The COVID-19 pandemic has drastically increased Commercial Mortgage Backed Securities (“CMBS”) default rates. But careful attention should also be paid to the underlying collateral that constitutes CMBS, particularly the arguments being made by tenants in the commercial real estate context to excuse performance under force majeure clauses.
In that respect, despite the numerous (and creative) COVID-19-related arguments propounded in recent months, this emerging body of law remains largely undeveloped. There are only a handful of reported decisions on these matters, and the substance of the rulings echoes the principles that were applied in the pre-COVID era: Force majeure clauses are strictly and narrowly construed, and the party seeking to excuse performance must show a clear causal nexus between the force majeure event and the inability to perform.
This article analyzes two recent federal district court decisions on this subject: one rejecting a force majeure argument and one endorsing it. The article then offers practical tips for contract drafting and litigation strategy.
Force Majeure Rejected
Unsuccessful litigants have continued to try to fit the facts of their case into a force majeure event without careful attention to the specific language of the operative force majeure clause or a thoroughly developed argument connecting the force majeure event with the purported inability to perform. A recent opinion from the U.S. District Court for the Southern District of Florida, Palm Springs Mile Associates Ltd. v. Kirkland’s Stores Inc., 2020 WL 5411353, at *2 (S.D. Fla. Sept. 9, 2020), follows suit. There, the plaintiff sued Kirkland’s Stores for breach of a commercial lease based on failure by Kirkland’s to pay rent beginning in April, 2020.
Kirkland’s then moved to dismiss, arguing that its obligation to pay rent was relieved by the force majeure provision in the lease, which was triggered by COVID-19-related government shutdowns and restrictions. But the court firmly rejected this argument.
The court began by noting the traditional principles governing force majeure clauses: (1) force majeure clauses are limited in scope, (2) performance should only be excused upon the occurrence of a specific event beyond a party’s control, and (3) parties will generally be excused based on a force majeure event only if the event that justifies nonperformance is specifically identified in the contract. The court then turned to the lease’s force majeure clause, which provided as follows:
Whenever a period of time is prescribed in this Lease for action to be taken by either party, such party will not be liable or responsible for, and there will be excluded from the computation of any such period of time, any delays due to strikes, riots, acts of God, shortages of labor or materials, war, governmental laws, regulations or restrictions or any other causes of any kind whatsoever which are beyond the reasonable control of such party.
In this respect, Kirkland’s asserted that the restrictions on business operations and nonessential activities qualified as force majeure events, and therefore its obligation to pay rent was automatically suspended. None of these arguments succeeded.
First, the court noted that Kirkland’s failed to “explain how the [government action] it describes as a force majeure event resulted in its inability to pay rent,” and instead lodged only a general argument that the shutdown excused its rent obligations. Second, the court explained that even if Kirkland’s properly demonstrated causation between the government restrictions and its inability to pay rent, the analysis would be an inherently factual determination that is improper on a motion to dismiss. And third, the court noted that force majeure is an affirmative defense under Florida law, which generally cannot be decided on a motion to dismiss.
Force Majeure Accepted
In Richards Clearview, LLC. v. Bed Bath & Beyond, Inc., 2020 WL 5229494 (E.D. La. September 2, 2020), a commercial landlord sought to evict a tenant for failure to pay rent. The lease contained a force majeure clause, “under which the failure to perform an act required by the Lease may be excused for the period of the delay in the event that performance is hindered by strikes, failures of power, riots, insurrection, war, earthquake, hurricane or tornado . . . or other reasons of a like nature which are beyond the reasonable control of the party.”
In response to the landlord seeking an eviction on an expedited schedule, the tenant asserted a force majeure defense (among others) based on the governor’s restrictions on commercial businesses in malls. The tenant also explained that it had tried to make good on late rent payments, but the landlord rejected them.
The court partly rejected the tenant’s first argument, noting that the exterior access to the tenant’s store (from the mall), as well as tenant’s status as a seller of “essential goods,” actually rendered it exempt from strict regulations of businesses in malls. Nonetheless, the court ultimately found in the tenant’s favor. Citing to Louisiana’s doctrine of “judicial control,” wherein a court may decline to terminate a lease even where it may be justifiable, the court noted that the tenant had “a plausible basis for believing that [rent] was not due.” Additionally, while the tenant had technically not followed the standard lease procedures for curing their default under the lease, the court held that “any deficiency in that regard is excusable by the global circumstances.” Notably, while the force majeure clause did not include governmental regulations or restrictions as one of its enumerated events, the court applied it regardless.
Takeaways
These decisions signal to businesses that while courts remain open to considering force majeure as a defense to claims of breach of contractual obligations in the commercial context, some courts will require a strong causal connection between the claimed force majeure event and the litigant’s failure to perform, and that courts may look more favorably on those who attempt to uphold their financial obligations even under current circumstances.
On the transactional side, drafters of force majeure clauses should understand that government shutdown orders may serve as a basis for excusing failure to perform as long as they are explicitly mentioned as a force majeure event. While the Clearview case departed from this approach, that decision appears to have been motivated, in part, by the tenant’s attempts at repaying missed rent before the lawsuit. Not all defendants find themselves in that position, however, which means careful drafting to include COVID-like force majeure events is critical.
On the litigation side, it is important to recognize that shutdown orders do not provide carte blanche to invoke a force majeure event. As with Kirkland’s, a party seeking to excuse its contractual obligations based on a force majeure event must carefully connect the dots between the cause — whether a government order or the effects of the pandemic — and the frustration of the specific conduct sought to be relieved.
As a procedural matter, moreover, Palm Springs strongly suggests that motions to dismiss based on force majeure events are likely nonstarters because of (1) the factual matters inherent in deciding such issues and (2) the characterization of force majeure as an affirmative defense. Thus, the only seemingly good target for a motion to dismiss in this regard would be a complaint that effectively establishes the defense through its pleadings, which is rare.
In terms of substantive arguments, practitioners should be mindful that if a business is still operating and thus generating revenue for rent, then it is likely that impact of the pandemic or related shutdown orders will be seen as a market event that merely reduces profitability, which falls short of establishing impossibility of performance. Commercial tenants seeking to be relieved of performance obligations, therefore, should consider focusing less on profitability and instead fine-tune their arguments to how specific government orders made it impossible for them to continue their business, in whole or in part.
Litigants seeking to make this argument should also anticipate the counter: The proximate cause of the breaching party’s inability to pay is not the pandemic or shutdown orders but rather the broader financial crisis caused by the pandemic. Thus, a successful force majeure litigation strategy should incorporate alternative theories.
Force Majeure and CMBS
The above cases suggest that mounting a successful force majeure argument is still a high bar. But as this area of jurisprudence becomes more developed, it is possible that commercial tenants (and others) will take heed of these decisions and tailor their arguments accordingly. If successful, this could result in more courts excusing performance in the commercial real estate context and others, which in turn will have rippling effects in the CMBS market.
