Local government in New York City has adopted recent legislation adversely impacting commercial landlords by abolishing personal guarantees that were used at lease inception, to induce those landlords to enter into those leases. Based upon longstanding legal precedent, this legislation could be found to be facially invalid on constitutional grounds.
May 26, 2020 at 11:30 AM
On March 27, 2020, shortly after Gov. Andrew Cuomo adopted shelter-in-place mandates in New York, the Legislature introduced Assembly Bill No. A10226. This proposed legislation, if enacted, would broadly extend an insurance policy’s business interruption coverage to cover losses sustained “due to the coronavirus disease 2019 (COVID-19).” The deep-pocketed insurance industry—with their powerful lobbying groups vociferously opposing the legislation on constitutional grounds for violating the contracts clause of the U.S. Constitution—likely stand on firm legal footing since the Legislature is effectively attempting to rewrite the parties’ insurance contracts by extending coverage beyond the areas explicitly covered under the original policy language.
Although there was clamor for the bill in Albany when it was first introduced on the State Assembly floor, it has been languishing in committee for nearly two months now and appears to have run out of steam. Without the Legislature interjecting sweeping coverage to COVID-19 related insurance claims, the courts will be charged with shaping insurance coverage issues going forward on an ad hoc basis. While insurance companies are breathing a sigh of relief, local government in New York City has adopted more recent legislation adversely impacting commercial landlords by abolishing personal guarantees that were used at lease inception, to induce those landlords to enter into those leases. Based upon longstanding legal precedent, this legislation could be found to be facially invalid on constitutional grounds.
Proposed Instrument No. 1932-A
On May 13, 2020, the New York City Council adopted Int. No. 1932-A, which proposes to amend the Administrative Code of the City of New York (the NYC Administrative Code) to absolve an individual guarantor from personal liability in connection with a commercial lease where the tenant has defaulted, as a result of the COVID-19 pandemic. Pursuant to the legislation, a personal guaranty becomes unenforceable if the default occurred any time between March 7, 2020 through and including Sept. 30, 2020, and the tenant is: (1) a facility authorized to conduct video lottery gaming, casino gaming, gym, fitness centers or classes, and movie theaters, or one that had to cease serving patrons food or beverages onsite; (2) deemed a non-essential retailer; or (3) directed to close.
The legislation goes even further by expanding the definition of tenant harassment to cover instances where a landlord seeks to enforce personal liability under the individual’s guaranty. See NYC Administrative Code, Subdivision A of §22-902.
Historically, Mayor de Blasio has never vetoed a bill passed by the New York City Council. If the Mayor takes no action on the legislation for 30 days, on or before June 15, 2020, the bill will become a part of the NYC Administrative Code. Should the Mayor instead veto the bill, it will be returned to the Council, who can then override his veto by a two-thirds vote, but that seems remote, especially since the bill is presently scheduled to be signed by the Mayor on Tuesday, May 26, 2020. Moreover, given that the vote on the proposed underlying legislation was 44-6, there is wholesale support for the proposed legislation from local politicians, making its chances for passage in the near term a fait accompli.
The Constitutional Dilemma
If passed, Int. No. 1932-A, will tear up many of the guarantees that induced commercial owners to enter leases with New York City retail tenants ex post facto, and which owners principally relied upon prior to the beginning of the tenancy in order to securitize the tenant’s rental obligations under the lease. This flies in the face of prevailing New York case law holding that “sophisticated parties negotiating at arms-length” can agree to pretty much anything, particularly a guarantee to collateralize the tenant’s monetary obligations during the leasehold. 159 MP Corp. v. Redbridge Bedford, 33 N.Y.3d 353, 363 . More importantly, the parties entered into their commercial transaction with the express understanding that such guarantees will remain in effect and be enforceable in the event of a subsequent monetary default by the tenant. Louis Dreyfus Energy v. MG Refining and Marketing, 2 N.Y.3d 495, 500 (2004).
History of the Obligation of Contracts Clause. On July 13, 1787, Congress in New York, acutely conscious of the evils engendered by state laws interfering with existing contracts, passed the Northwest Territory Ordinance, which provided: “[a]nd, in the just preservation of rights and property, it is understood and declared, that no law ought ever to be made or have force in the said territory, that shall, in any manner whatever, interfere with or affect private contracts, or engagements, bona fide, and without fraud previously formed.” The Framers heavily relied upon this language when crafting the Obligation of Contracts Clause, often referred to as the Contracts Clause, which is located in Article I of the United States Constitution and states that “[n]o State shall … pass any … Law impairing the Obligation of Contracts…” Therefore, as originally conceived, the clause was added to the Constitution for the purpose of prohibiting states from interfering with private contracts between debtors and creditors.
As enunciated by the U.S. Supreme Court in Ex Parte Milligan, 71 U.S. 2 (1866):
The Constitution of the United States is a law for rulers and people, equally in war and in peace, and covers with the shield of its protection all classes of men, at all times, and under all circumstances. No doctrine, involving more pernicious consequences, was ever invented by the wit of man than that any of its provisions can be suspended during any of the great exigencies of government. Such a doctrine leads directly to anarchy or despotism.
In support of the legislation, local political factions argue that it will pass constitutional muster because it is sanctioned by their broad police powers. The Constitution was adopted in a period of grave emergency, its grants of power to the federal government and its limitations of the power of the states were determined in the light of emergency, and they are not easily cast aside by emergency. This power, which, in its various ramifications, is known as the police power, is an exercise of the sovereign right of the government to protect the lives, health, morals, comfort, and general welfare of the people, and is paramount to any rights under contracts between individuals. Hudson County Water Co. v. McCarter, 28 S.Ct. 529 (1908) (Sustaining New Jersey statute prohibiting the transportation of water of the state into any other state despite impairing the obligation of private contracts to furnish the water outside of the state); see also Stone v. State of Mississippi, 101 U.S. 814 (1879) (ending lotteries to protect public health against nuisances).
In fact, the economic interests of the State may, in certain instances, justify the exercise of its continuing and dominant protective police power notwithstanding interference with contracts. Wilson v. New, 37 S.Ct. 298 (1917). However, this principle explicitly “precludes a construction which would permit the State to adopt as its policy the repudiation of debts or the destruction of contracts or the denial of means to enforce them,” such as commercial guarantees. Home Bldg. & Loan Ass’n v. Blaisdell, 54 S.Ct. 231, 240 (1934); see also Marcus Brown Holding Co. v. Feldman, 41 S.Ct. 465 (1921) (upholding temporary emergency legislation preventing landlords from evicting tenants due to a housing shortage crisis).
This legal precept was wrought by Chief Justice Marshall in Von Hoffman v. City of Quincy, 71 U.S. 535 (1866) when he wrote:
[I]t is competent for the States to change the form of the remedy, or to modify it otherwise, as they may see fit, provided no substantial right secured by the contract is thereby impaired. No attempt has been made to fix definitely the line between alterations of the remedy, which are to be deemed legitimate, and those which, under the form of modifying the remedy, impair substantial rights…
The guarantees that are subject to be axed by virtue of the City’s currently proposed legislation were contracts that were lawful when made, and have never been anything else. Notwithstanding, what the New York City Council has done here is to adopt legislation eviscerating guarantees forever, and has even taken a giant leap beyond that by holding that owners who seek personal recompense against their guarantors may actually now bear their own personal liability for harassment. Had the Council merely deferred the effective enforcement of the guarantor’s obligations, the legislation would certainly be standing on more firm constitutional ground, as the guarantees would remain lawful and enforcement possible at some point in time after the passage of the legislation, just as they were before.
The present COVID-19 pandemic, despite significantly damaging our economy, has not created any novel conditions. From the inception of our nation, we have witnessed periods of depression, industrial failure, the 1918 Pandemic, and financial distresses, which are naturally cyclical. In fact, most recently, we lived through the Market Crash of 2008/2009, and prior to that, the Great Depression, but personal guarantees made between two contracting parties in the context of a commercial transaction have never been abolished in our history. As such, the current attempt by legislative devices to shift the misfortune of the guarantor upon the shoulders of the owners, at least on its face, seems to blatantly violate the Contracts Clause of the Constitution, as well as long-established precedent. In effect, if the current legislation passes, the precarious financial positions of our nation which produced the rule at the outset would now be invoked to destroy it.