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COVID-19 Legal Considerations for Franchisees and Franchisors

April 2, 2020

The emergence and widespread prevalence of the COVID-19/coronavirus epidemic has created unprecedented challenges for both franchisees and franchisor.

In this ongoing Legal Insight series, we will highlight some of the challenges that have arisen and suggest possible avenues by which those challenges can be addressed. It is important to appreciate that the COVID-19/coronavirus pandemic is rapidly evolving, such that the information conveyed in this Legal Insight series is subject to similarly rapid change. Whether you are a franchisee or franchisor, you should consult with legal counsel concerning any of the issues we discuss.

In this installment of Hoffer Adler LLP’s Legal Insight Series, we will consider the following question:

How Can the COVID-19/coronavirus Pandemic Affect the Rent Obligations of a Franchised Premises?

Franchised locations often occupy leased premises. The tenant is typically either (i) the franchisor or a company closely related to the franchisor, which in turn enters into a sublease with the franchisee; or (ii) the franchisee itself. As with any tenancy, regular (usually monthly) rent must be paid to the landlord as a condition of continued occupancy.

As a result of the COVID-19/coronavirus pandemic, many franchised businesses have been forced to close temporarily. This is particularly true of franchises within the restaurant and service industries. Due to their closure, those businesses are not capable of generating revenue, which in turn makes it challenging if not impossible for them to continue paying rent (either to the franchisor under a sublease, or to the landlord directly under a head lease).

When placed in that difficult position, the tenant of a franchised premises may look for relief by reference to both legal and business considerations. We will consider these in turn.

Legal Considerations: Force Majeure Clauses and the Doctrine of Frustration

The sublease or head lease, as the case may be, may contain a so-called “force majeure” clause. Typically, the effect of such clauses is temporarily or permanently (depending on the wording of the clause) to relieve one or both of the parties to the lease from their obligations upon the occurrence of certain triggering events that were anticipated by the parties at the time the contract was negotiated.

While a pandemic such as COVID-19/coronavirus may constitute such a triggering event (depending again on the exact language of the force majeure provision contained in the lease) it is important to appreciate that force majeure clauses in commercial leases, are typically drafted in a way that does not relieve the tenant from its obligation to pay rent. In other words, in many cases, the COVID-19/coronavirus pandemic will not relieve the tenant of a franchised premises from its obligation to pay rent.

When confronted with a lease containing either no force majeure provision or a force majeure provision that requires rent to continue to be paid, the tenant of a franchised premises may wish to consider the availability of the legal remedy of “frustration”.

Frustration is a contractual remedy that may be available when an unforeseen triggering event (not caused by any of the contracting parties) occurs that prevents one or more of the contracting parties from achieving their objectives under the contract. Stated differently, a contract is said to have been frustrated when its performance has become impossible, or when the triggering event has rendered the contract “radically different” from what the parties originally intended. A party that successfully claims that the contract has been frustrated will be discharged (excused) from its obligations under that contract, and can also be entitled to recover any payments that have been made to the other party.

The important thing to appreciate about frustration is that it is difficult to prove. It will generally not be sufficient for a party to a lease involving a franchised location to claim frustration on the basis merely that it has become too expensive to continue occupying the premises due to the COVID-19/coronavirus event. As a result, it may be that the doctrine of frustration is not practically available in the context of commercial leases governing franchised locations.

Business Considerations: Negotiating with the Landlord

Regardless of whether a force majeure provision or the doctrine of frustration are available to relieve the tenant to a franchised premises from its rent obligations to the landlord, the tenant would be well-advised to enter into negotiations with the landlord for relief.

Rent relief can take a number of different forms.

In most cases, to the extent the landlord is prepared to negotiate, the landlord will typically prefer a form of rent deferral over rent relief/abatement. Rent deferral is a form of relief by which the landlord permits the tenant to pay later during the term of the lease rent that would otherwise be due imminently.

The term of the lease could be extended if the landlord is prepared to accept rent at the end of the term of the lease, instead of requiring payment of the deferred rent to take place sooner. Care should be taken to ensure that the franchise agreement is similarly amended (which will require coordination between the franchisor and franchisee) so that its term is similarly extended.

Instead of rent being deferred, rent can also be forgiven altogether. This is sometimes described as a rent “holiday” or rent “forgiveness”. Commercial landlords typically are resistant to an outright forgiveness of rent; it is important to understand that the landlord has its own obligations that require rent revenue to discharge.

Each landlord’s willingness to negotiate a deferral or abatement/forgiveness of rent will vary depending on the circumstances of the franchise system, the industry to which the franchise system belongs, the financial realities of the franchisor/franchisee tenant and the landlord, respectively, and the availability of competing tenants to replace the franchising tenant upon default.

Takeaways: The COVID-19/coronavirus pandemic has created unique challenges for tenants and landlords of franchised premises. There may be available legal and business solutions that can relieve some of the financial pressures that have arisen. Parties are well-advised to remain flexible and be creative in seeking out those solutions.