Shutdowns radically changed commercial lease negotiations

The pandemic shutdowns of 2020 radically changed commercial lease contract negotiations, likely forever, say attorneys who worked on these agreements through the turbulence of the real estate market tailspin.

Commercial tenants are scrambling to keep their businesses afloat after the state, county and city governments ordered them to shut down in March. Landlords, desperate to fill vacancies, are making more and more concessions in lease agreements and hoping certain businesses will return when restrictions are lifted.

"The leverage has changed," Manhattan Beach real estate lawyer Daniel S. Brozost of Blackacre LLP said in a phone interview discussing his recent contract work. "Now, if you're a tenant, and you're willing to sign a lease in this environment, landlords are much more accommodating. They understand the issues and probably have shopping centers that are half vacant. If they find someone willing to sign a lease, they'll make some accommodations."

The accommodations mostly come in the form of bolstered force majeure clauses -- a provision excusing a party from delays in performing certain obligations otherwise required by the lease. The force majeure clauses in new lease agreements allow not only for delayed rent commencement dates and relaxed deadlines for construction but other tenant protections once the lease begins, such as deferment or abatement of rent during the pandemic, Brozost explained.

"As of the time the pandemic started, we didn't have anything other than your standard force majeure clause, which didn't cover rent," Brozost said. "And so now we're often building in a pre-negotiated rent abatement provision if the same thing or something similar happens going forward, so that the tenants won't have to go back to the landlords and beg for mercy. Instead, we'll have a lease that covers it."

Fernando Landa of Crosbie Gliner Schiffman Southard & Swanson LLP in San Diego, who represents landlords in commercial real estate and transactional matters, said most existing leases will not excuse payment of rent when it comes to force majeure clauses.

"In some instances, in more tenant friendly leases, the force majeure will apply to the payment of rent, so yes that has been used as leverage to negotiate rent deferment or rent abatement," Landa said. "But I think on the whole, you're seeing leases saying force majeure will not be the basis for the nonpayment of rent."

While Landa expects a bolstering of force majeure clauses in future commercial leases, most landlords will only agree to them if they are narrowly tailored to apply to COVID-related events, he said.

Brick and mortar retail stores, already trying to stave off the extinction level event that is Amazon, are barely hanging on or have completely fallen off the cliff during the pandemic. Establishments dependent on in-person customers like dine-in restaurants, gyms, and hair salons took a huge blow in 2020, real estate lawyers say.

Daniel Teitelbaum

On the other hand, businesses with infrastructures capable of adapting to a socially distanced world, such as quick-serve and delivery-focused restaurants able to employ cloud kitchens and online ordering, not only survived but thrived during the pandemic, attorneys say.

Cloud kitchens, also known as ghost kitchens or virtual kitchens, are licensed commercial food production warehouses, where anywhere from one to dozens of delivery-focused restaurants can rent space. Although they're not an entirely new invention, cloud kitchens have been gaining popularity and will likely continue to be in increased demand after the pandemic comes to an end, experts say.

"We have clients using cloud kitchens who are doing excellently," said Daniel Teitelbaum, a real estate attorney also from Blackacre in Manhattan Beach. "We have clients that are having their best years and have never done this well and probably benefited from the pandemic."

The biggest concern for the real estate market is the growing number of companies, including Google and Facebook, that have announced extended work from home policies, some extending to July 2021 and beyond.

Dean Pappas

While many believe office tenants will look to reduce their footprint, others including Dean Pappas, a Los Angeles partner in the Goodwin Proctor LLP real estate industry group, are optimistic that some form of in-person office workplace will return.

"I think that's the biggest question mark," Pappas said. "Some say, 'Oh, that's it, the urban office is finished. ... Everyone is going to zoom in and work from home.' But I'm not so convinced. I think short-term trends tend to reverse themselves pretty quickly, and there are still enough issues with working from home, and you lose enough especially in the professional services area like we are in -- law."

Some think law firms will swop their large spaces for several smaller offices, dispersed throughout the city and surrounding areas.

One possible lifeline industry stakeholders are hoping will raise all boats during these uncertain times, and stabilize an otherwise chaotic business environment, is a federally backed business insurance product. They envision a business interruption insurance policy backed by the government that would kick in during a pandemic.

Such a policy would cover business losses due to pandemic-related government closures, allow commercial tenants to pay rent, and in turn give lenders confidence when providing loans to commercial borrowers, attorneys say.

"Our practice of real estate law requires certainty in our transactions," Teitelbaum said. One solution involves the federal government stepping in to act as some sort of insurance underwriter, so insurers could offer government-backed business interruption policies, Teitelbaum said.

"Similar to what you see with flood insurance is what is necessary," he explained. "While some people think everybody is cutting deals and changing the force majeure clause, we need a pandemic insurance program, we need an act of Congress, and we need the storm to pass."

The good news, for those who support the idea, is that such an insurance program is being talked about. The bad news is there is very little certainty as to whether it will ever come to fruition.

The Pandemic Risk Insurance Act introduced by House Financial Services Committee Member Carolyn Maloney, D-New York, is a proposed program in which insurers would be required to make policies available without an exclusion, limitation or other special condition for pandemics. In return, the program would reimburse participating insurers for a certain amount of losses from those events, referred to as the federal backstop.

The measure has received little support from Republicans, however, despite widespread backing from the business community.