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The Impact of Covid-19 on Rental Contracts and the Real Estate Market

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Office building. Photograph by Patrick Tomasso.

The State of Emergency declared by the Spanish Government through Royal Decree 463/2020, Royal Decree 10/2020, dated 29 March and the rest of the measures adopted under the framework of the health and economic crisis caused by COVID-19 have led to substantial changes in the daily operation of the real estate market and in the relationships between operators.

The suspension of non-essential activities, the generalised stoppage of building projects, the closing of borders and the limitations on freedom of movement have radically affected all areas of the market, including in the hotel, retail, residential, office and coworking sectors, as well as construction activity itself.

The legal debate is especially intense in the area of continual performance legal contracts, such as the case of lease contracts, regarding the possibility of suspending rental payments or of terminating contracts early, amongst other aspects. The resolution of these issues will depend, mainly, on what is agreed by the parties to each contract and the capacity of the lessor to ensure the peaceful use and enjoyment of the spaces leased.

The discussions are focusing on several arguments at the moment:

1. The application of the rebus sic stantibus principle due to the modification of circumstances outside the contract;

2. The possible existence of a force majeure event caused by COVID-19 and the State of Emergency; and

3. The application of article 1.124 of the Civil Code, whereby the injured party in a contract may demand the fulfilment or resolution of an obligation in the event that the other party is in breach.

As has happened in the past in previous crises, the current situation could generate an apparent contradiction between the pacta sunt servanda principle, by virtue of which the parties agree to comply with what has been agreed in the contract, and the rebus sic stantibus principle, whereby one of the parties could demand the modification of the terms of the contract, due to a material and exceptional alteration of the circumstances that contextualise the contract and that led the parties to its formalisation. In our experience, the application of the rebus sic stantibus principle by the Spanish courts is reserved and its application has always been made by taking into account the distribution of risk between the parties. In this sense, this principle may serve as a solid legal basis for starting a new commercial negotiation between the parties to a lease contract.

On the other hand, the eventual qualification of COVID-19 as an event of force majeure will also be an element with the capacity to impact existing contracts. In this sense, analysis of the clauses that regulate force majeure cases in lease contracts, if they exist, will be decisive in order to determine whether said clauses include a numerus clausus list of the events that are capable of being classified as force majeure. Therefore, a closed list of the events that define the concept of force majeure could imply that the health and economic crisis caused by COVID-19 is not considered a force majeure case, with the implications that that would entail in each case.

Nevertheless, for those cases in which there is no contractual delimitation in relation to cases of force majeure, the Spanish courts have defined said circumstance as an extraordinary event that is triggered by external circumstances and that is unexpected and inevitable even with a high degree of diligence by the parties. That concept would fit perfectly in a context of generalised crisis such as that caused by COVID-19. In each case, the existence of a potential link between the event of force majeure and the lessee’s inability to fulfil its obligation to pay the rent will also have to be assessed.

Another way would be the possible application to these cases of article 1.124 of the Civil Code. Thus, it could be argued that insofar as the lessee does not have effective and peaceful possession of a property, it is not obliged to make good on its consideration, which consists mainly of paying the rent.

In short, unanswered questions exist about the application of legal instruments, intended of course for different circumstances, and in light of which we must be open to reaching new agreements that allow for existing contracts to be adapted to the new realities and needs demanded by our clients.

José María Oliva is a Real Estate partner and Alejandro Márquez is a Real Estate Associate at DLA Piper.

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