NYC Law Providing Relief for Commercial Tenants Faces Constitutional Scrutiny

This article appeared in Commercial Leasing Law & Strategy, your monthly source for practical, must-have information on the business and legal aspects of commercial leases.

New York City Mayor Bill de Blasio delivered another striking blow to property owners when he signed into law N.Y.C. Council Int. No. 1932-A (2020) on May 26, 2020.

The new legislation, which amends the NYC Administrative code, prohibits landlords from enforcing personal guaranties on certain commercial leases for defaults occurring between March 7, 2020 and Sept. 30, 2020. 2020 N.Y.C. Local Law No. 55, N.Y.C. Admin. Code §§22 -1005 (5/26/2020). The personal guarantor is absolved of liability if the tenant meets one of the following three conditions: a) the tenant was required to cease service of food or beverage for on-premises consumption or to cease operation under executive order 202.3 issued by New York Governor Andrew Cuomo; b) tenant was a non-essential retail establishment subject to in-person limitations spelled out by Governor Cuomo in executive order 202.6; or c) the tenant was required to close to members of the public pursuant to executive order 202.7. See, id.

It was made clear that the intent of the legislation was to assist businesses such as restaurants, bars, salons, barbershops, movie theaters, gyms, etc. who were forced to close in March 2020 as a result of the COVID-19 pandemic. However, the devastating effect of this new legislation on property owners seemingly was overlooked.

Unlike in residential leases where tenants take possession in their personal name, commercial tenants often form corporate entities that thereafter sign a lease with the property owner. These entities have little to no assets upon formation and for this reason commercial landlords rely on personal guaranties as a security blanket given that they help mitigate risk in the event of default. This gives the property owner a liquid entity to sue in the event of default. This is similar to a residential tenant with bad credit who offers a guarantor to entice the landlord to rent him or her an apartment.

It comes as no surprise that many restaurants and bars in New York City have been unable to remain open given restrictions on indoor dining. Of course revenue has thus been greatly affected, which has led to many of these establishments failing to remain current on their rental obligations. The NYC Hospitality Alliance conducted a survey of the owners of nearly 500 restaurants and bars in New York City. Of those owners, 37% said they paid no rent at all during the month of July 2020, and 83% said they did not pay their full rent. See, NYC Hospitality Alliance, July 2020 Rent Report  (August 2020). Many tenants can utilize this new legislation to their advantage, as it has in essence afforded them a “get out of rent free” card.

The concern is that the city has not provided similar relief for property owners. If these commercial tenants decide to never reopen their businesses, the personal guarantors would not be liable for rental obligations missed from March 7, 2020 through the end of September 2020. In practicality, this is money that the property owner will never recover. However, the property owner will still be on the hook for its mortgage obligations, property taxes, water and sewer bills, as well as fees for upkeep of the building. If the owners fail to pay these charges, they face foreclosure due to no fault of their own. For all intents and purposes, the property owner is now shouldering the burden of the pandemic.

In fact, there are some restaurants that have been able to maintain revenue through a vibrant delivery business and the addition of outdoor seating. Still, some of these tenants are attempting to use the new legislation to avoid paying rent. This is a risky proposition as there are major concerns as to the constitutionality of the legislation.

On July 10, 2020, a complaint was filed in the United States District Court for the Southern District of New York challenging N.Y.C. Council Int. No. 1932-A as well as two other newly enacted city laws. Melendez et al v. The City of New York, et al, No. 1:20-cv-05301 (S.D.N.Y.). The plaintiffs bringing the complaint are two individuals and their real estate companies that own properties in New York City. The defendants are the City of New York, Mayor de Blasio, Louise Carroll (the Commissioner of the New York City Department of Housing Preservation and Development) and Jonnel Doris (the Commissioner of the New York City Department of Small Business Services).

The plaintiffs allege that, “[t]he Guaranty Law substantially alters leasing arrangements between commercial landlords and their tenants by stripping them of critical personal guaranties, thereby violating the Contracts Clause of the U.S. Constitution.” See, id.; Compl. para. 183. Further, the plaintiffs argue that the new law substantially impairs the contractual obligations, which thereby disrupts the reasonable expectations of the parties. By doing so, the landlord-plaintiffs are stripped of an essential right of remedy, namely enforcing the guaranty, and as such the lease becomes worthless during the period in which the guaranty may not be enforced.

An even more salient point raised by the plaintiffs alleges that the new law was not a reasonably necessary means of achieving a legitimate public purpose. See, id.; Compl. para. 187. The plaintiffs argue that the defendants did not consider other alternatives to accomplish the goal of providing relief to businesses forced to close pursuant to Governor Cuomo’s Executive Orders. Further, the law is overly inclusive as it applies the same to businesses who may not be in need of the relief provided. These are common problems with hastily drafted legislation.

One potential alternative to would have been to provide rent vouchers for those businesses most affected by the pandemic and subsequent Executive Orders. Instead of having the property owners shoulder the burden, the City would instead step in to provide the needed assistance.

New York City spends a significant amount of money on a similar program in the residential context called the “One Shot Deal” program. The program is administered by the New York City Human Resources Administration, who will approve emergency grants of up to $30,000.00 for qualifying residential tenants who are in arrears. These payments are made directly from the city to the landlords. In Brooklyn alone, $62.6 million was spent on one-shots in fiscal year 2017. See, N.R. Kleinfeld, “Where Brooklyn Tenants Please the Case for Keeping Their Homes,” NY Times (May 20, 2018). While this money is supposed to be an interest-free loan that tenants pay back, many times tenants cannot afford to do so and the money ultimately ends up as a grant. Why could the City not have done the same for commercial tenants in need?

This seems to be a clear case of the government impermissibly intervening in private contracts. These leases were the product of negotiations by two sophisticated parties that usually each invoke the assistance of counsel. This new law changes the game entirely by absolving one party of its obligations.

The ultimate question becomes how does this play out in practicality? Should business owners rely on this new law when making decisions on whether or not to pay their rent or surrender their lease?

Counseling commercial tenants as to whether or not to rely on the new law has to come with the ultimate caveat. As the law currently stands, the personal guarantor would not be responsible for rental arrears between March 7, 2020 and Sept. 30, 2020. However, if the court rules that this law is unconstitutional, the same guarantors may find themselves on the hook for arrears they no longer have the money to afford. This could prove to be an excellent time for tenants to negotiate with their landlords, given the bargaining strength this law provides.

Ultimately, the effects of N.Y.C. Council Int. No. 1932-A will be felt by property owners throughout New York City. The hastily drafted legislation faces an uphill battle against the constitutional challenges brought by the Plaintiffs in Melendez et al v. The City of New York, et al. Only time will tell how this all will shake out.

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Ian Steinberg is a New York City real estate attorney with the firm Sperber Denenberg & Kahan, P.C. His practice areas include real estate litigation, commercial leasing and handling residential closings throughout New York City. Ian may be reached at isteinberg@sdkpc.com or through the firm’s website at www.sdkpc.com.