COVID-19 and commercial leases in Italy: an important judgment

On 29 May 2020, the Court of Rome ruled on the interim-relief application brought by a commercial tenant seeking to be discharged from their obligation to pay rent.

This appears to be the first (published) judicial decision extensively dealing with the implications of COVID-19 for lease agreements. It launches (and possibly sets the tone for) a big flow of new cases expected to arise out of the outbreak.

The Order is welcome in that it offers some guidance on how Italian courts are likely to apply (and adapt) the existing legal framework to the unprecedented situations stemming from the COVID-19 pandemic, while also clarifying the meaning and significance of the legislation passed by the Italian government to respond to the emergency.

The main issue considered by the Order is whether a commercial tenant is entitled to a reduction of their payable rent given shops’ closure imposed by the government. 

According to the Court of Rome, the answer is a big, prima facie yes.

Background to the Court of Rome’s decision 

The claimant is the tenant of a business unit operating in a shopping mall in Rome. Under the lease, the claimant had the right to use the premises in the mall, to run its business (namely, the sale of bags, luggage and leather goods) from there and to benefit from the central services of the mall.

Due to government restrictions, the claimant’s shop had been closed since March 2020, thereby reducing business turnover. The claimant had filed an interim-relief application urging the Court of Rome to, among other things, relieve it from its contractual obligation to pay the rent for six months, starting from the beginning of the lockdown.

The Court of Rome’s decision 

Under Italian law, interim measures are subject to two requirements:

1. a credible, prima facie case for the claim (fumus boni iuris); and
2. a risk of irreparable harm to the right that the interim measure seeks to protect (periculum in mora).

As for the first requirement, the Court has focused on one aspect: the doctrine of impossibility. But it also considered most of the main arguments that scholars have been discussing since the beginning of the pandemic, and namely force majeure clauses, hardship, good faith as well as the significance of the emergency legislation.

Emergency legislation

The Court noted that the emergency legislation does not provide any moratorium on rent payment but contains many specific and sectorial norms suspending, for example, judicial proceedings and tax deadlines, and postponing mortgage payments. These norms cannot be applied to lease agreements nor do they express any general principle.

Furthermore, the Court appears to tacitly accept the defendant’s argument on art.91 of Decree 'Cura Italia' (no.18/2020). Under this provision, the duty to comply with the restrictive measures adopted by the government must always be taken into account for the purpose of 'excluding the debtor’s liability' under general principles of law.

The defendant argued that the provision was of no help in the case at hand, since a distinction should be drawn between discharge from contractual obligations and limits on damages liability for breach. In other words, art.91 may shield the debtor from the liability in damages for non-performance, but it cannot extinguish (or relieve from) a contractual obligation.

Force majeure

The lease agreement between the parties contained a force majeure clause excusing the landlord (not the tenant) for any non-performance caused by force majeure.

According to the defendant, by means of this clause, the parties implicitly excluded that the tenant, unlike the landlord, could invoke a force majeure event like the lockdown. 

The Court rejected the argument and has taken the position that, just like art.91 of Decree 'Cura Italia', the force majeure clause was only concerned with the liability for damages, whereas it had nothing to say about the different issue, central to the case, as to whether the tenant could be relieved from its obligation to pay the rent.

Hardship

Under art.1467 of the Italian Civil Code, long-term contracts might be terminated if exceptional and unforeseeable events occurred during the duration of the contract, making one of the parties’ performance excessively burdensome with respect to the original contractual balance. In these situations, the affected party may seek termination of the contract, which the other party may avoid by offering to renegotiate the contract on fairer terms.

The Court did not delve too deeply into this argument, but confirmed the traditional wisdom, as reflected in the case law, that hardship can be used to terminate a contract but not to modify (and adjust) the parties’ obligations. In other words, hardship can be invoked by the party bringing a claim for contract termination, but it cannot be raised as an objection to resist the claim of the counterparty seeking the payment due under the contract. 

Since the beginning of the pandemic, some scholars have started to wonder whether such restrictive understanding of the rule needed to be rethought in order to cope with the situation created by COVID-19. 

The Court of Rome chose a different route.

Good faith

According to the claimant, the duty of good faith warrants a general remodulation of the obligations assumed under a contract that predates an exceptional change in circumstances. To this end, the claimant also argued that the duty of good faith implies a general obligation to renegotiate long-term contracts affected by exceptional and unforeseeable events.

The Court did not fully address this last point. It concluded that, although important, the duty of good faith cannot go as far as to materially affect the main obligations of the parties (such as the one to pay rent under a lease agreement). 

According to the Court of Rome, a different approach would not be supported by the case law and would, in an unduly manner, undermine the stability and predictability of the agreement.

Impossibility 

Pursuant to the old maxim 'nobody can be held to the impossible', when the obligation becomes objectively impossible, it ceases to exist. 

To this end, the impossibility must come from a supervening and unforeseeable circumstance that is not attributable to the debtor. 

If the impossibility is partial, the debtor is only bound by the portion of the obligation that is still possible. In reciprocal contracts, the result will be either the automatic termination of the entire contract (in case of complete impossibility) or a reduction of the counterparty’s obligation (in case of partial impossibility).

The common opinion holds that these principles do not apply to payment obligations as these can hardly become ‘objectively’ impossible. Applying this logic, some scholars, and the defendant in the case, argued that commercial tenants cannot be discharged from their contractual payment obligation despite the forced closure of their shops.

The Court of Rome took a different perspective. What the lockdown made impossible is not the obligation of the tenant to pay the rent, but rather the obligation of the landlord to provide and maintain the premise fit for the agreed purpose (ie to host a commercial activity). This obligation stems from the law and is usually specifically incorporated into the contract, as in the case at hand.

The conclusion reached by the Court is that the lockdown gave rise to a peculiar type of partial and temporary impossibility: partial because, unlike the obligation to maintain the leased premise fit for the agreed purpose, the landlord could still comply with its obligation to let the tenant use the premise (as storage, for example); temporary because, since the beginning, the impossibility had been limited in time and ended (at this stage) on 18 May 2020.

The partial impossibility (and extinction) of the landlord’s obligation determines the corresponding reduction of the tenant’s obligation to pay the rent, in order to restore the balance between the position of the parties. 

According to the Court, the reduction must be done taking into account: 

• the fact that the tenant kept the premises during the lockdown; and 
• the remaining usage of the premises open to the tenant. 

In the case at hand, the Court found that the reduction amounted to 70 per cent of the rent.

Ultimately, the claim was rejected by the Court of Rome for lack of urgency (periculum in mora). Nevertheless, the key takeaway from the Order remains that, given the lockdown imposed by the government, commercial tenants may successfully claim a reduction of the rent payable under the lease. 

Other courts appear to be taking similar stances in other interim proceedings so more cases are expected to follow.