Impact of the coronavirus on the real estate and construction industries

The official declaration of an epidemic threat in Poland and the related problems in conducting business activities will significantly affect companies operating on the commercial real estate market. This is particularly true of shopping centres, which are mentioned in Article 5 par. 2, read in conjunction with Article 6 par. 2, of the Regulation of the Minister of Health of 13th March 2020 on declaring an epidemic threat within the territory of the Republic of Poland (“MH Regulation”). Pursuant to this Regulation, the operations of certain stores is prohibited (e.g. those selling clothing, electronic and household equipment), along with food courts, cinemas etc. in shopping centres having a sales space exceeding 2,000m2. No restrictions have been introduced regarding other types of activities in shopping centres. Moreover, pursuant to Article 5 par. 1 of the MH Regulation, the operations of restaurants, bars, gyms, cinemas etc. is also prohibited.

Below, we discuss selected issues that are of importance to the real estate and construction sectors.

Lease agreements concerning space in shopping centres

The interpretation of the MH Regulation will be fundamental to assessing the situation of tenants whose activities have been prohibited. We are aware, following extensive discussions with our clients, that the scope of the prohibition remains somewhat unclear. Since the prohibition is addressed solely to tenants, the operators of shopping centres may decide that no circumstances exist such as would allow tenants to suspend their rent payments because the landlord is willing to perform its side of the contract by granting access to the premises. On the other hand, if the MH Regulation is interpreted as being of general application (addressed to everyone), the prohibition on conducting specific types of business would also prevent landlords from allowing such business activities to be performed, so tenants would be entitled to rely on the so-called involuntary inability to perform a contract (Article 495 of the Civil Code) and to suspend their rent payments on that basis.

The key issue in that context, for both tenants and landlords, will be the issue of monetary liabilities (rent and service charges), i.e. what should be paid and to what extent. This will, in turn, affect the financial standing of those commercial entities. Tenants will strive to eliminate (often very high) costs connected with renting space that cannot presently be used to conduct business. Landlords will seek to maintain their operating income from rent receivables and to cover the costs of a building’s operations from the fees payable by tenants.

Therefore, particular attention should be paid to lease agreement provisions regarding so-called force majeure situations, to assess whether they apply in the current situation. The same applies to contractual provisions concerning the so-called obligatory commercialisation level of shopping centres, turnover, the presence of specific types of tenants etc. and any related adjustments to tenants’ rights in such cases (e.g. the right to decrease rent fees, to terminate the agreement etc.).

A legal assessment of whether rent or service charge payments can be lawfully withheld will also affect the possibility for landlords to enforce payment collaterals provided by tenants (deposits, bank guarantees, sureties etc.). Regardless of the automatic nature of such instruments, landlords should carefully assess whether they are authorised to enforce them.

If, during subsequent litigation, it is confirmed that a tenant was entitled to suspend their payments, a landlord would be obliged to return the collected amount together with interest and possibly be obliged to pay additional costs for having unjustifiably enforced the collateral.

Following the closure of certain points in shopping centres, pursuant to the MH Regulation, landlords can minimise expenses by attempting to limit the scope of services provided to the shopping centre by external contractors (e.g. security or cleaning services). We wish to highlight the need to carefully examine any service agreements concluded with shopping centre operators to assess whether such services may be temporarily suspended or restricted so as to lower the amounts payable to the service provider. A shopping centre’s operator / administrator should also review the content of lease agreements to assess which services it is obliged to provide to the entire shopping centre and/or to particular tenants. Additionally, a landlord which applies the so-called prudent landlord standard should assess which services are necessary for the operation of the shopping centre and which can be restricted or suspended during the period in which they may receive lower rent income from tenants. Any changes to the scope of services provided by the shopping centre’s operator or administrator should not directly affect tenants or the amounts they pay, because any reduced expenses of the operator will be settled within periodical settlements of service charges.

In our opinion, notwithstanding the current epidemic threat, tenants whose business activities have not been prohibited have no justification to close stores or suspend rent payments, because they can lawfully continue their business operations in shopping centres with no direct threat to the health or life of their employees or customers.

Office and warehouse space lease agreements

As no restrictions have been introduced regarding the functioning of other commercial real estate (offices and warehouses), we do not currently see any justification for suspending lease agreements for such commercial space. Please note, however, that the situation is dynamic and that further restrictions may be introduced in the nearest future.

The obligation to deliver commercial space

Different issues arise regarding lease agreements for commercial space that is currently being constructed. The timely delivery of such space to tenants and the possible consequences for landlords who fail to meet contractual delivery deadlines are very important issues.

We are already aware of the first negative signals connected with:

changes to the functioning of certain authorities (consequences of delays in obtaining necessary permits),
delivering correspondence,
outflow of employees,
quarantining a growing number of people (resulting in staff shortages at construction sites and related delays in completing the construction works) or
problems in the delivery of materials.

Each such problem may, individually or collectively, result in postponing the date of delivering space to a tenant. This should be taken into account while analysing:

the contractually-permissible ways for a landlord to delay performance of the agreement,
the related consequences (contractual penalties, termination, pre-conditions for tenants to avail themselves of such rights),
a tenant’s obligation to deliver collaterals for the lease agreement earlier if delays occur in transferring the leased space.

Investment agreements (Shareholders’ Agreements, Joint Venture Agreements), forward transactions, sales agreements

It is necessary to consider certain issues regarding investment agreements (e.g. forward purchase transactions), share purchase agreements, agreements to sell the rights and obligations of companies holding real estate assets (shopping centres, office buildings, warehouses) and joint venture agreements (JVA, SHA). Such issues include:

any price-variation mechanisms contained in such contracts (particularly as regards indices based on the generated NOI),
deadlines for performing specific obligations and the consequences of non-compliance, particularly as regards forward purchase transactions and joint venture agreements (JVA, SHA) – e.g. deadlines for completing specified milestones and for completing construction of a facility/collection of facilities in the originally agreed period which may prove impossible due to the behaviour of other participants in the construction process (e.g. the general contractor),
MAC (material adverse change) clauses from the perspective of minimising the risk of a significant decrease in net operating revenue levels from the acquired assets,
provisions and rules governing transition periods between the conclusion of a preliminary agreement for an investment sale and the execution thereof (i.e. the final acquisition), in order to assess possibilities for amending the transaction parameters or for the investor/seller to withdraw from the deal entirely
the possibility to exercise put/call options or to impose contractual penalties if financial assumptions/deadlines are not complied with

Financial agreements

Suspending the payment of liabilities by tenants may have grave consequences regarding obligations arising from investment financing agreements (concluded with banks, bondholders or entities that provide mezzanine financing).

Particular attention should be paid to:

financial indices and covenants, which must be maintained/reported by the entity receiving the financing, such as DSCR (debt service coverage ratio) or the level of monthly NOI, turnover level etc.,
the possibility that any event of default occurs and the consequences thereof (including the risk of the agreement being terminated by the financing party),
the financing party’s ability to increase the interest rate,
the need to create additional collateral in favour of the financing party,
the terms of financing a repayment suspension (standstill clauses),
prolonging the period for fulfilling other liabilities/ covenants.

Construction contracts (agreements with contractors, Development Management Agreements)

The current situation also affects the construction sector. Recent conversations with entities operating on the construction market demonstrate that the situation may necessitate changes to agreed schedules, particularly in the context of attempts to qualify the current situation as force majeure so as to justify a contractor’s suspension of their work. This significantly impacts on whether developers/ investors/ financers can comply with contractual deadlines and potential liability to tenants who are waiting for the transfer of leased space on the date specified in the lease agreement.

Such analysis should in particular be made by service developers operating on the basis of the DMA and obliged to complete investments in the originally-agreed period. The assessment should consider whether contractual penalties may be imposed or whether the investor may be liable to pay additional compensation (also as part of contractual penalties payable to tenants for non-delivery of the leased property on time). The same rules also apply to general contractors who usually bear the legal/commercial risks (via-a-vis the investor) that were passed on to them by the service developer.

For example, we are aware that some construction supervision controls conducted by the Regional Construction Supervision Inspectors have been delayed until the end of April. This may significantly affect the ability to officially confirm the completion of certain facilities and, in turn, impact on the entire investment schedule.

Insurance agreements

If tenants suspend their rent payments, it would be natural to rely on insurance instruments to guard against the loss of profits from business activities, including rents. However, it may transpire (and we have already noticed this in practice) that insurance companies deny their liability because epidemic threats are not usually included in the catalogue of insured events in accordance with the insurance terms and conditions. In order to properly confirm the position, it is necessary to analyse any applicable insurance agreements and their General Terms and Conditions.

Simultaneously, the Ministry of Development is currently working on legislation to mitigate the epidemic negative consequences on Polish entrepreneurs, including those within the construction sector. At present, data is being collected to enable the new legislation to be drafted.

We will regularly inform you about the issues connected with the legislation developments regarding the real estate and construction sectors in Poland.