- The Covid-19 pandemic provides a good case study for a little known, but commonly used clause in commercial contracts and leases known as “Force Majeure.”
- Force majeure is a legal clause that releases the affected parties from liability or obligation under the contract in an extraordinary event like war, terrorism, or a global pandemic.
- The declaration of a force majeure event and the relief offered as a result is highly dependent on the specific language in the contract and the outcome of a series of legal tests.
- If the event is determined to qualify, the affected party may be entitled to several forms of relief including a temporary suspension of their obligations or a cancellation of the contract all together.
- If the event does not qualify, the affected party is required to continue with their obligations per the contract.
In March of 2020, the World Health Organization (WHO) declared the novel Coronavirus to be a global pandemic. This designation put the entire world on notice that a new and unknown virus was spreading and posed a threat to the health and safety of everyone. As the virus spread, one of the primary tools used by government and health agencies to combat it – including those in the United States – was to place their cities and countries on “lockdown.” For many, this meant closing restaurants, bars, movie theaters, retail stores and any other places that people gather in an effort to prevent the spread of the virus. While these measures ultimately proved to be effective in reducing case counts, they also proved to be devastating for the businesses that were closed…and the property owners who lease space to them.
The Covid-19 pandemic was a completely unforeseeable event so it presents an interesting case study for a little known, but commonly used clause in commercial real estate contracts called “Force Majeure.”
What is Force Majeure?
Force Majeure is a common clause in commercial real estate contracts that frees both parties from liability or obligation when an extraordinary event prevents one or both parties from fulfilling their obligations under the contract. In most cases, the clause does not free the parties from liability completely, but just for the duration of the force majeure event. Examples of force majeure events include things like: war, strike, riot, crime, a global pandemic, and any other “act of god” as described by the specific language in the lease.
So, given the economic devastation incurred by the businesses shuttered by the WHO declared pandemic, it is only logical to ask, “does Covid-19 qualify as a force majeure event?” The answer is legally tricky, but there are several “tests” that can be applied to determine the answer.
Force Majeure – Legal Tests
Although the clauses in many commercial contracts and real estate leases are similar, the specific language in them varies. It is this specific language in the Force Majeure clause that will determine whether or not Covid-19, or any other event, qualifies as a force majeure event. It should be stressed that this designation is often decided by lawyers or judges, but there are several legal tests that can be applied to determine an outcome:
- Was the event specifically contemplated by both parties at the time the contract was made? Usually, the language within the contract will cite specific events that qualify as force majeure events. They could include things like: strikes, labor lockouts or disputes, acts of war, acts of god, terrorism, inability to obtain raw materials needed for manufacturing, governmental actions, or fire. If the event is specifically cited in the list contained within the lease, it may qualify as a force majeure event.
- Was the event beyond the reasonable control of the affected party? This test explores whether or not the event could have been controlled by the affected party. For example, assume that a manufacturer’s supply chain is interrupted and they are unable to obtain the raw materials needed to complete their product due to a labor strike at a major port. As a result, they can’t sell their product to obtain the funds needed to pay their rent. In such a case, it could be reasonably argued that the labor strike at the port was beyond the control of the manufacturer and therefore qualifies as a force majeure event.
- Is the affected party’s ability to perform its contractual obligations prevented by the event? If the event impacts the tenant’s ability to pay their rent, it may qualify. For example, if a global pandemic causes a restaurant to shut down indefinitely, there is a strong argument that the restaurant’s non-performance under the contract is directly related to the pandemic induced shutdown.
- Could the event have been reasonably foreseen by both parties? If a manufacturer has lax safety protocols that result in a chemical spill that shuts down their facility for a month, it could be argued that this event was inevitable given lack of attention to safety so it does not qualify as a force majeure event.
- Did the affected party take all reasonable precaution to prevent the event? Using the same example above, a property owner could state that the tenant did not take reasonable safety precautions and therefore is not entitled to any relief from the closure.
- Is there fraud, negligence, or malfeasance? If it is found that a tenant committed fraud or intentionally behaved in a way that caused the event, it likely does not qualify as force majeure.
Using the tests above, the Covid-19 pandemic likely qualifies as a force majeure event overall, but it likely comes down to the force majeure provisions in each individual contract and lease to determine if the affected party is entitled to any sort of relief.
Types of Relief
If all parties agree that an event qualifies as a force majeure event, there are two major types of relief that could be offered by a property owner.
First, there could be a temporary suspension of one party’s obligations for the duration of the event. Often, this could be relatively minor and could result in a month or two of rent relief, which the property owner should be able to cover through their operational reserves. But, in the case of the Covid-19 pandemic, where the “duration of the event” is many months, the relief calculus could become more complicated. Commercial property owners, like us, always keep some level of operational reserves for just these types of events. However, if multiple tenants are impacted for an indefinite period of time, those operational reserves eventually run out and other arrangements must be considered.
The other major source of relief is a complete cancellation of the lease or contract. This option is rarer because, by definition, force majeure events tend to be temporary in nature. But, there could be certain circumstances where it may make the most sense to cancel the contract and they tend to be outside of real estate use cases. For example, assume that a concert promoter planned an outdoor music festival and signed contracts with many different vendors to put it on. The day before the concert, a natural disaster like a hurricane or flash flood, destroys the site and makes the planned concert impossible. Depending on the specific contractual provisions of the agreement with each vendor, the most logical source of relief may be just to cancel the contracts.
These aren’t the only sources of relief, other options could be unique to the specific situation. For example, in some cases, it may make sense to give an extension of time on a payment. In others, a reduced payment may make sense. For property owners and tenants, it is always important to obtain qualified legal advice on the concept of force majeure, to take all reasonable steps recommended, to follow all applicable laws, and to abide by the terms of the contract when negotiating relief.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.
Take the Next Step
The Ultimate Guide To Investing In Private CRE
The comprehensive A-Z Guide Every Accredited Investor Should Read Before Investing in Private CRE Deals. Instant eBook Download. Updated for Q1 20201.Download Ebook
The Shoppes at Cross Keys
The Shoppes at Cross Keys is a 394,000+ sq ft retail center anchored by Home Depot. Targeted returns include an 8.1% Avg. Annual Cash Distribution & 2.3x Equity Multiple.INVEST NOW