China – Special Series Regarding The Legal Impact Of The COVID-19 Epidemic On The Real Estate Industry – Topic Three: The Impact Of The COVID-19 Epidemic On Property Lease Agreements.

20 March, 2020

 

1. The Impact on Rental Payments of Commercial Property Lease Agreements

 

The impact of the COVID-19 Epidemic (the “Epidemic”) on commercial properties (hereinafter referred to as “store(s)”) is more obvious and easy to detect as stores are open to the public. Since late January 2020, many local governments have introduced policies to adjust or restrict the operation of public places where people gather, such as cinemas, restaurants, entertainment venues, etc. Meanwhile, quite a few shopping malls have voluntarily adjusted their operational hours to avoid people gathering, in an effort to stop the spread of the epidemic. A lot of stores that are still operating normally have suffered sharp drops in customer flow and income.  Given the unique circumstances, does a tenant have the right to request from the landlord a rent reduction or exemption due to the impact of the Epidemic, and does a landlord have any defense against such a claim? It depends on the situation.

 

(1）Situation 1: A store/mall is closed due to an order from the government to control the spread of the Epidemic, causing the tenant to not be able to operate as usual.

 

Under this situation, the tenant is entitled to a rent reduction or exemption during the period of closure.

 

According to Article 117 of the Contract Law of the People's Republic of China (hereinafter referred to as “Contract Law”), contract liability shall be partially or entirely exempt in case of failure to perform a contract due to force majeure, subject to the impact of force majeure and unless otherwise provided by law. Force majeure means unforeseeable, unavoidable and unconquerable objective situations. The Epidemic constitutes force majeure. The outbreak of the Epidemic is an unforeseeable event for both parties who executed before the outbreak of the Epidemic. The government’s order requiring stores/malls to close and suspend operations is unavoidable for the contract parties. The tenant's inability to use the property for normal operations cannot be overcome. 

 

According to the Notice of the Supreme People’s Court on Trial and Enforcement of the People’s Court During the Prevention and Control of SARS (Fa [2003] No.72, hereinafter referred to as “Supreme Court Notice”1), which was promulgated on June 11, 2003 by the Supreme People’s Court (hereinafter referred to as “Supreme Court”), the courts may invoke force majeure under Articles 117 and 118 of the Contract Law, to resolve disputes over contracts that have failed to be performed due to administrative measures taken by governments to prevent the SARS Epidemic or the SARS Epidemic itself.

 

Therefore, administrative orders to control the spread of the Epidemic that render the tenant unable to operate as normal is most likely to be identified as force majeure.

 

However, it should be noted that the above force majeure event would impact on the lessor’s obligations (i.e., the obligation to provide the tenant with a property that can be used for business), rather than the tenant’s obligations (i.e., the obligation to pay rent). The tenant’s claim for rent reduction or exemption shall be based on the inability of the landlord to perform the contract, rather than the inability of the tenant to perform the obligation to pay the rent due to force majeure. Therefore, in a property lease contract relationship, the party affected by the above-mentioned force majeure is the landlord. Furthermore, the obligation to give notice and provide proof of force majeure as stipulated in Article 118 of the Contract Law2, shall be borne by the landlord, which is the party affected by force majeure in a property lease contract relationship.

 

(2） Situation 2: Although a store/mall has not been required to close or suspend operations by an administrative order, the operational income of the store is severely affected by the Epidemic and has sharply decreased.

 

In this situation, the tenant may request an appropriate rent reduction during the period affected by the Epidemic on the basis of the Principle of Frustration of Purpose.

 

According to the “Principle of Frustration of Purpose” stipulated in the Interpretation of the Supreme People’s Court on Issues Concerning the Application of the Contract Law of the People's Republic of China (II), (hereinafter referred to as “Interpretation of Contract Law (II)”), the court shall determine whether to change or terminate a contract in accordance with the principle of fairness and the actual circumstances if a significant change in the objective situation occurs, which the parties could not foresee when the contract was executed and it was not due to a business risk or caused by force majeure, and the continued performance of the contract would be obviously unfair to such a party, or the contract purpose could not be achieved.

 

For some stores that have not been forced to suspend operations during the Epidemic, the lease contract may have not yet reached the level where it cannot be performed fundamentally; however, it would be obviously unfair to the tenant to continue paying the rent amount as agreed in the original lease contract due to the severe decrease in customer flow, or the sharp drop in the income of the tenant due to the impact of the Epidemic makes it impossible for the tenant to achieve their operational purpose. In this situation, the tenant may request an appropriate rent reduction during the period affected by the Epidemic on the basis of the Principle of Frustration of Purpose. 

 

In addition, since some stores can still operate normally and the impact of the Epidemic has not reached the level of “causing the contracted parties to be unable to perform the contract fundamentally”, it is difficult for a tenant to request a rent reduction or exemption on the basis that the contract cannot be performed due to force majeure. However, the principle of fairness as stipulated in the Supreme Court Notice may be invoked if the performance in accordance with the original contract would have a significant impact on the rights and interests of one of the parties due to the Epidemic.

 

On the other hand, if the tenant requests an appropriate rent reduction during the Epidemic on the basis of the Principle of Frustration of Purpose, the landlord may pay attention to the following defense perspectives:

 

a) Whether the amount of rent agreed in the lease is linked to the tenant's turnover; if so, it can be argued that the actual rent has been taken into account after the sharp decline in the store’s operating income; 

 

b) Whether the tenant’s sharp decline in operation income is sufficient to affect the performance of the original lease contract, or whether it is sufficient to cause the original rent amount to be significantly unfair to the tenant; 

 

c) Whether the period for rent reduction proposed by the tenant is consistent with the period affected by the Epidemic;

 

d) If the lease contract is a long-term lease while the impact period of the Epidemic is relatively short, whether the tenant paying rent during the period of the Epidemic is sufficient to cause the entire lease to be significantly unfair to the tenant. 

 

(3） Situation 3: The landlord requires the tenant to close the store or to adjust operational hours due to the impact of the Epidemic, causing the tenant to be unable to operate as normal.

 

Under this situation, the tenant may claim a rent reduction or exemption on the basis that the landlord failed to provide a leased store for the tenant to operate. The tenant may also claim compensation for losses during this time.

 

Since the Epidemic, some shopping malls have shortened their business hours or even ceased their operations to avoid people gathering in an effort to stop the spread of the Epidemic. In this situation, a landlord’s failure to provide the leased store as agreed in the lease contract shall be attributed to the landlord’s own business decision, rather than force majeure. As such, the tenant may claim for a reduction or exemption in the rent, as well as compensation for losses for the period that it could not operate as normal, due to the landlord’s breach of their obligation to provide a leased store under the lease contract. 

 

On the other hand, if a tenant claims for rent reduction and compensation on the above-mentioned basis, the landlord may pay attention to the following defense perspectives: 

 

a) Whether the landlord is entitled to adjust the operational hours of the store under the lease contract (the landlord should also be aware whether such a right is accompanied by any obligation of notification or be subject to the prior consent of the tenant);

 

b) Whether the tenant has accepted or agreed to the adjustment of operational hours, which may constitute a bilateral agreed amendment to the original lease;

 

c) If the landlord continues to provide the leased store during the agreed operational hours, whether it would cause a significant increase in operational costs, which might lead to obvious unfairness to the landlord (i.e., the landlord may claim for changing the contract on the basis of the Principle of Frustration of Purpose).

 

2. The Impact on Rental Payments of a Residential Property Lease Agreement

 

(1) Generally, for residential properties, the Epidemic does not necessarily result in a landlord’s failure to provide the property or the tenant’s inability to achieve their operational purpose. Therefore, it may be difficult for a tenant to make a claim for rent reduction or exemption on the basis of a landlord’s failure to perform the contract (due to force majeure) or the principle of Frustration of Purpose.

 

(2) Operators of long-term rental apartments may act as both tenant (i.e. rent properties from owners or other landlords) and as landlord (i.e. sub-lease properties to the sub-tenant for operational purposes). Are the operators of long-term rental apartments, as tenants, entitled to a rent reduction or exemption against a landlord due to the impact of the Epidemic? It is difficult for operators of long-term rental apartments to claim rent reduction or exemption because the purpose of the lease contract is not necessarily affected by the Epidemic, as long as the leased properties can still be used for residential purposes, although the operator rents the properties for business purposes. 

 

(3) Residential properties used for home-inn operations are more similar to a hotel, as the purpose for the lease contract is to operate a short-term accommodation business, in contrast with an apartment rental business. Therefore, we are of the view that:

 

a) In the event that the home-inn is closed in accordance with the administrative order to control the spread of Epidemic, causing the tenant to be unable to normally operate, the tenant may claim a reduction or exemption of rent during the closed period;

 

b) In the event that the home-inn has not been required to close or suspend operations by an administrative order, but the operational income of the home-inn is severely affected by the Epidemic and has sharply decreased, the tenant may request an appropriate rent reduction during the period affected by the Epidemic on the basis of the Principle of Frustration of Purpose. 

 

3. The Impact on Rental Payments of Office and Industrial Property Lease Agreements

 

Since the Epidemic started, some local governments have successively introduced policies to postpone the resumption of work. As a result, some enterprises have not been able to work or resume manufacturing as per usual, which has also affected the tenants' normal use of leased properties for offices and manufacturing.

 

Generally, the tenants of office and industrial properties can continue occupying and using the property during the postponed resumption period. Though the frequency of use has decreased or the difficulty and inconvenience of using the property has increased, it has not necessarily caused the parties to be unable to perform the lease contract fundamentally (i.e. as the office building or the plant has not been closed by an administrative order, the landlord may still provide the leased properties to the tenant for the use of offices, manufacturing or storage), nor would paying rent during this period cause the tenant significant unfairness. With the development of technology, enterprises can work remotely using various tools. For example, although employees cannot enter an office due to policy restrictions, data storage or network equipment in the leased property can still be accessed remotely during the postponed period; and, during the postponed period, the tenant and their employees still have regular access to enter the leased property. Therefore, it may be difficult for a tenant to claim for a rent reduction for office and industrial property on the basis of the impact of the Epidemic or the administrative order of postponing resumption of work, unless the leased office or industrial property is closed due to the Epidemic, causing the tenant to not be able to use it.

 

4. The Impact on Other Obligations under Property Lease Agreements

 

(1) Impact on Landlord’s Maintenance Obligations 

 

According to Contract Law, the landlord shall perform the maintenance obligations of the leased property, unless the parties agree otherwise; the tenant may require the landlord to perform maintenance within a reasonable period when the leased property requires maintenance.  If the landlord fails to perform the maintenance obligation, the tenant may make repairs themselves, and the cost of the repairs shall be borne by the landlord. If the repairs effect the tenant's ability to use the leased property, the rent shall be reduced accordingly or the lease period shall be extended. Generally in property lease agreements, the parties would clarify the scope of the landlord’s maintenance obligations. During the impact period of the Epidemic, if the landlord is required to perform a maintenance obligation, the landlord shall still perform it in accordance with the contract (or in accordance with the law if not provided in the contract). However, if the landlord can prove that the Epidemic or the administrative policies for the prevention and control of the Epidemic directly and fundamentally cause the landlord’s failure to perform the maintenance obligation, the landlord may claim on the basis of force majeure an exemption from liability for their failure to perform the maintenance obligation. 

 

(2) Impact on the Commitment of Opening Dates

 

In some commercial property lease agreements, the landlord would require the tenant to commit to the latest opening date, and if the tenant fails to commence operations on or before such a date, it will be liable for breach of contract. If on the opening date, the store is unable to start operations due to the policies for the prevention and control of the Epidemic, the tenant may claim on the basis of force majeure to exempt them from liability for breach of contract. 

 

5. Conclusion

 

The above is a brief discussion on the possible impacts of the Epidemic on the performance of property lease agreements and the legal rights of both parties in different situations. However, it would be better if the parties of a property lease agreement can agree on supplementary arrangements with respect to the impact of the Epidemic through friendly negotiations within the legal framework. 

 

Some local governments have successively introduced support and guidance policies for enterprises affected by the Epidemic, which also include the adjustment of lease agreement relationships. For instance, the Municipal Government of Beijing issued Several Measures on Dealing with the Impact of COVID-19 Epidemic and Promote the Sustainable and Healthy Development of Medium, Small and Micro Enterprise on February 5, 2020. According to those measures, for medium, small and micro enterprises which rent properties from city-owned or district-owned enterprises:

 

• The rent in February shall be exempt if such enterprises (i) rent properties for the purpose of manufacturing or operations; (ii) keep operating or stop operating in accordance with the policies for the prevention and control of the Epidemic; and (iii) do not lay off employees or only lay off few employees;

 

• The rent in February shall be reduced to 50% of the original amount if such enterprises rent properties for office work;

 

• It is encouraged that landlords (property owners) reduce or exempt the rent of other leased properties, which is subject to the negotiation of the contract parties;

 

• For landlords that reduce or exempt rent for medium, small and micro enterprises, the municipal or district government would provide subsidies.

 

Although the policies above are only applicable to qualified "small, medium and micro enterprises", it may also act as a guide for other leasing parties.