Posternak Blankstein & Lund LLP is now Arent Fox. Read the press release

New Developments in COVID-19 Litigation for New York City Landlords: Saving Grace or Hail Mary?

Since the COVID-19 pandemic began, real estate owners and tenants have faced unprecedented day-to-day operational challenges from the loss of business and income. Two new real estate lawsuits seek to address these issues.

The first is by a flagship retail lingerie store tenant doing business in the heart of Herald Square. The second is by property owners seeking a judicial declaration that new legislation enacted by the City Council on June 20 [Commercial Harassment Law (New York City Local Law 53 of 2020), Residential Harassment Law (New York City Local Law 56 of 2020), and the Guaranty Law (New York City Local Law 55 of 2020), collectively, the “Harassment Law”] is constitutionally defective and unenforceable. Victoria’s Secret Stores v. Herald Square Owner LLC, No. 651833/2020, (N.Y. Cty. Sup. Ct. 2020) and Melendez et al. v. City of New York et al., No. 20 Civ. 05301, (S.D.N.Y. 2020). The outcomes of these two cases may significantly impact the real estate industry and subsequent lawsuits, shifting the burdens of the pandemic from one segment of society to another.

Victoria’s Secret: The Parties and Dispute

On June 8, 2020, Victoria’s Secret sued its landlord, Herald Square Owner LLC, in New York State Supreme Court in connection with its lease of Two Herald Square claiming the store has been shuttered since mid-March and abandoned due to COVID-19. Victoria’s Secret seeks a declaration that its obligation to pay the $937,734.17 monthly rent is rescinded. The suit is predicated on three legal theories: frustration of purpose, impossibility of performance and reformation of the lease.

The Landlord recently moved to dismiss the Complaint. It first alleges that the parties negotiated and agreed to limit the abatement of rent (in a provision not found in the standard form commercial leases), whereby the Tenant agreed that if forced to close its store for 6 consecutive days solely because Landlord failed to perform any obligation, where such failure is expressly not caused by governmental preemption in connection with a national emergency or government order. Second, it argues that the contractual defenses of frustration of purpose and impossibility of performance are limited to cases where the event was not foreseen at the time the lease was made and the parties could have limited their exposure contractually, but did not do so. Third, the Landlord contends that the two types permissible reformation (scrivener’s error and mutual mistake) do not apply here, insofar as this particular lease generally allocated risk requiring the Tenant to pay rent for any forced store closing that is not due to an inexcusable failure solely by the Landlord, that the mistake was not about a fact existing at the time of lease execution and that such reformation is time-barred (6 years from the date of signing here, August 2001).

Victoria’s Secret’s opposition to the Landlord’s motion is not due until July 29, 2020. Oral argument awaits.

Challenging the City’s New Legislation Regarding Non-Paying Tenants

On July 10, plaintiffs – Marcia Melendez and Ling Yang – both first-generation immigrants and landlords, sued in the Southern District of New York seeking to invalidate the Harassment Laws and Guarantee Law. They allege that the Harassment Laws violate the First Amendment, insofar as they prohibit otherwise lawful commercial speech (i.e., owners requesting the payment of rent and back rent). They contend that the Harassment Laws impermissibly restrict speech, and do not directly advance a government interest, nor are they tailored to meet that interest. Plaintiffs claim that the interest in helping small business owners is not advanced by the legislation, which actually hurts them as “small business” property owners insofar as it prevents them from making otherwise lawful requests for rent and back rent. The Plaintiffs further claim that the legislation is overly broad and vague by failing to define material terms. (Notably, the law itself does not define the term “threatening” or “impacted by COVID-19.”) The Harassment Laws impose civil penalties of $10,000 - $50,000. Parallel Fourteenth Amendment due process claims are also alleged under both federal and state law.

The Plaintiffs also bring another constitutional challenge against the Guarantee Law, claiming that it violates the Contracts Clause of the US Constitution that restricts passage of any law impairing the obligation of contracts (here, leases), by prohibiting landlords from enforcing personal (“good guy”) guarantees for unpaid rent owed by the tenant for the period March 7, 2020 to September 20, 2020. They argue that the law bars them forever from collecting unpaid rent, utilities, fees, building maintenance charges, or taxes owed by the tenant for defaults occurring during the same seven-month period by defining such collection efforts as “harassment.”

Finally, the Plaintiffs allege that the Harassment Laws directly conflict with existing New York State laws, particularly the State Legislature’s conferring exclusive jurisdiction upon the Governor the authority to shape the contours of his Executive Orders on a state-wide basis to address the pandemic. The City has not yet responded to the lawsuit, which has been assigned to Judge Gregory H. Woods.

The Takeaways

As we noted in our prior AF Alert, the force majeure defense in New York generally does not apply to the obligation to pay rent. This may be why Victoria’s Secret did not allege it (or possibly because as the landlord alleges, no such clause is in the lease). By the same token, New York law restricts the defenses of impossibility of performance and frustration of purpose to instances where the event triggering the lawsuit was unforeseen at the time the parties signed the lease. Victoria’s Secret – like many other suits recently filed – thus pits the classic battle between the express language of the lease against the tenant’s contention that COVID-19 was unforeseen. Parties would be advised to review their lease with a view toward negotiating appropriate language in connection with amendments, renewals, or rent adjustments. It would also be prudent to review insurance policies for coverage for specific causes of loss.

In regard to the Melendez case, the United States Supreme Court’s decision in Central Hudson Gas and Electric Corp. v. Public Service Commission (1980) set up the first question that the district court likely will address: whether the “speech” at issue here (owners’ request for rent or back rent) is fraudulent or illegal. The Plaintiffs contend that there was negligible evidence demonstrating that landlords were using fraudulent means in requesting the rent. If the speech is found fraudulent or illegal, though, government regulation may be freely applied without First Amendment constraints. Proper consideration of whether the government’s interest in protecting tenants was sufficiently tailored will also be at issue. The claims will also test whether the demand for rent during such a pandemic is fraught with overreaching or simply a contractual obligation that ought to be enforced. Stay tuned. 

Contacts

Continue Reading