Illinois Bankruptcy Court Rules Force Majeure Clause Partially Excuses Rent Payments
July 8, 2020
As concerns over COVID-19 grew, nearly every state was forced to impose new restrictions and guidelines to help slow the spread and protect its citizens. By mid-March, Illinois bars and restaurants were ordered to close their dining rooms and were forced to adapt to a pick-up and delivery only business model.
COVID-19, Chapter 11 Bankruptcy and Force Majeure Clauses in Leases
As restaurants saw their revenues plummet and the usual monthly bills, like rent, continued to roll in, they began to panic. Hitz Restaurant Group (Hitz), a multi-concept restaurant operator based in Chicago, was one of them. The restaurant group leased space from Kass Management Services, Inc. (KSM) and on February 24, 2020, filed for Chapter 11 bankruptcy protection from its creditors, KSM, citing the loss of sales from the COVID-19 pandemic as to why they were unable to pay rent.
Hitz did not pay their rent, which was due on the first of February and March, nor did they pay rent due in subsequent months. Hitz’s lawyers argued the government-mandated order to suspend dine-in service invoked a common lease stipulation, the force majeure clause, that canceled their obligation to pay rent for April, May and June. The restaurant group’s lease with KSM specifically stated:
“Landlord and Tenant shall each be excused from performing its obligations or undertakings provided in this Lease, in the event, but only so long as the performance of its obligations are prevented or delayed, retarded or hindered by…laws, government action or inaction, orders of government….Lack of money shall not be grounds for Force Majeure.”
However, Hitz filed for bankruptcy 20 days prior to the governor’s executive order prohibiting dine-in services went into effect. Under bankruptcy law, unpaid rent due before or after the filing of the bankruptcy petition is still part of the landlord’s rent claim, as long as the landlord does not reject the lease due to unpaid rent.
In this specific case, the landlord, KSM, did not reject the lease and contended that Hitz’s rent should be paid in full because the restaurant was not forced to close completely and was still able to offer takeout and delivery. KSM also argued Hitz could have borrowed money under the Paycheck Protection Program (PPP) to meet its rent obligations.
Court Decision Says Force Majeure “Unambiguously Applies”
The judge presiding over the case ultimately decided the following:
Hitz was obligated to pay its February and March 2020 rent in full due to the fact that the governor’s executive order barring dine-in services at restaurants did not come into effect until March 16, 2020.
Hitz was also obligated to pay a portion of its rent for April-June 2020. In the judge’s ruling he noted that Hitz had said its kitchen was still in use during the pandemic, and the back of house accounted for roughly 25% of the restaurant’s footprint. Therefore, Hitz was directed to pay 25% of its rent for April, May and June.
Lastly, the judge rejected KSM’s argument that money could have been obtained through the PPP because the force majeure clause in Hitz’s lease said nothing about having to borrow money to meet its obligations.
You can read the full opinion here.
Implications for Future Cases, Landlords and Tenants
As one of the first decisions to appraise the effects of force majeure provisions on commercial rent obligations during the COVID-19 pandemic, the decision raises many questions for landlords and tenants.
Many commercial leases do no include a force majeure clause. Where there is no force majeure clause, tenants may try to invoke the doctrine of impossibility of performance as the basis to excuse non-performance, like not paying rent, in its lease. The impossibility doctrine applies where the “destruction of the subject matter of the contract or the means of performance” renders it objectively impossible for a party to execute its obligations under a contract. The impossibility must have resulted from an unanticipated, unforeseen event that the parties could not have “guarded against in the contract.” As with force majeure clauses, courts very narrowly apply the impossibility doctrine, reserving it for extreme circumstances. Nonetheless, this recent ruling enforcing the force majeure clause may allow courts to apply the impossibility doctrine more frequently.
Under Gov. Pritzker’s executive order, many businesses were deemed “essential.” These businesses were allowed to remain open, however due to health and safety concerns, many chose to close their office spaces and allow employees to work from home. In these instances, tenants could have elected to use their office spaces, but did not, and therefore it will be much more difficult for them to assert they should be excused from paying rent.
Tenants relying on a force majeure clause to subvert paying rent risk having to open up their accounting records to be reviewed by a court of law.
Landlords still have general rights under the general principles of debtor/creditor law. Tenants who decide a force majeure clause precludes them from having to pay rent in full must be careful about distributions or salary increases to shareholders and management. If no rent is paid, but there are distributions, a landlord could assert the management of the business siphoned off funds that should have been used to pay rent under the lease.
Lastly, this decision provides an early data point into how courts may apply force majeure provisions to issues related to the COVID-19 epidemic, including government shutdown orders. This case exemplifies the impact that the COVID-19 crisis is having on businesses nationwide and the importance of the language of a lease. As a result, landlords and tenants will need to analyze current and future leases and any force majeure clauses carefully.