As commercial real estate landlords consider their strategies for dealing with the impending possibility of nonpayment of rent due to COVID-19’s economic impact, they should be aware that rent accommodations may trigger liability under loan documents, joint venture agreements or other contracts. This update explores such possibilities and provides recommendations when dealing with nonpayment of rent.
Almost all loan documents restrict Transfers (broadly defined) of any interests in the property securing such loan, but identify certain “Permitted Transfers” that are allowed. Many loan documents provide that leasing and amending leases in the ordinary course of business are Permitted Transfers if entered into in accordance with the provisions of the loan documents, which usually restrict amendments impacting financial components of leases such as rent amounts, timing for rent payments and lease terms. without the lender’s approval. That means any leasing activities/lease amendments not entered into in accordance with the Permitted Transfer provisions are Transfers in violation of the Permitted Transfer provision. A violation of the Permitted Transfer provision is almost always a violation of the non-recourse carveout provisions for which the borrower and/or non-recourse carveout guarantor(s) can be liable for 100% of the principal and interest on the loan. Read your loan documents and, if applicable, obtain lender’s consent before amending a lease and remember that a lease amendment could be an email from a landlord to the tenant agreeing to waive, reduce, or defer any rent.
In addition to loan documents, certain other contracts, such as joint venture agreements, may have provisions prohibiting rent accommodations/modifications without the counterparty’s consent. Joint venture agreements, for example, may contain leasing parameters, which prescribe leasing guidelines (sometimes general, but sometimes rather specific) within which the manager/general partner is allowed to operate without obtaining its joint venture partner’s consent. A landlord who makes certain rent concessions may be inadvertently stepping outside of permitted leasing parameters, and therefore taking an act that requires its joint venture partner’s consent. In certain cases, a manager/general partner’s failure to obtain consent from its joint venture partner is afforded no cure right and is presumed to be a bad act for which the manager/general partner can be removed from authority, can lose economic rights (for example, promote distributions), and/or potentially trigger other exit remedies, such as a call right or forced sale. Read your joint venture agreement and other contracts that may be similarly implicated, and, if applicable, obtain the counterparty’s consent to any COVID-19 strategy that involves rent accommodations.
Whether or not it desires to accommodate tenants, a landlord of single-family or multifamily properties with federally backed loans cannot initiate eviction action against tenants for nonpayment of rent until July 25, 2020 due to the provisions of Section 4024 of the CARES Act. By leaning on the provisions of the CARES Act such landlord can avoid affirmative rent concessions that could amount to inadvertent breaches under loan or joint venture documents. For further discussion of Section 4024 of the CARES Act, see here.
For landlords not covered by Section 4024 of the CARES Act (e.g., multifamily landlords without federally backed mortgage loans, and retail landlords) who wish to make some concessions regarding rent, conversations with lenders and other contract counterparties may be necessary to avoid any potential breaches, as discussed above. In making a concession, deferral should be considered as opposed to waiver or reduction in rent payments. Being overly generous to tenants in financial distress may adversely impact landlords beyond the loss of revenue. Many loans, but not all loans, have debt service coverage ratios and other financial covenants that must be maintained in order, for example, (a) to avoid a loan being in default, (b) to avoid the sweeping of rents, (c) to avoid a pay down requirement, (d) for borrower to exercise the right to extend a maturity date or (e) for reductions in loan guaranties to become effective. Many tenants will be receiving stimulus funds to cover operating expenses (e.g., rents) as well as employee payroll and hopefully the economic situation will improve later in the year. Specifically, Title I of the CARES Act created a new SBA 7(a) loan program called the Paycheck Protection Program (PPP) and $349 billion has been allocated for PPP loans to businesses of 500 or fewer employees to be used for operating expenses, including rent. For further discussion on SBA Loans, see Payment Protection Program Under the CARES Act. Thus, landlords should position themselves to ultimately seek payment of deferred rents. Generally, a loan will not go into default as a result of a tenant’s default under a lease, though we have seen lenders try to include a material tenant default in borrower default provisions.