The Force Majeure Clause And Covid In North Carolina Commercial Leases

The COVID-19 pandemic was devastating for many commercial tenants in all kinds of businesses. Many are still feeling the effects, even as restrictions have eased. As commercial tenants have suffered, so too have commercial landlords. Some tenants abandoned their space. Others simply stopped paying rent. Where the landlord and tenant were unable to agree on a lease modification, litigation often ensued. Who wins in these cases where a global pandemic caused catastrophic economic injury to so many?

In North Carolina, the plain language of the lease agreement controls. In particular, these kinds of cases are often determined by the language contained in the force majeure clause found in many, if not most, commercial leases. A force majeure clause is a clause which allocates the risk of loss if performance is hindered, delayed or prevented because of an event such as a pandemic, Act of God or new governmental restrictions. It provides a contractual defense, the scope and effect of which will depend on the plain language of the lease agreement. Usually, the terms are boilerplate. However, in light of the pandemic, landlords and tenants would be wise to take a fresh look at their force majeure clause so that they may negotiate the particular terms they feel are necessary to protect their interests.

RULE

In North Carolina, “[w]hen the language of a written contract is plain and unambiguous, the contract must be interpreted as written and the parties are bound by its terms.'” Atlantic & E. Carolina Ry. Co. v. Wheatley Oil Co., 163 N.C. App. 748, 752, 594 S.E.2d 425, 429 (2004) (quoting Five Oaks Homeowners Assoc., Inc. v. Efirds Pest Control Co., 75 N.C. App. 635, 637, 331 S.E.2d 296, 298 (1985)).

ANALYSIS

1.  North Carolina Law

There is little law in North Carolina regarding force majeure clauses in general. As of this writing, this author is not familiar with any North Carolina cases interpreting a force majeure clause in the context of the COVID-19 pandemic in commercial leases. However, North Carolina is clear that such clauses, as written, will be enforced.

In South College Street, LLC v. Charlotte School of Law, LLC, a lease’s force majeure clause contained a “carve-out” requirement which required rent payments even if a triggering event – such as a loss of licensure – occurred. S. Coll. St., LLC v. Charlotte Sch. of Law, LLC, 2018 NCBC 80. The North Carolina Business Court enforced the clause as written, obligating the tenant to pay rent despite its lost accreditation. While the decision is not binding authority, it is instructive and consistent with the general law in North Carolina that parties are bound by the plain language of the contract.

Specifically, in South College Street, Defendant Charlotte School of Law, LLC (“CSL”) was accredited by the American Bar Association (“ABA”). Defendant InfiLaw Corporation (“InfiLaw”) owned CSL. On or about October 11, 2012, Hines Charlotte Plaza LP (“Hines”) and CSL executed an Office Building Lease Agreement (the “Lease”) pursuant to which CSL agreed to lease approximately 250,000 square feet of space in an office building then owned by Hines (the “Charlotte Plaza”) in Charlotte, North Carolina (the “Premises”). On or about that same day, InfiLaw executed a Guaranty of Lease (the “Guaranty”).

On December 3, 2014, Plaintiff entered into an agreement with Hines to purchase the Charlotte Plaza. The purchase closed on April 17, 2015, and on or about that same day, Hines informed CSL that the Charlotte Plaza had been sold to Plaintiff and that CSL was to make all future payments under the Lease directly to Plaintiff. From April 2015 to October 1, 2017, CSL paid its monthly rent to Plaintiff.

On December 19, 2016, the United States Department of Education (“DOE”) denied CSL’s application for recertification to continue to participate in the student financial assistance programs authorized pursuant to Title IV of the Higher Education Act of 1965. As a result, effective December 31, 2016, students could no longer obtain federal financial assistance to attend CSL. Ultimately, the DOE did not agree to restore CSL’s participation in Title IV programs. Accordingly, CSL’s state license to conduct post-secondary degree activity expired, and CSL ceased operating on August 11, 2017.

On October 1, 2017, CSL failed to pay its monthly rent due under the Lease. By letter dated October 10, 2017, Plaintiff notified Defendants that CSL had failed to pay rent and demanded payment of all sums due. On October 26, 2017, CSL notified Plaintiff that it had abandoned the Premises. Beginning October 1, 2017 CSL and InfiLaw failed to make monthly rent payments due under the Lease.

The Lease contained a force majeure clause that stated:

“When a period of time is herein prescribed for any action, other than the payment of any monetary sums due hereunder, to be taken by [Plaintiff] or [CSL], [Plaintiff] or [CSL], as applicable, shall not be liable or responsible for and there shall be excluded from the computation for any such period of time, any delays due to strikes, riots, terrorism, acts of God, shortages of labor or materials, war, laws, regulations or restrictions, inability or delays in obtaining governmental permits, or any other causes of any kind whatsoever which are beyond the reasonable control of [Plaintiff] or [CSL.]”

(emphasis in original).

Plaintiff filed its Complaint on January 12, 2018. The Complaint asserted a claim against CSL for breach of the Lease and a claim against InfiLaw for breach of the Guaranty. Plaintiff moved for partial summary judgment. The Court noted the “carve-out” language in the clause and held in favor of the Plaintiff as follows:

“In this clause, the parties to the Lease agreed that CSL would not be liable or responsible for delays in timely carrying out its obligations under the Lease—other than its payment obligations—due to regulations or restrictions or the inability to obtain government permits. Thereby, the parties expressly agreed that if CSL fails to timely pay sums due under the Lease, it is in breach and not excused due to its inability to obtain government permits. The fact that the Lease expressly excepts CSL’s rent payment obligation from the protections of the force majeure clause precludes CSL’s argument that it is somehow excused from paying rent because it lost its license to operate a law school.”

Thus, even though CSL lost its license, the plain language of the force majeure clause carved out an exception requiring payment of rent despite the occurrence of a triggering event. Both parties had the opportunity to negotiate the terms of the agreement. The lease reflects the parties’ agreement that the risks attendant to loss of license should be borne by the Tenant, and not the Owner/Landlord.

Under South College Street, LLC, if a force majeure clause requires payment of rent despite the occurrence of an Act of God, governmental restrictions, or even a pandemic, then the parties are likely bound by that agreement.

2.  Other Jurisdictions

The case of 1600 Walnut Corp. v. Cole Haan Co. (E.D. Pa. 2021), while not controlling, was decided in the COVID-19 setting and is persuasive authority for cases where the plain language of the Force Majeure carves out exceptions for rent payments despite Acts of God or new governmental restrictions arising from a pandemic.

In Walnut Corp. v. Cole Haan Co., Defendant (“Cole Haan”), a global footwear and accessories brand, entered into a long-term commercial lease with Plaintiff 1600 Walnut Corporation, General Partner of L-A 1600 Walnut LP (“1600 Walnut”) in 2004. 1600 Walnut Corp. v. Cole Haan Co. (E.D. Pa. 2021). In 2014, the parties agreed to extend the lease through March 31, 2025. The lease allocates certain risks between the parties. Under the force majeure clause of the lease:

If either party is delayed, hindered or prevented from the performance of an obligation because of strikes, lockouts, labor troubles, the inability to procure materials, power failure, restrictive governmental laws or regulations, riots, insurrection, war or another reason not the fault of or beyond the reasonable control of the party delayed (collectively, “Force Majeure”), then performance of the act shall be excused for the period of the delay; provided, however, the foregoing shall not: (A) relieve Tenant from the obligation to pay Rent, except to the extent Force Majeure delays the Commencement Date; and (B) be applicable to delays resulting from the inability of a party to obtain financing or to proceed with its obligations under this Lease because of a lack of funds.

Id., at pp. 1-2 (emphasis in original). Cole Haan permanently vacated the storefront in March 2020 and had not paid rent since that time. The March 23, 2020 Pennsylvania Governor’s COVID-19 executive order prohibited Cole Haan from operating the store, but after June 5, 2020 Cole Haan and other retailers in Philadelphia were permitted to reopen with restrictions. Cole Haan did not reopen and did not restart rental payments.

1600 Walnut brought suit against Cole Haan to recover arrearages owed, base rent, additional rent, late fees, interest, attorneys’ fees and costs. Cole Haan offered six counterclaims: (I) for a declaratory judgment discharging its duties under the lease for frustration of purpose; (II) in the alternative, for a declaratory judgment for rent abatement for frustration of purpose; (III) for a declaratory judgment discharging Cole Haan’s duties under the lease for impossibility or impracticability of performance; (IV) in the alternative, for a declaratory judgment for rent abatement for impossibility or impracticability of performance; (V) for a declaratory judgment discharging Cole Haan’s obligations under the lease for failure of consideration; and (VI) for a declaratory judgment of the contractual termination of the lease because the government’s COVID-19 restrictions constituted a taking under the Fifth Amendment. 1600 Walnut filed a motion to dismiss all of Cole Haan’s Counterclaims. Id., at 2-3.

The Court found that the force majeure clause of the lease explicitly allocated the risk of the pandemic to Cole Haan. As such, the Court dismissed the amended counterclaims because the force majeure clause of the lease prohibited the requested relief. In Pennsylvania, parties have broad discretion to allocate risks between them in a contract. Albert M. Greenfield & Co. v. Kolea, 475 Pa. 351, 380 A.2d 758, 760 (1977). Only where there has been no contractual allocation of a risk should a court determine the allocation based on common law theories, such as impossibility and frustration of purpose. Id.; Portnoy v. Omnicare Pharm., Inc., No. CIV.A.02-2905, 2004 WL 1535780, at *3 (E.D. Pa. June 25, 2004).

Under the lease, Cole Haan remained obligated to pay rent, even in the face of a force majeure event. The parties agreed in the lease that, if “strikes, lockouts, labor troubles, the inability to procure materials, power failure, restrictive governmental laws or regulations, riots, insurrection, war or another reason not the fault of or beyond the reasonable control of the party” cause “delayed, hindered or prevented performance,” Cole Haan is not relieved of its obligation to pay rent. Id., at 5 (quotations in original). “[L]ack of funds” is also not an excuse to performance of the contractual obligations under the terms of the lease. Id.

The Court further found that the COVID-19 pandemic was an event covered in the force majeure clause and held, “We construe the clause, an unambiguous writing, as a matter of law.” Id., at 6. “[I]n order to constitute a force majeure, an event must be the proximate cause of nonperformance of the contract.” Hong Kong Islands Line Am. S.A. v. Distribution Servs. Ltd., 795 F. Supp. 983, 989 (C.D. Cal. 1991), aff’d, 963 F.2d 378 (9th Cir. 1992) (citing Wheeling Valley Coal Corp. v. Mead, 186 F.2d 219, 223 (4th Cir. 1950)(quotations and citations in original). The Court stated that the Governor’s COVID-19 orders closing and restricting retail businesses were the most obvious proximate cause of Cole Haan’s non-performance. Id. Further, that restrictive laws or regulations, such as the Governor’s orders, however, clearly were within the meaning of the force majeure clause and would not excuse Cole Haan’s contractual obligations. Cole Haan, instead, averred that the pandemic itself, not governmental regulations, prevented Cole Haan from fulfilling its obligations under the lease. Cole Haan argued that the pandemic fell outside of the force majeure clause because the listed examples in the clause were limited to “manmade events of relatively short duration,” whereas the pandemic was a “naturally occurring phenomenon.” Id., at 6 (quotations in original).

The Court disagreed with Cole Haan and concluded: “The COVID-19 pandemic, however, is within the defined force majeure events of the lease.” Id., at 6-7. Further, that the pandemic was in the same category as the other life-altering national events listed, such as war, riots, and insurrection. Id., at 7. The pandemic is, then, included within the catchall provision of “another reason not the fault of or beyond the reasonable control of the party delayed.” Id. (quotations in original). Because the cause of Cole Haan’s prevented performance was a force majeure event, the common law doctrines of frustration of purpose, impossibility/impracticability of performance, and failure of consideration were held by the Court to be inapplicable. Id.

Ultimately, the Court held: “Accepting all of Cole Haan’s factual allegations as true and construing them in the light most favorable to Cole Haan, 1600 Walnut has demonstrated that Cole Haan is not entitled to relief ‘under any reasonable reading of’ the counterclaims.” Id. (citing Mayer v. Belichick, 605 F.3d 223, 229 (3d Cir. 2010)). Consequently, the Court granted Plaintiffs’ motion to dismiss Cole Haan’s counterclaims.

3.  Alternative Argument – Decreased Rents

It appears that under the law of North Carolina and other jurisdictions, the specific “carve-out” language requiring continued rent payments even in the face of a pandemic (as well as Acts of God, war, governmental restrictions, etc.) in a force majeure clause will be enforced. However, commercial tenants may argue that such continuing rent payments should be reduced to reflect the pandemic’s effect on its business. This author has found no North Carolina case on point, but law from other jurisdictions may provide some guidance.

On June 3, 2020, a Bankruptcy Court for the Northern District of Illinois offered us an early look into how courts might interpret some force majeure clauses in the midst of the pandemic. In In re Hitz Restaurant Group, No. 20-B-05012, 2020 WL 2924523 (Bankr. N.D. Ill. June 3, 2020), the Bankruptcy Court ruled that Executive Order 2020-7, the Stay-at-Home Order (the “Order”) enacted by Illinois Governor, J.B. Pritzker, on March 16, 2020, triggered the tenant’s force majeure clause. As a result, the tenant was partially excused from its obligation to pay rent for the duration of the Order.

In the case of In re Hitz, the force majeure clause provided that the “Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in [the] Lease, in the event, but only so long as the performance of any of its obligations are prevented or delayed, retarded or hindered by…laws, governmental action or inaction, orders of government…Lack of money shall not be grounds for Force Majeure.”

The Bankruptcy Court held that the Order “unambiguously” triggered the force majeure clause under the lease as it constituted both “governmental action” and an “order of government.” The Bankruptcy Court also found that the Order “hindered” the tenant’s ability to fully operate and generate revenue due to its express prohibition against offering on-premises consumption of food and beverages – notwithstanding the fact that the tenant was still permitted (and even encouraged) to provide take-out and delivery services.

In its motion, the landlord, Kass Management Services, Inc., claimed that rent was still payable and the force majeure clause was inapplicable for the following reasons: (i) despite the Order, banks were open and the tenant had the ability to write and send checks; (ii) the tenant’s failure to perform was due to lack of money, which is carved out from the force majeure clause; and (iii) the tenant could have obtained funding by applying for a Small Business Administration (“SBA”) loan.

The Bankruptcy Court dismissed the landlord’s claim that the tenant could still write and send checks as a “specious argument that [was] unresponsive to [the tenant’s] arguments and one that lacks any foundation in the actual language of the force majeure clause in the lease.” Additionally, the Bankruptcy Court rejected the landlord’s argument that the tenant’s failure to perform was due to lack of money, agreeing with the tenant that the Order was the proximate cause of the tenant’s inability to pay rent, as it impeded the tenant’s ability to fully operate and generate revenue. Finally, the Bankruptcy Court rejected the landlord’s claim that the tenant could have obtained the money to pay rent by applying for an SBA loan on the basis that there was no requirement in the lease or case law to support such an argument.

In reaching its decision, the Bankruptcy Court considered the fact that the tenant was not forced to completely shut down its operations and was still able to provide take-out and delivery services. In doing so, the Bankruptcy Court determined that the tenant should still be required to pay some rent, but only “in proportion to its reduced ability to generate revenue due to the [O]rder.” Since neither party proposed a methodology by which the Bankruptcy Court could calculate the proportionate rent, the Bankruptcy Court ordered the tenant to pay 25% of the rent payable for the duration of the Order. The Bankruptcy Court reached this conclusion based on the tenant’s estimate that the kitchen, which was still usable for takeout and delivery, comprised 25% of the restaurant’s total square footage.

The Bankruptcy Court’s decision illustrates how strictly courts may be willing to construe force majeure clauses in the context of the pandemic. And while the Bankruptcy Court’s decision is not binding on other jurisdictions, it could nevertheless serve as precedent for courts to, at least partially, excuse tenants from their obligation to pay rent in light of the pandemic where the language of the force majeure clause in the lease does not expressly carve out monetary obligations like the payment of rent, which such clauses oftentimes do.

4.  Doctrines of Impossibility and Frustration of Purpose

Where a commercial lease does not contain a force majeure clause or is otherwise silent on the allocation of risk for events like a pandemic, governmental restrictions, Acts of God, etc., the Court will look to North Carolina common law. North Carolina recognizes the doctrines of Impossibility and Frustration of Purpose. These issues shall be addressed in a subsequent article coming soon (hopefully).

CONCLUSION AND RECOMMENDATIONS

Where a tenant or a landlord have been injured by the COVID pandemic, governmental restrictions, Act of God, or something else, look to the plain language of your force majeure clause to see how the risk was allocated. Otherwise, you will have to look to North Carolina common law to determine your rights and liabilities. The best practice going forward is to take another look at your force majeure clause and: (1) specifically allocate the risks of such an event in your lease; and (2) specifically add “pandemic” or other similar term to the force majeure clause. Only a few leases contained the term “pandemic” prior to COVID-19. That left courts to determine whether the hardships caused by COVID-19 fell under some other language in force majeure clauses such as “Act of God” or the resulting “governmental restrictions.” The holdings across jurisdictions are not uniform. As a result, more and more commercial tenants and landlords are specifically including the term “pandemic” in their leases to provide more certainty in terms of their respective rights and liabilities.