The impact of Covid-19 on the Italian retail market and the first reactions of tenants and landlords
The Italian situation
In a few weeks from the discovery of the first official Covid-19 case Italy has been paralyzed in a way which is unprecedented.
The lockdown adopted on March 11 by the Italian Government went stricter ten days later, when further measures were adopted regarding productive activities (whose stop was previously only suggested, and not required).
The end of the lockdown is now scheduled for May 3rd (although it might be extended for certain Regions – especially Lombardy – if the contagion is still at high level), and a large group of experts selected by our government is already working on Phase 2 to identify all the necessary measures to ensure a safe recovery of the various activities.
The measures adopted by the Italian government and by some of the Regions most affected by the pandemic, are mainly aimed at guaranteeing social distancing among the people. They also provide for the lockdown of most retail activities, of bars and restaurants and for the lockdown of most of the productive activities.
With reference to retail activities, stores are all currently closed except for those selling food, medicaments, hygienic products, and several other categories of first necessity items, although from April 14 libraries, stationers and clothing stores for babies and children have reopen. Bars and restaurants are still closed. Hairdressers and beauticians are mandatorily closed as well.
The lockdown of the retail activities has caused a huge damage to brick & mortar stores which were already suffering for the strong competition of the online purchases. Because of this lockdown, e-commerce has greatly increased its numbers during the last few weeks.
Some retailers have already declared to close permanently their stores. Other retailers have taken a very tough approach vis-à-vis their landlords suspending the payment of the rent.
The Governmental support’s measure of the tax credit on 60% lease rent paid in March
Such difficult situation has put a lot of pressure in the relationships between property owners and retailers and the measures adopted so far by the Italian Government to mitigate the damages caused by the forced closure of the stores have not brought much help to reduce such pressure. Indeed, the Italian Government has recognized to retailers a tax credit equal to 60% of the lease rent paid in March. Unfortunately, such provision has a limited application. It applies only if the contract between the tenant and the landlord is a lease agreement and only if it refers to small stores which have a cadastral destination as C1 (i.e. commercial destination, usually attributed to premises located in cities). More precisely, it does not apply if the contract between the landlord and the tenant is a business lease agreement (i.e. lease of a going concern) – as it happens quite frequently in the Italian retail market – and if the stores are located within a Shopping Center. Finally, retailers operating within a Shopping Center cannot benefit of such tax credit also because the cadastral destination of the premises is different from C1.
At present, the Government has not provided for other support measures for the month of April 2020 although it seems that an extension in time of the above tax credit should be implemented also with respect to other types of contracts and premises, now excluded.
In the light of this, I will briefly analyze below how the present situation generated by the pandemic may impact on contracts between property owners and tenants and how the parties have reacted so far.
Does the COVID-19 pandemic constitute a force majeure reason in the Italian legal system?
It is first of all important to understand how this pandemic caused by COVID-19 may be qualified under Italian law and if it may constitute a force majeure event, which would justify the tenant not to pay the lease rent.
The Italian legal system does not provide for a precise definition of force majeure. The case law usually qualifies the force majeure as an objective, extraordinary and unforeseeable event that prevents and makes impossible the fulfilment by the obliged party of its obligation.
Commercial agreements may contain a specific force majeure clause. Of course, the content of such a clause and, therefore, the consequences of a force majeure event may be partially different from case to case. It would, therefore, be necessary to analyze the single clause to ascertain if and to which extent the COVID-19 falls within the scope of the provision.
The supervening impossibility to perform a contractual obligation due to an unpredictable event and relevant consequences in the landlord-tenant relationships.
Our legal system provides for the impossibility for one of the parties of a contract to perform an obligation due to an unforeseeable and external event occurred after the execution of the contract itself. In this case, the debtor is not liable for the breach of contract, as its obligation expires, and the agreement automatically terminates.
If the obligation becomes only partially impossible the other party has the right: (i) to a reduction of its obligation or (ii) to withdraw from the agreements if it has no interest in the partial fulfillment.
In case the obligation is only temporarily impossible, the obligation does not expire but the debtor is not liable for the delay in the performance. In this case the obligation is extinguished only if the temporary impossibility persists until the debtor can no longer be considered obliged to perform it, or the creditor has no longer an interest in achieving it.
Many tenants have decided to suspend the payment of the lease rent on the assumption that the forced closure of the majority of their stores, imposed by the Italian Government, prevents them from utilizing the premises for the concrete purpose indicated in the contract (assuming, therefore, that the obligation of the landlord has become temporarily impossible during the days of forced closure): based on the above retailers maintain that they have the right to a reduction of the rent.
This is an aggressive approach which result mainly depends from the reaction of the landlord as any contract cannot be modified without the agreement of the other party.
Moreover, such approach may be more easily justified in case the contract entered into with the landlord is a lease of a going concern (as the object of the contract is a productive good) than a simple lease of the premises (which object is mainly the granting of the premises enjoyment).
Most of the landlords, especially in case of simple lease agreements, challenge the above approach of tenants, by stating that their obligation is just to assure the enjoyment of the premises for the entire duration of the contract and that they are performing such obligation vis -a-vis their tenants even during the pandemic. More in general, landlords are not willing to assume on their shoulders the burden of an event which is totally out of their control. And some rules of the recent decrees enacted by our government could be interpreted as supporting their views.
The application of the equity principle set forth in the Italian civil code
On a different perspective, the tenants’ right to a reduction of the rent could also arise from the application of the equity principle set forth in the Italian civil code, which states that the contract obliges the parties not only to what it is therein expressed, but also to the consequences deriving from the equity principle (in other words, the contract should be integrated in accordance with the equity principle). The Italian judges have invoked such a principle to avoid unjust damages to one of the parties of a contract and to restore the balance between their respective obligations, in case of extraordinary and unpredictable events. It could be argued, therefore, that the forced closure of the stores, caused by this pandemic, has determined an unbalance between the obligations of the landlord and the obligations of the tenant that need to be readjusted on the basis of equity principles and good faith principles in the performance of an agreement, thus granting the tenants a reduction of the lease rent, at least for the stores’ forced shut down period.
The requests of contracts termination
The reactions of retailers, however, are not limited to that of suspending the payment of the rent with the aim of renegotiating the terms of the contract. For some brands, less strong on the market, this crisis will lead to the definitive closure of their businesses. For other stronger brands, on the other hand, it will be an opportunity to accelerate the process of rationalizing their sales networks already started before COVID-19, keeping only the best performing stores.
The contractual instruments to achieve this result are (i) the termination for hardship provided for art. 1467 of the civil code and (ii) the typical tool of commercial leases: the withdrawal for serious reasons provided for in art 27 paragraph 8 of L 392/78.
Article 1467 of the Italian civil code specifically regulates the termination of the agreement for Hardship. According to such a provision, if the obligation of one of the parties has become excessively burdensome due to the occurrence of extraordinary and unforeseeable events that do not fall within the normal contractual risk, such party may request the termination of the agreement. However, the party against whom termination is sought may avoid it by offering to amend the terms of the agreement fairly.
The termination due to hardship does not work automatically but must be ascertained by a judge.
The party which intends to avail of it must act in court for the termination while the party against whom the termination is requested may avoid it by offering to amend the conditions of the agreement fairly.
In short, by recurring to the request of termination of the contract for hardship the tenant does not necessarily obtain the result of terminating the lease, if the landlord offers a substantial reduction of the rent. On a different perspective, to obtain the termination for hardship the tenant must give evidence that the continuation of its activity in the store is unsustainable.
As mentioned above, a typical remedy to walk out from lease agreements is provided by article 27, paragraph 8, of law 392/1978 pursuant to which the tenant has the right to withdraw from the lease agreement for “serious reasons” at any time, with six months’ notice.
The COVID-19 pandemic may not be sufficient to justify the tenant withdrawal but the economic consequences that the tenant’s business suffers due to the pandemic and due to the measures adopted by the Italian Government to limit and contain it, could be considered as serious reason.
To ascertain the concrete applicability of such a remedy to terminate the lease agreement, it is necessary to verify the actual economic consequences of such an event on the single lease relationship, on a case-by-case basis.
Although such remedy implies a six months’ notice period before termination during which, in principle, the rent should be paid by the tenant, many retailers are already utilising this remedy as it is automatic (it must not be ascertained by a judge) and it allows them to eliminate several less performing stores in their sales network.
The COVID-19 pandemic has hit the real estate sector tremendously and a clash is underway between property owners and retailers with reference to the rent to be paid during this 0-turnover period. Each party has good arguments to spend and there are currently no certainties. The support measures adopted so far by the Italian Government are not sufficient to give relief to retailers and balance their relationships with property owners. It would be desirable that the parties instead of arguing among themselves would sit down at the negotiating table and act responsibly to find an agreement and march together on the front of the request for a concrete support from the Government.