From our vantage point, the effect of COVID-19 on the local economy and the real estate market has been as dire as it’s being reported in the financial press. The credit and CMBS markets have continued to seize, despite unprecedented intervention by the Federal Reserve, and deal flow is grinding to a halt. In the past week, we have been called upon time and again to evaluate whether various contractual provisions would justify a decision to cease performance under a contract or not to proceed with a transaction.
Some common issues have included:
Contractual Contingencies or Conditions
Many real estate purchase and lease agreements contain contingencies or conditions precedent to closing that may be impacted by the breakdown in financing markets and the various governmental closures and stay-at-home orders in effect. The failure to meet such conditions may be fatal when the contract also contains a “time of the essence” clause strictly requiring performance within a set time period.
Force Majeure Clauses
Many real estate and commercial contracts, including loan and joint venture documents, contain provisions excusing the performance of a party in the event of an “act of god” or similar event such as civil unrest. Whether events constitute a force majeure event will depend upon the definition, if any, in the contract.
Material Adverse Effect Clauses
A material adverse effect clause (“MAE”) is one which excuses the performance of a party upon an event that would undermine the parties’ intention in contracting. Whether an event triggers an MAE clause will depend upon the specific provision and the scope of any carve-outs. If the MAE clause is open-ended, a court will consider whether the event is “material” to the agreement as a whole.
Application of Common Law Concepts
There exist common law defenses to performance under a contract, which may excuse performance where the non-occurrence of an event was a basic assumption upon which the parties’ contracted.
Real estate agreements often contain provisions regarding the governmental condemnation or taking of property, and a party may argue that a government-mandated shutdown of a commercial property constitutes a temporary taking.
In evaluating the foregoing, the touchstone remains the terms of the parties’ particular agreement and how it allocates risks amongst them. It also remains to be seen how courts will evaluate such claims in the context of the COVID-19 crisis with the benefit of hindsight once the crisis subsides.
We urge caution, as a mistaken invocation of any of these provisions may amount to a breach of contract with serious consequences. Parties faced with these challenging issues should seek legal advice from a firm whose transactional and litigation counsel work hand-in-hand. Our ability to integrate both has proven critical to working through the novel issues now facing the industry. Please feel free to reach out if we can be of any assistance.