How mediation can resolve commercial lease disputes outside of court in coronavirus economy
In a properly functioning economy, there’s a synergy between the three main components of commercial real estate: the lender typically provides most of the capital for the landlord to purchase the property; the landlord provides the physical space for the tenant to generate income; and the tenant produces the income that is used to pay rent for the landlord to service the loan and other expenses. In the current coronavirus economy, which has deprived millions of commercial tenants of the ability to generate the income required to meet their rent obligations, the system has broken down.
The result? Commercial tenants who can’t pay their rent; commercial landlords who can’t pay their mortgages; and commercial lenders faced with underperforming — or nonperforming — loans.
The solution? Throughout the country, commercial landlords, tenants, and sometimes lenders as well, are entering into negotiations and agreements for lease and loan modifications to get through these difficult times. As a mediator, a real estate attorney, and a commercial landlord, it’s clear to me that these times cry out for the application of the principles of mediation — and if necessary the process of mediation — in order for us to get through this crisis with as little collateral damage as possible.
Landlords, tenants, and lenders all come to the table with significant constraints on what they are financially able to do, now and for the foreseeable future. Landlords are constrained by what they need to maintain their properties and service their debts. Tenants are constrained by the amount of income, if any, their businesses are still able to generate, and by the financial resources of any guarantors.
Lenders’ constraints vary depending upon, for example, whether they are subject to loan regulators or committees, and whether the loans are held on the lender’s own books or whether they have been packaged with other loans and sold to third-party investors as part of commercial mortgage-backed securities. And all three are constrained by the current limitations on the judicial system if needed as a last resort, and by the fact that, at least for now, California courts are prohibited from issuing summonses in unlawful detainer actions (which means that non-performing tenants cannot be evicted).
As a result, viewing the process as a “zero-sum game” (“the more you get, the more I lose”) is a recipe for disaster. Instead, the negotiating parties must bring a new mindset to the table — one that is based on flexibility, creativity, and transparency, and that recognizes that for all of us to get through this together, all players are going to have to be open to compromise.
And with that new mindset, the principles and process of mediation can be essential to resolving COVID-19 commercial lease dispute, without litigation.
Two key principles of mediation can be helpful in resolving COVID-19 commercial lease disputes. The first is comparing best- and worst-case potential outcomes if the dispute is not resolved, vs. what might be voluntarily achieved through negotiation. In the COVID-19 commercial lease setting, here are factors to consider in assessing best- and worst-case potential outcomes:
- Whether the tenant can “break the lease” either by a Force Majeure clause in the lease or by Civil Code Section 1511 or the common law doctrine of “commercial frustration of purpose.”
- Whether the landlord can terminate the lease and sue for past and future lost rent (or, alternatively, keep the lease in effect and recover rent as it becomes due).
- How long, under the current circumstances, it would take the landlord to get relief from a court.
- Whether the landlord is prevented by law from evicting the tenant.
- Whether the tenant or any guarantors have sufficient assets to respond to a judgment for damages.
- How long it might reasonably take to replace a non-paying tenant.
The second principle of mediation that can be helpful in resolving COVID-19 commercial lease disputes is the principle of “Positions” vs. “Interests.” This principle focuses on the difference between what people say they want and why they want it. What you say you want is your Position; why you want it is your Interest.
In the context of a COVID-19 commercial lease dispute, if the parties are willing to share with each other their underlying Interests and not just their Positions, in the right situation there could be the foundation for a creative outcome beneficial to both sides, that might otherwise be lost if the parties aren’t open to sharing their underlying goals. For example, let’s assume that the property is an old, single tenant building that is zoned for higher and better use as mixed-use multifamily, and the landlord would like to be able to develop it. Let’s also assume that the non-paying, long-term commercial tenant has a few years left on his lease but would much prefer to just shut down the business and retire. The obvious solution? A negotiated lease buy-out.