Lease agreements and COVID-19 - a practical guide for entrepreneurs
09/04/20
How does the COVID-19 epidemic affect the performance of lease agreements? What are the new regulations concerning lease agreements introduced in the so-called "anti-crisis shield"? What does the expiry of lease agreements in shopping centres mean and which agreements are affected? What about other lease agreements which are not addressed in the anti-crisis shield?
The situation of the parties to a commercial lease agreement in relation to the COVID-19 epidemic varies depending on whether the premises are located in a shopping centre (i.e. in a commercial object with a sales area above 2,000 sqm), whether the activity of the tenant has been temporarily banned, as well as whether the tenant incurs losses due to the epidemic.
Lease agreements in shopping centres
With regard to lease agreements in shopping centres, Article 15ze of the Act of 2 March 2020 on special solutions for preventing, counteracting and combating COVID-19, other infectious diseases and crisis situations caused by them (introduced by the amendment dated 31 March 2020) provides for the expiry of mutual obligations of the parties to the lease agreement during the period of the ban on conducting business activity.\
The tenant, after the ban on conducting business activity ceases, is obliged to submit to the landlord an offer to extend the lease period by the duration of the ban increased by additional 6 months. If the tenant does not submit an offer, the landlord ceases to be bound by the expiry of obligations.
What does it mean that the mutual obligations of the parties expire for a certain period?
In our view, mutual expiration of obligations should be understood as a temporary release of the parties from the obligation to provide the services to which they are obliged under the lease agreement during the period of the ban on conducting business activity. It seems that "mutual obligations" should be understood specifically as obligations of both parties to the agreement, whereas the exemption from the obligation to provide services applies only to those services which arise (become due) during the period of the ban.
In relation to the tenant, this means that the tenant is, inter alia, temporarily exempt from the obligation to pay rent and service charges, while the landlord is exempt, for example, from the obligation to conduct marketing activities.
It seems, however, that the legislator's intention was not to lead to the extinguishing of the entire lease agreements, and as a consequence, there are no grounds to release the parties from the remaining obligations under the lease agreement - the tenant is not obliged to hand over the premises and has the right to store its belongings there, and the landlord is not obliged to return to the tenant bank guarantees, security deposits securing the amounts due under the lease agreement, or declarations of the tenant on voluntary submission to enforcement.
Nevertheless, the Act is not precise in this respect and other interpretations may not be ruled out. Such interpretations could serve as a basis for demanding remuneration from the tenant for the use of the premises (storage of items) during the ban.
The release from obligations during the period of the ban entails no liability for non-performance of obligations. Therefore, there are no grounds for charging tenants with e.g. contractual penalties for not conducting business activity in the premises and for the landlord to use a bank guarantee or security deposit to satisfy their receivables during the period of the ban.
In which case is the temporary expiration of obligations applicable?
The Act does not directly specify to which lease agreements the temporary expiration of obligations applies. It may be argued that it applies to all lease agreements in shopping centres. However, it should be remembered that some tenants may and do conduct business.
Furthermore, tenants who are not covered by the prohibitions may also include those who, instead of a decrease, have recently recorded an increase in turnover. Thus, in a situation where business activity in the premises is being conducted, in our view there is no justification for considering that the obligations resulting from the lease agreement have expired.
The Act indicates that the expiry is applicable "during the period of the ban on conducting business activity". Hence, in our opinion, the scope of application of the provision should be linked to the scope of the prohibition, and the temporary expiration of obligations should apply only to those lease agreements which concern the premises covered by the prohibition.
The ban on certain types of activity results from the Ordinances of the Minister of Health (dated 13 and 20 March this year) and the Council of Ministers (dated 31 March this year), and its scope extends with the advancement of the epidemic. Therefore, the expiration period will vary depending on the type of activity conducted by the tenant and will apply during the period when the activity is covered by the ban. If the expiration was to apply to all lease agreements in shopping centres, the scope of temporary expiration would be not clear in case of tenants whose activity is not prohibited.
Interpretative difficulties may also be caused by the limitation of the rule on the expiry of obligations to 'commercial space', which might suggest that service space is not covered by this provision. It may seem that in this case we should refer to the justification of the government's auto-amendment to the bill and consider that also service premises where banned activity is carried out should be covered by the regulation.
It is also worth mentioning that the temporary expiration refers not only to lease agreements, but also to tenancy agreements and other similar agreements through which commercial space is made available for use. Additionally, this regulation applies not only to leases of premises, but to any commercial space (including the so-called stands).
How long does the expiration remain applicable?
In accordance with the Act, the regulation concerning the expiration of mutual obligations enters into force as of the date of the ban on conducting business activity. As we understand, it means that the parties are released from their obligations under the lease agreements retroactively - from the moment the ban was introduced.
As discussed above, the scope of the ban on conducting business activity was extended in subsequent Ordinances of the Minister of Health and the Council of Ministers. Therefore, in our view, the point in time when the expiration took place should be determined separately for each group of tenants, i.e. from the moment when the conduct of a given type of business was banned.
The expiration of mutual obligations will cease to apply when the ban on conducting business activity is lifted. In other words, once the ban is lifted, the agreement returns to its pre-established state. If the bans are partially lifted, it must be assumed that only the relevant part of the contracts will be "revived".
What is the tenant's obligation to make an offer?
As a part of the compensation for landlords in connection with the expiry of the tenants’ obligation to pay rent and service charges, the Act provides for the possibility to extend the lease period.
Within 3 months from the expiry of the ban on conducting business activity, the tenant will be obliged to submit to the landlord an offer to extend the lease period by the period of the ban extended by additional six months. Thus, if the ban lasts one month, the offer should cover 7 months.
It is worth emphasizing that other terms and conditions of the lease (e.g. rent) are to remain unchanged during the extended lease period. A tenant may not submit an offer proposing, for example, lower rent.
As we understand, the landlord is not obliged to accept the offer. Therefore, the scenarios may be the following:
- the landlord can accept the tenant's offer - as a result, the lease is extended under the existing terms for a period of the ban plus 6 months,
- the landlord may reject the tenant's offer - as a result, the lease should be continued on the original terms,
- the landlord may submit a counteroffer, modifying the terms of the offer made by the tenant - as a result, if the tenant does not accept such a counteroffer, it should be assumed that the agreement is not extended and should be continued on the original terms, whereas if the tenant accepts it, the agreement should be continued on the terms indicated in the counteroffer.
What if the tenant does not submit an offer?
Expiry of the obligations ceases to bind the landlord when the deadline for the tenant to make an offer to extend the lease period (by the way, this word is missing from the regulation) expires.
The aforementioned provision is not entirely clear. In our view, this means that if the tenant does not make an offer within the three-month deadline, the landlord may require from the tenant to pay the rent and service charges (or to fulfil other obligations that arose during the period of the ban, such as the obligation to provide a new bank guarantee).
Since the rent and service charges will apparently become due on the first day after the deadline for submission of the offer by the tenant, any interest on late payments should only be calculated from this date.
What does it mean that the provisions on the expiration of obligations do not infringe the provisions of the Civil Code on states in which restrictions on freedom of establishment are introduced?
The Act provides that the regulations on the expiration of obligations do not violate the relevant provisions of the Civil Code governing "the obligations of the parties in states in which legal restrictions on the freedom of establishment are introduced".
The Civil Code does not contain any explicit regulations relating to this type of situation. We assume that the intention of the legislator was to enable the parties to a lease agreement to invoke, for example, the clause of an extraordinary change of relations or an inability to perform a service through no fault of their own.
Hence, the tenant may decide whether to take advantage of the regulations on expiration and make an offer to the landlord to extend the lease term - the tenant is then exempt from rent for a period of the ban, or not to make an offer to extend the lease - the tenant is then no longer exempt from rent for a period of the ban, but may try to use other legal instruments to obtain a reduction or exemption from rent.
It should be noted that the use of the expiration of the obligations, although it does not seem to exclude the possibility for a tenant to use other instruments, will in fact make it more difficult to invoke them.
It is worth remembering that the use of other legal instruments may involve the necessity to resort to court or arbitration proceedings, and both its outcome and the time necessary to achieve a settlement are uncertain.
Other lease agreements
The anti-crisis shield does not regulate other matters related to lease agreements than the aforementioned temporary expiration of agreements in shopping centres, the possibility of extending the lease period by the tenant, and the prohibition of termination of agreements and rents by the landlord (the possibility of extending the lease period by the tenant and the prohibition of termination of agreements and rents by the landlord are mentioned in the section: Prolongation and prohibition of termination of lease agreements).
The above implies that there is no special regulation concerning the performance of lease agreements relating to, among others:
- premises in shopping centres not covered by the ban on conducting business activity (however, some experts claim that the termination of lease agreements applies to all leases in shopping centres with a sales area of more than 2,000 sqm; the Act is unclear in this respect),
- premises in small shopping centres (with sales area up to 2,000 sqm),
- retail premises outside shopping centres (e.g. on shopping streets),
- area in logistics centres,
- production area,
- office area.
Both landlords and tenants are wondering what the execution of such agreements will look like. Tenants seek grounds to avoid payment or to reduce their rent by invoking an extraordinary change of relations, an impossibility to perform a service with no fault attributable or a defect in the object of lease.
The landlords, on the other hand, indicate that they fulfil their contractual obligations - the premises remain at the disposal of the tenants, and the tenants, even if they do not operate, use the premises, e.g. by storing things in them.
Below we briefly describe the legal instruments which may be applicable in the current situation if no agreement is reached:
Hardship
The Polish law provides that if, as a result of an extraordinary change in relations (which the COVID-19 epidemic can be classified as), the performance of the service would be associated with excessive difficulties or would threaten one of the parties with a gross loss, which the parties did not foresee when the contract was concluded, the court may change the manner in which the obligation was performed, the amount of the service or even declare the contract terminated.
It may be anticipated that at least some of the tenants most affected by the epidemic might be able to prove undue hardship or gross loss, and they might be able to obtain temporary rent relief or a reduction of rent. It seems that this possibility may be invoked in particular by tenants whose activities have been prohibited or significantly restricted by the regulations introduced in connection with COVID-19.
Nonetheless, it should be borne in mind that there are court rulings which limit the ability to invoke the extraordinary change of relations in case of cash payments (such as payment of rent). It is also argued that the extraordinary change of relations cannot be relied upon by debtors who are in default (and therefore culpably failed to deliver the benefit on time).
It will take a longer period of time to obtain a final judgment, e.g. a rent reduction during an epidemic, but a tenant may apply for security in the form of e.g. a prohibition for termination of the agreement, for the use of rent payment security (bank guarantee, security deposit or declaration of voluntary submission to enforcement) despite the absence or incomplete payment by the tenant. At the moment, the courts, although to a limited extent, operate and the security is being granted.
Force majeure
It is often indicated that the COVID-19 epidemic is a circumstance for which the parties are not responsible. Such a circumstance may be regarded as force majeure, that is, the occurrence of a sudden, external event which the parties could not have foreseen at the time of conclusion of the contract and the consequences of which could not reasonably have been prevented.
However, will the invocation of force majeure release the tenant from the obligation to pay rent? In our view, it is difficult to prove that an epidemic prevents the tenant from paying rent. Such payment can be made even if the shops or service premises are closed. Therefore, if the lease does not contain special provisions, the possibility of invoking force majeure seems limited.
Nevertheless, in our view, it is reasonable to assume that force majeure (epidemic) relieves tenants of their obligation to operate in the shopping centre or allows them to operate to a limited extent (and therefore also exempts tenants from contractual penalties in this respect) and may under certain circumstances relieve tenants from paying interest on outstanding rent.
Nonetheless, the provisions of the lease agreement, which may involve the suspension of the obligation to pay for the period of force majeure, should be verified first. If there are no such provisions in the agreement, the possibility of invoking force majeure with respect to the obligation to pay rent is limited.
Other solutions
When analysing a specific situation, it is worth considering whether the parties have the possibility to apply other legal solutions, e.g. related to the inability to perform the contract for the purpose for which it was concluded.
The costs incurred by landlords should also be taken into account (no or reduced rent from turnover paid by tenants, fixed costs of functioning of commercial facilities and of conducting a business activity).
Prolongation and prohibition on termination of lease agreements
Possibility of extending the lease period based on the tenant's declaration
The Act introduced the possibility of prolonging until 30 June 2020 lease agreements which would end before that date. The prolongation is based on the tenant's declaration, which must be received by the landlord on the last day of the lease term at the latest.
As a result of the prolongation, the terms of the agreement remain unchanged. The tenant's declaration must expressly indicate that the extension takes place until 30 June 2020 and is made on the terms and conditions previously applicable. The possibility of prolongation applies to all lease agreements concerning premises.
The tenant cannot exercise the right to prolong the lease term if the tenant was in breach of the provisions of the agreement in the manner specified in the Act, in particular if the tenant:
(1) was in default with payments exceeding the amount of one rent,
(2) used the premises in a manner contrary to the agreement, or
(3) sublet the premises without the required consent of the landlord.
The circumstances excluding the right of prolongation are described in detail in the Act, but are not fully clear and must be analysed on a case-by-case basis.
Prohibition on termination of lease agreements
The Act introduced a ban on the termination of lease agreements or the amount of rent by landlords until 30 June 2020. However, landlords of non-residential premises (both in shopping centres and elsewhere) may terminate the agreement if:
(1) the tenant is in breach of the lease agreement or the rules governing the use of the premises, or
(2) the landlord must demolish or renovate the building in which the premises are located.
Our remarks
The COVID-19 epidemic significantly affected the performance of lease agreements.
Both landlords and tenants are aware that a dialogue is needed to work out a solution acceptable to both parties in a particular situation. It is indeed difficult to find a universal solution that will apply to all leases and will at least partially secure the interests of both parties.
The institution of temporary termination of lease agreements introduced within the anti-crisis shield, although it will significantly influence the activity of shopping centres, may be interpreted in various ways. Additionally, the scope of application of this regulation is quite narrow.
The use of other legal instruments may be connected with the necessity of court or arbitration proceedings, which will be accompanied with time and costs, and both its outcome and the time of achieving the settlement are uncertain.
We see reasonable arguments on both sides. Nevertheless, we believe that the wider context of the current situation and the time that will follow the COVID-19 epidemic should not be forgotten, especially as lease agreements are concluded for a longer period. It is in the best interest of landlords and tenants to return to normal operation of retail, office, production and logistics facilities. Loss of liquidity and radical steps may disrupt the return to balance.
An optimal solution for tenants and landlords (taking into account the position of banks financing landlords’ investments) is to reach an agreement on the principles of performing lease agreements during the epidemic.
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