What the Permitted Use Clause Means Under COVID-19 Restrictions

While many commercial real estate insiders have focused on the force majeure clauses, there are other aspects of lease contracts that may come into play.

Josh Migdal and Jordan Nadel

When the COVID-19 pandemic arrived, everyone had an immediate, visceral reaction to review their force majeure clauses. Shortly thereafter, articles touting the implications of contractual force majeure clauses quickly flooded legal publications nationwide. Seemingly, it was worthwhile to review this provision and obtain analysis. However, a bigger question needed to be answered. Can an unforeseen event rise to a level which renders the contract unenforceable? We think that the answer is …yes!

Generally, a lease contains an express provision, which includes what a tenant is permitted to use the premises for during the lease term. These uses coincide with legal uses, as permitted by zoning laws. However, government restrictions on the federal, state, and local levels stemming from COVID-19 upended zoning laws. Even though a use in a certain location was permitted prior to the pandemic, the government restrictions that sprung out of the pandemic made certain non-essential tenant uses illegal.

While no court of law, that we are aware of, has ruled as to whether a landlord can seek rent when the permitted use is illegal, we think that a tenant will be absolved from payment. It’s a settled concept of contract law that parties cannot contract to engage in an illegal activity. By way of example, a landlord and tenant cannot contract for the sole permitted use of the premises to be used as a casino on Miami Beach. The reason they cannot is because gambling is illegal and thus not a permitted use pursuant to the zoning laws on Miami Beach. Correspondingly, if the landlord tried to collect rent after the government precluded the tenant from that use, the landlord could not because the contract would be void as a matter of law because the purpose of the contract is illegal.

The analysis of the permitted use clause should not end there. When the permitted use language is more specific and restrictive, it is more likely to result in a court excusing performance when there is a government mandate precluding the tenant from using the property for its intended purpose. Frustration of purpose is intertwined with another important concept: constrictive eviction. Courts have routinely held that a tenant is constructively evicted when a leased property is rendered unsuitable, in whole or in part, for the intended purpose for which it was leased. The end result, whether through the application of purpose principals, or through a court viewing a restriction as a constructive eviction, is a compelling argument for a tenant to be relieved of its obligation to pay rent during the restricted period.

It also bears noting that during the first year of law school, it is drummed into young lawyers’ minds that for a contract to be enforced, there must be mutual obligations. To give some pizazz to this concept, legal scholars and courts have found that when there are not mutual obligations, a contract is illusory. The logic behind this is that one party should not be required to perform when the other party does not have to do anything. In that context, a lease at its core requires a landlord to provide space for a permitted use and the corresponding obligation for the tenant is to make payment. That being so, does a tenant need to pay rent when a landlord cannot provide space that a tenant can use? We think such an agreement is one-sided and thus illusory.

Frustration of purpose, illegality and illusory contracts are just some creative ways commercial tenants can navigate post-pandemic litigation.