Contractual Obligations During COVID-19: Material Agreements and Commercial Leases
Many small businesses are feeling the economic effects of stay-at-home, work-from-home orders and an effective halt on national and international economic activities. Business owners are asking questions about their obligations under material agreements, including their leases; and rightly so. Material agreements, such as commercial leases, are contractual obligations, and unless there are specific provisions or governmental orders excusing them from performing their contractual obligations during these unprecedented times, the parties continue to be contractually obligated.
This is a scary prospect as revenues dwindle and operating expenses remain the same. Small businesses are contemplating furloughs or have already furloughed employees; and are weighing their options on what to do about their contractual obligations.
I have advised clients not to make hasty decisions about their contractual obligations, and instead to develop a plan. Keep in mind that vendors, landlords, and customers are all generally in the same boat; so taking the lead to develop and propose a plan to them can actually help them think through issues that not only impacts you, but also their obligations to other third parties (like their vendors, lenders, customers, etc.). With an interconnected economy and supply chain, there is a ripple effect beyond just the parties to the contract – think of a tenant being obligated to pay rent to the landlord who is then obligated to make mortgage payments to a lender and so on.
I suggest thinking about and doing the following. I don’t suggest just breaching your agreement (like not paying rent or making a delivery) without first considering these items. Because contractual obligations are enforceable, the other (non-breaching) party has the right to sue for damages; and with statutes of limitations extending as long as four years in some cases, the other party doesn’t have to bring suit right away to exercise its rights.
With a plan and proposal, the parties may agree to just suspend all obligations under the agreement all together; but without a plan, proposal and communication, this will be hard to accomplish. Communication and making a well-developed proposal show good will, which goes a long way during these unpredictable times.
- Understand Your Contractual Rights and Obligations: Before you can develop a plan, you must understand your rights and obligations under the particular contract. Using the commercial lease as an example for discussion, is there a force majeure provision that excuses performance? Usually, commercial leases (and most other agreements) will include a provision (force majeure) that excuses the parties from performance of their obligations when certain events are beyond their reasonable control – the typical ones are war, terrorist events, and acts of god (like hurricanes, tornadoes, etc.). However, every contract is different, so review your contract and seek advice on what it says. Does COVID-19 or governmental orders qualify as force majeure under your agreement? It may be that the obligation for rental payments is specifically excluded from the force majeure provision or the provision doesn’t contemplate pandemics or governmental orders as an excuse. On the landlord’s side, are there obligations to maintain the premises, provide access to the premises, keep the premises clean and safe, etc. These obligations may all be impacted by COVID-19 or governmental orders; and failure to perform them may allow the tenant to declare a default. If that’s the case, then perhaps it may be better to work with the tenant than enforcing payment or other obligations against the tenant.
- Seek Input and Advice: Work with your advisor, broker, attorney, and CPA to collect ideas, suggestions and advice about your particular situation in light of the particular contract. These professionals understand your business and may have negotiated your particular contract. Additionally, they may have helped clients in similar situations, and can bring their breadth of experience to advocate your position. They can dive deeper into the contract to look for exceptions, exclusions, loopholes, and other provisions that can support your position while developing a plan.
- The Plan/Proposal: In developing the plan or proposal, keep in mind that the party on the other side has contractual obligations of their own. How will your inability to perform affect them – landlords for instance have payment obligations to their lenders but must also meet certain financial and operational covenants? Can performance be delayed? What are the true underlying reasons for non-performance – like inability to get materials or supplies, workers not able to come to work, customers have cancelled orders, etc.? What’s the remaining term of the agreement – if it’s short enough, perhaps the parties can mutually agree to just terminate the agreement? In the context of a commercial lease, landlords have to make mortgage payments, meet other contractual obligations for the building, and pay employees too. Perhaps your plan includes asking if they have received deferments from their lenders, which means they should be more willing to defer rental payments. If the landlord has to clean and maintain the premises, perhaps agreeing to take on that obligation can be exchanged for reduced rent for a certain period of time. How can the agreement be restructured? The key here is to use the contractual provisions as levers that can be pulled to come to a mutually acceptable plan going forward – get creative and understand what the other side’s obligations to you and other third parties may be. Mutual agreement (vs. unilateral action or default) removes the prospects of breach and potential litigation down the line and shifts them to an understanding for a path forward that can then be memorialized in writing.
Although these are uncertain times, and some business decisions have to be made quickly, it’s worth it to take a bit of time to understand your rights and obligations and to come up with a plan. When normal business starts to resume, the relationship between parties will continue to be supported by these good-will and productive efforts. And if the final decision is to breach an agreement, at least it’ll be an informed decision.
About the Author:
Tri Nguyen has served as general counsel and company lawyer to businesses, executives, startups and entrepreneurs for over 18 years. He particularly enjoys helping companies grow and achieve their strategic plan, and believes that every business needs a Chief Legal Advisor. He can be reached at www.trilawoffice.com.