlords in nearly the identical circumstance. It stands to reason that trial on the matter is not likely to even commence until at least July 2022 (which is an educated guess on the author's part).
To be clear, none of this means that the tenant cannot actively operate her business from your property. She certainly can (and frankly, should). While no reasonable person would argue that the tenant is making a killing in the current challenging business environment, it does seem patently unfair for the tenant to keep the income without paying a dime to the landlord in the interim. But alas ....
To summarize, the situation is no bueno for commercial landlords.
Need the rent money to pay your own obligations? Too bad. Figure it out. Get a loan to hold you over and suffer the interest accrual expense at your own peril. But don't expect PPP funds, those are not available for you given the nature of your business.
But surely you could go after lease guarantors, right? Wrong. While the LA Ordinance and County Moratorium are somewhat vague in many regards, they appear to suggest that rent accruing during the COVID moratorium period is legally deferred for all purposes. This seems to mean that neither the tenant nor the lease guarantor can be legally coerced to pay until many months after the emergency declaration is called off. Why? Because if the rent is deferred (which it is), then the tenant does not yet have to pay it and, arguably, neither should the guarantor of the tenant's debt. You see, guarantors of debt benefit from the same defenses as the primary obligor (in this case, the tenant).
This state of affairs gives lessees and lease guarantors a ton of negotiating leverage over their landlords. The debt continues to balloon for many months (e.g., from April 2020 through April 2021; $10,000/month x 12 months = $120,000). All the while, everyone knows that sooner or later something has got to give. This gives both the primary obligor and the guarantors time to take evasive action to protect against the likely future collection maneuvering by the landlord. While this is not the appropriate forum for that discussion, the implication is simple: fraudulent conveyance (now referred to as voidable transfers) are expected.
Stated otherwise, lessee and guarantor assets are being stored away during the pandemic, making it that much more difficult for landlords to collect and get paid on the deferred COVID rent they have been promised and continue to patiently wait around for. Not to mention the obvious and distressing risk of bankruptcy filings that will further make collection less likely. So once it comes time to pay the piper, so to speak, many tenants will demand a huge discount on the deferred rent or simply walk away from the lease and dare the landlord to try to sue and collect. They will, by then, have rendered themselves judgment proof, leaving the landlord to hold the bag.
Now right about now you may be asking about whether the landlord can terminate the lease or sue the tenant for breach of lease. Again, it is the author's opinion that the answer to this question is: no. As discussed, the rent obligation is deferred. It is technically, by force of law, not yet due and payable due to the City Ordinance and the County Moratorium. I expect that some of my esteemed real estate law colleagues may disagree with this, but I strongly believe that I have the better argument.
Why? Because the very purpose and intent of these emergency laws is to avoid pressuring a tenant to close shop or pay now. It is, therefore, implied that the obligation to pay rent has been modified by the city and county to be frozen for the time being. Therefore, any suit for breach of lease is almost certainly premature and would give rise to affirmative defenses that the court (and certainly a jury) would be strongly sympathetic to; not to mention that it may and likely will also give rise to affirmative claims against the landlord for violating the provisions of the City Ordinance.
Riddle me this: What is a landlord to do?
Undoubtedly you have heard the saying that a good lawyer is worth his or her weight in gold. That adage has never been more appropriate than it is in this set of circumstances. You see, the emergency laws prohibit eviction for failure to pay rent (and also for other reasons not particularly relevant to this article). They do not, however, prohibit a landlord from holding a tenant's feet to the fire on other, non-payment related obligations under the lease; nor do they prohibit the landlord from doing the same vis-a-vis any lease guarantor. The following is a list of things I believe every commercial landlord in the City of Los Angeles who is currently carrying any substantial unpaid COVID-19 deferred rent should do to protect his interests.
First, get prepared. Sooner or later you will need to deal with this issue and unless you are planning on getting bullied into rent forgiveness or substantial rental concessions, you are extremely likely to need a competent, qualified and experienced real estate litigation attorney on your team. Preferably, someone with a strong working knowledge of creditor rights work and fraudulent transfers (now referred to a voidable transfers). The sooner you retain your preferred counselor at law, the better off you will be when the hammer finally drops.
Second, get prepared (again). Landlords are wise to work with their attorneys to review all existing commercial leases and lease guaranties with a fine tooth comb. Understanding all lease-related obligations is absolutely critical. A good, detail oriented attorney can invaluably assist in this endeavor. More on this below.
Third, get prepared (yes, again). Work with your lawyer to retain the services of a high-quality, proven private investigator that can help identify assets vested to the lessee and lease guarantors. To do this you will need to spend a little money, but don't be penny wise and pound foolish in this regard. Remember, once the assets have been hidden, disposed of, transferred or encumbered, your likelihood of recovery drops precipitously. Knowledge is power and if you know what the state of assets are today, you can proactively monitor and defend your interests before it's too late.
Fourth, get prepared (you get the idea here). You and your lawyer should thoroughly review and analyze any existing financial statements, tax returns, and other financial information provided to you earlier by our tenant and the guarantors. This will help identify social security numbers (which you will need to provide to the private investigator to assist with asset research (see above)), bank and securities account information, corporate ownership and LLC membership information, etc. A virtual treasure trove of information may also exist in your files and help you to identify voidable transfers that need to be unwound before things get out of hand.
Fifth, have your attorney check to make sure that the tenant is in compliance with all non-payment related lease obligations, including insurance coverages, property maintenance, service contract obligations, etc. If not, these non-payment obligations could give you grounds to file an immediate eviction action - since those may still be permissible notwithstanding the city and county emergency laws (but must be handled with extreme caution and delicacy, otherwise you can easily cause a problem for yourself). This sort of thing is definitely best left to an experienced real estate attorney, so please proceed with caution.
Sixth, to the extent that your lease and guaranty contracts allow for it, it may be appropriate to make demand on the tenant and guarantors to provide you with updated financial statements and, in certain cases, a written reaffirmation of guaranty obligations. Done right, a failure to comply with these demands could itself constitute good grounds for filing a kosher eviction action (since such defaults are not technically arising from a failure to pay rent).
Seventh, if you are able to determine a substantial, negative change of financial circumstances of guarantors, your guaranty may authorize you to require the tenant to provide a different guarantor. If so, your tenant may again be in default of his lease obligations in a way that could allow you to terminate the lease and proceed with eviction (since again, such a default is not technically a violation of the City Ordinance or County Moratorium).
Eighth, after you have done the foregoing, if you can get the tenant to cooperate and come to the table, you are well advised not to rush out and evict or sue for breach of lease damages. Instead, in most cases, the landlord will be better off working with the tenant to secure a fair resolution that protects the landlord's interests (i.e., to ensure the ability to collect on the deferred rent) by securing concessions by way of a written agreement or lease modification. Those concessions will depend on your individual circumstances, but may include collateral (which an experienced financial or secured transactions attorney can properly document and get done), additional guarantors to guaranty the lease obligation, an interim pay down of some of the accrued, unpaid and deferred rent, even a security interest in the tenant's assets (which again should be properly collateralized by an experienced attorney), and extended lease term, a shortening of the existing lease term, rent adjustments, etc.
Ninth, do not become a bully or over-aggressive. Stay polite. Be professional and willing to bend. Flexibility and respect (honey) will in most instances go further than acrimony (vinegar) in any dispute and this sort of dispute is no different. At the end of the day, we are all Americans and we are all in this nightmare together. We are not in the business of destroying one another or burning down everything a fellow American has worked to achieve in their lifetime. Keep your eye on the ball. Be kind. But do not allow yourself to get unfairly taken advantage of. It is a fine line and in the heat of the moment it is easy to lose sight of where that line is.
Again, an experienced and qualified, real estate litigation attorney knowledgeable in these matters can help guide you through the legal issues and potential pitfalls, while also acting dispassionately as a third-party counselor, shinning a light on that easy to miss line in the sand between what you can do and what you really ought to do as a moral and ethical business person.
Benjy Law Corporation offers the ideal balance of experience, knowledge, client commitment and integrity suited for these matters. Bob Benjy, Esq., the firm's founder, has two decades of directly relevant experience working at some of the finest firms in the State of California as a litigation attorney, partner and loyal client representative and counselor at law.
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DISCLAIMER: Nothing in this article is intended as legal advice. Nor is this article intended to give rise to the establishment of any attorney-client relationship. The article is nothing more than the opinion of one local real estate attorney and, as with all such opinions, may give rise to one of many differing opinions on this very issue. Please consult your own lawyer before taking any action or relying on the opinions herein.
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