Frustration of Purpose, Impossibility, and the Pandemic's Effect on Commercial Real Estate Leases
Updated: Jul 30, 2020
With a recent Wall Street Journal report estimating that more than 20% of small businesses will be shuttering throughout this pandemic, it is hard not to wonder what happens to the void left behind. Many of those business owners, though trying to save financial ruin by shutting down, may still be on the hook because of long-term leases, guarantees, and other mechanisms that keep them locked into their investment. Owners have not been relieved of any financial obligations on their end, limiting options for tenants in turn.
Commercial property owners are mindful that forces beyond our control drive this downturn, and people should take the opportunity to openly discuss the current situation, looking for reasonable solutions to weather the storm together. We suggest that this is the best approach to any challenging situation and that we are stronger together than separate.
No Resolution. What Next?
Assuming there is no resolution, does an Owner have any exposure in trying to enforce the contract? Does a legal justification exist for the tenant to terminate the agreement? Given the unprecedented nature of this pandemic, we won’t know the answer until these issues, there are three defense doctrines under the umbrella of impossibility that tenants may assert in a contract claim, and we should know what’s coming: (1) Impossibility of Performance; (2) Commercial Impracticability; and (3) Frustration of Purpose.
Impossibility of Performance
Impossibility is straightforward. The defense arises in contract law when performing the contract becomes physically or legally impossible at no fault of the breaching party. Over the years, the definition of impossibility includes practicability.
Commercial impracticability occurs after a contract is signed. The defense arises when “performance is made impractical at no fault of the breaching party based on an event whose “nonoccurrence…was a basic assumption on which the contract was made.” (Impracticability, Restatement (2nd) of Contracts § 261 (1981))
In California, the impossibility doctrine expanded in the case of Mineral Park Land Co. v. Howard, 172 Cal. 289. There the court accepted the impracticability defense standard on a contract involving the mining and using of gravel for a construction project whose cost was underestimated by a factor of 10 to 12 times the initial cost.
Courts are hesitant to accept a defense of impracticability unless it borders on impossibility. The Court’s are especially reluctant when there is evidence that the impracticability is a “mere difficulty or an unusual or unexpected expense.” (Snow Mountain W. & P. co. v. Kraner, 191 Cal. 312, 324-325)
Frustration of Purpose
The frustration of purpose defense arises when performing the contract remains possible, but the primary value is destroyed or substantially reduced. The legal defense applies when performance is frustrated by an unanticipated, supervening circumstance.
Impossibility defenses become more relevant as courts lift the eviction moratorium, and there is a reckoning between landlords and small businesses about unresolved rent and lease disputes.
Impossibility can become especially glaring in the context of retailers who pay premium rents to be in high foot traffic or high net worth areas that can no longer justify those premiums post-pandemic. Businesses in and around malls, arenas, main streets, etc. will not see the kind of historic foot traffic for a year, if not more. How can those businesses survive paying premium rents? Or survive at all without the ensured foot traffic. When indoor activities reopen, capacity will likely be curtailed to 25% and will only start substantially increasing when an effective vaccine is widely available.
Some tenants will likely find some shade under one of the above defense doctrines, though the extent truly depends on the factual context and the lease itself. But only if you want to spend years (especially with current backlogs) litigating the matter without resolution.
When we look back to how courts balance risk and loss in this context, history (and most likely the courts) will favor landlords and tenants who first attempted to work through their problems together, in a collaborative fashion, to address a mutual threat to their respective business.