Will Courts Allow Lease Cancellation in the Wake of COVID-19?

by Marc L. Hamroff & Danielle J. Marlow July/August 2020
Moritt Hock & Hamroff Partners address COVID-19 lease defaults, which party to the lease bears the risk of loss — the landlord or the tenant — and if the rationale extends to personal property or equipment leases.

Marc L. Hamroff,
Managing Partner ,
Moritt Hock & Hamroff

Moritt Hock & Hamroff has been following the impact of the COVID-19 pandemic on creditors’ rights.  On May 21, 2020, it reported on the pandemic’s impact on Uniform Commercial Code (“UCC”) Article 9 sales — specifically, whether Article 9 sales may proceed in light of Governor Andrew Cuomo’s Executive Order barring foreclosures (MHH Blog Article: UCC Sales Held Not Subject To Cuomo Executive Order Barring Mortgage Foreclosures).

And on June 24, 2020, it reported on a recent New York state court decision addressing Article 9’s “commercial reasonableness” standard in the present environment (MHH Blog Article: Lender Stayed From Proceeding With UCC Article 9 Sale). This alert addresses lease defaults and which party to the lease bears the risk of loss resulting from the pandemic: the landlord or the tenant.  Also, can the rationale extend to personal property or equipment leases?

In the wake of COVID-19 lockdown orders and drastically reduced business activity, many tenants are facing defaults and potential evictions. The question thus arises as to how courts will approach issues related to alleged lease defaults in light of the tremendous economic pressure the pandemic has exerted on commercial tenants and whether as a result courts will be more lenient in determining whether a tenant clearly affected by the COVID-19 shutdowns is in default?

One court recently faced these issues in the lawsuit entitled The Gap Inc. et al v. 44-45 Broadway Leasing Co., LLC (New York State Supreme Court, County of New York). That case involves 44-45 Broadway Leasing Co. LLC’s (“Landlord”) attempt to terminate The Gap, Inc.’s (“Gap”) and Old Navy, LLC’s (“Old Navy”) 15-year leases on their flagship store locations in Times Square. The combined rent for the two locations was approximately $3,000,000 a month.  As a result of the pandemic-related shutdown, Gap and Old Navy failed to pay the rent due in May and June 2020. In response, the Landlord sent notices of default, stating its intent to terminate the Leases. Gap and Old Navy argued that such terminations would unfairly force them to surrender the premises, while, at the same time, obligate them to pay accelerated rent for the remainder of the duration of the Lease terms, totaling tens of millions of dollars.

In response to the Landlord’s notices, Gap and Old Navy filed a their own lawsuit seeking: (i) a Yellowstone injunction enjoining the Landlord from terminating the Leases,[1] (ii) rescission of the Leases, and (iii) a declaration that the Leases are unenforceable as a result of the COVID-19 pandemic and the related government-mandated shutdowns. Gap and Old Navy asserted that

because of the dramatic and unforeseen decrease in business and commercial activity in the Times Square area resulting from the shutdowns, “the purpose of the Leases ha[d] been completely frustrated, and the object and purpose of the Leases ha[d] been rendered impossible, illegal, and impracticable.”

As support, Gap and Old Navy noted that “before the COVID-19 pandemic, approximately 330,000 people passed through Times Square daily, many of them tourists, while over 460,000 pedestrians walked through Times Square on its busiest day. Plaintiffs would never have agreed to pay rent in excess of $1.5 million per month for each of the Gap and Old Navy retail stores (increasing to $2.3 million per month by the end of each lease term) without Times Square’s teeming sidewalks and hordes of eager shoppers.”

Gap and Old Navy thus contended that, as a result of the drastic decrease in the volume of people who passed through Times Square and visited their stores, the Leases should be terminated as a matter of law because the object and purpose of the Leases had been frustrated and was impracticable, excusing them from any further obligation to pay rent.

Based on these allegations, Gap and Old Navy sought (i) a Yellowstone injunction enjoining the Landlord from terminating the Leases and tolling their time to cure, (ii) a declaration that the Leases have been terminated and/or the obligation to pay rent has been abated due to the alleged frustration of purpose and impracticability of the Leases, (iii) reformation, rescission and/or cancellation of the Leases, and (iv) damages in the amount of rent Gap and Old Navy claimed they overpaid during March and April 2020 due to the shutdown.

On June 21, 2020, Justice Debra A. James granted Gap and Old Navy’s motion for a Yellowstone injunction, tolling Gap and Old Navy’s time to cure until the Court determines whether Gap and Old Navy are in default. In doing so, the Court did not show its hand on Gap and Old Navy’s argument that the Leases were rendered unenforceable in light of the COVID-19 pandemic.  Instead, the Court granted the requested injunctive relief based solely on its finding that Gap and Old Navy had satisfied the four requirements of a Yellowstone injunction.

Significantly, however, as a condition for granting the Yellowstone injunction, the Court required Gap and Old Navy to post a bond in the amount of $5,842,531, which represented the amount of the May and June rent arrears, with only a 10% discount, and pay the full amount of the July rent due.  The requirement to post a bond in nearly the full amount of the rent due, and pay the July rent in full might suggest that the Court was not swayed — at least without further consideration — by Gap and Old Navy’s contention that the Leases are no longer enforceable as a matter of law.  But ultimately, it remains to be seen how the Court will rule on the issue, as it did not directly address this question.  Discovery will now proceed, and a determination on the merits will likely be made during the upcoming months.

Key Takeaways

As litigation of disputes over commercial lease obligations rise in the wake of COVID-19, a central issue that courts will have to decide is who bears the risk of loss caused by the pandemic-related shutdowns that have wreaked havoc on the business community. Commercial tenants, like Gap and Old Navy, will likely raise defenses based on the exceptional and wholly unforeseeable nature and impact of COVID-19, such as frustration of purpose, impracticability, and force majeure to excuse performance.

In adjudicating these questions, courts will need to consider not only the express language of the lease, but whether the particular fallout from COVID-19 on the tenant was a foreseeable risk that the tenant assumed. For example, in the action brought by Gap and Old Navy, was the continued tourism and foot and vehicular traffic of Times Square an essential assumption inherent in the leases they signed, and the rent they agreed to pay? Or did Gap and Old Navy assume the risk that their Times Square location may not be as desirable in the future in return for obtaining a long-term lease for such a (previously) premier location at a set rate of rent? And if so, does the pandemic nonetheless excuse performance because COVID-19’s impact was so extreme that the purpose of the lease was frustrated or so beyond the parties’ control that performance was rendered impossible?

It will be interesting to see how Justice James and other courts address similar commercial disputes and issues. It would seem that the sanctity of contractual bargained for terms should remain undisturbed as there are equities on both sides of the transaction. Courts have traditionally been hesitant to assess equity where there are clear contractual terms.

Moritt Hock & Hamroff will continue to provide updates on commercial legal issues presently affecting the business community as they develop and are determined by the courts and remains available to provide advice on how to best approach contract negotiation to reduce uncertainty and maximize protection going forward.

[1] A Yellowstone injunction permits a commercial tenant who has been served with a notice of default by its landlord to obtain a stay tolling the cure period and enjoining the landlord from terminating the lease and/or evicting the tenant pending a determination of whether the tenant is, in fact, in default.  To obtain a Yellowstone injunction, the tenant must demonstrate that it: (i) holds a commercial lease, (ii) received from the landlord a notice to cure threatening the termination of the lease, (iii) requested injunctive relief prior to the expiration of the cure period in the notice to cure and (iv) is prepared and maintains the ability to cure the alleged default by any means short of vacating the premises.  Notably, the proof required for a Yellowstone injunction is far less than the normal showing required for preliminary injunctive relief. The tenant does not need to demonstrate a likelihood of success on the merits, i.e., that it will prevail in its claim that no breach has occurred. The tenant simply needs to deny that a breach — or, at least, an incurable one — has occurred.

Marc L. Hamroff joined Moritt Hock & Hamroff in 1983 and became a name partner in 1989.  He currently serves as the firm’s Managing Partner. Hamroff Chairs the firm’s Financial Services Practice which includes the Bankruptcy, Equipment Leasing, Secured Lending, Distressed Assets and Creditors’ Rights Groups. He provides special concentration in litigation, workout and bankruptcy matters nationwide.

Danielle J. Marlow is a Partner in Moritt Hock & Hamroff’s Litigation Practice Group. Marlow has over 23 years of experience and has litigated extensively in both state and Federal courts throughout the country, and before the American Arbitration Association. Marlow’s practice areas include class actions, financial services and securities litigation, employment litigation, estate litigation and real estate litigation.

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