March 2020 was a month that none of us will ever forget. It was the month that the first Covid-19 lockdown orders went into effect in California and nationwide. It was also the beginning of major challenges to be faced by commercial tenants who found themselves unable to pay the rent, either because their businesses were temporarily closed due to governmental Order, or because they no longer had the income stream required to cover the rent even if their businesses were able to remain open. It was also the beginning of major challenges to be faced by commercial landlords who found themselves with their own financial obligations but with tenants who were no longer able to pay the rent.
Earlier strategies for commercial tenants faced with Covid-19 rent problems
In December 2020, we wrote about a legal strategy that might be used by commercial tenants whose businesses were shut down by governmental Covid-19 Orders, in their efforts to obtain some rent relief. In general, the strategy was based on the concept referred to by California courts as “commercial frustration.” Simply put, it means that when the purpose of a contract becomes nearly or totally impossible to achieve due to an event that was neither contemplated nor foreseeable by the parties, the injured party’s performance under the contract will be excused and that party’s obligations under the contract will be considered “discharged” (i.e., no longer required). (Dorn v. Goetz (1948) 85 Cal.App.2d 407, 412.) As mentioned in our earlier article, the doctrine is not new and has been applied in a number of different contexts over the years. Here are some examples:
- In 1922, a lease for commercial space that was to be used for a wine and liquor business was held by the court to have been discharged when the passage of Prohibition made the object of the lease impossible to perform (Industrial Development & Land Co. v. Goldschmidt(1922) 56 Cal.App. 507, 509);
- In 1944, a lease for neon advertising lights to be placed upon the tenant’s business was permanently discharged due to a wartime government order banning nighttime illumination, even though the order was only temporary (20th Century Lites, Inc. v. Goodman(1944) 64 Cal.App.2d Supp. 938, 945); and
- In 1978, a lease for an electric burglar alarm system was discharged when it became unlawful to use the radio waves required for the system because they interfered with secret government radio frequencies (Federal Leasing Consultants, Inc. v. Mitchell Lipsett Co.(1978) 85 Cal.App.3d Supp. 44, 47).
The common thread in all these cases is that, whereas the lessee was still able to lease the commercial space, the advertising lights, and the burglar alarm system, the value of the lease was destroyed because the lessee could not use those things for their intended purpose.
Another strategy mentioned in our earlier article was based on Civil Code Sec. 1511(1), which provides that performance under a contract is excused “[w]hen such performance…is prevented…by…operation of law, even though there may have been a stipulation that this shall not be an excuse.” From this, commercial tenants might argue that performance under the contract (the operation of its business) has been “prevented…by the operation of law” (COVID-19 orders preventing the business from operating), thereby excusing the rent obligation under the case law we cited in the earlier article. The tenant might also argue that even if the lease provides that its inability to operate its business does not excuse the payment of rent, that provision is unenforceable under Civil Code Sec. 1511(1) if the inability to operate results from a governmental order.
An update on the law on Covid-19 and commercial property rent obligations
When we wrote the earlier article there were no published California appellate decisions on the subject dealing specifically with Covid-19. That has now changed. Earlier this year, the California Court of Appeal (4th District; San Diego) weighed in on the subject in favor of the commercial landlord. In SVAP III Poway Crossings, LLC v. Fitness International, LLC (2023) 87 Cal.App.5th 882, a fitness center tenant had 5 ½ years remaining on its lease when, in March 2020, it stopped doing business due to Governor Newsome’s Covid-19 lockdown Order. It remained intermittently unable to operate its business through March 2021 due to government closure orders. The fitness center withheld more than 8 months of rent but continued to occupy the space. The landlord sued for unpaid rent, late fees, interest, attorney’s fees, and costs. In response, the tenant claimed among other things that it was excused from paying rent by Civil Code Sec. 1511(1), and under the doctrine of frustration of purpose.
In affirming the trial court’s dismissal of the action, the Court of Appeal held that Civil Code Sec. 1511(1) did not provide an excuse for paying rent, because “the pandemic and resulting performance did not prevent Fitness from performing its contractual obligation to pay rent.” (Id., 87 Cal.App.5th at 873.) It also held that the doctrine of frustration of purpose didn’t apply because the lease spanned more than 23 years, the government closure was only temporary, and the closure therefore “does not amount to the kind of complete frustration required for the doctrine to apply.” (Id., 87 Cal.App.5th at 874.) The court also noted that the doctrine requires that the purpose of the contract that was frustrated be contemplated by both parties in entering into the contract, whereas the lease required only that the tenant operate a fitness facility for one day and permitted other uses thereafter. (Id., fn. 5.)
What this means for commercial landlords and tenants with Covid-19 issues going forward
On its face, the SVAP III Poway case stands for the proposition that Covid-19 shut-down orders don’t excuse commercial tenants from paying rent. However, different factual circumstances (such as a longer shut-down period and shorter total lease term), and different lease provisions (such as one that allows for only one specific use of the premises throughout the term of the lease) might lead to a different result. Further, some of the court’s legal conclusions were arguably in conflict with those reached by the courts in the earlier cases mentioned above, which means that it’s possible that another appellate court, from a different appellate district, might reach a different result at some point in the future.
Nevertheless, the SVAP III Poway case has given strong ammunition to commercial landlords who are looking to recover unpaid rent and other damages resulting from Covid-19 shut-downs. Commercial landlords and tenants with unresolved Covid-19 rent issues should consult with experienced counsel to review their leases and the circumstances of their particular situation to see how closely they align with those in the SVAP III Poway case. The more closely they align, the more likely that a court would reach the same result, and the stronger the landlord’s position in resolution efforts.
If you need any assistance with a commercial real estate dispute, we’re here to help. Just contact us on line or call us at (415) 448-7778 to schedule an appointment.
We look forward to working with you!
Best,
Phil
Philip R. Diamond, Esq.
Of Counsel, CunninghamLegal
* Phil Diamond is a real estate attorney, Of Counsel to CunninghamLegal, where he handles a wide range of real estate-related disputes and transactions, including commercial lease disputes. He is also a mediator and arbitrator through his independent practice, DIAMOND DISPUTE RESOLUTION. Phil is also a licensed real estate broker, and former commercial landlord and developer. You can reach him at [email protected], or (415) 883-7915.
