Covid-19 has brought business changes and legal challenges to the field of real estate. In a Q&A with the editor of the firm’s newsletter, Steeg Law Firm co-managing partner Robert Steeg discusses these legal issues.
Legal Issues In Real Estate During Covid-19: A Q&A With Robert Steeg
Q: How would you compare the impact of Covid-19 on the real estate industry to the impacts of other crises in past years?
A: It is more widespread and far-reaching than anything I have seen in my 40-year career. The dot-com bubble of the late 1990’s and the Great Recession in 2008-09 both had a tremendous impact on real estate, but those events were primarily financial. Covid-19 is not only financial, but it is also political and social. It has affected literally everyone, from the consumer through the retailer (tenant), the landlord, the lender, and the secondary markets. The other events had “ripple” effects in sectors other than financial. Covid-19 has had multiple direct effects in all sectors.
Q: Based on your experience with your clients over the last 7 months, which real estate sectors are affected the least, and which are affected the most?
A: Because the Fed is maintaining interest rates low and because of the increased emphasis on staying home and on working from home, the residential market is booming. Industrial and warehouse properties, and properties that are leased to tenants whose businesses have remained open and are doing well, like groceries and drugstores, are sustaining themselves pretty well. Retail has been the hardest hit, of course. Office properties present the most complicated challenges, because no one really knows whether the demand for office space will be permanently reduced as a result of changes in the workplace that result from the Covid-19 experience.
Q: For your landlord clients whose properties have suffered, what kinds of legal challenges are they facing?
A: At the beginning of the pandemic, the buzzword was “force majeure.” Landlords wanted to know if tenants could be relieved from their rental obligations under the doctrine of “force majeure.” The answer depended upon each state’s law and upon the exact language of each lease. Generally speaking, landlords usually had the stronger argument, but the tenants did still press their case strongly.
Larger tenants flexed their economic muscle and emphasized the importance of their long-term relationships with their landlords. In most cases, some kind of accommodation was reached. The main elements of these accommodations were rent abatement (whether full or partial), rent deferral (under which the landlord would recover the deferred rentals later), and extensions of the tenants’ lease terms.
Q: Were there other legal issues at play?
A: Yes, several. In Louisiana, there are several additional legal doctrines that sometimes can be invoked to give tenants relief from the leases, primarily “failure of the cause” of the lease under Civil Code Articles 1966-67 and “impairment of the use” of the leased premises under Civil Code Article 2715. Those doctrines are very extreme, and most often lead to a complete dissolution of the lease, and in many cases neither the landlord nor the tenant wanted a complete lease dissolution; the tenants only wanted relief until the pandemic eased.
And on a completely different front, landlords and tenants were pursuing business interruption insurance claims. There the key issue was whether physical damage was required in order to trigger business interruption coverage. Those cases are still being litigated, and the question has not been decided.
Q: You said that these were the issues at the beginning of the pandemic. Have the legal issues changed since then?
A: Yes. Landlords and tenants seem to have decided what their positions are on the various issues, and negotiations have proceeded, and for the most part those negotiations have concluded and the parties have moved toward documenting their long-term relationships. Leases are being amended between landlords and tenants on a long-term basis. Loans are being restructured between lenders and borrowers.
In some cases, the parties, for any variety of reasons, have decided to take hard stands and have reached an impasse. Those situations are leading to litigation now. Banks are foreclosing, landlords are suing tenants, and of course tenants (and some landlords) are filing for bankruptcy reorganization protection.
Q: What you have talked about so far concerns commercial real estate. What are the main developments in residential real estate? Specifically, multi-family apartment complexes, not sales of single-family homes.
A: Multi-family real estate has shown the impact of the political and social effects of Covid-19, as opposed to the legal issues. In properties with federally-backed mortgages or direct financing from federal agencies, which is a large proportion of multi-family properties, evictions were prohibited through July 25, 2020, and a thirty-day notice to vacate was made mandatory, which essentially meant that evictions could not begin until August 26, 2020. The closure of state courts also came into play, effectively preventing any evictions until the courts began to reopen, generally in August of 2020. Then, on September 4, 2020, the Centers for Disease Control issued an order prohibiting evictions for non-payment of rent throughout the United States for the vast majority of residential tenants. The legal validity of that order has not yet been tested or confirmed, but as of the time of this discussion, it is in effect.
For multi-family properties, we are seeing a real conflict of the various factors involved in the Covid-19 crisis. Residential tenants have lost their jobs and cannot pay their rent. Yet there is an emphasis on staying home for safety reasons, and many workplaces are closed, leading to an increased emphasis on working from home. Tenants who have jobs and can pay rent need a home, often as a place to work from as well as a place to live. So, there are tenants who cannot afford to pay but do not want to leave, and there are other tenants who can afford to pay and need a new place.
Q: Any predictions for the next major areas of legal conflict in the real estate field as a result of Covid-19?
A: The issues that I have already discussed seem to have resolved a lot of the smaller problems. Now I think the legal arena is turning to the much larger problems, complete failures by major entities and complete repudiations of legal agreements.
Q: Can you give us an example or two?
A: Sure. I think that major tenants under long-term leases will simply be unable to perform. Landlords will be forced to decide between pursing their remedies against these tenants and thereby risking bankruptcy by the tenants, or trying to find substitute tenants to take over the properties. If the landlords pursue the latter alternative, they will often suffer some financial losses on account of the new deal, and they will be in the position of trying to find some way to become compensated for those losses before they agree to let the existing tenant off the hook.
Lenders will be facing the same issues. Major land developers and property owners, and major tenants, will find themselves unable to service their debts and will need large concessions from their lenders. Lenders who are unable or unwilling to grant those concessions will face the same types of issues, whether to accommodate their distressed borrower (often to an extent greater than the lender would like) or whether to hold firm to their positions and risk the borrower’s bankruptcy.
When a landlord or a lender decides to make a deal with a major tenant or borrower, the dollars at stake will be large, and all of this requires careful legal drafting, to make sure that the documents are set up in a way that they are enforceable and provide enough clear remedies that a breach of the documents further down the line does not result in years of litigation.
Q: What legal issues are implicated there?
A: The full range of issues under lease law, the law of guaranty and suretyship, lending law, and the general law of contracts and obligations. There is a contractual relationship that already exists. How, exactly, that existing contractual relationship turns into the new contractual relationship must be carefully spelled out, so that there is no gap that is created in the rights of the landlord or lender. You must be careful to spell out exactly when the existing contractual relationship is ending, when the new one begins, and how any obligations from the earlier relationship are legally allowed to continue in effect.
Q: Any final thoughts?
A: Look forward to a vaccine, and always listen to Dr. Fauci.
Editor: Thanks very much.