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HomeCOVID-19 virus: Restrictions on business leaseholds

COVID-19 virus: Restrictions on business leaseholds

On 17 March 2020, the government announced a number of additional initiatives to reduce the spread of the COVID-19 virus. The new initiatives entered into force 18 March 2020. The new initiatives involve, inter alia, closing of shopping malls, department stores, restaurants and cafés for customers. The initiatives may have substantial impact on both lessors and lessees.
19. March 2020

New temporary bans restrict the use of commercial leaseholds

At a press conference held 17 March at 19:00, the Danish government announced a number of additional initiatives directed at reducing social contact, ensuring proper distance between the Danes and increasing the effect of social distance.

The new initiatives entered into force on 18 March under ministerial order (bekendtgørelse) no 224 of 17 March 2020 and derive from the amendments to the Epidemic Act (epidemiloven), which the Parliament passed on the 12 March 2020. You can read more about the amendments to the Danish Epidemic Act (epidemiloven) here.

The new initiatives entails, inter alia, a temporary ban on:

  • shopping malls, department stores, arcades and bazaars etc. The ban does not include grocery stores, super markets and pharmacies located in shopping malls etc.
  • places where food, beverages or tobacco are served (e.g. restaurants, cafés, nightclubs, discotheques, bars, taverns, shisha bars, etc.). It is still allowed for restaurants, cafés etc., under more specific conditions, to serve food and beverages to go (takeaway).

For the time being, all bans remain in force until 30 March 2020. You can find more details about the specific bans on the website of the Danish police and in the above-mentioned ministerial order.

The new bans raise a number of issues for both lessors and lessees related to business leaseholds in the retail, catering and tourist industries. This newsletter primarily deals with the impact of the new bans in connection to

  • the lessors’ duty to make the leasehold available to the lessee;
  • the lessee’s duty to keep the leasehold open and pay rent;
  • the lessor’s or lessee’s breach of their obligations, including in cases of force majeure.

What is agreed in the lease agreement?

To a wide extent, the parties of a business lease agreement (lessor and lessee) can agree freely on the terms of the lease agreement. Thus, it is of paramount importance to determine what the parties have agreed upon in the lease agreement. If the parties, e.g., have specifically agreed which circumstances constitutes force majeure or who bears the risk of using the leasehold, it is that specific agreed term that will be taken into consideration when determining the right of the parties.

If the parties have not specifically agreed upon the terms of the lease agreement, the parties’ legal position must be viewed in the lieu of the standard terms of the Danish Business Lease Act.

Force majeure

It is most likely that the latest government actions constitute force majeure in relation to some of both lessors and lessees obligations under a lease agreement, as

  • fulfillment of terms of the lease agreement can be impossible due to the extraordinary situation created by the outbreak of COVID-19 virus and the bans imposed by the government, and
  • the extraordinary situation – at least for the lease agreements drafted prior to the outbreak of COVID-19 virus – must be assumed to have been unpredictable for the parties.

Furthermore, as argued in newsletter dated 2 March 2020 “Coronavirus as force majeure? Implications for commercial contracts”, it is – in addition to the two conditions mentioned above – a condition for exemption from liability that the party claiming exemption dutifully notifies the other party thereof. This also applies for business lease agreements.

Under Danish law, generally, the consequence of force majeure is that the party unable to fulfill his commitment is temporarily exempted from liability.

The lessor’s obligation to make the leasehold available

The primary obligation of the lessor under a lease agreement is to provide the premises to the lessee during the lease period. The risk of amendments, public orders or other external circumstances arising during the lease period is usually considered to be the responsibility of the lessee, which also often will be reflected in the terms of the lease agreement.

The lessors’ obligation to make the leasehold available to the lessee will, in principle, be fulfilled even in a situation where the use of the leasehold has been prohibited. However, this is not given if there are specific circumstances either as a result of individual lease agreement terms (e.g. guarantees), circumstances concerning the draft of the lease agreement or the nature of the leasehold that may lead to a different result.

What can a lessee do when it is not possible to conduct business from the leasehold due to a temporary public ban?

Can the lessee terminate the lease agreement or demand a rent reduction? And does it  affect the lessee’s obligations to keep the business open and pay rent?

Termination of the leaseagreement?

A public ban of the use of the leasehold does not constitute a breach justifying termination of the lease agreement. Thus, the lessee will not be able to terminate the lease agreement.

If the lessee experiences a significant decline in revenue, the lessee may consider terminating the lease. Under the Danish Business Lease Act the lessee in general has an unrestricted right of termination, unless othervise agreed in the lease agreement.  Termination is subjec to the agreed notice – or if no term has been agreed with three months’ notice. However, if non-termination is agreed, this constitutes a restriction on lessee’s notice of termination.

According to the Danish Business Lease Act, Section 23 (2) the lessee is entitled to terminate the lease agreement umtimely “because a public authority has banned use of the premises by the lessee for health or other reasons” and “ the lessee is only under an obligation to pay rent until the day on which such ban becomes effective”.

If, however, the ban merely restricts the use in a manner, which is of minor importance, the lessee is only entitled to proportionate reduction of the rent, cf. 23 (2), last sentence.

It is stated in the preparations for the Danish Business Lease Act, section 23 (1) that the provision “relates to the situation where it is due to the lessor’s affairs, or affairs of which the lessor bears the risk, that the public authorities due to health reasons or other reasons has banned the lessee’s use.”

The provision typically aims at situations, where the state of the building or the leasehold means that the use of the leasehold must be prohibited. The current situation most likely cannot be regarded as covered by section 23 (2), but there is no relevant case law related to the provision which may contribute to definitive clarification. Therefore, it is uncertain whether the current ban on shopping malls, etc. will be covered by the provision – either directly or indirectly.

However, even if the provision applies, individual terms may be agreed in the lease agreement, which means that the risk still is incumbent on the lessee.

Finally, in case the latest governmental ban constitutes force majeure, the lessor will most likely not be in breach of contract, even if the leasehold (temporarily) is not available for the lessee.

Is the lessee obligated to pay rent and other expenses?

The operation of the lessee’s business is, as a general rule, not the risk of the lessor. Unless otherwise agreed in the lease agreement the lessee alone carries the risk of any decrease of customer flow and consequently any decline in revenue.

Therefore, in a situation where the lessee experiences a significant decline in revenue, the lessor maintains the right to collect rent and other expenses and claim breach of contract, including termination, if the lessee fails to pay rent.

It may be considered whether the ban constitutes force majeure that relives the lessee from paying rent. Most likely this will not be the case, but here may be specific circumstances either because of the terms of the individual lease agreement (e.g. gaurantees) or because of specific cirumstances surrounding the conclusion of the lease agreement that will lead to a different result.

Reduction in the rent?

Under the Danish Business Lease Act the lessee is entitled to demand a proportionale reduction of the rent, if the state of the leasehold deminishes the lesse’s actual use of the leasehold (section 18) or where the use is wholly or partly contrary to legislation (section 22). It is doubtful whether these provisions will apply as a result of the new bans – and thus entitle the lessees to a reduction in the rent. This is due to the intentions of Section 18, which intends to regulate specific (especially physical) defects in the lease, while Section 22 relates to original (and not subsequent) legal defects.

In addition, the lessee may be entitled to reduction in the rent under the Danish Business Lease Act section 23 (2), last sentence, cf. above, e.g. in a situation where the public authorities impose a ban that only “limits the use [of the leasehold] in a less substantial way (…)”.

As stated above, it is uncertain whether the present situation of bans concerning shopping malls, etc. will be covered by section 23 (1), and thus whether the provision provides the foundation for a claim of reduction of the rent.

Does the lessee have an obligation to keep the business open?

According to the Danish Business Lease Act section 39 (1), shops and restaurants – which is quite often in accordance with terms agreed in the lease agreement – have an obligation to “keep the business open and operating to the customary extent“.

Failure to comply with this obligation will, after the lessor’s demand and the lessee’s failure to remedy, give the lessor the right to terminate the lease agreement, cf. section 69 (1), no. 9.

Note, that there is a difference between the situation where the lessee of a shop or restaurant voluntarily chooses to close the business for customers or guests, and the situation where the lessee is forced to close as a result of the new ban.

If the lessee voluntarily closes the business, this likely constitutes a breach of the lease agreement, cf. section 69 (1), no.  9 – also in the current situation.

If the lessee of a store or restaurant is forced to close the business, that’s an entirely other matter. With the government’s latest initiative to ban shopping malls, etc. it is most likely this constitutes force majeure. If this is the case, the lessee is not in breach of contract if the busines is (temporarily) closed.

Summary

It is beyond doubt that the current situation with COVID-19 virus – especially in light of the new bans – can and will have a significant impact on the retail and restaurant industry, among others.

This is an extraordinary situation and the initiatives taken by the public authorities are unprecedented. This also means that in relation to the legal consequences this is without precedent.

It can be risky for both the lessor and the lessee – and may have major financial consequences in the form of claims for damages – to take positions on (i) the other party’s failure of performance, (ii) the claim for rent reduction or no (temporary) rent or (iii) even termination. Both the lessor and lessee risk unintentional bankruptcy for the lessee and thus considerable vacancy and losses of otherwise healthy businesses.

The concrete and indivual situation and lease agreement should therefore be subject to a specific assessment, and the results may well differ for shops, restaurants and hotels.

In relation to existing lease agreements, we recommend that the effects of the current situation are sought to be mitigated by negotiating voluntarily commercial solutions between lessor and lessee. Such solutions could include, for example:

  • full or partial extension of payment, which has already been seen in several cases;
  • temporary rental discount (possibly with a built-in stepway solution);
  • redistribution of the total rental amount payable within the period of non-termination;
  • (temporary) transition to cost-based rent;
  • Non-performance or mitigation of indexing the rent.

It is important that such agreements are properly concluded and take into account that the situation may be prolonged, that the government can provide supportive initiatives to both lessor and lessee, which can affect the relationship between the parties. Furthermore, such agreements must consider the position of the parties, when the situation is normalized.

In relation to entering into new lease agreements, it is essential that the parties take COVID-19 virus into account so that, for example, a situation does not arise where the leasehold cannot be made available to the lessee on the day of commencement.

In the coming days, we will be sending out further newsletters on other lease related issues derived from COVID-19 virus.

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