Stock market crashes, mass unemployment, and disruptions hinting a recession – are only the tip of the iceberg and its underlying repercussions are likely to unfold with time. The COVID-19 pandemic is adversely affecting commercial real estate (CRE) as it continues to wreak havoc in industries throughout the economy. For many years, the primary declining CRE sector in India has been brick and mortar retail stores. However, the retail sector is no longer suffering alone, as the COVID-19 outbreak is hurting most other CRE sectors: office, hospitality, multi-family, restaurant, personal services, entertainment and construction.
Central, state and local governments have ordered business shutdowns and social and travel restrictions limiting most social and commercial activities. As a result, commercial tenants throughout the country are going out of business, temporarily closing, curtailing operations, laying-off employees and suffering sharply declining revenues.
Even so-called “essential” or “life-sustaining” companies that are largely exempt from governmental restrictions are experiencing declines in business. The spread of this deadly virus can prove to be the biggest black swan event for the real estate sector. Where all commercial real estate may see a decline, retail businesses may find that their regular flow of customers substantially reduced thereby essentially placing a period on the rental incomes of commercial landlords.
- ‘Force Majeure’ provision
In the absence of any clarity by the Government on rental obligations under commercial lease agreements, businesses are left struggling with zero sales coupled with salary and rental obligations. Amid the pandemic, the much forgotten ‘Force Majeure’ provision in contracts and leases has gained traction and attention. The commercial tenants could invoke the ‘force majeure’ to absolve them from rental payments during “an event beyond the parties’ control”. However, force majeure events are not exhaustively laid out under the law and applicability of this provision depends on the language of the rental agreement and interpretation of the courts. Therefore, the parties must renegotiate the terms of the agreement to provide breathing room to both parties.
- Doctrine of Frustration
A question that may arise is whether a Lessee can invoke the Doctrine of Frustration in the absence of a Force Majeure Clause for Non-Payment of Lease Rent? Typically, the Doctrine is invoked in circumstances where the purpose of their contract is held to be frustrated under Section 56 of the Indian Contract Act. However, the Supreme Court in Raja Dhruv Dev Chand v Raja Harmohinder Singh, observed ‘’Authorities in the courts in India have generally taken the view that Section 56 of the Contract Act is not applicable when the rights and obligations of the parties arise under a transfer of property under a lease’’.
Thus, it is unlikely that a lessee can claim frustration of contract in the absence of a Force Majeure clause under a lease agreement and seek waiver of lease rental as consequence of a Force Majeure event. However, most tenancy agreements don’t have the provision of ‘force majeure’ and cannot invoke the doctrine of frustration and so unless announcements are backed by ordinances, the uncertainty of its enforceability remains.
- Common Area Maintenance Costs
Commercial landlords responsible for common parts (Common Area Maintenance) are providing more frequent and thorough cleansing of those common parts, particularly frequently touched surfaces (e.g. door handles, elevator buttons and toilets), although, there is no legal obligation on them to provide such services to prevent the spread of the virus. Supplying these extra cleaning services will have cost implications, and commercial landlords should check the service-charge provisions in their leases to ensure such charges are recoverable.
Wider regulatory issues regarding any steps taken (such as cleaning or surface disinfection) by a commercial landlord or its managing agents should also be addressed. For example, municipal permission for commercial premises will often contain conditions that restrict or limit the hours within which such operations may take place. This could possibly catch enhanced or additional cleaning activities, for example, if additional garbage clearance is required or additional traffic and noise is caused.
But there could be a possible solution in order to save the commercial leases and the solution can lie in one of the most important statutes.
- Transfer of Property Act
Section 105 of the Transfer of Property Act (TPA) defines a “lease”. The recognizes certain situations under which unforeseen circumstances may give rise to a justified ground to treat the lease as terminated. Section 108(B)(e) shows three criteria must be satisfied before any benefit can be derived: (i) the existence of an ‘irresistible force’; (ii) property becomes substantially and permanently unfit for use for which it was let; and (iii) the lessor must be informed of the lessee’s decision to render the lease deed void. Therefore, under Section 108(B)(e), it is as important to establish that COVID-19 rendered the property permanently unfit for the purpose for which it was leased out, as it is to establish that COVID-19 is in itself an instance of an ‘irresistible force’.
In this context, it becomes important to examine whether COVID-19 and the lockdown can be termed as an ‘irresistible force’ for the purposes of Section 108(B)(e). Black’s Law Dictionary defines force majeure, inter alia, as a “superior or irresistible force” (4th ed. 1972). While the authors have not come across a judicial precedent where the definition of ‘irresistible force’ has been specifically settled, obiter indicates that the Courts have not made a distinction between ‘irresistible force’ and force majeure. Whether COVID-19 itself would qualify as a force majeure event is a question of fact and is most likely to be settled on a case to case basis.
- Payment obligations and unforeseen circumstances
An obvious and major concern is whether the payment obligations under the lease remain active despite the lessee not having access to the property. The question as to COVID-19 and not having access to the property is a question of fact for the courts to determine on a case to case basis. But Courts have deemed that the lessee is in possession of the property and has access to is unless a notice under Section 108(B)(e) of the TPA is sent to the lessor.
- Considerations for a Lessee
The relationship between the lessee and the lessor are primarily governed by the terms of the lease deed. If the lease deed does not have a force majeure clause, resort has to be had to Section 108(B)(e) of the TPA. The lessee will have to first satisfy himself that the event is one of ‘irresistible force’ and has to notify the lessor to avoid future rental payments.
This analysis is complicated by two important considerations. First, a lessee can only seek the benefit of Section 108(B)(e) if the lease in question is duly registered under the Registration Act, 1908. In the absence of registration, a lessee must examine their protection under common law for a month to month tenancy. Second, most lease agreements for commercial establishment contain an arbitration clause as the means for dispute resolution. The arbitrability of disputes under a lease deed is currently pending resolution by the Supreme Court. In Himangni Enterprises v. Kamaljeet Singh Ahluwalia (2017) the Court held that disputes under the TPA were non-arbitrable. The correctness of this view has been doubted in Vidya Drolia vs Durga Trading Corporation(2019) and a reference to three judge bench is currently pending. Given the large number of open-ended questions, it would be interesting to observe how courts react to the impact COVID-19 has had on various economic relationships.
Impact on the Sector
The Indian residential sector has been grappling with subdued demand for the past few years. In an attempt to stay afloat amidst changing dynamics, developers tried to pull all levers like restricting supply, focussing on execution, reducing unit sizes and developing affordable housing projects. However, the liquidity crisis initiated by IL&FS fiasco and subsequent fallouts of various financial institutions further impacted residential sector. Amidst these changing dynamics, PE players shifted their attention totally towards commercial assets.
As per ANAROCK Research, residential PE investments’ share of the overall inflows declined from 53% in 2015 to a mere 8% in 2019. COVID-19 has severely hit residential real estate business and the sector has come to a standstill. With a screeching halt to site visits, discussions, documentation and closures, the early indicators depict that we are likely to face a tough time for the next few quarters and the sector’s recovery has been pushed further away by at least a couple of years. As per ANAROCK Research, more than 15.62 Lakh units launched between 2013 till 2019 across the top 7 cities of India are in various stages of construction. Of this, MMR and NCR together comprise of 57% or about 8.9 Lakh units. With India being locked down until mid-April 2020 (as per the current advisory) there will be massive disruptions in the construction material supply even after the lock down ends, leading to disturbances and delay in the construction activity.
The customary strained landlord-tenant relationships are further distressed with the lack of clarity in central and state government announcements bringing fore questions of eligibility and applicability of relief measures. Until the air clears (pun intended), Indians will continue to rely on legislations that hugely favors tenants in rental disputes, leaving landlords grappling to survive the crisis without any respite. In the interim, as parties await clarification from the government, it is advisable to facilitate a shared objective of contractual performance through collaboration and provide a win-win solution to all until normalcy returns.