COVID’s Impact on Construction Duties Under the Lease: Lessons for the Future

By Sujata Yalamanchili and Dylan Weber

 

In mid-March 2020, COVID-19 began its devastating impact across the U.S. as various state governments began shutting down businesses and industries they deemed “non-essential.” The impact of the shutdown on the construction industry largely depended on whether a state considered construction activities for certain industries essential. As COVID-19 ebbed and flowed throughout the ensuing 12 months, the construction industry had to follow state guidelines on closing, and subsequently reopening, businesses and industries.

Here’s an overview of how the pandemic affected and continues to affect construction and how to factor these impacts into your current and future lease arrangements.

PART I. STATE COVID-19 REGULATION OF CONSTRUCTION

At the beginning of the pandemic, state government shutdown orders created confusion as to what would be considered “essential” businesses and industries allowed to continue operating. Two states from opposite coasts, New York and California, offer a snapshot of how states across the country dealt with construction activities during COVID-19.

New York COVID-19 Construction Regulation

Beginning the week of March 16, 2020, New York Governor Andrew Cuomo issued a string of executive orders that dealt with business and industry shutdowns. By March 20, Gov. Cuomo had signed the New York State on PAUSE Executive Order [NY Exec. Order No. 202.6 (Mar. 7, 2020)], which directed all non-essential businesses statewide to close in-office personnel functions. Construction activities were listed among “essential” businesses not subject to the PAUSE order. However, subsequent guidance from the Empire State Development Corporation limited the scope of the exemption by listing the specific types of construction deemed essential going forward, including:

• Construction in support of “critical infrastructure,” such as roads, bridges, transit, and hospitals;
• Construction in support of affordable housing;
• Construction to protect the health and safety of occupants of a structure; and
• Construction to continue a project if allowing the project to remain undone would be unsafe.

All construction not falling into one of these categories was deemed “non-essential,” and limited to staging activities only. However, as part of New York’s phased reopening plan in the months that followed, construction that had previously been considered non-essential was included in phase one, which began once a particular region hit numerous health benchmarks dealing with COVID-19.

Adjustments were made based on statewide COVID-19 transmission and hospital rates. Thus, in late October, after rates slowly rebounded from the declines of the summer and early fall, Gov. Cuomo issued Executive Order 202.68 that included, among other things, a “Cluster Plan Initiative” listing construction work as an essential business allowed to continue even in “red zones” containing the initiative’s tightest restrictions. Unlike the March 2020 executive order, the Cluster Plan Initiative didn’t differentiate between essential and non-essential construction. It allowed all construction work to continue regardless of whether the project was within a designated hotspot.

California COVID-19 Construction Regulation

California Governor Gavin Newsome began issuing shutdown and stay-at-home executive orders at around the same time as New York. Thus, on March 19, 2020, the governor issued Executive Order N-33-20 requiring all of those not working in one of the 16 “critical infrastructure sectors” to remain home. Guidance issued soon thereafter acknowledged construction workers as part of the “essential workforce” that would exempt them from the stay-at-home order. However, unlike in New York, the California guidance allowed not just specifically listed but all construction projects to continue, including housing, commercial, and mixed-use purposes. The California guidance even made the effort to include businesses that supported the supply of building materials among the essential workforce.

Still, despite the statewide executive order and guidance, confusion arose when various cities and counties throughout the state issued their own shelter-in-place orders and interpretive guidance, many of which exempted only specific types of construction work.

For example, Los Angeles’ stay-at-home order expressly allowed “construction of commercial, office, and institutional buildings” to continue (Public Order Under City of Los Angeles Emergency Authority). San Francisco County issued guidance advising that “most commercial construction projects are non-essential and must stop” and describing the types of construction projects that could continue, including “public works, residential construction, airports, utilities, oil refining, highways and roads, public transportation, waste removal and collection and internet and telecommunications systems.”

California allowed construction work to continue in accordance with the original March statewide order and guidance even as COVID-19 cases rose over the summer and again in the winter.

PART II. THE FORCE OF FORCE MAJEURE CLAUSES

The other significant aspect of the pandemic’s impact on constructions involves commercial lease and bankruptcy litigation in which tenants strapped for cash as a result of COVID-19 raised various lease defenses for failing to pay rent. The most frequent battleground for litigation was the so-called force majeure clause.

The term “force majeure,” which comes from U.S. common law—that is, case law as opposed to statute or regulation—is a defense for failure to perform contractual duties when such failure is due to natural and unavoidable catastrophes. Over the years, force majeure clauses have become a staple of boilerplate leases that get little to no attention unless and until catastrophic events potentially triggering force majeure relief actually occur. And that’s precisely what happened during the COVID-19 pandemic when force majeure clauses suddenly became the focal point of commercial leasing litigation.

Typically, one of the key issues of force majeure cases is which events the clause covers. It’s safe to say that nobody foresaw the COVID-19 pandemic and government shutdown orders it led to. Consequently, the vast majority of force majeure clauses drafted before the pandemic didn’t expressly list these things as force majeure events. Does this omission doom a plaintiff’s force majeure case? Or is there some other way a plaintiff can claim it’s entitled to force majeure relief?

Once more, looking at the issue from the perspective of New York and California is instructive. That’s because the divergent approaches that these states follow in interpreting force majeure clauses reflect the fundamental approaches used in many if not most other states.

Is COVID-19 a Force Majeure Event—the New York Perspective

In New York, tenants can make the case that COVID-19 is a force majeure event even though the lease doesn’t expressly list it as one. To do this, the tenant would have to rely on the force majeure events the lease does list. The most likely candidates are commonly included catchphrases such as “Acts of God” and/or “other similar causes beyond the control of such party.”

While lease interpretation is almost always about the parties’ intent, one counter argument landlords can make is the basic doctrine courts generally follow in interpreting a contract. One of these doctrines is called “ejusdem generis,” which means that “words constituting general language of excuse are not to be given the most expansive meaning possible, but are held to apply only to the same general kind or class as those specifically mentioned.” Courts following the ejusdem generis approach would probably not interpret “Acts of God” or other catchall phrases as covering a pandemic or government shutdown. And so far at least, attempts by plaintiffs to rely on COVID-19 for force majeure relief outside New York have been largely unsuccessful.

The other question is how force majeure applies to parties that were unable to meet their construction-related obligations under the lease due to COVID-19. Although courts in New York haven’t yet issued a ruling on this, a recent case called Tabor v. 148 Duane LLC does raise the issue [2020 WL 6591376 (N.Y. Sup. Ct. 2020)]. The plaintiffs in Tabor are residents of a building owned and operated by the defendant who sought to have construction and repairs done on their apartment and relocated while the construction work was to be done. Their lease included a force majeure clause purporting to excuse the landlord for “inability to provide services.” The key language:

[B]ecause of a national emergency, repairs or any other cause beyond owner’s reasonable control owner may not be able to provide or may be delayed in providing any services or in making any repair to the building. In any of these events, any rights you may have against owner are only those rights which are allowed by laws in effect when the reduction in service occurs.

After agreeing to the 12-month relocation, the tenants and landlord further agreed that there’d be a $500 per-diem penalty if the relocation had to be extended beyond 12 months due to the landlord’s failure to complete the construction on time. The agreement was made before the pandemic. So, when New York City COVID-19 construction limitations made it impossible to complete the work on time, the tenants demanded that the landlord pay the per diem penalty. The landlord sought to “toll”—that is, extend—the 12-month deadline on the basis of the force majeure clause above.

The court hasn’t yet issued a decision, so it’s unclear whether the force majeure clause will be deemed to apply to the current situation and, if so, whether tenants are still entitled to any recourse or remedy for the construction delay.

Is COVID-19 a Force Majeure Event—the California Perspective

California takes a different approach to force majeure enforcement. Under California law, the party whose performance has been made impractical or impossible to perform is protected even if the force majeure event isn’t expressly identified in the contract. Specifically, California Civil Code §1511(2) states that performance of an obligation is excused “when it is prevented or delayed by an irresistible, superhuman cause, or by the act of public enemies.” Once this is established, the analysis shifts to whether such a situation was an “insuperable interference” that could “not have been prevented by the exercise of prudence, diligence and care.”

Another difference is that California courts have held that the inability to perform “must consist in the nature of the thing to be done and not in the inability of the obligor to do it.” Thus, courts would likely give weight to COVID-19’s impact on the specific industry. Accordingly, parties seeking force majeure relief will be able to cite how the pandemic and shutdown orders disrupted different supply chains and imposed other obstacles enhancing the inability to perform due to the “nature of the thing being done.”

In short, force majeure clauses are far more likely to excuse failure to perform construction obligations in California than in states that follow the New York approach.

PART III. COVID-19’S IMPACT ON CONTRACTS WITHOUT FORCE MAJEURE CLAUSES

Many standard construction contracts, including American Institute of Architects (AIA) and Federal Acquisition Regulation (FAR) forms, typically don’t include specific force majeure language. Rather, they utilize “excusable delay” or “termination or suspension of the contract” provisions that likely can apply to COVID-related issues. For example, Section 8.3.1. of AIA form A201-2017 provides that:

If the Contractor is delayed at any time in the commencement or progress of the Work … (3) by labor disputes, fire, unusual delay in deliveries, unavoidable casualties, adverse weather conditions documented in accordance with Section 15.1.6.2, or other causes beyond the Contractor’s control; . . . or (5) by other causes that the Contractor asserts, and the Architect determines, justify delay, then the Contract Time shall be extended for such reasonable time as the Architect may determine.

The categories in this language seem broad enough to include COVID-19 impacts. Thus, for example, supply-chain delays could fall into the “unusual delay in deliveries” category, while inability to get the minimum required workforce on a project due to COVID-19 illness or death would likely fall into the “unavoidable casualties” category.

Termination for suspension of work is addressed in Section 14.1.1.2 of the AIA form, which gives the contractor the right to terminate the contract if work is paused for a period of 30 consecutive days due to “an act of government, such as declaration of national emergency, that requires all work to be stopped.” Stay-at-home orders, mandated quarantines, or even “state of emergency” orders would likely qualify for a suspension of contractual obligations under this section.

FAR provisions, which are commonly used in federal contracts, also don’t include “force majeure” language but instead rely on extension clauses that account for delays that are outside a party’s control. If you’re dealing with a federal contract, FAR 52.249-14 dealing with excusable delays would be directly on point. It provides that:

The Contractor shall not be in default because of any failure to perform this contract under its terms if the failure arises from causes beyond the control and without the fault or negligence of the Contractor. Examples of these causes are (1) acts of God or of the public enemy, (2) acts of the Government in either its sovereign or contractual capacity, . . . (5) epidemics, (6) quarantine restrictions.

Again, this language seems to strongly indicate that COVID-related impacts would be covered.

COVID-19, CONSTRUCTION & COMMERCIAL LEASES: THE PATH FORWARD

As the world emerges from COVID-19, how do we plan for future disruptions to construction projects, whether due to new pandemics or other unforeseen events? For starters, contracting parties should anticipate construction delays so they can intentionally and purposefully allocate the risks and design creative solutions to minimize disruption and dislocation.

Among these risks are the actual out-of-pocket costs the landlord or tenant may incur as a result of disruption to construction activities (such as tenants’ relocation costs in the Tabor case discussed above). The lease should identify and provide for resolution of those risks. 

In coming up with resolutions, consider which party is in the best position to deal with delays. If a construction delay will prevent a party from occupying a building, can that party find alternate space? If not, can the contractor put the space into useable condition, even if it can’t complete the work?

Finally, the parties should consider whether there are insurance products that could help mitigate risk. Business interruption insurance policies largely failed to provide coverage during the current COVID-19 pandemic, but new insurance products may evolve to help mitigate the risk of disruption to construction projects.

About the Authors

Sujata Yalamanchili is a partner at Hodgson Russ LLP. She regularly counsels clients on leasing and other real estate matters, across all asset categories. She has experience with complex leasing structures such as ground leases, shopping center leases, and project development including construction and financing of new projects.

Dylan Weber is a third year law student at Hofstra Law. He earned a bachelor’s degree from Binghamton University in 2018. He previously clerked for the Honorable Louis A. Scarcella in Bankruptcy Court in the Eastern District of NY as a summer clerk. He will join Hodgson Russ LLP as an attorney following his graduation from Hofstra Law in 2021.