Spain – The effects of COVID-19 on Lease Agreements of Premises and Offices

Royal Decree-Law 8/2020, of March 17, on extraordinary urgent measures to face the economic and social impact of COVID-19, even though it affects and produces effects in many different legal fields, does not include any reference to contracts for leases of real estate, or houses, premises or offices.

The purpose of this note is to analyze the effects of the situation of the State of Alarm regarding those leases of offices or premises that have been forced to close in application of the decree; those others that remain totally or partially open and in operation, although with a reduced or minimal activity, in principle are not subject to the conclusions reached below without prejudice to the fact that there are individualized cases to which, despite the fact that there is not a complete closure, reasonably and logically can be applied to them.

It is not excluded in any way that in the event of an extension of the validity of the State of Alarm, a regulation that affects the leasing contracts could be published, but for the moment this has not happened. If this were to happen, the content of said norm would apply.

Based on the principle of freedom of covenants enshrined in art. 1255 of the Spanish Civil Code, which allows the parties signing the contract to agree (i) what scenarios and situations should be considered as constituting cases of Force Majeure and Act of God and (ii) what the contractual consequences of such scenarios should be, the first exercise that must be done is to check if the contract includes a regulatory clause of Force Majeure and its effects; if so, such clause must be followed and its analysis is left out of this note.

In the absence of express regulation in the contract, the provisions of the Civil Code and specifically article 1105 would apply.

COVID-19 as Force Majeure

COVID-19 is an event that in principle meets the requirements of the Civil Code to be classified as an event of Force Majeure (art. 1105 Civil Code) since:

• It is a foreign act and not attributable to the contractor who is the debtor of the benefit or obligation.
• It is unpredictable, or if it were said to be “predictable”, it is certainly inevitable.
• The event in question, the pandemic, must be a cause and result in the breach of the obligation, that is, there must be a causal link.

Therefore, fulfilling the three requirements, the first conclusion that we reach is that very foreseeably, the Spanish Courts will classify as “Force Majeure” the situation caused by COVID 19 when a judicial dispute is raised in which such matter is discussed between litigants. We will now analyze the consequences of this status.

Consequences of considering COVID-19 as an event of Force Majeure

Most of the doctrine and jurisprudence understand that the effects of classifying a scenario as a case of Force Majeure in principle are:

• Total and definitive impossibility of complying; releasing the debtor from the fulfillment of the obligation.
• Partial inability to comply; the debtor is released only in the part that it is impossible to fulfill, but still bound by the part that can be carried out.
• Temporary inability to comply; the debtor is released from the responsibility for default as long as the exceptional situation persists.

Now, let us analyze how it would affect to considerate the epidemic as Force Majeure in relation to lease agreements for uses other than housing.

Regarding the payment of rent

The question to answer is if the classification of the current pandemic situation as a case of Force Majeure frees the tenant (whose premises have been forced to close by order of the government authority) from the obligation to pay the rent while said closing obligation persists, including in the concept of “release” different alternatives: total or partial cancellation and / or total or partial postponement.

We are meeting these days with a frequent reaction among some tenants, who, unilaterally have informed their landlords that considering COVID 19 an event of force majeure and having been forced to close the premises / office, they suspend the payment of the rent while said situation remains. They do not terminate the contract, they do not hand over the possession, they remain in it (the premises remain closed and not operational) but they suspend the payment (it is not clear whether suspending in this case means liberating himself from the payment of the rent or postponing its payment for when the Force Majeure scenario ends).

Arguments against liberation

As much as this attitude can be considered “understandable” from the perspective of the lessee, not from the point of view of the lessor, said consideration runs into an obstacle: the interpretation of the Force Majeure made by the Supreme Court regarding pecuniary payment obligations, according to the Civil Sentence of May 19, 2015:

“Not being able to consider, in the case of pecuniary debts, the subjective impossibility – insolvency – nor the objective or formal imposition, the doctrine concludes that it is not possible to imagine that if the impossibility is due to a fortuitous event it could have as effect the extinction of the obligation.

The exoneration of the debtor by fortuitous event is not absolute, it has exceptions, as provided for in article 1105 CC, and one of them, by application of the “genus nunquam perit” principle, would be in cases of obligations to deliver generic things.

In such circumstances, the pecuniary debtor is obliged to fulfill the main obligation, without the economic adversities freeing him from it, since what is owed is not something individualized that has perished, but something generic such as money”.

In conclusion: it does not seem that this jurisprudential criterion allows to defend that the fulfillment of the pecuniary obligations is released, extinguished or that its breach is justified in cases of Force Majeure, therefore the pecuniary debtor, in this case the lessee, in application of this criterion and due to the generic condition of the money, would be obliged to fulfill his main obligation not being freed from it by the unforeseen economic adversities on the basis of Force Majeure.

Arguments in favor of liberation: art. 1575 of the Civil Code

Having said the foregoing, reference should be made to an article of the Civil Code that, with certainty, will be profusely cited in the upcoming judicial conflicts.

The art. 1575, dealing with the leasing of rustic estates, recognizes the lessee’s right to the reduction of rent in the event of loss of more than half of the fruits (unless otherwise agreed) in “fortuitous, extraordinary and unforeseen cases … such as fire, war, plague, unusual flood, locust, earthquake or another equally unusual that the contractors have not been able to rationally foresee ”.

Is this article, foreseen for rustic leases, applicable to urban leases?

The art. 4.1 CC allows the analogical application of the rules when (i) they do not contemplate a specific assumption and (ii) they regulate a similar situation in which “identity of reason” may be appreciated.

The Sentence of the Supreme Court from January 15, 2019, that solved a conflict of a lease of a building used as hotel, in which the tenant had sought the reduction of the rent under the clause “rebus sic stantibus” by the crisis of 2008 and had alleged in his favor the application of art. 1575, established:

“The argumentation of the appealed judgment rejecting the claim to lower the agreed price is also not contrary to the legal criterion that follows from art. 1575 CC, which is the rule that allows the reduction of income in the leasing of productive assets that do not derive from risks of the business itself, it also requires that the loss of benefits originates from extraordinary and unforeseen fortuitous cases, something that by its own rarity could not have been foreseen by the parties, and that the loss of fruits is more than half of the fruits. In this particular case, none of these circumstances concur. The decrease in rents comes from market developments, the parties anticipated the possibility that in some years the profitability of the hotel would not be positive for the lessee and the losses alleged by NH in the operation of the Almería hotel are less than fifty per hundred, without taking into account that the overall result of his activity as manager of a hotel chain is, as the Audience considers proven in view of the consolidated management report, positive”.

The Supreme Court does not admit the application of art. 1575, but not because it is considered not applicable to non-rustic leases, but because the Court concludes that the requirements are not fulfilled since the 2008 crisis was neither unpredictable and because the lessee’s losses do not exceed 50%.

But, that interpretation of the Supreme Court together with the wording of art. 4.1 CC would support the claim of the lessee who has no incomes during the State of Alarm to demand a reduction in rental fee that fits the principle of proportionality.

Regarding early termination at the request of the lessee

However, we may find situations in which the lessee considering the current situation, decides to terminate the lease in advance, delivering the premises to the lessor.

They are cases in which the early termination of the contract is intended, without respecting (i) or the mandatory term (ii) or the previous notice, in both cases under the hypothesis that they are thus regulated in the contract.

In these scenarios, we understand that it may be defendable that, due to the situation of force majeure caused by COVID 19 and in application of art. 1105 of the CC, the lessee is exempt from the obligation:

1. To respect the mandatory term of the lease
2. To give prior notice to the lessor in case of early termination of the contract

In both cases, the contract would be terminated with the delivery of possession of the premises, without prejudice to having to respect the other obligations set forth in the contract for termination and delivery, provided that they are not equally affected by the situation of Force Majeure.

Our opinion is that, also in application of Article 1,105 of the CC, the thesis that the lessee would be released from any obligation to compensate damages to the lessor for said advance resolution or breach of the obligatory duration of the contract could be defendable before the Courts.

Conclusion

In conclusion, when the Courts decide on the effects of the current pandemic (that they will surely classify as Force Majeure), and how this will affect the obligations of leaseholders who have been forced to close their business, our opinion is the following:

• Regarding the obligation to pay the rent, despite the contrary criterion of the sentence from May 19, 2015, we find defendable the analogue application of art. 1575 of the CC, based as well on the Supreme Court Sentence from January 15, 2019, in order to demand a proportional and equitable reduction of the rent.
• Regarding the power of the leaseholder to terminate the contract in advance, in case the leaseholder hands the possession of the property to the lessor, we find defendable to exonerate the leaseholder from complying with the advance notice or mandatory term in case provided in the contract, without the obligation to indemnify the lessor for this reason.

Application of the Rebus Sic Stantibus clause (“RSS” clause)

We will analyze below if the RSS clause can be applicable to the case that we are studying and with which consequences.

Requirements of the RSS clause (Latin aphorism that means “things thus standing”)

The principle RSS operates as an intrinsic clause (that is, implicit, without the need to expressly agree by the parties) in the contractual relationship, which means that the stipulations established in a contract are so in view of the concurrent circumstances at the time, that is, “things thus standing”, so that any substantial and unforeseen alteration of the same could lead to the modification of the contractual content.

The RSS clause is not regulated in any article in our laws; It is a doctrinal construction that the jurisprudence has traditionally admitted (examples among many other Supreme Court Sentences from June 30, 2014, February 24, 2015, January 15, 2019, July 18, 2019), with great caution, only in certain cases, and requiring the following requirements:

• That there has been an extraordinary alteration in the circumstances of the contract, at the time that it must be fulfilled, in relation to those present at the time the parties entered the contract.
• To analyze whether an incident can determine the extraordinary alteration of the circumstances that gave meaning to the contract, we must a) contrast the scope of said alteration regarding the meaning or purpose of the contract and the commutativity or performance balance thereof; and b) the “normal risk” inherent or derived from the contract must be excluded.

• That there has been an exorbitant disproportion, out of all calculation, between the obligations of the contracting parties, causing an imbalance between them.
• That the above occurs because of radically unpredictable circumstances.
• That there is no other remedy to overcome the situation.

Historically, our courts have been very reluctant to apply RSS, although since the economic crisis of 2008-2012 there has been a certain change in criteria and greater jurisprudential receptivity.

Consequences of the application of RSS

The doctrine establishes that the application of the RSS does not have in principle terminating effects on the contract, but only modifying effects, aimed at compensating the imbalance of obligations between the parties;  the doctrine establishes that this only applies to long-term contracts or successive contracts with deferred execution.

In application of the good faith principle, the reaction to an event of fortuitous event, force majeure or, in general, an event that generates a disproportion between the parties, such as that regulated by the RSS clause, should be the amendment of the contract to rebalance the obligations between the parties, and only in the event of material impossibility to comply with the obligations, the resolution of the obligation, in both cases without compensation for non-compliance.

For this reason, in relation to leasing contracts and in case of closure of the premises by mandatory mandate, we understand that the RSS clause may be:

• alleged by the leaseholder to request or urge the lessor to downsize or postpone payment.
• estimated by the judges, when these assumptions are debated before the Courts, when accepting such contractual amendment as equitable and legitimate in order to compensate the imbalance generated by the effects of COVID 19.

To summarize, the RSS clause can be a tool for the leaseholder that has had to close its premises during the State of Alarm, when negotiating with the lessor an amendment of the contract, trying to postpone the rent while the State of Alarm or negotiating a discount.

We should bear in mind:

• That the RSS clause is unavoidably applicable on a casuistic basis, there are no generalizations and it will be necessary to take into account the effect caused by COVID 19 in each specific contractual relationship (Supreme Court Sentence from June 30, 2014 and February 24, 2015) and the real imbalance of benefits produced, and
• That, as we have said, the Courts are generally reluctant to apply this clause, that they only apply in the absence of any other legal tool and in situations in which the maintenance of the contractual status quo reveals a manifest “injustice ”and a evident and resounding imbalance between the performance of the parties.

Does this mean that the leaseholder may impose on the lessor a modification of the economic conditions of the contract under the RSS clause (postponement or total or partial cancellation of the payment)?

We cannot assure this, what we think is that the application of this RSS clause should:

• Justify a reasonable request from the leaseholder to temporarily change the conditions of the contract (postponement or cancellation, total or partially) that the lessor must reasonably meet.
• In case of unreasonable refusal of the lessor, we recommend to document as much as possible leaseholder´s request and the possible negotiations or refusal, in order to substantiate a suspension of the payment of the rent, total or partial, during the State of Alarm aimed, not to extinguish his obligation, but to postpone it.

We will have to wait for the reaction of the Courts when they judge these conflicts, but if we dare to anticipate that it is quite possible that the judicial tendency will be to grant protection to the leaseholder with support in the RSS clause and the principle of business preservation, when it comes to validating certain modifying effects regarding the payment obligations of the leaseholder (total or partial remission of the rent payment during the pandemic crisis, postponement, or partial postponement).

In any case, it will be essential to prove, that the behavior of the leaseholder seeking protection in the RSS clause to amend the contract, has been strictly adjusted to the principle of good faith (Supreme Court Sentence from April 30, 2015).

It will also be important to analyze case by case why the displacement of the risk derived from the “exceptional and unforeseen event” from one contractor to the other is justified (Supreme Court Sentence from January 15, 2015) and could well be defended (Supreme Court Sentence from July 18, 2019) that both contracting parties must divide and assume the consequences between the two of them. The judicial decisions will vary in each specific case.

Conclusions and Recommendations

In conclusion, it seems that the leaseholder would have two instruments in order to try to successfully suspend or postpone the payment of the rents, the RSS clause and the principle of Force Majeure.

In our view, the replacement of the contractual balance altered by the exceptional event, may consist of either an extension of the lease payment terms or the application of a total, or partial cancellation of the rental payment obligation while it lasts the State of Alarm, but we understand that it will be defendable that the delay in the payment may not give rise neither to the termination of the contract under art. 1124 Cc nor to the requirement of damages art. 1105 Cc, therefore, will not empower the lessor to urge eviction.

Therefore, the steps to be followed in each case would be:

• Carry out an examination of the contract to check whether force majeure and acts of God are regulated and if the current situation is in accordance with the contract provisions.
• Should nothing be set forth at the contract, and in case the leaseholder has had to close the premises or office, notify the other party of this circumstance and try to negotiate a novation of the lease requesting:
  • Waiver of the payment obligation during the Alarm State.
  • The application of a discount on the payment obligations with both parties sharing the effects of the pandemic, in a proportion to be agreed.
  • Postponement of payment obligations until the premises or office can be reopened with a payment plan for the deferred debt.

If it is not possible to reach an agreement, it is advisable to try to maintain evidence that the parties have acted in good faith trying to reach a negotiated solution and at the extreme (from the leaseholder´s point of view) announce, without waiting to receive a communication or claim from the Lessor, the suspension of the rental fee payment until reopening of the premises/offices, justifying the same in the Alarm State.