Enforcing Commercial Lease Guaranties in the Age of COVID-19

As it has with most every other aspect of leasing, the COVID-19 crisis has played havoc with landlords’ efforts to collect unpaid rent from tenants’ guarantors. And now as a second and more deadly surge of cases threatens further government shutdowns, landlords need to be aware of the key cases involving attempts to enforce lease guaranties that came down as a result of tenant COVID-related defaults during the first round of shutdowns last spring. Here’s a rundown of the three kinds of legal obstacles landlords seeking to enforce a guaranty in the wake of a tenant’s COVID-19 payment default are apt to encounter.

Obstacle 1: Lease Defenses

Litigation between landlords and tenants for unpaid rent has focused largely on the force majeure clause and/or frustration of purpose rule. Not surprisingly, guarantors have also tried to rely on these lease defenses to avoid liability for a tenant’s default.

A recent example involves an office building tenant that stopped paying rent in February and moved out of the building five months later. With the tenant insolvent, the landlord proceeded against the “good guy” guarantor, which countered with frustration of purpose. The argument: The pandemic made the tenant’s business model of acting as a consultant to restaurants totally unprofitable by forcing its clients to shut down. And since the tenant’s failure to pay rent was excused, so were the guarantor’s obligations under the guaranty.

But the New York court didn’t buy it and awarded the landlord summary judgment on the liability issue (the question of damages still had to go to trial).

Frustration of purpose. While expressing empathy for the tenant’s financial hardship, the court quickly added that COVID-19 has hurt lots of businesses, including the landlord. But frustration of purpose is a narrow doctrine that applies only when the purpose that’s frustrated is “so completely the basis of the contract that, as both parties understood, without it, the transaction would have made little sense.” Not being able to afford the rent for leased space because a tenant’s clients could no longer pay for its services didn’t amount to frustration, the court reasoned. This wasn’t a situation where the leased office space was destroyed or where a tenant rented a unique space for a specific purpose that can no longer serve that function.

Impossibility. The court also rejected the guarantor’s impossibility defense. The pandemic didn’t make the tenant’s obligation to pay rent impossible to perform. While the public health decrees required restaurants to shut down, they didn’t force the tenant to close its consulting business. Besides, some restaurants could continue takeout and delivery operations. Reducing the need for the tenant’s services wasn’t impossibility but an industry change that sometimes happens in the course of business, the court concluded [1140 Broadway LLC v. Bold Food, LLC, 2020 N.Y. Misc. LEXIS 10358, 2020 NY Slip Op 34017(U)].

Obstacle 2: Deferral (or Dismissal) of Lawsuits Against Guarantors Pending Outcome of Eviction Case

Have you ever heard of the Colorado River Abstention Rule? You may learn about the rule if you try to collect on a lease guaranty while your eviction case against the tenant is still pending.

That’s what happened to an Illinois landlord when it sued to evict a day care center that no longer had the revenues to pay full rent due to COVID-19. The tenant raised a force majeure defense. While the state eviction case was still pending, the landlord sued the tenant’s personal guarantor in federal court for the unpaid rent. The guarantor then asked the federal court to “stay” the case—that is, put the proceeding on ice pending the resolution of the eviction claim. And that’s just what the court did.

Explanation: It’s not unusual for there to be simultaneous cases dealing with the same basic issue in both a state and federal court. Normally, federal courts proceed with the case without deferring to the state court. However, in rare cases, federal courts will abstain from exercising their jurisdiction—that is, their legal authority to rule on the case—pending the state court ruling in the interest of “wise judicial administration and conservation of judicial resources.” In other words, the most efficient way to resolve the dispute is to let the state court have its say first.

Federal courts will apply the so-called “Colorado River Abstention” on two conditions:

• The concurrent actions in state and federal court are parallel; and
• There are “exceptional circumstances” for granting a stay or dismissal.  

The Illinois federal court determined that both conditions were met and granted the stay.

Parallel proceedings. The issues in the state and federal case were “substantially the same.” Specifically, the liability of the tenant and guarantor were coextensive. If the tenant was liable for the rent, the guarantor would be too; if the tenant had an excuse not to pay the landlord, the guarantor wouldn’t have to pay under the guaranty. The only real difference was that the tenant was the defendant in the state case and the guarantor the defendant in the federal case.

Exceptional circumstances. The court then weighed the 10 factors courts must use to determine whether there are exceptional circumstances for granting the stay or dismissal. It found three of them irrelevant, one slightly militating against the stay, and six weighing in favor of the stay, including the value of avoiding “piecemeal” or broken-up proceedings and the adequacy of the state action to protect the federal plaintiff’s rights. Result: It granted the stay, forcing the landlord to win its eviction case against the tenant before coming after the guarantor [Bryton Props. LLC v. Cudnik, 2020 U.S. Dist. LEXIS 213713].

Obstacle 3: State and Local COVID-19 Guarantor Protections

In addition to freezing commercial evictions, some states and municipalities have adopted temporary restrictions on lawsuits against guarantors for a tenant’s COVID-19 rent default. One notable example is a May New York City law banning landlords from suing guarantors for defaults that occurred during the period from March 7, 2020, to March 31, 2021, if:

• The guaranty was given by a “natural person,” as opposed to a company or entity, in a commercial lease;
• The guaranty would make the natural person liable for the tenant’s payment of rent, utilities, taxes, or routine maintenance fees or charges;
• The tenant was subject to the COVID-19 shutdown orders that the city issued in the spring.  

A group of NYC landlords filed a lawsuit claiming the law was unconstitutional, but the federal court recently rejected the claim (see “Court Upholds NYC COVID-19 Commercial Tenant Anti-Harassment Law”). So, don’t be surprised if similar laws spring up in other parts of the country.