BBG News

Court Dismisses Constitutional Challenge to Local Law Precluding Enforcement of Certain Guaranty’s of Commercial Leases Through March 31, 2021

Dec 11, 2020

By Lewis A. Lindenberg and Scott F. Loffredo

In case you did not think that matters could get worse for property owners suffering from the economic effects of the Covid-19 pandemic, on November 25, 2020, a Federal Court dismissed a suit brought by three property owners challenging the constitutionality of three laws newly enacted by the New York City Council – the most significant being the limitation on personal liability of guarantor’s of commercial leases referred to as the “Guaranty Law”. In dismissing the constitutional challenge, the Court held the law was “reasonable and necessary” to address the legitimate public interest of preventing small business owners from not only going out of business, but going into personal bankruptcy. The Court also found that the recently enacted laws involving the Residential and Commercial Harassment Law to be constitutional. This decision will likely be appealed.

The Guaranty Law precludes enforcement of personal guarantees of commercial leases made by natural persons for the time period spanning March 7, 2020 through September 30, 2020 where the tenant was either: (i) a business required to cease serving food or beverage for on premise consumption by New York State Executive Order 202.3, (ii) a non-essential retail establishment subject to in-person limitations pursuant to New York State Executive Order 202.6, or (iii) the tenant was a barbershops, hair salon, tattoo or piercing parlors and related personal care services ordered closed to members of the public pursuant to New York State Executive Order 202.7; and “the default or other event causing such natural persons to become wholly or partially liable for such obligation occurred between March 7, 2020 and September 30,2020. On September 28, 2020, the Guaranty Law was extended to encompass all those liabilities that accrued between September 30, 2020 and March 31, 2021.

As set forth by the Court, the Contract Clause of the Federal Constitution provides that “no State shall…pass any…Law impairing the Obligations of Contracts”. Nevertheless, the Court clearly sets forth that the Contract Clause does not give private parties the unconditional right to contract without any government interference and that the State may interfere in private contracts so long as it is in furtherance of the “inherent police power of the State to safeguard the vital interest of the people”. Further, the Court explained that to decide whether the Guaranty Law violated the Contract Clause, the Court examined: (i) whether the contractual impairment was substantial, and if so, (ii) whether the law served a legitimate public purpose, and if such a purpose is demonstrated then, (iii) whether the means chosen to accomplish this purpose are reasonable and necessary.

The Court quickly concluded that the Guaranty Law does impose a substantial impairment on property owners whose primary inducement for entering into a commercial lease was the personal guaranty of performance of the leasehold obligations. The Court was equally quick to conclude that the City Council’s purpose to protect individuals from not only losing their businesses, but potentially being driven into personal bankruptcy which would “exacerbate the ongoing economic crisis for the entire City” was a legitimate purpose. Leaving the Court with what it described as the “closest question” before it—whether the Guaranty Law was reasonable and necessary to accomplish the stated legitimate public purpose.

It is here where the Court curiously made the decision to simply defer to the judgment of the City Council rather than engage in a meaningful analysis over why the Guaranty Law itself as written was “reasonable and necessary” to accomplish the stated legitimate public purpose. Specifically, the Court states “It is not the role of this Court… to opine on the wisdom of the policy decisions at issue here—that is, the decision to shift the economic impact of the pandemic from commercial tenants and their guarantors to landlords.”

As to necessity, the Court held that when determining “necessity” prior courts have looked at whether the law in question seeks to address “an emergency”—and because the COVID-19 Pandemic is in fact an emergency—that the Guaranty Law is “necessary for purposes of this analysis”. The Court did not analyze what, if any alternative less drastic measures could have been taken by the city council to accomplish the stated purpose (such as a mere deferment of enforcement of personal guarantees) nor did the Court examine the process, research or data the city council relied upon in drafting the Guaranty Law to apply to only specific types of personal guarantors when evaluating the necessity of the Guaranty Law.

This was surprising given the Court had invested considerable time at the outset of its decision laying out the steps taken by the New York State Legislature to address the COVID-19 Pandemic (including the passage of the New York Safe Harbor Act which requires a Court to undertake a detailed case-by-case financial audit of a residential tenants finances prior to affording that tenant eviction protections they otherwise wouldn’t have rather than simply granting all residential tenants who fall into a particular category or categories of people like the Guaranty Law effectively did). In fact, the Court went out of its way to highlight the fact that the City Council passed these laws hastily after first being introduced before the council only one month before being signed into law.

Surely, any law the City Council would have passed in response to the COVID-19 Pandemic would have survived this particular “necessity analysis” applied by the Court because the analysis amounted to nothing more than asking whether the City Council identified an emergency and then passed a law to address that emergency. As such, this is a vulnerability in the decision that may be seized upon on appeal, or in a separate legal challenge.

Finally, in reviewing whether the Guaranty Law was “reasonable” the Court analyzed whether the law was tailored to address the stated emergency and found it was because: (i) the Guaranty Law was limited to natural person guarantors of certain tenants such as restaurants, non-essential retail and barbershop/salon facilities, (ii) the Guaranty Law only precludes enforcement of guarantees between March 2020 and March 2021 (without any discussion that the legislature could very likely extend this time frame); and (iii) The Guaranty Law doesn’t preclude owners from other remedies such as evicting a tenant, recovering rent from tenants or recovering damages from the tenant. Again, the Court stopped short of questioning why the city council “drew the lines where they did” or whether other less drastic steps could have been taken by the council to address the stated purpose while tempering the substantial impact on property owners. For example, why should a personal guaranty by a person(s) who is not the owner of the commercial operation be waived since it would not impact the commercial tenant’s operations and would not trigger the City Council’s purpose to protect individuals from not only losing their businesses, but potentially being driven into personal bankruptcy.

Simply put, the Court found that because the City Council found the Guaranty Law to be “necessary and reasonable”—that it was “necessary and reasonable”.

The Guaranty Law has likely not met its last constitutional challenge either in the form of an appeal of this decision or in subsequent challenges brought by other property owners. Hopefully, there are other challenges and/or this matter is further appealed – therefore giving property owners the opportunity to seek to enforce guaranty actions against it tenants. In the meantime, owners throughout the City of New York find themselves negotiating lease amendments, deferral agreements, and surrenders with various tenants throughout the City– some of which are legitimately impacted by the COVID-19 Pandemic and others who are taking advantage of a temporary freeze on evictions coupled with these new laws to demand new lease terms, rent forgiveness and concessions for their own profit at considerable expense to property owners.

As commercial property owners contemplate what terms to extend to their tenants and corresponding guarantors they likely will come to the conclusion that until such time as this area of law is settled that a “personal guaranty” may no longer be the dependable, valuable document it once was and now require commercial tenants to have at least one or more individuals sign the actual lease agreement as consideration for granting tenant any deferral, modification or amendment being sought. Also landlord’s might want to insist upon having the operating entity sign as an additional tenant or guarantor.

If you need any assistance in any facet of this process, including how best to pursue either the tenant or the guarantor for collection of rent or how best to protect the landlord’s interest in the lease, please feel free to contact either Lewis A. Lindenberg or Scott F. Loffredo.

Lewis A. Lindenberg and Scott F. Loffredo are partners in the Litigation Department of the firm.

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