Coopersmith and Coopersmith

On Friday, March 31, 2023, the Southern District of New York decided Melendez v. City of New York, a case affecting commercial lease guaranties.

In this alert, we summarize the decision in Melendez and what it means for commercial tenants and landlords.

Courts generally treat guaranties like any other contract, applying ordinary principles of contract construction. Under those principles, a written agreement that is complete, clear, and unambiguous on its face is enforced according to the plain meaning of its terms. However, courts also apply the principle of strictissimi juris to guaranties, by which a guarantor’s liability is limited to that which is strictly within the terms of the contract. For example, courts consistently find that a guarantor is discharged by any modification of the contract to which the guaranty applies, even if the modification is minor or immaterial, unless the terms of the guaranty specifically state otherwise.

Consistent with existing case law, the court in Melendez ruled to uphold the terms of the guaranty in questions as written.

The case stems from a 2020 law enacted by New York City known as the “Guaranty Law.” Under the Guaranty Law, provided certain conditions are satisfied, provisions in commercial leases under which natural persons other than the tenant are liable for payment of rent and other tenant obligation are not enforceable between March 7, 2020 and June 30, 2021:

  • If the tenant was required to cease serving patrons food or beverage for on-premises consumption or to cease operation under executive order;
  • If the tenant was a non-essential retail establishment subject to in-person limitations under guidance issued by the New York state department of economic development pursuant to executive order; or
  • The tenant was required to close to members of the public under executive order.

We posted an alert questioning the constitutionality of the law when it was passed. Click here to read “New York Forward Loan Fund and Personal Liability Provisions of Leases for Commercial Tenants”

In Melendez, the court found the Guaranty Law to be unconstitutional. Plaintiff in this case, local landlord, Elias Bochner, whose company 287 7th Avenue Realty LLC owns a mixed-use property in Manhattan, claims to have been harmed by the Guaranty Law because he was unable to recover $110,000 in rental income. Bochner’s commercial tenant stopped paying full rent, and then on March 20, 2020, gave a six-month notice of intent to surrender. Under the Guaranty Law, he could not enforce the guaranty clause in the lease.

The Contracts Clause of the United States Constitution at issue in this case provides that no State shall pass any law impairing the obligation of contracts. However, Courts have historically interpreted this clause to allow limited interference in contracts, so long as that interference is in furtherance of the inherent police power of the State to safeguard the vital interests of its people, considering –

  • whether the contractual impairment is substantial;
  • whether the law serves a legitimate public purpose; and
  • whether the means chosen to accomplish this purpose are reasonable and necessary.

In Melendez, the Court found that the contractual impairment imposed by the Guaranty Law was substantial, but that the City’s effort to mitigate the devastating economic impact of the COVID-19 pandemic constituted a legitimate public purpose. However, The Second Circuit identified five features of the Guaranty Law which raised serious concerns about the reasonableness of the Law to accomplish that purpose.

  • The Guaranty Law is not a temporary impairment. By contrast, a state moratorium law during the Great Depression which merely deferred a mortgagor’s obligations, and did not forever extinguish them, was found to be a reasonable means to afford economic relief. Under the Guaranty Law, landlords are forever barred from recovering rent from a guarantor during that 16-month period if a tenant is unable to pay.
  • Relief under the Guaranty Law is not conditioned on the presumed burdens of the pandemic. The Guaranty Law assumed that small businesses are owned by the individuals guaranteeing their leases, that these owner-guarantors would be financially ruined if required to pay their businesses’ arrears, and that financially ruined owners would be unlikely to reopen shuttered businesses, but the law does not condition the relief on any of these occurrences.
  • The burden of the Guaranty Law was placed exclusively upon landlords. The City did not afford relief by appropriating existing funds or raising taxes so as to place the burden of preserving neighborhoods on the citizenry that would benefit therefrom but instead transferred the burden to the few shoulders of commercial landlords.
  • The City did not condition the application of the Guaranty Law on need. The Court found the lack of any hardship requirement in the Law particularly significant and pointed to the various forms of state and federal pandemic relief which, by contrast, did condition a benefit on need, such as stimulus payments tied to individuals’ adjusted gross incomes and New York’s pandemic eviction moratorium, which only applied to those claiming COVID-19 related hardship.
  • The Law failed to provide for landlords or their principals to be compensated for damages or losses.

Contracts Clause cases make clear that a governmental entity may not impose a drastic impairment when an evident and more moderate course would serve its purpose equally well, and the Court ultimately concluded that the City was unable to adequately address the five serious concerns to demonstrate that the Guaranty Law was a reasonable and appropriate means to pursue the professed public purpose.

What does this mean for commercial tenants and landlords? The findings in this case are consistent with other case law in which guaranties are strictly construed and generally cannot be modified by a court or legislative body. This protects both the guarantor and the guaranteed. Guarantees should be carefully negotiated by the parties involved.

If you would like to discuss your specific circumstances and how they may be impacted by the foregoing, please feel free to contact us at (212) 625-8505.

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