Nicolas Fernandez – Government imposed lockdowns have made it nearly impossible for companies to generate sufficient revenue to pay rent. On December 31, 2019, the Chinese government reported the first case of COVID-19 and less than a month later the United States reported its first case. Countries around the world began locking down to slow the spread of the virus, with most of the United States following suit by March 2020. While the lockdown did succeed in slowing the spread of the virus, it also put the economy on hold and negatively impacted businesses and consumers.
COVID’s Impact on Business
Almost overnight, the United States economy fell into disarray – the Dow Jones fell almost 37% from mid-February to mid-March and the national unemployment rate skyrocketed to an all-time high of 14.7%. To compensate, retail stores shifted their focus to webstores, but consumers became more hesitant to spend their income as the uncertainty surrounding the pandemic continued to rise. The service sector, due to the personal nature of the industry, was the most negatively impacted. Restaurant owners were forced to close indoor and outdoor dining and, despite generating no income, still owed monthly rent to landlords. This caused countless hospitality groups to go out of business or file for bankruptcy. While the near-future of the service industry seems dull in the COVID-era, the doctrine of impossibility could potentially serve as a glimmer of light for the service industry by offering these companies an opportunity to be temporarily excused from their contractual obligations to their landlords.
The Doctrine of Impossibility
The doctrine of impossibility allows a party to be excused from contractual obligations when an unexpected event occurs that renders its performance under the contract temporarily or permanently impossible. This doctrine, however, cannot be invoked as a defense if a party assumed the risk caused by the event. Essentially, a court analyzes three factors when deciding the validity of the doctrine as a defense to inaction: (1) The foreseeability of such an event occurring; (2) the allocation by agreement or custom for the risk of the unexpected occurrence; and (3) the degree of hardship imposed by the occurrence. When applying these factors, the unexpectedness of such an event is determined by the insight obtained by the parties at the creation of the contract.
Determining the viability of the doctrine of impossibility as a defense to nonperformance is incredibly fact specific to the timing and circumstances of the contract. Historically, this doctrine has only been applied by courts in a limited scope, like when there is an “act of God” or government interference, for example. The COVID-19 pandemic constitutes a unique blend of these two scenarios: the pandemic itself is an “act of God” that can prevent many – if not all – of a company’s employees from coming in due to illness, and also government lockdowns prohibit certain types of companies from operating.
Due to the fact specific nature of this doctrine, the court’s acceptance of this doctrine as a defense for companies unable to meet rent obligations will likely vary from state to state. In New York, for example, courts have rejected two commercial tenants’ arguments that the economic conditions caused by COVID-19, which prohibited them from meeting rent obligations, should satisfy the doctrine’s defense. In Lantino v. Clay LLC, the tenant argued that the government lockdowns made it impossible for him to operate his gym and therefore could not generate enough revenue to pay rent. No. 1:18-cv-12247, 2020 WL 2239957 (S.D.N.Y. May 8, 2020). The court denied this argument because the tenant failed to demonstrate sufficient hardship. Although he did show that the orders caused him financial difficulty, he failed to demonstrate that it was impossible for him to meet his rent obligations. In Backal Hospitality Group LLC v. 627 West 42nd Retail LLC, the court noted that the contract contained a clause stating that the landlord was still entitled to rent payments regardless of any government order or regulation. No. 154141/2020, 2020 N.Y. Misc. LEXIS 4050 (Sup. Ct. Aug. 3, 2020). The court held that this clause demonstrated that the parties reasonably contemplated a government order or law that would make it impossible to meet rent obligations. As of now, New York courts have narrowly and strictly determined when a tenant will be able to use the doctrine of impossibility as a defense to COVID-19 lockdowns.
As we enter the next wave of COVID-19 infections, and a second potential lockdown, it will be interesting to see how courts around the country apply this doctrine.