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Status of NYC ban on collecting from some commercial-lease guarantors

Status of NYC ban on collecting from some commercial-lease guarantors

| Feb 26, 2021 | Commercial leases, Landlord/tenant

According to a New York City local ordinance enacted in response to the public health emergency, commercial property owners may not enforce third-party personal guarantees to pay rent, utilities, maintenance fees or taxes on which the tenant has defaulted from March 7, 2020, through March 13, 2021, under certain commercial leases. The tenant must have been subject to one of three kinds of limitations on business operations designated by Gov. Andrew Cuomo in executive orders, including restaurants, nonessential retail and personal care services.

New York City local law

Section 22-1005 (coverage date in this linked-to version has since been extended to March 13, 2021) specifies that only personal guarantors who are “natural persons who are not the tenant” and who are “wholly or partially personally liable …” for these defaulted obligations are protected. In other words, the limits on enforcement do not apply to companies or other organizational guarantors, only to individuals.

Response of commercial property owners

Commercial property owners are understandably concerned about this restriction on their ability to collect arrears from individual guarantors, especially since the unenforceability is permanent for unpaid lease obligations during this date range. Not surprisingly, three property owners sued the city of New York in federal court alleging that this ordinance – dubbed the Guaranty Law – and two other related ordinances were unconstitutional.

Court upholds Guaranty Law

The U.S. District Court for the Southern District of New York in Melendez v. City of New York disagreed, finding the Guaranty Law did not violate the U.S. Constitution’s Contract Clause, which forbids states from passing laws that would impair contractual obligations. While the property owners pointed out that the guaranty law prevented them from recovering rent and other monies due from guarantors under valid leases, the court explained that despite the Contract Clause, the U.S. Supreme Court says that contractual rights are subject to governmental police power that protects the public interest.

Applying the applicable test for whether a law violates the Contract Clause, the judge found:

  • Because the guaranty was an “essential provision” of the commercial lease, the enactment of the Guaranty Law was not foreseeable and the money lost is permanently uncollectable, the ordinance is a “substantial impairment” of the lease.
  • The Guaranty Law protects the legitimate public interest of preserving small businesses and the jobs they provide.
  • Deferring primarily to the lawmaker’s legislative judgment that the law is “reasonable and necessary,” the current emergency supports its necessity.
  • While reasonableness is a closer call because the financial burden shifts from the covered tenants and guarantors to their property owners, the law is tailored to apply to only some leases, certain guarantors and defaults within a date range, and the property owners still have other legal remedies.

In addition to finding the law constitutional, the judge also concluded that state laws on the same subject did not preempt (nullify) the city ordinance.

Takeaways

The property-owner plaintiffs have appealed the decision to the U.S. Court of Appeals for the Second Circuit, so more to come on this lawsuit. In addition, the issue is likely to be litigated in the New York state court system. We will report back on new developments on this topic of interest to property owners.

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