Coronavirus and the US commercial real estate sector

Building

Real Estate Alert

COVID-19 Alert

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Many of our clients engaged in the commercial real estate sector are asking us about the ramifications of the coronavirus disease (COVID-19) for their businesses. In particular, many are asking about the impact of the outbreak on agreements already in place.

The situation is changing rapidly, so it is important to remain attentive to government guidelines, directives, laws and orders (whether issued by the CDC or other federal, state or local health authorities) ("Health Guidelines").

As a general matter, owners, operators, developers, managers and users should always comply with Health Guidelines, review the relevant agreements and consult with counsel when considering the potential legal ramifications of action or inaction.  More specifically, the terms of the relevant agreements that have already been entered into will generally govern the obligations and responsibilities of landlords and tenants as they relate to COVID-19 or the impact that COVID-19 may have on the timing for performance. However, common law doctrines and prudent business practices require parties to act reasonably in the face of the issues presented by COVID-19.

Here are some issues to consider:

  • Owner communications with property managers: Many commercial property managers have, or are developing, plans for notification, enhanced cleaning and interruptions in operations.  Owners and managers are encouraged to work together to fine-tune such plans for each building based on asset type, how the building operates, the extent of COVID-19 in the applicable region, Health Guidelines and the laws of the applicable jurisdiction.Property managers may also be mindful of employment laws and Health Guidelines when asking employees to clean affected areas, and aware of recommended practices in the industry for cleaning standards and the safety of employees.
  • Notifying other parties regarding potential exposure to COVID-19:  The terms of the applicable lease, Health Guidelines, common law and prudent business practices will likely determine whether disclosure is required.  Tenants might even proactively request that landlords commit in writing to provide enhanced cleaning, commit to transparent reporting and prohibit potentially exposed individuals from entering the building.  While it may be unlikely that a landlord will be contractually obligated to comply with such a request under current leases, landlords could choose to proactively communicate their notification plan to tenants; modify rules and regulations to require disclosing any potential exposure or contraction by those in the building to the extent permitted by Health Guidelines; notify all users in the event of a potential or actual exposure in the building; and/or provide enhanced cleaning services when appropriate.  Landlord and property managers are encouraged to be mindful of lease confidentiality provisions, Health Guidelines and the privacy of affected individuals.All parties are urged to carefully weigh the pros and cons of action versus inaction.
  • Preparing for enhanced cleaning Commercial real estate buildings may not be sanitized every day, and some daily cleaning contractors may not have the workforce or skill to sanitize affected areas.  Owners or their property managers may anticipate the need for enhanced cleaning and confirm that their contractors have a plan for absenteeism within the work force.  For retail or other properties where tenants are responsible for cleaning public portions of the premises, owners and property manager may consider modifying rules and regulations to require tenants to perform enhanced cleaning of areas open to the public.
  • Supporting self-quarantined tenants: Owners and managers of multifamily projects may anticipate the needs of self-quarantined tenants and enhanced cleaning of common areas.  Some plans anticipate the need to limit use of amenities such as community rooms, health clubs and swimming pools.  Self-quarantined tenants may need services such as trash removal, grocery delivery, laundry and dog-walking.Areas used by all residents, such as lobbies and elevators, may need to be sanitized as recommended by the Health Guidelines.
  • Potential closures:  All parties are urged to prepare themselves for the possibility that a general quarantine or lock-down pursuant to Health Guidelines will prevent access to non-residential property.  The consequences of such closure may vary from lease to lease, especially among different asset classes.It is common for leases to include a requirement that the tenant comply with all laws.  Whether those “laws” include Health Guidelines may vary by lease or by the extent of the Health Guideline (a recommendation versus a directive). This will determine whether a landlord has the contractual right to prohibit access to the building even if a tenant is granted 24/7 access under the lease. Additionally, certain retail leases may require a tenant to be open and operating, and the specific language of such requirements and other lease terms will need to be reviewed against the specific requirements of a conflicting Health Guideline.
  • New leases/construction: If the landlord is committing to performing landlord work as part of a new lease, consider the timing impact that may be caused by COVID-19.  For any projects that are underway, owners, developers and construction managers are encouraged to review the force majeure provisions in construction contracts.  Travel bans and quarantines domestically and abroad may result in scarcity of materials, and self-quarantines may cause a reduction in work force or delay in construction approvals.  Building in timing flexibility in the lease or other contract through a force majeure or similar clause may be prudent. A party invoking the defense of force majeure will have to show how it falls into the definition of force majeure under the contract and how it directly delays its performance. In force majeure clauses in new agreements, one might even consider a reference to pandemics or COVID-19 specifically.
  • Current transactions:  Buyers of commercial property may consider the potential effect that COVID-19 will have on the market. Will due diligence or closing efforts be impacted by travel bans, self-quarantines or closures? Will loans be harder to obtain or close?  Purchase and sale agreements typically include provisions that “time is of the essence.”  A prudent buyer may seek to include force majeure clauses that will either excuse or delay performance under the agreement if certain circumstances occur or otherwise include some flexibility in the time for performance.  Sellers of commercial property are encouraged to consider whether to disclose to the potential buyer that tenants or employees who have been diagnosed with COVID-19 or areas in the building that may have been affected. Though in many states there may be no duty to disclose in commercial real estate transactions, state laws vary – some of which speak to the concealment or misrepresentation of material defects, as defined.
  • Expense recovery:  A landlord’s ability to pass through to a tenant costs for enhanced cleaning and preventative measures will typically be governed by the lease language.  However, some leases will include a “reasonableness” qualification for such passed-through costs, and some leases may have a cap on the amount which may be passed through to the tenant.
  • Rent withholding:  Many leases will not permit the tenant to withhold rent; however, leases may include provisions permitting rent withholding if a landlord is not providing required services or the tenant cannot access its premises.  The provisions of the applicable lease will govern in these circumstances, as well as local and state laws that may impact residential projects.It may be challenging to recover withheld rent under rental interruption insurance policies.  Insurance policies often exclude coverage for losses related to bacteria, mold, and other disease agents.  Whether or not COVID-19-related losses or liabilities are excluded from coverage will largely depend on the language of the policy and the nature of the losses incurred by the owner.  Property policies that include sub-limited coverage for income loss associated with decontamination costs, cleanup and interruption by a communicable disease are available in the insurance market, but are rarely purchased.  Previously, as in the case of SARs, bird flu and Zika, coverage for these situations was provided at times, but was determined by specific policy wording.  Policy-holders are encouraged to review their insurance policies closely with the broker or claims consultant. 
  • Compliance with loan documents:  Owners are encouraged to review their loan documents to determine whether there are any disclosure requirements in the event that a building or tenant is affected by COVID-19 and/or a building shutdown is required.

This alert is not intended to be comprehensive, nor does it constitute legal advice. Please contact your DLA Piper contact if you require more specific advice, whether on real estate matters or any wider business issues.

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