For commercial landlords and tenants, COVID-19 presents unprecedented challenges. To assist, Kamil Umar, Partner of Bishop & McKenzie LLP's Commercial Leasing group, has authored a COVID-19 Commercial Leasing FAQs sheet to answer your pressing legal questions.
Rent Deferral versus Rent Abatement?
Rent deferral allows the tenant to defer its payment of basic and/or additional rent to a future date. Rent abatement allows the tenant to entirely suspend paying basic and/or rent.
Are landlords obligated to give a rent abatement or a rent deferral?
Landlords are not obligated to provide rent abatement or rent deferral. In a typical commercial lease, numerous clauses protect the landlord. The clauses specifically state that rent will be paid when due, without deferral or abatement.
Some leases contain force majeure clauses, which excuse the tenant from the performance of certain obligations in the event of an unforeseen occurrence beyond the parties’ reasonable control. Arguably, the current pandemic could qualify as a force majeure event. However, most well drafted force majeure clauses do not explicitly cover pandemics, as a clause’s scope is interpreted and constrained by the words with which it is associated. Since force majeure clauses in leases typically list events of physical destruction as interpretive examples, illness and pandemics may not fall within the clauses.
Further, well drafted force majeure clauses “carve out” rent payments, meaning the tenant is still obligated to pay rent in the event of force majeure.
In sum, a tenant is likely not entitled to abate or defer rent. However, attention should be paid to clauses that might allow the tenant to do so, such as force majeure or undue delay clauses.
Choosing between rent abatement vs rent deferral?
In our view, rent deferral should usually be the preferred first option. By providing for rent deferral, the landlord preserves the right to collect rent when circumstances improve. Similarly, if circumstances do not improve and the tenant continues struggling, then a determination can be made at that time whether to grant an abatement instead of a deferral, or alternatively, take steps against the tenant for default.
How long should the rent deferral be? Should it be limited to basic rent or should it include occupancy costs as well?
Ultimately, these are entirely business decisions. The length of time and amounts of basic and additional rent will depend on the individual circumstances of the commercial property and the particular tenant. These factors are open to negotiation and widely fluid at this point. As a broad recommendation, shorter rent deferral periods may be preferable, as they can always be extended if the economic recovery is delayed.
How do we document a rent abatement or rent deferral? Can we ask for additional security?
There are rent deferral and rent abatement agreements. Our approach is to prepare templates for each property, then tailor them to meet the specific business deal reached with each particular tenant. We can also draft them to reflect the level of concern the landlord has with the ability of the Tenant to recover financially. For example, additional security in the form of a personal guarantee could be an option. Generally speaking, however, we favour leniency in these extraordinary circumstances, as a way of solidifying the business relationship and landlord’s reputation.
If we choose to give neither rent abatement nor deferral, what recourse do we have if the Tenant ceases to pay?
You should have all your usual remedies for default. However, consideration should be given to the fact that the courts are largely closed and no longer hearing non-emergency matters. A litigious approach is likely to result in even longer delays than usual.
Can we utilize rent or security deposits?
Typically, yes. The landlord can utilize a rent or security deposit to cover the cost of missed rent and demand that the Tenant replenish it. In a rent deferral situation, the landlord would delay that option until the end of the deferral period.
Should we document the fact that we are utilizing the deposit?
Yes, use of the deposit towards rent and any subsequent replenishment should be documented. Failure to document could later jeopardize the landlord’s entitlement to the funds.
For example, if the tenant became bankrupt, the security deposit would form part of the bankrupt’s estate [see e.g. York Realty v Alignvest Private Debt Ltd., 2015 ABCA 355 at para 2]. If the landlord did not properly document the deposit’s application towards rent, the landlord would be required to provide the amount of the security deposit to the tenant’s bankruptcy Trustee for inclusion in the estate. The Trustee would then distribute the funds among the bankrupt’s eligible creditors.
Can tenants access business interruption insurance?
Likely not. In order to be protected, the tenant would need to also carry separate pandemic coverage, in addition to business interruption coverage. It’s unlikely that tenants have that coverage. However, it may nevertheless be prudent to have your tenants inquire with their insurer and provide proof of denial of coverage before granting any rent deferral.
Is government assistance available to tenants or landlords?
The federal and Alberta governments are not specifically offering assistance to commercial landlords and tenants at this time, beyond the standard emergency assistance applicable to all businesses (e.g. tax deferral until after August 31, 2020 for the payment of any income tax amounts that become owing on or after March 18, 2020 and before September 2020).
In certain instances, landlords should consider whether to offer tenants a lease surrender rather than rent deferral. For example, problematic tenants, tenants who were already struggling and who won’t recover, and tenants nearing the end of their terms may all be receptive to a lease surrender. The advantage for the landlord stems from expediency and certainty. Having these tenants execute lease surrenders may be a cleaner and less costly way of terminating the relationship, in a manner that minimizes losses for all parties.
Should we amend our lease precedents?
It’s too early to say definitively what amendments to typical commercial lease provisions will arise from the COVID crisis. At this early stage, however, it seems likely that definitions of force majeure should be revised to contemplate pandemic situations, particularly where there are time-sensitive landlord obligations, such as the completion of landlord’s work. Likewise, it seems likely that landlords may begin to push for pandemic coverage, to the extent it is available, in addition to business interruption in tenant insurance policies. After first dealing with rent deferrals and other more pressing matters arising from the current crisis, we recommend consulting with a leasing lawyer to give due consideration towards how your leasing templates might best be amended.