Retailers Are Trying A 'Hail Mary' Legal Strategy To Get Out Of Leases
For most New Yorkers, March 15 was the last day of normalcy. For Darryl Whiting, it was also the day he signed a seven-year lease in SoHo to open a new gym.
He paid more than $91K in security deposits and rent to his landlord at 598 Broadway, according to court papers, and planned to embark on a three-month build-out of the space ahead of opening later this year.
But nearly five months later, though the city has regained some functionality, reopening gyms still isn't allowed. Whiting held out hope the situation would stabilize but eventually told the landlord he wanted out of the lease.
“In June, we said, 'Hey man, this is not going to work, because even if the gym does open, there are going to be revenue issues,'” he told Bisnow. “They haven’t answered us, but they keep sending us the bill.”
With no agreement reached, Whiting filed a lawsuit in New York State Supreme Court last week, arguing that without the ability to run a gym in the space, the whole purpose of the lease has been “frustrated” and should be terminated. He is also requesting money he paid in advance rent, an additional $74K, be returned.
“The first month rent they can keep,” Whiting said. The landlord, named as 598 Broadway Realty Associates, did not respond to a request for comment. “But if we are on the lease for seven years, there’s no way we can pay it. We’ll have to file for bankruptcy.”
Whiting is just one of many retailers across the country taking legal action against their landlords in an attempt to get out of their leases. The tactic is being attempted by businesses of all stripes, from boutique art galleries to some of the world’s biggest retail names — all of whom are arguing, that in the absence of a specific force majeure clause including a global pandemic, the purpose of their lease has been “frustrated” and the contract no longer binding.
“This is New York City, people work hard, play hard and they fight hard,” said Alexander Lycoyannis, an attorney at Rosenberg & Estis. “This is serious business, and people are going to be looking after themselves.”
Multiple real estate attorneys told Bisnow these lawsuits face a steep road to success. Courts, particularly those in New York City, are unlikely to undermine contracts between sophisticated commercial operators, they said. Many of these complaints hinge on contract law rules called “impossibility of business” or “frustration of purpose.”
The latter harkens back to a 1903 case in England when a tenant rented an apartment to watch the coronation of King Edward VII and Queen Alexandra in London but was able to get out of the lease when the king's illness led to the parade's cancellation.
While some say that a government-imposed shutdown very much fits the bill as a total frustration of the lease’s purpose, others said its application is narrow, and contracts are rarely torn up on that basis. Regardless, the slew of suits against landlords, many of which are countersuing, speaks to the complex position commercial landlords and their tenants are now facing.
“It’s a Hail Mary," aid Luise Barrack, who leads Rosenberg & Estis’ litigation department. "Rather than waiting to be sued, these tenants are thinking, ‘Let’s say we don’t have an obligation.”
Barrack is defending multiple landlords against such suits and is taking action against tenants who aren't paying their rents. She declined to give specifics on her clients.
“You have to enforce contracts or people can’t rely upon anything," she said. "I don’t think [courts] will let tenants walk.”
She said just like after 9/11 when many business owners started investing in terrorism insurance, pandemic and lockdown clauses will assuredly be included in lease deals going forward.
But that is no immediate help to people like Whiting, who is now running his fitness business entirely online and outdoors — and is often thwarted by rain.
“[Landlords] just don’t want to give the money back,” he said. “But they could’ve been renting out to someone else, a doctor's office or chiropractor's office. They could be doing that and making money.”
Upper East Side art gallery Venus Over Manhattan is making a similar argument, claiming that Gov. Andrew Cuomo’s March executive order banning in-person retail means its lease at RFR Realty’s 980 Madison Ave. is unworkable.
In a suit filed in July, lawyers for the gallery said the operation had lawfully terminated its lease because it cannot hold showings or exhibitions — frustrating its purpose — and that it wants the $365K security deposit returned and lease rescinded. Representatives for RFR and lawyers for the gallery didn't respond to requests for comment.
Davidoff Hutcher & Citron partner William Mack said he believes the argument that the government ordering a store to be closed “frustrates the purpose of the entire deal.” He is representing multiple tenants who have filed to have their leases rescinded on that basis, but declined to discuss client specifics.
“There is no reasonable way even the most sophisticated commercial party could have foreseen what has in fact occurred in the last five or six months,” he said.
To win the frustration of purpose argument, a party needs to prove that the event was substantial, according to Mack, and that it was unforeseen. While it is an old doctrine, he said, it has been relied on many times in the past. He has not, until now, had occasion to argue it.
“Nothing we are experiencing right now has occurred in American business,” he said. “They were not permitted to function. In their leases, it was a fundamental understanding that, in the case of retail stores, they were leasing the space in order to operate a store. Everyone knows that. That operates as a fundamental understanding for both parties as to why we are doing this deal.”
Legal experts said it will take some time for the bulk of these cases to work through the system to establish exactly how the courts will see them, but there have already been some decisions potentially providing a guiding light.
Last week, a judge decided a tenant at Moinian Group’s 627 West 42nd St. could not avoid its obligations. The tenant, Backal Hospitality Group, had argued it didn’t have to pay rent because of the ban on gatherings.
It filed the suit after Moinian drew down on its letter of credit in order to recoup in excess of $400K in unpaid rent, The Real Deal reported. The judge ruled the company still owes future rent. And last month, a judge ruled that the Gap and Old Navy couldn’t skip rent at their $3M-a-month Times Square location.
Some real estate insiders suggested these maneuvers are simply a creative ploy to force their landlords to the negotiating table. Many have managed to reach compromises and lease amendments, Compass broker Robin Abrams said, but not everyone.
“Some landlords will not negotiate with their tenants, and several of those tenants are measuring their potential liability if they are to walk away from their lease,” she wrote in an email.
There is no doubt, in some cases, disputes are becoming increasingly thorny. Crown Acquisitions, which owns 170 Broadway and where the Gap Inc. is suing to try and get out of its lease, says it is in danger of foreclosure because it hasn't collected rent.
Subsidiaries of the Gap Inc. — Gap, Athleta, Banana Republic, Old Navy, and Janie & Jack — have also filed a suit in the state of Illinois against Brookfield, saying its mall leases should be adapted or terminated. Brookfield and mall owner Westfield have both sued the retailer over unpaid rents, while Simon Property Group and Gap are also suing each other.
At Tishman Speyer’s Rockefeller location, Gap’s Banana Republic is trying the frustration of purpose argument, saying it should stay in the location but not have to meet its nearly $800K a month rent.
“We remain committed to working with our landlords on mutually agreeable solutions and fair rent terms, just as our industry and government partners have sat with us in good faith to shape the post COVID business landscape,” a spokesperson for Gap Inc. said in an email.
Meanwhile, Valentino has lobbed a lawsuit at its Fifth Avenue landlord, claiming in its complaint that it wants out of its lease there because the location is no longer prestigious, which has frustrated its purpose.
Victoria’s Secret is suing to get out of its lease at SL Green’s building at Broadway and West 34th Street where it has leased space for nearly 20 years and is currently obligated to pay almost $1M per month. In court papers, lawyers for the retailer argued with the city closed for business, the lease was rendered “nonsensical.”
"SL Green and landlords across the City have worked with retailers large and small to protect jobs and New York's tax base during this crisis,” SL Green counsel Stephen Meister said in a statement. “Victoria's Secret is a multi-billion dollar, publicly-traded conglomerate exploiting the situation in an attempt to avoid paying its contractual rent obligations."
L Brands, the retailer’s parent company, didn't respond to a request for comment.
Columbia Law Professor Jody Kraus, who specializes in "the relationship between moral and economic theories of law" with a focus on contracts, according to his school biography, said jurisdiction in New York City is very “unreceptive” to letting commercial parties out of their obligations.
In fact, he added, New York remains a popular choice for contracts to be governed because courts in the city are famous for following them closely. If courts declare many retail contracts no longer binding, Kraus expects it would open the floodgates to litigation into the trillions of dollars.
“You are paying your money and taking your chances. You are big girls and boys. [Courts] are not going to undermine the sanctity of contracts,” he said, adding that if the situation were reversed and locations suddenly became significantly more valuable, landlords wouldn't be able to alter the terms of the lease.
“This is a zero-sum game. Someone is going to bear this loss," Kraus said. "Letting tenants out of contracts, you are not avoiding the loss, you are just shifting it.”