Litigation counsel Ron Adelman covers everything that gallerists need to know about responding to the Covid-19 crisis.
My name is Ronald Adelman. I am a New York art lawyer. I have been representing people in the art world in the areas of real estate, intellectual property, corporate law and commercial law for 30 years. I am going to focus on the commercial real estate challenges and responses for galleries and other art-related businesses in the wake of the coronavirus crisis. I will also cover some related issues like bankruptcy and governmental programs to help small businesses get through the crisis.
The coronavirus crisis could easily be the worst disaster for the US in recent memory. As you know, all non-essential brick-and-mortar businesses have been shut. Art galleries and other art-related businesses have all been deemed non-essential. This is a time where every art professional must carefully review how to remain sustainable. If you are an arts professional with a commercial lease, then this presentation will discuss everything you need to know to get through this.
Before discussing leases, I will first cover the New York governor’s order preventing commercial evictions. Second, I will cover the potential rent freeze options galleries may have. Third, I will discuss the numerous options available regarding leases. Fourth, I’ll mention programs that are being set up to help small businesses.
Please remember this presentation is provided informational purposes only and is not legal advice. You should not act or refrain from acting because of any content included here without seeking the appropriate legal or other professional advice.
I will start with a couple of quick points comparing commercial leases with residential leases. In New York, courts view commercial tenants less favorably than residential tenants. For example, residential tenants can more easily terminate leases if the landlord fails to provide an essential service like running water. It has also been harder to evict residential tenants for non-payment than commercial tenants.
However, the pandemic has changed that, at least temporarily. I’ll discuss why that is shortly.
I have heard that some commercial landlords are willing to be more flexible with negotiating and enforcing leases as a result of the crisis. This makes sense. Forcing a good tenant out in the current situation may result in months or years of vacancy.
There is a five-month moratorium on eviction proceedings against commercial tenants in New York. The moratorium began on March 20 and will end on August 20. Further extensions are possible. Landlords cannot file new eviction cases during this period and cannot take any further steps in cases that were previously filed. Even threats to sue are unlawful harassment and can bring heavy fines. The courts are just barely beginning to reopen. That means that even when the moratorium ends there will be long delays due to the backlog.
But a moratorium does not mean that you don’t owe or need to pay rent. It only means that you can’t be evicted for now. Some state senators have proposed a bill that would free commercial tenants, including galleries, from the obligation to pay rent for three months if they can demonstrate that they were affected by the crisis. The bill is pending in the New York State legislature. Galleries were included in the non-essential businesses that had to close, so they would be eligible. Of course, this would be a great help to most galleries. But it would have to be approved by Governor Cuomo in addition to the state legislature. This is ongoing and you need to watch for further developments.
So let‘s assume that you have a commercial lease and have cashflow issues related to the crisis. What do you need to know? What can you do? I am now going to discuss some strategies for dealing with your lease.
The first thing you should look for in your lease is a “force majeure” clause. It can also go by other names, including “Act of God”, “Inability to Perform” or similar language dealing with natural or man-made disasters. Here is one sample, which covers “strikes or other labor disputes, fire or other casualty, accidents, any orders of any Governmental Authority or any other cause beyond Owner’s reasonable control”.
I highlighted the “Governmental Authority” language because that is the one that applies to this crisis. The second step is to see what it excuses the tenant from doing or not doing. In the best case it will be a reason a tenant can terminate the lease. Or, if the tenant doesn’t want to terminate, it may excuse the tenant from paying rent while the emergency is ongoing.
Next you should look at the section of the lease covering the landlord’s representations and warranties. In some leases the landlord warrants that the leased space will be usable for the intended purpose. In other words, the landlord makes a binding promise that a space leased as a gallery can actually be operated as a gallery. Government orders during the crisis mean that galleries cannot be operated in any meaningful sense. A warranty like the one I described would allow the gallery tenant to get out of the lease. Most leases say that landlords aren’t responsible for things that are out their control, which probably covers the current situation. But you should nevertheless look at the landlord warranties to see if yours is more favorable to you. There is no question that the courts enforce landlord warranties in favor of tenants.
Next, you should review the lease to see if there is a personal guarantee. In almost all commercial leases, the tenant is a corporation or limited liability company. This includes gallery tenants. If the tenant is a business entity, the individuals who run the entity are not personally liable for the lease. To counter that, many landlords require one or more individuals to make a personal guarantee. The guarantee may be in a separate document so don’t just rely on the lease itself. Look for any side agreements or amendments.
Carefully reviewing the guarantee is a crucial step in determining your degree of personal risk on the lease. If there is no personal guarantee the individuals who are part of the gallery entity are generally able to avoid liability for unpaid rent.
Until now, personal guarantees have been generally valid and enforceable. But on May 26, New York City passed an unprecedented law that bars the enforcement of a personal guarantee if it made by an individual and
• if the business is a retail establishment that was deemed non-essential or
• was ordered to limit number of employees and/or customers between March and September 2020.
Virtually every gallery in the city falls within that definition. Any attempts by landlords to enforce personal guarantees subject to the law are invalid. They will be considered unlawful harassment and could in theory be subject to criminal fines.
The law does not apply to those guarantors that are other corporate entities instead of individuals. It is important to check the identity of the guarantor and not simply rely on the wording in the agreement as a “personal guarantee.” It is a major step to have a law that declares a whole class of contracts unenforceable. The law will be challenged by landlords. However, until a court rules in favor of the landlords the law is valid.
Next, you should look to see whether your lease has a “good guy” clause, sometimes known as an early termination clause. A “good guy” clause permits a tenant to terminate a lease early if the tenant has fully complied with its obligations under the lease and wants to leave.
That means that
• rent payments must be up to date and the
• premises must be in good physical condition, referred to as “broom clean” condition.
The good guy clause can be a lifesaver if you have one.
In most cases, renegotiating the terms of the lease if possible is preferable to treating the landlord as an adversary. Of course, this requires that your landlord is willing to renegotiate and that you have a good relationship.
The main terms to renegotiate are generally
• the length of the lease,
• amount of rent and the
• right to sublease
However, any clause in a lease can be modified by mutual consent in writing. Never rely on anything agreed to verbally. Verbal changes to leases are unenforceable.
Standard commercial lease forms in New York generally prohibit subletting. If it is not in the original lease, it must be covered explicitly in an amendment or rider. Generally,the most important aspects of the subletting from the tenant’s perspective are the
• right to return after the sublet ends and
• the right to keep the difference, if any, between the amount of rent the tenant pays to the landlord and the hopefully higher amount the subtenant pays you under the sublease.
If you have the right to sublet (or can negotiate this right) and keep the excess rent this can go a long way to keeping you afloat until things settle.
Redemption means that if the landlord sues to evict for nonpayment of rent, the tenant can “redeem” the property by paying all rent due up to the date of redemption. The tenancy will then continue until the end of the lease. Redemption is a possible option for a tenant who has more than five years before his lease expires. But the right of redemption is waived if the tenant fails to use it within one year after the landlord starts the eviction proceeding. Redemption can be and is usually waived in the lease. If that’s the case, then paying back rent won’t allow you to redeem. But if it is not waived, it can be an important step towards keeping your space if you want to do that long term.
Until now, I have looked at solutions that avoid litigation. But sometimes, getting a court involved is the only viable option. If the landlord is threatening to bring an eviction case the tenant can beat him to the punch by bringing a motion asking the court to issue a “Yellowstone” injunction. If the court issues the injunction, the landlord is barred from evicting the tenant unless and until the eviction case is finally decided against the tenant. This has proved to be a powerful weapon for tenants fighting eviction. However, the highest court in New York limited its effectiveness in a 2019 decision holding that the right can be waived in advance in the lease. As with redemption, a careful review of the lease is vital before beginning a court proceeding.
If none of the options I’ve already mentioned are available or desirable, and you do not pay rent, there is a good chance that the landlord will sue after the moratorium to evict you and get damages for unpaid rent. Almost all commercial leases in New York provide for “acceleration” of rent. That means that if the tenant fails to pay rent for a particular month, the landlord can declare the tenant to be in default and then immediately seek ALL rent due through the last day of the lease. For example, if your rent is $10,000 monthly and you have three years left on your lease the landlord will sue you for $360,000.
New York courts generally enforce acceleration clauses. But a recent trend is for the courts to deny the full accelerated sum if it would give the landlord an unfair financial “windfall.” As with many parts of the law there is no clear definition of what is a “windfall.” It will be decided on a case-by-case basis. I expect that courts will have a sympathetic view of the hardships of gallery and other small business tenants, in the wake of the coronavirus crisis, but it is impossible to predict at this point.
If your current and/or prospective debts outweigh your assets by so much that the business cannot be operated without restructuring, bankruptcy may be a viable choice. Your attorney will advise you to file under Chapter 11 if you hope to continue the business after getting out of bankruptcy or under Chapter 7 if you intend to close the business and liquidate.
Bankruptcy can be a major stigma for small businesses regarding credit and other things. However, bankruptcy can also have significant benefits. Most important, it automatically stops all pending and threatened proceedings in other courts. Instead the bankruptcy judge will decide all disputes. He or she is much more likely have more experience and understanding of the issues facing an insolvent business than judges in other courts.
Chapter 11 is designed for businesses that are in financial difficulty but expect to be able to continue. Often, the court will agree that the same people who operated the business previously can continue as “debtor-in-possession.” The debtor-in-possession has a fair amount of leeway to operate the business as it did before, but all actions can be subject to court review.
The Court may decide that the operators of the business are not sufficiently responsive to the interests of creditors and appoint a Chapter 11 trustee to run the business. Alternatively, the court can decide that reorganization is hopeless and convert the case to Chapter 7, which is designed to liquidate the business. However, if everything works as planned, the business’s debts to creditors will be fully discharged and the business will leave bankruptcy with a fresh start.
Chapter 7 is designed for businesses that have no hope of continuing. The court appoints a trustee who removes the former operators. The only real purpose of a Chapter 7 case is to maximize assets to satisfy the claims of creditors.
In a Chapter 11 case, soon after filing for bankruptcy the tenant/debtor-in-possession must elect whether to accept or reject all current contracts, including the lease. Accepting the lease means that the tenant must continue to pay rent and comply with all other lease obligations. The lease can be amended only with the landlord’s consent or by order of the bankruptcy court. Rejecting the lease terminates it and terminates the tenant’s obligations, including rent. But it is likely that as a result, it will be extremely hard to get a new lease from a new landlord in the foreseeable future.
A bankruptcy filing also has a significant effect on artwork the gallery is holding on consignment. The key distinction is between “primary consignment” artwork and “secondary consignment” artwork. Primary consignment artwork refers to artwork the artist consigns to the gallery. Under New York law, artwork consigned by the artist who created it is subject to special protection. Creditors have no claim to those works. Without exception the artist gets them back.
Secondary consignment artwork usually refers to artwork consigned to the gallery by a collector. There are fewer legal protections for consignor-collectors. Instead the artworks can become part of the bankruptcy estate of the gallery and eventually sold, with the proceeds going to creditors generally rather than the particular collectors.
But a gallery can (and probably should as a sound business practice) advise consignors to protect themselves at the time of consignment. The way to do this is by perfecting a security interest in the artwork. This can be done through a executing a simple form and filing it with the relevant government office (in New York, the Secretary of State). For more on information on protecting your consignors it is best to consult with an attorney.
Litigation should be viewed as a last resort. It is expensive, with costs running five figures and up. The expense is potentially compounded if the lease has a clause providing that the loser pays the winner’s attorneys’ fees. It is also slow. A span of two years from start to finish is common.
Either side can start lease litigation. More commonly the landlord starts it, but tenants regularly start the process through the Yellowstone motion we discussed. The initial documents are usually the complaint and answer, although the answering party can also make whatever counterclaims it may have, if counterclaims have not been waived in the lease.
The parties then engage in discovery. This is where all parties must turn over all documents that are relevant to the case. The term “documents” includes electronic information, such as emails and texts. The parties then move to depositions. Depositions are questions asked by the lawyers responded to by the opposing party. The witness is under oath and the questions and answers are transcribed by a court reporter.
After discovery, one or both sides will usually file motions for summary judgment. In essence, they are asking the court to decide the case in their favor before it goes to trial. If the court does not grant the motion in favor of one side or the other, the case will then go to trial.
It is important to note that there are delays between each of these steps. These delays are usually measured in months. If a matter goes to trial and judgment, legal costs can easily exceed $50,000. After winning on summary judgment or at trial, a successful landlord will receive a judgment. The judgment is a dollar amount consisting of unpaid rent (and any other applicable charges) plus interest.
Collecting a judgment is often harder than getting one. As lawyers say, “you can’t get blood from a stone.” For individual tenants, certain property is exempt from judgments. And, with rare exceptions, the judgment creditor cannot seek to collect from spouses or family. For judgment debtors that are business entities like LLCs or corporations, the landlord almost always cannot try to collect from individuals who manage or own the business.
This is where the significance of a personal guarantee comes into play. And this is why the new New York City law adds an extra level of complication and protection for tenants, as we have discussed. However, landlords have an extremely long time to collect on a judgment. In New York it is 20 years.
I would like to talk briefly about government programs that may be available to galleries and other small businesses in New York. These programs change, so please understand that some of what I mention here may be out of date by the time you see this. I urge all of you to get all of the governmental assistance that is available to you.
Unfortunately, state and local programs are currently on hiatus due to lack of funding. Those programs were:
1. A grant of up to 40% of two months of payroll for business with five or less employees; and
2. A loan of up to $75,000 for business with less than 100 employees.
It is not clear if they will be restored.
The situation changes continually and so I can only suggest that you consult the brochure released by the New York City Department of Small Business Services found here. It is updated at least monthly and lists the available U.S. Small Business Association programs, which I will describe shortly. The NYC SBS offers a signup to see new developments as they come online. It can be found at this link.
The only available federal program right now is the Paycheck Protection Program. Businesses with 500 or fewer employees can seek loans of up to $10 million or 2.5x annual payroll (whichever is lower). If the money is used for payroll, rent, mortgage interest or utilities and employees remain on the payroll for the full eight-week period, the loan will be forgiven. Otherwise, it is repayable at a 1% interest rate over two years.
The other principal program from the SBA was an Economic Injury Disaster Loan and Advance of up to $150,000. The SBA is not taking new applications for those loans but the program may be restored if Congress provides additional funding.
Dealing with the SBA takes a lot of effort, and there are rumors that the Paycheck Protection Program has run out of money. However, as of now, this appears to be untrue. The best advice is to be persistent. Expert assistance may also be helpful. Without question, the Paycheck Protection Program is worth pursuing.
To sum up:
Review your lease for:
Keep following new legal developments, including the new bar on enforcement of personal guarantees. Take advantage of local state and federal small business assistance. Speak to an attorney about using every strategy available to you to deal sustainably with the crisis. Inaction is more likely to harm you than finding a way forward.
As difficult as it is to imagine, crises can create opportunities, if they can be seen and pursued. A large part of my job is to help art professionals find opportunities and protect their businesses under all circumstances. I wish you all the best of luck and insight in these unprecedented times.Please contact me at email@example.com if you have any questions, and I look forward to helping you.