Coronavirus as a reason for waiver or rent reduction for business premises?

In an article for EPRAVO.CZ, published on April 9, 2020, Petr and Kristian considered the possibilities given by the applicable law to tenants who have closed out stores and found themselves without fault at all without any income, whether it's a discount on rent or forgiveness of rent for a period of crisis measures.. More in the article below.

Coronavirus as a reason for waiver or rent reduction for business premises?

One of the authors considered the influence of coronavirus on contractual relations only few days after the first cases of infection in the Czech Republic were confirmed.[1] Eventually, some possible quarantine measures envisaged at the time did not take place (e.g. mandatory closure of large-scale production enterprises), while the extent and duration of other measures exceeded many expectations. On a daily basis, we deal with inquiries of entrepreneurs whose establishments must be closed due to the crisis measures.[2] This concerns, in particular, retail, hospitality and other services. These entrepreneurs found themselves overnight completely helpless without any sales and are obliged to continue to pay rent (among other costs). According to the information available, some of lessors, for example, shopping centers, still demand full rent from lessees whose premises had to be closed completely,[3] even though our experience shows that many lessors prefer to reach a compromise solution with their lessees.

In this article, we discuss several legal options for solving the situation.

The state seems to be offering a special legislative solution, as on Wednesday, 1 April 2020 the government approved the draft of a law on certain measures to mitigate the effects of the SARS CoV-2 coronavirus epidemic on lessees of business premises.[4] The Chamber of Deputies accepted the draft on 8 April 2020, however due to the disapproval of the Senate, it is not clear whether the new act will emerge until the end of April. Although the draft from the Ministry of Industry and Trade was presented by Minister Karel Havlíček as a possibility of "postponing rent" for entrepreneurs,[5] the real effect of the Act will be rather different. It shall provide a protection period from the date of entry into force of the Act until 31 March 2022, during which the lessor will not be able to give notice of lease to the lessee due to delay in payment of the rent if it occurred between 12 March 2020 and 30 June 2020 and the delay was “primarily due to the constraints resulting from the emergency measure in the epidemic, which made the pursuit of its business impossible or substantially impeded”. However, the inconspicuous provision of Section 3 (2) of the draft states that this is without prejudice to "other rights of the lessor arising as a result of the lessee's delay". Accordingly, it is not a postponement of rent in fact, as the obligation to pay rent in a timely manner will continue and sanctions, in particular interest on late payments and contractual penalties, may arise as a result of the delay.[6] We have also noticed proposals from opposition parties to compensate rent by the state, however they have not translated into reality yet. If the state eventually proceeds to do so, there is no legal obstacle for the lessee and the lessor to reflect this option in advance when negotiating the solution to the current situation (and share benefits of this compensation).

In our opinion, however, even the current applicable law offers certain (although not always tested and not always compatible) options for businesses whose establishments must be closed. The first option is, of course, an agreement between the lessor and lessee, whether to postpone the maturity of the rent, waive a part of it or to prematurely terminate the lease. However, as we noted above, there is not always a willingness of lessors to reach an agreement.[7] Following the previous, below we propose several alternatives that the Civil Code offers if negotiation is not possible.

1) Renegotiation or termination of the contract

The first option is the application of the provisions of the Civil Code on a substantial change in circumstances (rebus sic stantibus clause), as coronavirus and related quarantine measures of the government may establish a gross disadvantage of the affected party under Section 1765 of the CC. In such a case, the lessee may invoke the right to negotiate a contract change (typically concerning a reduction of rent) or, in case of a failure of such negotiations, to request the court to amend or cancel the contract (under the terms of Section 1766 of the CC). In the event of a coronavirus crisis, it will generally not be difficult to fulfill the condition that the change in circumstances was not foreseeable or under control and that it occurred only after the contract was concluded. The complication may be the agreement of the parties, as the rebus sic stantibus clauses have been excluded in many contracts across the board, resulting into the parties often taking the risk of changing circumstances without much consideration, or the lessors have enforced the incorporation of such provision by virtue of their stronger bargaining power.

We believe that the prohibition of the business activities of lessees justifies termination of the lease even for a definite period of time pursuant to Section 2308 (b) of the CC. For objective reasons, the premises ceased to be eligible to carry out the activity for which it was intended and due to the nationwide scope of the crisis measures the lessor is not able to provide the lessee with alternative premises. In our opinion, the standard six-month notice period can be shortened to three months, as the state-ordered closure of the premises fulfills the condition of a “serious reason” for termination within the meaning of Section 2312 of the CC.

2) Appropriate reduction of rent

However, if the entrepreneur has undertaken the risk of changing circumstances or has no interest in the termination of the lease (e.g. in shopping centers it may be strategic to "hold" certain stores, the entrepreneur believes that the measures will be only for a temporary period, etc.), one of the options that our law could offer is the appropriate reduction of rent.

We assume that the essential obligation of the lessor pursuant to Section 2205 of the CC is to relinquish the thing to the lessee so that he can use it for the stipulated or usual purpose, maintain the thing in such a condition to be fit for its use for which it was leased, and ensure that the lessee may peacefully use the thing for the period of the lease. The lessee thus pays rent (Section 2213 of the CC) not only for the opportunity of using the thing but also for the basic assumption that the thing will be usable for the agreed or usual purpose. Therefore, if the lessee does not have the possibility of undisturbed use of the subject of the lease, it is a breach of the essential obligation of the lessor. The commentary notes on this point that, whether the violation is caused by fault (of the lessor) or not, the lessee cannot be fairly required to continue to be fully obliged to fulfill his essential obligations in such a situation, in particular the obligation to pay rent.[8]

In the current situation, however, the provision of Section 2208 (1) of the CC cannot be a way to achieve a reduction of rent or its complete waiver, as the state-ordered closure of the premises does not constitute a defect, the removal of which is borne by the lessor.[9] For the same reason, the rights from defective performance under the general regulation under Section 1923 of the CC cannot be considered.

However, the general legislation concerning lease arrangements stipulates in Section 2212 (3) of the CC the lessee's right to claim from the lessor the reduction of rent if the lessee is disturbed in the use of the thing or otherwise affected by the conduct of a third person.

In our opinion, the mentioned third person can be theoretically also the state. The disturbance is an objective category, so in our opinion the reduction can be demanded from the lessor regardless of whether he is able to influence the disturbance itself or its intensity in any way. Reference may also be made to Section 21 of the CC, according to which the state is considered a legal person in the area of ​​private law. The text suggests that this is a broad concept according to which the state acts as a legal entity in all private law. In other words, it does not involve only the conduct of the state, but generally the operation of the state throughout the private law.[10] Nevertheless, the counter-argument could be that the state does not act here in a private capacity, but in the exercise of public authority, in the form of measures of a legislative nature (albeit of a temporary nature). The applicability of that provision may, therefore, be questionable.

In any case, the lessee is entitled to a reduction of rent only if the lessee informs the lessor in advance about the disturbance of his right of use. In the current situation, it is necessary that lessors shall be informed about the impact of coronavirus and crisis measures on lessee's activities and a reasonable rental reduction shall be proposed. Commentary literature states that "the amount of the reduction is determined by an amount appropriate to the restriction in the right of use, considering the amount of rent and the agreed state of the asset leased",[11] respectively, that the amount of the reduction should correspond to the actual impact on the lessee's rights.[12] Therefore, it can be imagined that it will be up to 100 percent if the lessee is not able to operate at all (e.g. hairdresser). However, if the activity can be performed at least partially or under difficult conditions (e.g., a take-out window, food delivery, e-shop), the reduction may be significantly lower.

3) Extinguishment of an obligation due to subsequent impossibility of performance

Another option that the law offers to lessees affected by the quarantine measures of the government is to invoke the subsequent impossibility of performance under Section 2006 et seq. of the CC. For the debtor, the discharge of debt becomes impossible, if there is any circumstance preventing him from performing in a timely and orderly manner, whether temporarily or permanently, or being of an objective or subjective nature.[13] If the premises are leased to carry out an activity which is prohibited as a result of crisis measures (e.g. pedicure or sale of musical instruments), the lessor temporarily has no possibility of properly fulfilling his contractual obligation for objective reasons (Section 2205 of the CC). In other words, the lessor is not able to provide the thing for a given purpose because that purpose has become prohibited.

This is known as the legal impossibility of performance, which the commentary describes that if the discharge of debt becomes possible only at the price of the unlawful conduct, it can no longer be considered legally "performable" and thus ceases to exist due to impossibility of performance.[14] The obligation is extinguished due to the impossibility of performance of the obligation in accordance with Section 2007 of the CC, either in its entirety (if the performance of the remainder is of no importance to the creditor) or only partially. In order to assess whether the impossibility of performance has occurred in a particular case, it will depend mainly on the formulation of the purpose of the lease in the contract. If the purpose is strictly expressed, for example, for the operation of a beauty salon or clothing store that cannot be currently legally operated (and is not possible to be operated through a window), in our opinion the obligation extinguish to the extent of impossibility to perform, i.e., for the duration of quarantine measures.[15] From our experience, such contractual arrangement is typical, including a prohibition on pursuing activities of a different kind on the premises, e.g., shopping centers are interested in a variety of brands and assortment of individual stores. Conversely, in the case of an agreement where the lessor does not guarantee the usability of the premises for the desired purpose, which becomes the responsibility of the lessee (known as shell and core), the subsequent impossibility of performance will probably not come into consideration.[16]

The clause on the subsequent impossibility of performance cannot be invoked if the discharge of the debt is possible, albeit with a delay (according to the law “after a certain period”) or at higher costs, under difficult conditions or through a third party. However, we believe that in the case of a long-term lease, the obligation cannot be fulfilled for specific weeks or months for good. In other words, the lease is essentially a fixed obligation in this respect, since the fulfillment of the "provision of the thing for use in April 2020" cannot be postponed to another month. In a given specific month, performance is simply impossible because it is prohibited. The use in the month of April cannot be replaced by use in another month,[17] unlike the contract of sale, where 20 tractors can be delivered in May instead of in April, without affecting the form of the item sold (although the delay in delivery can of course cause other problems).

If the lessor's obligation for the legal impossibility of performance ceases to exist, the lessee's obligation to pay the rent ceases to the extent given the reciprocal nature of the lease. Thus, the practical consequence of the subsequent impossibility of performance for lease relationships shall generally be the cessation of the lessee’s obligation to pay rent for the period during which he was forbidden by the crisis measures to carry out an activity which the lessor is obliged to provide. Regarding a short-term lease (e.g. a place for an ice cream stand at a canceled music festival as a result of crisis measures), the entire lease will extinguish and the lessor will be obliged to return, for example, the advance payment for the rent.

4) Corrective of good morals

Finally, the principle of private law should be recalled that the interpretation and application of law or the exercise of law shall not be contrary to good morals.[18] If the lessor requests payment of the full rent from the operator of a compulsorily closed store and the lessee refuses to perform, the lessor will necessarily have to go to court (or arbitration court). It was concluded in the case-law that “to assess whether the exercise of rights is contrary to good morals, the law gives the court a wide discretion so that its decision, in accordance with the rules of equity, takes into account all the circumstances of the case under consideration. The exercise of rights is contrary to good morals if it is in contradiction with the generally accepted opinion, which determines in relationships among people what their behavior should be, in order to comply with the fundamental principles of the moral order of democratic society, regardless of contractual freedom, regardless of who caused the conflict with good morals and whether the other party was in good faith or not “.[19] Thus, it is a very open and potentially broadly applicable term.

It will of course always depend on the law interpretation of each individual judge, the contract and all the circumstances of the particular lessee-lessor relationship. However, it is not difficult to imagine that the courts will tend not to approve the actions of the lessor, who will demand full rent from the lessee whose operation has been closed by the State due to the epidemic.

Conclusion

In this article, we have tried to outline several options under which a lessee may invoke reduction or even exclusion of the obligation to pay rent for an undertaking that must be closed as a result of "coronavirus" measures taken by the executive, in cases when lessors are not interested in negotiating an amicable settlement of this situation. In our opinion, the applicable law offers several tools to achieve a better balance in relations, without the burden of the situation, which is not attributable to anyone (at least to no one in the private sector), being carried by solely one party of the private-law. Finally, it should be emphasized that the actual wording of the lease will always be very important and the above considerations should not be taken as an all-embracing solution for each lease of business premises.