California Facing Commercial Foreclosures and Bankruptcy Crisis
There is legislation moving through the California Senate that would devastate the commercial real estate industry and upend the landlord-tenant relationship. SB 939, sponsored by Senator Scott Weiner (D-San Francisco), would provide commercial tenants with new rights and allow them to pay no rent for an indeterminate amount of time; this would lead to a commercial mortgage crisis within the state.
The legislation allows ALL commercial tenants to not pay their rent from March 4, 2020, until three months after the California’s COVID-19 emergency order is lifted. The tenant is also given an additional 12 months to make up the unpaid rent after this period of rent deferment is lifted.
This places tremendous pressure on the commercial property owner. For example, if the statewide emergency order is lifted on January 1, 2021, the tenant would not have to start paying rent until April 1, 2021, and would have until April 1, 2022, to make up any unpaid rent. The property owner, who still must make mortgage and debt service payments while forging rental income during this 13-month period, is provided no relief. In addition, the inability to seek collection for any of this unpaid rent through legal action until April 2022 – a period of 25 months – only augments the property owner’s critical financial situation, and could lead to foreclosure and bankruptcy.
This bill would also provide new rights for a certain class of commercial tenants, such as restaurants and entertainment venues, which would significantly alter the contractual relationship between the commercial property owner and the tenant in California. The legislation allows these qualifying class of commercial tenants to renegotiate any existing lease, and, if the terms are unacceptable, the tenant may immediately terminate the lease in its entirety and simply walk away. Section 2 provides the tenant with unprecedented leverage over the property owner, who would have no legal recourse.
The legislation also establishes a new legal cause of action for any tenant that feels “harassed, intimidated, or threatened” by a commercial property owner. The tenant would now be able to file a lawsuit under this cause of action for $2,000 per incident. This is in addition to the existing “unfair business practices” actions that carry a $2,500 fine per incident.
In addition, there are certainly constitutional questions about whether SB 939 violates the contracts clause and constitutes a “taking” under the U.S. Constitution. Article 1, Section 10 of the Constitution says that no state shall take action “impairing the Obligation of Contracts.” Commercial leases are clearly legal contracts between two private parties. The passage of SB 939 would set a terrible precedent in California in that any private contract, not just commercial leases, may be subject to state interference in favor of one party. In addition, the legislation arguably could be a “taking without just compensation” under the Fifth Amendment since the state’s action would prevent property owners from making economically viable use of their properties. If adopted and enacted, the state of California will likely end up in federal court defending the legislation.
Finally, SB 939 fails to also recognize that commercial property owners are already working with their tenants to address the financial challenges caused by COVID-19 through rent deferments and other measures. Property owners do not benefit from evicting tenants or from empty commercial buildings. In a recent press release, Rex Hime, president and CEO of the California Business Properties Association (CBPA), issued the following statement:
“All Californians – especially property owners – want businesses to thrive and be able to pay their rent, but SB 939 flies in the face of basic economics and would exacerbate the financial problems imposed on all residents and businesses by COVID-19’s mandated business shut-down.”
This misguided legislation certainly provides additional rights for business tenants to the detriment and inequity of commercial real estate and their owners. It will prolong the state’s desperately needed economic recovery by replacing a short-term loss in business revenue with a long-term commercial mortgage crisis. The California Senate needs to focus on legislation that will stimulate the economy, rather than provoke foreclosures and bankruptcies. CBPA’s legal issues and analysis summarizes these points in more detail.
The COVID-19 pandemic has caused personal, financial and economic hardship across North America and the world. NAIOP and its chapters are working with policymakers to emerge from this pandemic in a safer, stronger and more sustainable place. Our industry will recover, but with misguided legislation such as California’s SB 939, no one wins.
Visit the NAIOP Response: COVID-19 page for critical resources and knowledge to support you now.
