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Lease accounting Q&A: Lease provisions and COVID-19

Deciphering financial and contractual obligations of a lease can be a challenge. And that is especially true during an unprecedented event, such as the COVID-19 pandemic. All you really want to know is, what are you responsible for?

Below, we answer questions about some of the common lease provisions that may pertain to COVID-19 and how they could affect your lease obligations — and ultimately, your lease accounting.

Provisions That May Pertain to COVID-19 and Lease Accounting

Since every lease has different language, obligations and consequences, we always recommend talking to your legal counsel to get help interpreting lease provisions and determining if and how they pertain to your business.

Regardless, the common lease clauses below may include language that will have an impact on tenant/lessee or landlord/lessor responsibilities during unusual situations such as the COVID-19 crisis.

What is a Force Majeure provision?

Force Majeure is a clause excusing nonperformance by the landlord/lessor or tenant/lessee, with specific lease language that defines what events trigger an exclusion. This lease provision typically also defines whether or not specific types of performances are covered — for example, a landlord’s obligation to perform certain maintenance and repairs.

The lease language might provide different definitions of “Force Majeure” events, but they may include acts of God, terrorism, natural disaster, governmental action, riots, or more generally, events out of the party’s reasonable control. The more specific the language is, the less likely you can rely on the clause to postpone or cancel obligations under the lease.

What does Force Majeure excuse or not excuse?

The Force Majeure clause may excuse things such as a landlord’s requirement to make repairs or a tenant’s requirement to maintain janitorial services within the premises. Note that the payment of rent is often not excused.

What is an example of a Force Majeure clause under which rent payment is not excused under COVID-19? 

“This Lease and the obligation of Tenant to pay the due rent hereunder and perform all of the other covenants and agreements hereunder on the part of Tenant to be performed shall in no way be affected, impaired or excused because Landlord is unable to fulfill any of its obligations under this Lease . . . if Landlord is prevented or delayed from so doing by reason of strikes or labor troubles or by accident, or by any cause whatsoever beyond Landlord’s control, including, but not limited to, laws, governmental preemption in connection with a national emergency or by reason of any Requirements of any Governmental Authority.”

What is a casualty provision?

Most leases have a provision regarding what happens when the building, premises, or property is damaged by a casualty such as a fire, flood, hurricane, earthquake, and similar events.

What does a casualty provision mean in a pandemic like COVID-19?

Casualty provisions rarely cover government shutdowns or pandemics. Usually the only events covered are those that would physically damage or destroy a building or asset in some way.

What kind of obligations are included in leases regarding landlord vs. tenant responsibilities?

Generally, leases may include obligations such as maintenance and repairs, how common areas are handled, building hours, base-building cleaning, and extra cleaning. Specific lease language will differentiate what responsibilities fall on the landlord/lessor versus on the tenant/lessee for tasks such as:

  • Maintaining the building
  • Maintaining the specific tenant space
  • Emergency repairs/maintenance
  • Common area maintenance (CAM) and use

Are there specific lease obligations that may be more relevant during the COVID-19 pandemic?

Due to the nature of the virus, any lease clause concerning maintenance and cleaning of the building and tenant’s premises is relevant. Additionally, clauses concerning any “above and beyond” maintenance and cleaning are relevant.

For instance, specific lease language may include expenses that the landlord can choose to undertake but then pass on to the tenant — such as extra deep-cleaning that might be required during the pandemic (or at other times).

Are there any third-party agreements that should be reviewed?

Depending on the specific lease language requiring tenants to maintain and clean their own premises, any third-party agreements concerning the “Supplemental Cleaning of Tenant’s Premises” would be relevant. Other obligations with third-party contracts may include construction or renovations and other premises maintenance.

Most supplemental cleaning contracts can be terminated with 30 days’ notice, which means a tenant can potentially renegotiate scope and pricing changes depending on how the current situation develops.

What insurance provisions are included in leases?

Most leases contain requirements for both the landlord/lessor and the tenant/lessee to obtain and maintain certain insurance policies. While not all are applicable during the COVID-19 pandemic, some may be, depending on the exact policy and what coverage it includes.

Some policies — such as business interruption insurance — may help with rent, operational costs, lost profits, and similar issues. However, the policies must have been put in place prior to the current COVID-19 pandemic.

What is a business interruption insurance policy?

This is usually an add-on to a business’s property/casualty insurance policy to cover loss of business income in a disaster that is covered by the main property/casualty policy. However, since it is usually applicable to a natural disaster or fire, the policy would have to be reviewed and interpreted to determine if the current COVID-19 situation is covered.

Do government orders, regulations, or laws concerning COVID-19 take precedence over lease provisions?

Any government order, regulation, or law issued concerning the pandemic may take precedence over any lease provision. This could include anything from the payment of rent and the status of evictions to the physical use of buildings.

For example, the governor of New Jersey issued a lockdown order for nonessential businesses, requiring them to close to the public. But whether this action cancels lease performance or obligations would depend on the specific Force Majeure language contained in the lease.

As time goes on, there may be additional government actions that supersede any lease language to allow for delayed performance and even delayed evictions. New York, for instance, delayed all commercial lease evictions until at least June 20, 2020, and there are proposals to consider delaying rental payment obligations for 90 days.

What is a Continuous Operations clause?

A Continuous Operations clause is lease language that requires a retail tenant to be open and operational for a certain number of hours per day and/or days per week. This provision generally applies to retail tenants, although it does not necessarily appear in all retail tenant leases. The provision is rarely found in other commercial tenant leases.

Are there exceptions to a Continuous Operations clause?

Specific lease language may give exceptions, such as Force Majeure events, that allow for not continuously operating. But again, this depends on the specific language in the lease. In most cases, Continuous Operation provisions still require payment of rent.

What are some other lease provisions that may be relevant during COVID-19?

  • Notice provisions provide guidance for ensuring that notices between tenant and landlord are legal and binding — for example, regarding lease renewal, lease termination, lease options, and general requirements for providing official notice of any action to the other party.
  • Gross-up provisions state that if a building is shut down for an extended period, landlords must credit back the costs of any unprovided services when issuing their year-end reconciliations. Tenants should keep an eye on this issue when reviewing their year-end statements.
  • Percentage or profit-sharing rent provisions specify a rent charge based on the gross income of the tenant rather than a fixed monthly or annual value.

Get Help from the Experts

Your legal advisor and accounting advisory partner can both help you understand how lease provisions may pertain to COVID-19 and result in lease concessions and other changes that will affect your lease accounting.

In addition, a lease accounting and administration software solution such as Visual Lease can help during this process — providing abstracted clauses and tools for organizing your lease data.

Visual Lease is providing the information above for informational purposes only and should not be construed as legal or accounting advice.

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