NEW YORK: An Introduction to Litigation: General Commercial: Highly Regarded
Chambers HSG Litigation Trends Forecast 2021
The novel coronavirus (COVID-19) pandemic caused significant economic disruptions in 2020, including the cancellation of large public events, office closures and curtailed travel. While a strong stock market and government aid blunted the damage caused by these disruptions in the near term, we still expect that the fallout from COVID-19 will shape the commercial litigation landscape for the remainder of 2021 and beyond. Below we highlight some of the trends that we expect to see.
Commercial Real Estate-Related Litigation
Government closures of retail establishments and office buildings, followed by significant restrictions on reopening, have had substantial deleterious effects on the commercial real estate market. This downturn has led to disputes between landlords and their tenants, which we expect will continue through 2021. This is particularly true in the retail and hospitality sectors, where the ongoing limitations on typical shopping and travel activity has caused and will continue to cause commercial rent to go unpaid.
Commercial tenants have relied on force-majeure or casualty clauses in their leases to argue that their nonpayment should be excused. Courts interpret these clauses narrowly, so relief is often limited to specific types of disruptions explicit in the applicable clause. Even when the clause includes a broad catch-all provision, courts still may interpret the clause narrowly to provide an excuse only for those types of unforeseeable circumstances enumerated in the contract. Tenants have also attempted to rely on the common-law doctrines of frustration or impracticability to excuse performance. In those instances, courts excuse performance when the principal purpose of the parties’ agreement has been thwarted by the unforeseen circumstances such that performance by one party becomes essentially worthless to the other.
The circumstances of the COVID-19 response present hurdles to commercial tenants seeking complete relief from commercial lease obligations. Indeed, several courts have already held that pandemic-related restrictions are not casualties within the meaning of the relevant commercial lease agreements, because the casualty terms refer to physical damage to the rental space. And while government-mandated shutdowns often are enumerated in force-majeure clauses, even in the most stricken jurisdictions, complete shutdowns only lasted a few months. Thereafter, the resumption of limited commercial activity through reduced in-person shopping and curbside pickup provides counterarguments to claims that the purpose of the lease has been entirely thwarted.
Ultimately, whether the business disruptions associated with the pandemic will provide leasing parties a basis to be excused will depend on the terms of their particular leases and the relevant jurisdiction’s treatment of these issues.
CMBS Litigation
Issues with commercial leases may also lead to an uptick in litigation involving commercial mortgage-backed securities. Residential mortgage-backed securities were at the heart of the last financial crisis, during which homeowners’ inability to make mortgage payments and a decrease in the value of the housing collateral resulted in substantial losses to the RMBS in which the mortgages were securitized and widespread litigation that is still ongoing. While we do not foresee CMBS litigation reaching the levels of RMBS litigation that resulted from the 2008 financial crisis, we expect to see increased CMBS litigation due to distress in the commercial mortgages supporting the securities.
As noted, the commercial tenants whose rent payments support the commercial mortgages securitized in CMBS have been hard hit by COVID-19 restrictions, and many have defaulted on their payments. Additionally, while foreclosure moratoriums have thus far spared the multifamily residential mortgages that are securitized in CMBS, we expect that to change in 2021. Notably, while we have not seen widespread commercial foreclosures, commercial mortgages under special servicing reached record levels in 2020, with large numbers of loans either delinquent or subject to forbearance by lenders. Losses to CMBS investors may follow if commercial tenants remain unable to pay and the value of the underlying real estate is depressed due to decreased demand. We expect litigation by investors looking to stem those losses by challenging actions taken to manage the securities’ mortgage portfolios. Taking a page from RMBS litigation, investors may also look to challenge the standards used to underwrite commercial mortgage loans, which largely escaped scrutiny pre-pandemic due to low default levels and stable asset valuations.
The volume of these cases depends, among other things, on the nature and speed of the post-pandemic recovery in the commercial real estate sector, and courts may look to precedents established in the RMBS litigation to determine the outcome of CMBS litigation.
Ongoing Business Interruption Litigation
Pandemic-related closures also have led to disputes between insurers and their business policyholders regarding coverage for business interruptions. These cases are playing out in federal and state courts, and we expect that developments in 2021 will continue to clarify the rights and obligations of policyholders and insurers for past and any future interruptions. Thus far, insurers have held the advantage, particularly where policies contain explicit exceptions for viruses. Even in the absence of explicit references to viruses, insurers have argued that coverage must be triggered by a physical loss or property damage, with several courts holding that government-imposed closures do not qualify. Although such policies also may contain provisions addressing closures mandated by governmental authorities, policyholders seeking to rely on those provisions face hurdles similar to commercial lessees seeking relief from leases, in that most government-mandated closures were limited, with opportunities to recoup any losses provided by the lifting of complete shutdown orders. Whether policyholders will be permitted to recover depends on the relevant clauses in the particular policy at issue and the courts’ interpretation of them, including at the appellate level.
The “New Normal”
The pandemic’s most wide-ranging effect on commercial litigation may be on the practice itself. In 2020, litigators learned to prepare for and conduct depositions, hearings, arbitrations, and trials remotely, broadly incorporating technologies that remain available as we look to a return to “normal” practice. How busy lawyers, judges, and clients will continue to use these technologies will depend on the participants’ views as to the costs and benefits of remote proceedings. But having shown that it can be done, many participants will seriously consider the time and travel costs saved by conducting proceedings remotely.