California closed your business to stop coronavirus, but that may help you terminate your commercial lease early
This has been a terrible year if you own the kind of business governments have made unlawful for you to operate, yet your lease still obligates you to pay rent.
For many businesses, Black Friday and the period through Dec. 31 have been when the business can go from a losing year (in the “red”) to a profitable year (in the “black”). But that period will not save your business if coronavirus public policy makes it completely unable to operate (see “The List”). And with the current COVID-19 surge and the uncertainty of further government assistance, the situation may not get any better anytime soon.
However, there is a strategy that could enable you to stop the bleeding and restructure or terminate your commercial lease now.
‘Commercial frustration’ and lease performance
The strategy is based on the concept that is referred to by California courts as “commercial frustration.” Simply put, it means that when the purpose of a contract becomes nearly or totally impossible to achieve due to an event that was neither contemplated nor foreseeable by the parties, the injured party’s performance under the contract will be excused and that party’s obligations under the contract will be considered “discharged” (i.e., no longer required). (Dorn v. Goetz (1948) 85 Cal.App.2d 407, 412)
The doctrine is not new, and it has been applied by California courts to commercial leases on many occasions — including occasions when the unforeseen event was a new law or governmental order that made unlawful the operation of a business that had been lawful at the time the lease was entered into. When the unforeseen event occurred, the lessee/tenant’s obligations under the lease, including the obligation to pay rent, were discharged. Here are some examples:
- In 1922, a lease for commercial space that was to be used for a wine and liquor business was held by the court to have been discharged when the passage of Prohibition made the object of the lease impossible to perform (Industrial Development & Land Co. v. Goldschmidt (1922) 56 Cal.App. 507, 509).
- In 1944, a lease for neon advertising lights to be placed upon the tenant’s business was permanently discharged due to a wartime government order banning nighttime illumination, even though the order was only temporary (20th Century Lites, Inc. v. Goodman (1944) 64 Cal.App.2d Supp. 938, 945).
- In 1978, a lease for an electric burglar alarm system was discharged when it became unlawful to use the radio waves required for the system because they interfered with secret government radio frequencies (Federal Leasing Consultants, Inc. v. Mitchell Lipsett Co. (1978) 85 Cal.App.3d Supp. 44, 47).
The common thread in all of the above cases is that, whereas the lessee was still able to lease commercial space, the advertising lights, and the burglar alarm system, the value of the lease was destroyed because the lessee could not use those things for the intended purpose. Commercial tenants therefore have a strong argument that, where a lease is for a business that was lawful to operate when entering into the lease but which thereafter became unlawful by operation of a COVID-19 governmental order, all obligations under the lease (including the obligation to pay rent) are terminated as of the time it became unlawful to operate the business, and even if the prohibition is only temporary.
The argument is strongest when the tenant’s business has been and remains completely unlawful to perform by COVID-19 orders, and where the lease expressly makes that the only purpose for which the premises may be used. In other words, it’s when no indoor use can be made, as opposed to indoor use at limited capacity or potential outdoor uses.
Force majeure clauses and rent carve-outs
Finally, there is a related strategy that commercial tenants should know about as well. Many commercial leases contain a clause titled “force majeure.” That’s French for “superior force,” and it is sometimes colloquially referred to as “act of God.” These clauses essentially restate the legal principle that when an unforeseeable and unpreventable event occurs that makes performance under a contract virtually or completely impossible, whether by “act of God” or otherwise (e.g., a hurricane or the outbreak of war), the obligations of the impacted party will be terminated.