Court Finds Pandemic Does Not Satisfy Lease’s Casualty Clause

The Gap Inc. v. Ponte Gadea New York LLC

It is not new to suggest that the COVID-19 pandemic and related governmental closure orders have had a significantly negative impact on retailers and other commercial tenants, nor is it new for those tenants to argue that the pandemic should relieve them of their obligation to pay rent. What is new, or at least newer, is the argument that the pandemic is a “casualty” that would permit the tenant to abate its rent payments or terminate the lease in its entirety. That is what the tenant argued in The Gap Inc. v. Ponte Gadea New York LLC, No. 20 CV 4541-LTS-KHP (S.D.N.Y. March 8, 2021), where the court granted summary judgment to the landlord and rejected the tenant’s arguments that it properly terminated the lease due to business disruption caused by the COVID-19 pandemic.

Gap closed the subject stores in March 2020 when New York State ordered all non-essential businesses to close. At that time, Gap stopped paying rent and has paid no rent since. In June 2020, after receiving a notice of termination from its landlord, Gap began offering curbside pickup at one of the subject stores, later adding the same service at the other store, and used both locations for online order fulfillment. Also, in June 2020, Gap sued its landlord arguing that the lease terminated, or should be deemed terminated, as of March 19, 2020 (the beginning of the government lockdown restrictions), and the landlord counterclaimed for damages for non-payment of rent and holdover rent following the landlord’s termination of the lease for non-payment.  

Gap sought to avoid its payment obligations under the lease by arguing that the COVID-19 pandemic and related governmental closure orders resulted in a termination, or deemed termination, of the lease in March 2020. Gap argued that the pandemic: (i) constituted a “casualty” under the lease; (ii) frustrated the purpose of the lease or rendered impossible the parties’ performance; and (iii) resulted in a failure of consideration. Gap also argued that the lease should be reformed because the parties made a mutual mistake in failing to foresee and address a possible pandemic in the lease.

Casualty

The lease permitted the tenant to abate rent following a casualty while the landlord was repairing the damage to the premises and permitted the tenant to terminate the lease if the damage could not be repaired. The Gap court noted that pursuant to the terms of the lease, a casualty is an event that causes physical damage to property that can be repaired, and it is that damage and the landlord’s ability, or not, to repair the property that gives the tenant the right to abate payments or terminate the lease. The court found the pandemic did not cause physical damage to the premises capable of being repaired. It reasoned that “[i]t is self-evident that [landlord] is not in a position to do restoration work that could eliminate the pandemic or alter the governmental restrictions that constrain Gap’s operations.” The court concluded that a “casualty” event did not occur under the lease and thus, Gap was not permitted to abate rent or terminate the lease on that basis.

Frustration of Purpose and Impossibility of Performance

As we discuss in our ninth alert on insolvency topics affecting real estate, the doctrine of frustration of purpose permits a party to avoid its obligations under a contract where an unforeseeable event makes the contract essentially valueless to that party. See Bankruptcy Court Denies Retail Debtor’s State-Law Based Arguments to Avoid Paying Rent During Chapter 11. Similarly, the doctrine of impossibility relieves a party of its contractual obligations where an unanticipated event makes performance of the contract objectively impossible. Here, the court held the doctrine did not apply. First, citing the lease’s definition of “force majeure event,” which includes a “governmental preemption of priorities or other controls in connection with a national emergency or other public emergency,” but no corresponding right to abate rent, the court reasoned that the parties did, in fact, foresee and address the possibility that governmental orders could impact lease performance during a public emergency; and in such event they did not agree upon rent abatement. Second, as in the Chuck E. Cheese case, the premises could be used, and indeed, the tenant here operated (curbside) out of both locations.

Failure of Consideration and Mutual Mistake

Under the doctrine of failure of consideration, a party may rescind a contract when the counterparty, through no fault of its own, fails in a material way to give the performance required under the contract. Here, Gap argued that because it was unable to operate the subject stores as it intended, it was not receiving its bargained-for consideration. The court rejected this argument, reasoning that Gap retained the retail premises for its operations and, in fact, used the premises to store merchandise and for curbside pick-up operations. As a result, the court found that Gap received the consideration or use of the premises it bargained for under the lease.

The Court also rejected Gap’s argument that the lease should be reformed under the doctrine of mutual mistake because the parties made a mutual mistake in drafting the lease. Gap argued that the so-called “mistake” was a failure to foresee and address the possibility of a pandemic like COVID-19. However, the lease contained a force majeure provision that addressed the impact of governmental regulation on lease performance but provided no corresponding relief in rent payment obligations. As a result, the court ruled that the parties had not been mutually mistaken about the lease’s terms, and instead understood and addressed the very issue Gap asserted as the basis of the “mistake.”

Conclusion

Many commercial leases contain unambiguous, absolute rent payment obligations, and much of the COVID-19 pandemic-related litigation has involved commercial tenants’ attempts to modify their leases’ plain meaning based upon the pandemic, force majeure arguments and equitable theories such as frustration of purpose. Those efforts have been largely unsuccessful, and courts have been generally unwilling to modify contract terms under such arguments and theories.

This case represents another, newer (although the case was filed last summer) variant of retail tenant arguments—that the COVID-19 pandemic is a “casualty” permitting tenants to terminate their leases. In general, courts have thus far rejected arguments grounded in the idea that the pandemic is akin to a fire or other event that causes physical damage to a particular location that can be remedied by the landlord.