Retail Tenants Assert Frustration Of Purpose To Avoid Lease Payments Based On Covid-Related Closing

The New York Appellate Division in Manhattan recently issued an important decision for commercial landlords and retail tenants suffering through store closings and diminished business as a result of the COVID-19 pandemic.  In The Gap v. 44-45 Broadway Leasing, the Court affirmed the lower court’s issuance of a “Yellowstone” injunction (issued to maintain the status quo) which permitted continued occupancy of two high profile retail locations while the parties continue to litigate the question of whether the doctrine of “frustration of purpose” applies to terminate or alter leases as a result of state-mandated closure orders due to COVID-19.  While the case proceeds, the Court ordered the tenants to continue to pay for use and occupancy.   

The dispute involves prime retail space at Times Square leased by The Gap and Old Navy.  Each tenant executed a lease in June of 2015 that called for a combined monthly rental of approximately $3 million (which amounts escalated over time).  In their Complaint (which can be found here), The Gap and Old Navy assert that the high rent was agreed to in consideration of the 50 million people who visit Times Square annually. This pattern changed overnight in March of 2020, when New York City became a “ghost town” after Government authorities mandated an absolute shut down of retail stores such as The Gap and Old Navy.  Reopening was permitted only in “a drastically different [manner] from what was contemplated when the retail leases were negotiated” according to the Complaint.  While the parties may have imagined an “ebb and flow” to the economy and tourism, “nothing like COVID-19 could have been foreseen.”  The tenants asserted further that, “It is likely to be years before retail has even a chance to return to the pre-COVID form, which served as the basis for what both landlords and tenants relied on in agreeing to such enormous monthly rents.”  Therefore, the “purpose of tendering …rent…[h]as been completely frustrated.”  

The Complaint was precipitated by a 10-day Notice which reported a default due to nonpayment of the May and June 2020 rent, which default would allow the landlord to seek lease terminations if not cured. The tenants argued in response that rent was not owed after March 19 (when the stores were forced to shut by government mandate) because the purpose of the leases was frustrated.  In their Complaint, the tenants seek damages for breach of contract and a declaration that the leases should be reformed.

The tenants then moved for, and were granted, an injunction to prohibit eviction and termination of the leases by the landlord (click here to view).  The injunction was made conditional upon the tenants’ payment, by way of an undertaking to the Court, of $2.9 million in monthly use and occupancy prospectively, and the posting of an additional $5.8 million for rent in arrears. The Court based these amounts on a use and occupancy rate of 90% of the stated rent.  

The landlord appealed, challenging the Court’s determination that use and occupancy charges be set at 90% of rent and that ongoing use and occupancy be paid into Court and not directly to the landlord.  The Appellate Division (click here to view) concluded that the 90% use and occupancy rate was appropriate but the ongoing use and occupancy charges should be paid directly to the landlord.  

Thus, at least in this instance, the Court would not allow lease termination and eviction without a full determination of the facts so long as the tenants are able to pay a reasonable portion of the rent while the litigation proceeds.  The issue of whether the leases should be reformed or terminated based on the frustration of purpose has yet to be decided.  However, a decision on that may be issued shortly as a summary judgment motion is now pending before the Court. 

Oddly juxtaposed with this circumstance is a recent article in Bisnow (click here to read) reporting that some retailers have seen increased revenues during the pandemic.  Among them is Target, with a 21% growth in revenue in the fourth quarter of 2020 over the same period in 2019.  While most of the growth was due to digital sales, in-store sales grew at 6.9%.  The article also reported positive sales growth at Kohls and hobby and craft specialist Michaels. Winners in the retail field at this time, however, are clearly the exception.

This article is the second in a three-part series discussing various decisions affecting commercial real estate related to the COVID-19 pandemic. The information provided does not, and is not intended to, constitute legal advice; instead, all information and content are for general informational purposes only. If you have any questions, please contact the author, Stephen Willig, or the Donovan Hatem attorney that handles your matters.

Steve Willig is a partner in the firm’s Litigation department and has been defending professionals, business owners, and contractors, and representing insurers, in commercial and casualty litigation for more than thirty years

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