In response to the COVID-19 pandemic, Gov. Larry Hogan signed a statewide order shutting down all “nonessential businesses” on March 23, 2020. If not designated an essential business by the order, a business had either severely restricted operations or was unable to operate altogether.
While affected by the order, many businesses have looked to their leases to determine what contractual rights are available to tenants to avoid paying rent while unable to operate at full capacity.
In commercial contracts allocating risk to the tenant, the tenant may be able to avoid a rent obligation depending upon how Maryland courts interpret the language in that contract. For commercial contracts not allocating the risk, the doctrine of “frustration of purpose” provides one of the strongest arguments for tenants to avoid rent obligations.
Force majeure clauses are included in contracts to determine the rights and responsibilities of parties if either one or both parties are unable to perform their side of the contract due to factors outside the parties’ control. In determining whether frustration of purpose is applicable when a contract can be performed, the court must find that the event was not reasonably foreseeable. Even if the event is not foreseeable, a force majeure clause may preclude the option of a frustration of purpose defense by allocating the risk to the tenant.
For example, in Chuck E. Cheese’s bankruptcy case, the U.S. Bankruptcy Court held that Chuck E. Cheese’s contract would have been frustrated by the government-mandated shutdown, had the contract not accounted for the possibility of a “governmental regulated shutdown,” in the force majeure clause.
Frustration of purpose
Unlike residential failure to pay rent cases, businesses affected by the order may be able to use the frustration of purpose doctrine as a defense. The coctrine is a common law defense that may be available to tenants as a breaching party.
Maryland follows the Restatement (Second) of Contracts § 265 (1981), which states that an obligor’s duties may be discharged if that party’s “principal purpose is substantially frustrated without his [or her] fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made.”
When applying the frustration of purpose doctrine, the breaching party argues that the purpose of the contract has been frustrated or impossible to perform, discharging the breaching party from their duty to perform.
Maryland courts have created a three-factor test to determine whether the frustration of purpose doctrine applies: whether (1) the intervening act was reasonably foreseeable; (2) the act was an exercise of sovereign power; and (3) the parties were instrumental in bringing about the intervening event.
The frustration of purpose defense can be an appealing argument at first because it covers unexpected circumstances. However, as many large corporations like Chuck E. Cheese, Victoria’s Secret, and Gap have figured out, it can be difficult to implement successfully for two reasons: 1) the use of force majeure clauses in contracts, and 2) states do not have uniform force majeure clauses interpretations.
Maryland does not have many reported cases invoking the frustration of purpose doctrine in the context of a COVID-19 rent dispute. As restrictions are lifted and litigation progresses, Maryland may look to other state court opinions for guidance on how to interpret the law around this issue.
In CAB Bedford LLC v. Equinox Bedford Ave Inc., the New York Supreme Court held that a mandated shutdown for a few months does not frustrate the purpose of a 15-year lease.
Conversely, the Massachusetts Superior Court ruled that the frustration of purpose doctrine applied to Caffè Nero’s lease. The lease only permitted Caffè Nero to sell items to customers eating inside the cafe. Due to the shutdown in Massachusetts shutdown, Caffè Nero could not allow customers to eat inside the cafe, resulting in the court finding that Caffè Nero should be discharged of its duty to pay rent since the purpose of the lease had been frustrated.
It remains to be seen how the Maryland courts will deal with commercial tenants using the frustration of purpose defense regarding COVID-19. Based on other state court’s decisions, Maryland courts may loosely apply language in the force majeure clause, or may strictly apply language only written in the contract. But, it is clear that each decision will include highly factually specific analysis.
Nicholas Nelson and Jack Tiernan, rising second-year law students at the University of Baltimore School of Law, were interns at John H. Denick & Associates P.A. in Baltimore. John H Denick & Associates P.A. can be reached at [email protected]