COVID-19 and the Real Estate Sector

Dear Clients and Friends,

Covid-19 is already having implications in the real estate sector. Developers, constructors, financial investors, and users of commercial real estate must remain abreast of developments in the sector. As in other fields, the description of relevant subjects below may change rapidly, as the legal framework and regulations may vary significantly in case a state of public health emergency and containment measures are adopted by Federal, State and local authorities.  Also, note that this analysis is not comprehensive and does consequently not constitute legal advise. We encourage you to contact legal counsel to analyze the specific contractual scope of your obligations and your particular legal standing before adopting any measures.

Is COVID-19 a Force Majeure event?

A pandemic like COVID-19 likely falls within the scope of force majeure (a variable of which under Mexican law, is known as fortuitous case, or caso fortuito) to the extent it can be evidenced that the occurrence may not have been prevented or predicted and that it impairs a party from complying with its obligations (as a result of a legal mandate or from a practical perspective). In general terms, the existence of force majeurereleases the parties from the liability of their obligations to the extent directly related to theforce majeure event. Note, however, that an event of force majeure is not absolute and the direct effect of the force majeure event on the specific contractual relationship must be analyzed on a case-by-case basis, where a causal link between the force majeure event and the breach of contract are inextricably related. It is especially important to point out that in addition to the force majeure concept, there is a legal concept under Mexican law known as improvidence theory (teoría de la imprevisión) which would allow the amelioration of the effect of the obligational content of a contract between the parties when a materially adverse event occurs. Such improvidence theory is however generally available only in certain jurisdictions and normally not valid as a defense for breach of contract in commercial contracts. Courts in Mexico have consistently limited the scope of such improvidence theory.

Force majeure risk burdens

Applicable laws provide specific rules for the liabilities of the parties in the event of force majeure. However, those default rules can be modified by contract. It is key for incumbent participants in the real estate sectors to review their underlying contractual relationships to verify the terms under which force majeure risk may have been regulated in their specific agreements, as it is a standard contractual practice.  For purposes of our analysis we assume no specific liability shifts exist in the contract and is based on general rules. Force majeure provisions usually entail notice and specific term obligations, which in turn accentuates the importance of reviewing any such rules as early as practicable.

Cleaning and preventive measures

It is very useful to verify that applicable laws and regulations (including sanitary measures) be adopted by all participants. Whereas there may be a primary party responsible for such compliance (e.g. the tenant), it is useful and normally contractually permissible for other incumbent parties (e.g. landlord, creditors) to verify such compliance to mitigate the risk of adverse liability. In certain cases, failure to comply with those obligations may entitle such other incumbent parties to adopt such measures upon default by the primary party obligated to perform such obligations and then recoup the costs from the primary obligor. Also, the effect of failing to adopt those measures to multi-user projects must be assessed. For example, lack of proper implementation of sanitary measures in one facility may trigger the closing of multitenant projects or even entire developments.

Leases

The general rule is that rental payments are waived to the extent tenants become impaired from using the leased property. To the extent applicable regulations may impair such use (e.g. health agencies prohibit the operation of certain facilities), such use impairment may be claimed. After two months of use impairment, both landlord and tenant have the right to rescind the contractual relationship. The tenant remains liable for risk of loss during any use impairment due to force majeure. Normally, rent withholding is not permitted in commercial leases, yet such provisions may be not applicable if a use impairment is determined.

Construction

It is likely that COVID-19 will impact the construction schedule for many ongoing projects, which may result in delays impacting developer and contractor obligations due to unavailability of materials, loss of available workforce and governmentally mandated work stoppages. We encourage all incumbent participants to review their contractual obligations and reaching out to their counterparties to develop and document revised workplans for their ongoing projects.

Market reaction

COVID-19 and its economic effect will probably impact the forecasted business behavior and/or the real estate market. Accordingly, it will be useful for market participants to consider slower than normal absorption, cost cuts, delayed development, ongoing transaction lagging, and limited/modified financing terms and adapt their business plans accordingly.

Loans. MAC and MAE Clauses

It is key to review loan and financing documentation to verify any effects of force majeure on contracts. Of special concern are MAC (Material Adverse Change) and MAE (Material Adverse Event) clauses commonly included in financing agreements. MAC and MAE clauses may trigger significant impact on the terms of financing transaction, ranging from the right to terminate to pricing/rate adjustments and other special conditions. Also, the enforceability of MAC and MAE clauses must be analyzed on a case-by-case basis, as it may be limited under local legal rules or public policy concerns. Once those terms have been identified, as with all contractual relationships, reaching out to other parties and business partners to adapt the contracts to contingency plans under the new circumstances would decrease the likelihood of potential future conflicts.

Insurance and Bonds

Insurance and bond policies must be reviewed as they may provide relief in force majeure cases such as use impairment in leases or delayed schedules in construction projects. Business interruption policies may provide coverage for interrupted rental flows where force majeure events exist. We suggest reviewing existing policy language to verify if any such form of potential relief exists.

How can we help?

Our real estate group has implemented a task group specifically designed to help clients in navigating through the COVID-19 phenomenon impact on their business and can assist in effecting a sound strategy for addressing the multiple implications of this novel environment. Please feel free to reach out to us and we will be happy and ready to assist you.