Addressing Economic Downturns in Commercial Real Estate

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As a result of the economic downturn, there have been cases of borrowers using the “Force Majeure” clause to excuse performance. 

 

In all of the cases, both sides could have avoided much expense and uncertainty if the force majeure clause specific addressed economic downturns and economic downturn-related events.  The lender should obviously avoid the expense and uncertainties involved in having a court interpret the scope of a force majeure clause by specifically addressing economic downturns and economic downturn-related events.  Addressing these helps to avoid the uncertainty of whether an event will meet the unforeseeability requirement necessary to invoke temporary impossibility or temporary commercial impracticability and avoid reliance on the general reluctance of courts to interfere with commercial agreements.   

 

If the real estate loan documents specifically address economic downturns and economic downturn-related events, a court is less likely to interfere because the parties expressly negotiated that risk.   

 

If correctly done, the parties themselves, and not the court, will decide if and when an economic downturn or economic downturn-related event is sufficient to temporarily excuse performance.

   

Drafting to Exclude Economic Downturns or Economic Downturn-Related Events

 

If the parties want to exclude economic downturns as a basis for invoking force majeure, they should specifically do so, by adding a newly defined term such as adverse economic event and specifically excluding such event from the force majeure. 

 

An adverse economic event could be defined, for example, as follows: 

 

Any level of economic downturn or economic or financial event or circumstance that adversely affects the local, national or global economy so that loans or credit are generally unavailable.

  

This definition is broadly worded to cover any level of economic downturn or any economic or financial event that results in the general unavailability of loans or credit.

 

Drafting to Include Economic Downturns or Economic Downturn-Related Events

 

If, however, the parties wish to include economic downturns, they should include factors that will define what level of economic downturn and what type of event as a basis for temporarily excusing performance.   

 

1.         Defining an “Economic Downturn” 

 

The parties could adopt the GDP 2 quarter rule or a variant.  An example of how to define an “economic downturn”: 

 

a decline of more than 5% of the Gross Domestic Product (GDP) of the U.S. economy for two or more consecutive quarters.  The percentage of decline in GDP shall be determined by reference to the “third” or “final” estimate of GDP issued by the U.S. Department of Commerce Bureau of Economic Analysis. 

 

This definition establishes a relatively high threshold since other than the most recent downturn, the only other time the U.S. economy has experienced a decline of more than 5% for more than 2 consecutive quarters is during the Great Depression.   

 

2.         Defining an “Economic Downturn-Related Event” 

 

The parties should also address economic downturn-related events.  An example of how to define an “economic downturn-related event”: 

 

any event or circumstance that is a cause or result of an Economic Downturn, provided that such event or circumstance [causes] [is accompanied by] a general unwillingness or inability of lenders to provide loans or credit. 

 

This definition provides an alternative.  If the parties choose the cause alternative then the possible range of events will be much narrower.  If the parties choose the is-accompanied-by alternative, then the possible range of events will be broader. 

 

3.         Incorporation into the Force Majeure Clause 

 

If a qualifying economic downturn or economic downturn-related event occurs and can serve as the basis to invoke force majeure, what recourse will the borrower then have?  The borrower then, of course, will argue that the cause excuses repayment until after the force majeure ceases and a reasonable time afterward.  This flexibility is probably not acceptable to most lenders; instead a lender will want the recourse provided to be a loan workout in accordance with the workout program guidelines.  In any case, it should address either specific loan workout or specific guidelines for determining the workout which could provide a variety of measures including modification of the loan terms or time extensions. 

 

After the 401 N. Wabash case and the 2008 credit crisis, parties to commercial real estate loans should not ignore force majeure clauses or the issue of economic downturns or economic downturn-related events as a possible basis for invoking force majeure for perhaps temporary impossibility or impracticability.

 

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Materials excerpted from an article titled “Clause Majeure?:  Can a Borrower Use an Economic Downturn or Economic Downturn-Related Event to Invoke the Force Majeure Clause in its Commercial Real Estate Loan Documents?” by Carlos A. Encinas in the Real Property, Trust and Estate Law Journal, Volume 45, Number 4, Winter 2011, an ABA publication.
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