COVID-19 Meets “Yellowstone” at a Restaurant on Avenue A: Was Pandemic a “Casualty” that Excused Payment of Rent?

This was originally published on the SGR Blog.

Our Courts have recently issued several decisions addressing (and, for the most part, rejecting) arguments by commercial tenants that payment of rent was excused due to pandemic and Executive Order-related impossibility or frustration of performance. In a ruling released last week, the Court tackled the novel question of whether or not the pandemic constituted a “casualty” that excused the payment of rent.

188 Ave. A Take-Out Food Corp. signed a commercial lease with Lucky Jab Realty Corp. on May 1, 2017, to operate an indoor dining restaurant. On March 16, 2020, Governor Andrew Cuomo issued Executive Order 202.3 that suspended indoor dining within the State of New York until further notice to prevent the spread of the COVID-19 pandemic. Per the Executive Order, Food Corp. suspended indoor restaurant operations and did not use the premises for such purposes until November 2020.

Food Corp. partially reopened for take-out service in mid-May but could not sustain its business, so it closed down again until mid-July when it reopened solely for outdoor dining services.

During April 2020, Jab Realty, without express permission from Food Corp., drew down the sum of $14,935.00 from the security deposit and applied it to allegedly outstanding rent. In May 2020, and again in June 2020, July 2020, and August 2020, Jab Realty again drew down the sum of $15,383.05 from the security deposit and applied it to allegedly outstanding rent. On August 7, 2020, Jab Realty served a 15-day notice upon Food Corp. demanding that the security deposit be replenished and notifying Food Corp. that “if Tenant fails to replenish the Security Deposit on or before August 24, 2020, Landlord will terminate this Lease.”

Food Court filed suit on August 20, 2020, seeking a judgment declaring that rent was not owed to Jab Realty from March 2020 forward because the premises were rendered partially unusable due to a “casualty,” a term that was left undefined in the lease but construed by Food Corp. to include the state of emergency in New York engendered by the COVID-19 pandemic and consequent suspension of all indoor dining for several months.

The complaint also sought a judgment directing Jab Realty to replenish the security deposit and credit back a rent payment. Simultaneously with the start of the action, Food Corp. made a motion for a Yellowstone injunction prohibiting Jab Realty, pending the action’s disposition, from taking any steps to terminate the lease or evict Food Corp. based on any failure to replenish the security deposit. In order to show cause initiating the motion, the Court temporarily restrained Jab Realty, pending the hearing of the motion, from “terminating the lease … instituting any action or proceeding in connection with terminating the lease … and enforcing any remedy upon the alleged defaults contained in the [r]eplenishment [d]emand.” The Court further tolled the alleged period for curing the claimed defaults.

The purpose of a Yellowstone injunction is to allow a tenant confronted by a threat of termination of the lease to obtain a stay tolling the running of the cure period. After determining the merits, the tenant may cure the default and avoid a forfeiture of the leasehold.

An applicant for a Yellowstone injunction must establish that it: (1) holds a commercial lease; (2) received from the landlord either a notice of default, a notice to cure, or a threat of termination of the lease; (3) requested injunctive relief before the termination of the lease; and (4) is prepared and maintains the ability to cure the alleged default by any means short of vacating the premises.

Since courts cannot reinstate a lease after the lapse of time specified to cure a default, an application for Yellowstone relief must be made not only before the termination of the lease—whether that termination occurs as a result of the expiration of the term of the lease, or is effectuated because of the landlord’s proper and valid service of a notice of termination upon the tenant after the expiration of the cure period—but must also be made before the expiration of the cure period outlined in the lease and the landlord’s notice to cure. Food Corp. started the action and sought Yellowstone relief both within the cure period and the lease term.

A plaintiff need not admit responsibility for the alleged default outlined in a notice to cure to establish entitlement to relief under Yellowstone, provided that the plaintiff remains willing and able to cure, should the default be found. If the default is not susceptible to cure, the Yellowstone application will be denied. Nonetheless, a tenant is not required to prove its ability to cure before obtaining a Yellowstone injunction, only that it will be able to cure in the future.

On May 7, 2020, Governor Andrew Cuomo issued an executive order that provided that:

[t]here shall be no initiation of a proceeding or enforcement of either an eviction of any residential or commercial tenant, for nonpayment of rent or foreclosure of any residential or commercial mortgage, for nonpayment of such mortgage, owned or rented by someone eligible for unemployment insurance or benefits under state or federal law or otherwise facing financial hardship due to the COVID-19 pandemic for a period of sixty days beginning on June 20, 2020

The Governor extended the term of that moratorium pursuant to Executive Order 202.48, which provided that:

[t]he directive contained in Executive Order 202.28, as extended, that prohibited initiation of a proceeding or enforcement of either an eviction of any residential or commercial tenant, for nonpayment of rent or foreclosure of any residential or commercial mortgage, for nonpayment of such mortgage, is continued only insofar as it applies to a commercial tenant or commercial mortgagor, as it has been superseded by legislation for a residential tenant, and residential mortgagor[.]

Pursuant to Executive Order 202.64, dated September 18, 2020, the Governor extended the moratorium to commercial tenants until October 20, 2020. On October 20, 2020, the Governor issued an executive order extending the moratorium on the “eviction of any commercial tenant for nonpayment of rent … through January 1, 2021”.

Consequently, even if not inclined to grant Yellowstone relief, the Court was nonetheless obligated to grant a preliminary injunction prohibiting Jab Realty from seeking to evict Food Corp. at least until January 1, 2021. The Court concluded, however, that Yellowstone relief was also warranted here.

To obtain a preliminary injunction, a movant must demonstrate, by clear and convincing evidence; (1) a likelihood of success on the merits; (2) irreparable injury if a preliminary injunction is not granted; and (3) a balance of equities in its favor. The decision whether to grant a preliminary injunction rests in the sound discretion of the Court.

Food Corp. established a likelihood of success on the merits of the claim that it was not obligated to Jab Realty for rent for March through August 2020 and was is not obligated to replenish the security deposit equal to the rent otherwise owed for those months, even if the lease, by its terms, authorized a drawdown of the deposit to cover rent.

Paragraph 9(b) of the lease states that:

[i]f the demised premises are partially damaged or rendered partially unusable by the fire or other casualty, the damages thereto shall be … at the expense of Owner, and the rent and other items of additional rent…. shall be apportioned from the day following the casualty according to the portion of the demised premises which is usable.

Paragraph 9(c) states that:

[i]f the demised premises are totally damaged or rendered wholly unusable by the fire or other casualty, then the rent … shall be proportionately paid up to the time of the casualty and then shall cease until the date that the demised premises shall be … restored by Owner.

The term “casualty,” as employed in a lease, is generally defined as an accident or an unfortunate occurrence, that is, something other than a common occurrence constituting a sudden or unexpected event or series of events. Food Corp. established a likelihood of success on the claim that the COVID-19 epidemic, and the consequent state-mandated suspension of indoor dining at restaurants, constituted a sudden, unexpected, unfortunate set of circumstances and, hence, a “casualty” within the meaning of the lease that rendered the premises unusable for a period of time and thus relieved Food Corp. of its obligation to pay rent.

Consequently, Food Corp. showed a likelihood of prevailing on the argument that, even if the lease otherwise permitted Jab Realty to draw down the security deposit to cover unpaid rent and rent arrears, under the unique circumstances of this case, Jab Realty was not authorized to do so here. Food Corp. would clearly suffer irreparable harm in the potential loss of a leasehold in the absence of the injunction. Moreover, the balance of equities favored Food Corp., as any loss sustained by Jab Realty would be compensable by money damages. Thus, the issuance of a Yellowstone injunction was warranted.

Food Corp. also established a likelihood of success on the merits of the claim that it was not obligated to replenish the security deposit but, instead, Jab Realty was obligated to do so. Food Corp. established the likelihood that it would prevail on that claim even if Jab Realty lawfully drew down the security deposit to cover rent.

Paragraph 31 of the lease provides that the “Tenant has deposited with Owner the sum of $72,500.00 for faithful performance and observance of the Tenant of the provisions and conditions of the terms of this Lease.” Although that paragraph permitted Jab Realty to draw down from the security deposit in certain limited circumstances, it does not obligate Food Corp. to replenish the security even where the deposit was legally drawn down.

A security deposit provides a fund from which the landlord can draw for unpaid rent or damages and puts the landlord into the status of a secured creditor. Generally, a landlord is entitled to retain a deposit in escrow until the expiration of the lease absent the lease stating otherwise, and an action for the return of a security is premature where the term has not yet expired.

Generally, commercial leases do not permit tenants voluntarily to offset their obligations to pay rent or additional rent with their security deposits, at least until a landlord has secured a judgment against the tenant in a nonpayment proceeding. Conversely, some leases, such as the one here, expressly permit a landlord to apply a security deposit to cure a tenant’s default arising from nonpayment.

Leases can also be drafted to obligate a tenant to replenish a security deposit when the landlord properly draws it down. The lease here contains no provision compelling Food Corp. to replenish a security deposit that Jab Realty drew down to cover allegedly unpaid rent. Food Corp. correctly asserted that such an obligation could not be implied into the terms of the lease. In any event, since Food Corp. established, because of the lease’s casualty clause, that it was likely to succeed on the claim that it did not owe rent during the duration of the state-mandated suspension of its business activities, it was also likely to succeed on the claim that Jab Realty was not entitled to draw down the security deposit in the first instance.

In addition, Food Corp. also established a likelihood of success on the merits of the claim that Jab Realty violated the New York City Administrative Code by engaging in commercial harassment of a commercial tenant that has been adversely affected by the COVID-19 pandemic. The Code provides that:

[a] landlord shall not engage in commercial tenant harassment. Except as provided in subdivision b of this section, commercial tenant harassment is any act or omission by or on behalf of a landlord that (i) would reasonably cause a commercial tenant to vacate the covered property or to surrender or waive any rights under a lease or other rental agreement or under applicable law concerning such covered property, and (ii) includes one or more of the following:* * * * *threatening a commercial tenant based on … the commercial tenant’s status as a person or business impacted by COVID-19.

Pursuant to the Code, “a business is `impacted by COVID-19′ if … it was subject to seating, occupancy or on-premises service limitations pursuant to an executive order issued by the governor or mayor during the COVID-19 period.” The term “COVID-19 period” is defined as March 7, 2020, through the later of the end of the first month that commences after the expiration of the moratorium on enforcement of evictions of any tenant, residential or commercial, outlined in executive order number 202.8, as issued by the governor on March 20, 2020, and extended thereafter.

The Code creates a private right of action permitting a tenant to commence an action in the Supreme Court for a judgment “restraining the landlord from engaging in commercial tenant harassment and directing the landlord to ensure that no further violation occurs” or awarding “such other relief as the court deems appropriate, including but not limited to injunctive relief, equitable relief, compensatory damages, punitive damages, and reasonable attorneys’ fees and court costs.”

The Court found that Food Corp. established the likelihood that it would prevail on that claim by showing that: (a) Food Corp. was a commercial tenant “impacted by COVID-19” and was subject to the Governor’s executive orders limiting seating, occupancy, and on-premises services between March 7, 2020, and January 1, 2021; (b) Jab Realty, in serving a notice to cure in August 2020, based on the failure to replenish an existing security deposit, and thus during a period when Jab Realty knew that Food Corp. was unable to generate any revenue precisely because of the executive orders, committed an act that would reasonably cause Food Corp. either to vacate its commercial leasehold or surrender its rights under the lease; and (c) Food Corp. sought injunctive and equitable relief to remedy service of the notice to cure, as authorized by the Code.

The Court granted Food Corp.’s motion for the issuance of a Yellowstone injunction. It enjoined and restrained Jab Realty from terminating or canceling the lease or from taking any action to evict Food Corp. based upon the grounds alleged in the notice to cure the default, dated August 7, 2020 and tolled Food Corp.’s time to cure any alleged defaults under the lease.

The Court’s decision, in all likelihood, is bound for the Appellate Division – where it may be a short-lived “outlier” considering the wholesale “lease busting” implications of the definition of “casualty” to include the pandemic and Executive Orders.

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