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Partial Condemnation Regarding Commercial Leases During the COVID-19 Pandemic

Author: Bradley A. Nevills, J.D.

Contributing editors: Craig Galanter 

When the proverbial ‘powers-that-be’ issue orders that mandate certain business are “non-essential” and must therefore close and citizens must ‘shelter-in-place,’ usually the first questions raised by business owners in response are: (1) “Can the government even do that?” and (2) “How are my contractual obligations affected if my business is adversely affected by the government?” These are important questions that are especially relevant to the legal and contractual obligations attributable to commercial tenants and landlords, who must determine what rights and responsibilities are available to each in order to remain operational while attempting to avoid any breach of their commercial leases.

In this article, we’ll attempt to determine whether the COVID-19 pandemic and the subsequent orders released by the State and Federal governments constitute the partial condemnation of commercial properties and business and how this may affect the legal rights and obligations regarding commercial leases, generally.

Every commercial tenant and landlord has at least heard of the concept ‘Eminent Domain,’ if for no other reason than it commonly appears, albeit briefly, in standard commercial leases. However, fewer understand the concept of condemnation, which appears in commercial leases less frequently, and even fewer understand the process of partial condemnation, which appears in commercial leases even less frequently. While Eminent Domain is the name of the power the State and Federal governments have to appropriate private property, pursuant to the policing powers provided by the Texas Constitution and Federal Constitution, condemnation is how such appropriation is achieved.

Stated simply, condemnation is the process whereby a governing authority declares that a property is to be “condemned,” or appropriated by said governing authority for a stated purpose (e.g., for public use and/or public necessity). An easy example is the State of Texas desiring to build a new highway to reach isolated rural communities and then “condemning” the properties that sit in the proposed pathway of the new highway so that the State can take these properties from the owners, demolish any structures within the properties (such as a commercial shopping center), and proceed with the new highway’s construction.

Partial condemnation, then, is the process where only a portion of a property and/or business is condemned by a governing authority, leaving a portion of the property intact and, hopefully, operational.

With the ‘shelter-in-place’ mandates and orders closing “non-essential” businesses by the State during the current pandemic situation, the novel question thus arises as to whether the government’s decision to close businesses and restrict traffic to certain commercial properties would constitute partial condemnation since the business and revenue experienced by these commercial businesses have been adversely affected.

Further, if the restrictions currently mandated by the government have partially condemned commercial property through adversely affecting the businesses residing upon same, then do the terms of any applicable commercial lease even still apply?

The answer is a resounding yes, but that is not to say that the lease terms of adversely affected commercial properties and businesses do not apply in a reduced or otherwise altered capacity.

Although widely a rare occurrence, a sophisticated commercial lease will include a detailed condemnation clause which contemplates partial condemnation and how such partial condemnation affects the terms of the lease. There is no set standard to how lease terms are to be altered in light of partial condemnation, and these clauses are as varied as the businesses to which they apply. However, when a commercial lease does include a condemnation clause, this clause often contemplates a reduction in rent and CAM (Common Area Management) fees in direct proportion to the portion of commercial space which as been partially condemned. The reasoning here is that the lease originally contemplated paying a certain price for a certain amount of space, so it stands to reason that a reduction in that space would result in a reduction in the price tendered for the same.

Further, some condemnation clauses are drafted more broadly and in such a way as to anticipate an event such as COVID-19, which, while not considered a “condemnation” for purposes of the clause itself, constitutes an event which adversely affects or restricts ordinary access to a business. Clauses drafted in this fashion are designed to provide resolution for situations where a condemnation has not legally occurred, but certain events (e.g., the closure of business and restriction of travel by the State or Federal government) have directly created a negative impact on operations and revenue of certain commercial businesses. If you have a clause such as this within your commercial lease, then you may be among the fortunate few who are better equipped to weather the economic storm that we now find ourselves in.

A commercial lease lacking a condemnation clause or failing to provide for revising the terms of the lease in light of an unforeseeable economic downturn, however, presents little support for altering the lease obligations. Rather, the terms of the commercial lease would still control, and the lease would continue as originally contemplated.

Let’s apply this to the situation that most commercial tenants and landlords will find themselves in, currently: Do the restrictions placed on businesses by the government that are adversely affecting revenue constitute a partial condemnation so that rental payments may be reduced or suspended until such restrictions are lifted?

Unfortunately for commercial tenants, the answer is almost certainly, No. Besides requiring a stated purpose such as public use and/or public necessity, for the appropriation of property and/or business by the government to be considered a condemnation, whether partial or complete, the government is further required to tender just or adequate compensation to the property and/or business owner.

Despite the several measures authorized by the State and Federal government to stymie the economic quagmire presented by COVID-19, such as the Economic Injury Disaster Loan Emergency Advance (EIDL), Paycheck Protection Program (PPP), and even the recent Harris County COVID-19 Forgivable Loan Program Assistance, these assistance measures are not intended to compensate the appropriation of property, but to provide short-term relief for the general reduction in business revenue experienced by both tenants and landlords.

While it is apparent that the governments’ restrictions have adversely affected business operations in the private sector, proving that these restrictions constitute the governments’ appropriation of private commercial property is a difficult uphill battle. Condemnation contemplates that the property appropriated by the governing authorities is never returned to the property owner – otherwise just or adequate compensation would not be necessary – and the current economic downturn, although the effects of which may be long-lasting, is not permanent.

Because the adverse effects wrought upon commercial properties is not permanent, no just or adequate compensation is required, and therefore there has been no “taking,” or condemnation, performed by the government. In turn, without specific contractual clauses within a commercial lease to the contrary, there is no relief to be expected by any commercial tenant or landlord under the legal process of partial condemnation. This is true even if the governments’ current mandates restrict access to property or practically and actually close certain businesses, as this would be considered the exercise of the governments’ general policing powers during a public crisis.

This very potentially leaves commercial tenants in the precarious position of choosing between maintaining operations or paying rent and commercial landlords in the unenviable position of choosing between covering the loss in rental payments or expending legal resources to evict tenants and recovery unpaid rent. None of these choices are ideal and there will undoubtedly be unrecoverable losses associated with the downturn created by COVID-19. However, the question as to which parties will bear those losses requires the consideration of practical concerns deserving of their own article and discussion.

If you or anyone you know are currently experiencing adverse economic effects due to the COVID-19 pandemic, the assistance measures discussed briefly above may be available to help. Please see below links for the following:

In order to ensure that you preserve and protect your legal rights with regard to any commercial lease to which you may be a party, as well as to ensure that all of your commercial leases contain the proper language regarding condemnation for potential future tenants and events, I strongly encourage you to make an appointment with the capable legal team at Kearney, McWilliams & Davis, PLLC.