Temporary Frustration As a Defense In Commercial Leases Post Covid-19

While the focus, rightfully so, over the past year has been on shortterm impacts of COVID-19 on the practice of law, with more Americans getting vaccinated each day, the focus has begun to shift toward long-term impacts. Although recent cases are centered around unique circumstances resulting from COVID-19, the subsequent rulings provide guidance to transactional attorneys on how courts might interpret certain provisions going forward.

In Bay City Realty, LLC v. Mattress Firm, Case No. 20-CV-11498 (E.D. Mich. Apr. 7, 2021) (“Bay City v. Mattress Firm”), the United
States District Court for the Eastern District of Michigan took a close look at the provisions in a lease concerning the tenant’s failure to pay rent. Bay City Realty, LLC (“Bay City”) alleged that Mattress Firm, Inc. (“Mattress Firm”) had breached its lease by refusing to pay rent for three months. Relying on shutdown orders issued by the State of Michigan regarding COVID-19, Mattress Firm did not pay its base rental payments for three months in 2020.[1] The question before the Court was whether Mattress Firm had an affirmative defense – frustration of purpose – for this breach.[2]

Bay City argued that language requiring Mattress Firm to pay base rent “without any setoffs or deductions whatsoever, except to the extentotherwise expressly provided herein” prohibited Mattress Firm from raising any defenses. Bay City further argued that language requiring Mattress Firm to bear costs associated with complying with “all laws, . . . regulations and orders of any governmental authority having jurisdiction concerning environmental, health or safety matters” contemplated the situation at hand. Mattress Firm countered that the lease was silent as to the “viability or availability of any substantive defenses to liability that may exist under the law” and that the latter provision contemplated environmental hazards, not public health concerns.[3]

After consideration, the Court determined that the language relevant to resolving the dispute was the phrase “without any setoffs or deductions whatsoever, except to the extent otherwise expressly provided herein.” The Court held that this language did not in any way
bar Mattress Firm from asserting common law defenses, nor did any other language prohibit common law defenses. Other language in the lease requiring Mattress Firm to continue to pay rent “regardless of any defense, counterclaim or offset” was cited by the Court as further proof that other defenses were allowed under the lease because this language “would be superfluous if all defenses were identified in the contract.”[4]

Relying on language in the Second Restatement of Contracts, the Court stated that, for a valid frustration of purpose defense, “[t]he
frustration must be so severe that it is not fairly to be regarded as within the risks . . . assumed under the contract” and “the non-occurrence of the frustrating event must have been a basic assumption on which the contract was made.”[5] The Court began by looking to the language the parties agreed to in the lease: the premises would be used “for the retail sale of bedding products . . . [and] for storage and office uses incidental to the permitted use . . . [.]”[6] The Court found that, per the terms of the lease, the primary purpose was the retail sale of bedding products. While the lease permitted “portions” of the building to be used for “storage and office uses incidental to the permitted use” as well as “any other lawful retail use,” the Court found that the storage and office use was “predicated upon the main purpose of the lease,” and during the shutdown order no other retail use, the secondary purpose, was lawful.
Therefore, the primary and secondary purposes were frustrated because of the shutdown orders.[7] The Court granted Mattress Firm’s motion to dismiss and held that Bay City could not seek to recoup the base rent withheld by Mattress Firm.[8]

The Court’s holding in Bay City v. Mattress Firm is in stark contrast to other courts who have dismissed similar arguments by reasoning
that “temporary closure[s], even if complete, [are] not substantial” and that such closures are “change[s] in economic circumstance[s]” that the parties could have foreseen and were risks that both parties agreed to take on. Generally, commercial landlords have argued that for frustration of purpose to apply as a defense, the entirety of the purpose of the lease must be frustrated. Therefore, it would not be sufficient that a business had to temporarily close.[9]

The major takeaway for transactional attorneys is that it is time to go back and review template documents and boilerplate language to
ensure that a client does not run into a similar situation to Bay City. In commercial leases, attorneys might want to consider drafting permitted use clauses more broadly. Rather than allowing for a tenant to use the leased premises for “any lawful use” as a catch-all, it may be wise to permit the tenant to use the premises for their primary business purposes and spell out all possible ancillary business purposes. If Mattress Firm’s lease had, for example, clarified that storage and office uses could function as a primary purpose of the lease, the Court in Bay City v. Mattress Firm may have ruled differently. Transactional attorneys should also be careful when drafting provisions waiving defenses under a contract to ensure that these provisions actually waive all defenses that might be available, whether at law or in equity. Finally, transactional attorneys would benefit from a close review of all provisions within a contract to ensure that no
ambiguities, or worse, inconsistencies, result that could lead a court to interpret terms differently from the drafter’s intent.

Republished with permission. This article was published in the Knoxville Bar Association’s monthly magazine DICTA, September 2021, Volume 49, Issue 8.

[1] Bay City Realty, LLC v. Mattress Firm, Case No. 20-CV-11498, at *1-3 (E.D. Mich. Apr. 7, 2021).
[2] Id. at 3.
[3] Id. at *9-10.
[4] Id. at *9-11.
[5] Id. at *11-13.
[6] Id. at *5.
[7] Id. at *11-13.
[8] Id.. at *18.
[9] Aaron Gordon, Mich. Pandemic Rent Ruling Is A Critical Win For Tenants, Law360 (Apr. 21, 2021), https://www.law360.com/articles/1377207/mich-pandemic-rentruling-
is-a-critical-win-for-tenants