How New Legislative Policy May Affect COVID-Related Lease Disputes

by Mark E. Ellinghouse

Over the last eighteen months, we have been forced to devote significant resources to interpreting how largely-forgotten legal doctrines apply to real estate contracts in a post-COVID world. These principles, including force majeure, frustration of purpose, and impossibility/impracticability, were generally overlooked in real estate transactions until life-altering global events required their use. Indeed, many of the cases interpreting these doctrines date back to the world wars that dominated the first half of the twentieth century. Modern practitioners often did not even address these concepts in their agreements.

Now, these policies have come front and center, driving the discourse between parties trying to adjust their expectations to an entirely different business environment. As I have previously discussed, the judicial process is slow to provide guidance on these issues, failing to provide many opportunities for expedited resolutions and the judicial policy which flows from them. Legislators have, perhaps unsurprisingly, been happy to step into this role, and we have seen a tremendous amount of new policy designed to address the impact of COVID on existing and future contractual relationships. One such new policy is particularly noteworthy.

As a quick background, the frustration of purpose doctrine generally provides that where the fundamental reason of a party entering into a contract has been frustrated by an unanticipated, supervening circumstance which substantially destroys the value of that contract and purpose, that party can be discharged from its duty to perform its contract and the contract can be extinguished. Historically, the defense is available only when the frustration is substantial. It is not enough that the transaction will be less profitable than originally anticipated, or even that one party will sustain a loss; rather, the frustration must be so severe that it is not fairly regarded as within the risks assumed by that party under the contract.

On August 4, 2021, the San Francisco Board of Supervisors passed Ordinance 122-21, which provides that for certain commercial tenants, COVID-19 is presumed to have frustrated the purpose of the lease, excusing these tenants’ obligation to pay rent. This ordinance has essentially rewritten how the frustration of purpose doctrine applies, allowing temporary interruptions of normal operations, such as during the COVID-19 pandemic, to be deemed sufficient to allow for relief. While the ordinance does not override an agreement to the contrary and sunsets after 2025, it should assist small retailers who might otherwise be left without relief.

I find this ordinance disconcerting for several reasons. First, by altering the application of a fundamental legal doctrine, the Board of Supervisors undermines at least a century of existing case law, potentially creating even more uncertainty regarding how these doctrines apply now and going forward. Second, the ordinance ignores the interests of landlords, who risk losing their income stream due to COVID and may not be any more capable of sustaining their business than the tenants protected by the ordinance. Finally, the approach manipulates a legal doctrine to achieve its purpose rather than attacking the issue head-on by, for example, offering cash, tax, or other incentives to parties affected by COVID.

Of course, San Francisco is one of perhaps the most progressive political communities in the country. We have not seen similar enactments in other jurisdictions and I do not predict they will follow. The ordinance highlights the importance of understanding the political climate in which properties are located, as these sorts of policies may be more or less prevalent depending on such factors. While the overall impact of the Board of Supervisors’ ordinance is unlikely to have mass application or significantly change the market, it is a notable development in the global reaction to the unique circumstances presented by a global pandemic.