In March 2022, the Covid19's Omicron variant rapidly conquered the city of Shanghai, pushing at home million residents of this beautiful and energetic city, while leaving commercial properties empty and unutilized for several weeks. Department stores, shopping malls, retails stores, office buildings are totally empty and both landlords and tenants wonder how the law and jurisprudence regulate this hot issue.
Needless to say, only future decisions of the Courts will determine the cases; however we can try to investigate and foresee what will be the general orientation of the courts in Shanghai, having clear in mind that the damage to both parties is relevant and careful consideration to each single case shall be given.
The leasing contract is the contract under which one party (the lessor, landlord) grant to the other party (the lessee, tenant) the faculty to utilize a certain property for a certain period of time in return for a price to be paid in cash (the leasing fee).
Given the above definition, the lessee obligation is the payment of the leasing fee (in the agreed time and amount), while the lessor obligation is to allow the lessee to utilize the property.
How the lockdown intervenes in this scenario?
The "lockdown" is provision or notification issued by Shanghai municipal government according to Article 42 of the "Law of the People's Republic of China on Prevention and Treatment of Infectious Diseases"1, which consists of requesting the residents of city not to leave their personal residence. The notice is however not a unique piece of administrative provision for the whole city and whole lockdown period. It consists of several different administrative acts for different districts in different time periods.
When the resurgence of Omicron was spotted in early March, the Shanghai government said a citywide lockdown is not necessary; instead, it designated several key areas according to the regional risk levels and conducted PCR testing block by block. However, such measures did not bring the desired effects, and the government had no choice but to declare a gradual lockdown on March 27th, requiring the residents in Pudong and a few near districts to stay at home other than taking PCR tests in the compound from March 28th, and then the residents in Puxi and rest districts were asked to stay at home from April 1st. The time of lockdown lifting will be decided based on the PCR test result, if there is no infection reported for the past 14 days in the community, then the lockdown can be lifted.
Under such scenario, it is common that the commercial rented property cannot be utilized as usual. Since the lockdown is unpredictable, unavoidable and insurmountable objective events, the lockdown is a typical force majeure event which may lead to a partial or total failure of performance of the leasing contact.
Most of the communities in which the rented properties located are closed as required by the government, on the other hand the staff of the lessee cannot enter or utilize the rented properties since they were asked to stay at home, so the lessor cannot provide the property for the lessee to use, and the lessee cannot use the rented property due to objective reasons.
In general, the Chinese Civil Code provides that where any party is unable to perform the contract due to force majeure, it shall be partially or wholly exempted from liability in light of the impact of the force majeure2. In compliance with this, the Shanghai High People's Court updated the series of "Reply to the Issue of Law Application in Cases Involving the COVID-19", providing guidance to various questions, among which the third reply issued on April 10, 2022 gave practical guideline to the performance of leasing contract in COVID outbreak3, which is echoed and emphasized by the Shanghai government.
With the above being discussed, how to perform the leasing contract during the lockdown and whether the lessee can stop paying leasing fees depend on the nature of the landlord and the status of office usage.
In case the landlord is a State-Owned Enterprise what shall the lessee expect?
We know that central government has recommended to all SOEs to alleviate the damage brought from lockdown, including the exemption or reduction of leasing fees for lessees of micro and small enterprises and individual businesses. And Shanghai government announced similar policy for the rent reduction and exemption of the commercial households owned by SOEs on March 31, 20224.
The exemption announced by government consists of two levels.
- The first level is a 3-months exemption of leasing fees in 2022, and if the rental term is less than one year in 2022, the lessee will enjoy free rent in proportion to the lease term.
- The second level is for the lessee with the following circumstances: (i) of which the rented office is in high or medium risk regions, (ii) the rented office is sealed up, suspended or requisitioned as required by relevant departments for epidemic prevention, (iii) or their business suffers operating loss for the year, then they can be exempt from another 3 months of leasing fees in 2022, which is in total 6 months.
How to define if the landlord is SOE? What is a SOE?
Therefore, one of the key prerequisites for the exemption or reduction of leasing fee is that the landlord is SOE, State-Owned Enterprise. What is a SOE and how to tell whether the landlord is SOE? Usually, the SOE is the enterprise of which partial or total of the shares are owned by the whole State, and in this case, the Shanghai government has specified SOE to "Municipal and district State-owned enterprise groups supervised by Shanghai and District SASAC5 (including entrusted supervised enterprises) and subordinate enterprises in the scope of consolidated financial statements"6. To confirm whether the landlord is SOE, the lessee can log on the "National Enterprise Credit Information Publicity System" and find out whether the shares of the landlord is owned by State.
And what if the landlord is not SOE?
Under such circumstance, though the government suggested the landlords reducing the leasing fee, the suggestion is not mandatory and whether the leasing fee can be exempted or reduced depend on the actual usage status of the property and the business operation status of the lessee.
Firstly, if the landlord of the commercial property (office or retail space) is not a State-owned enterprise, and the lockdown has prevented the lessee from entering and using the rented space, the lessee might be entitled to an exemption or a reduction of the leasing fee.
For this case, which probably represents the majority of cases, there is not a clear guidance from the Court. The requests will be supported by the court based on the actual circumstances (on case-by-case basis).In a judicial case determined by Shanghai First Intermediate People's Court in 20217, the defendant Mr. Han rented a commercial property to run a boxing center. Due to the Covid19 situation his business operation stopped at the end of February 2020, so he did not pay any leasing fee to the landlord. Soon the landlord sued Mr. Han to the court and asked him to pay the leasing fee. Based on the case scenario, the court decided that Mr. Han should be exempt from the leasing fee of 1.5 months.
Definitely it makes sense to ask for a reduction of the leasing fee. However, in case the landlord does not agree to grant a reduction it might be not a good choice to auto-determine and pay a reduced leasing fee.
What if the property is accessible but there is no or little business?
Secondly, if the commercial space can be used but the lessee claims that its business is affected by the Covid lockdown, its request of exemption or reduction of such leasing fees will be more difficult to be determined than the above situations. For example, enterprise A rented a shop to sell fruits, and during the Covid lockdown the fruit shop is allowed to open in order to satisfy basic needs of residents, but the sales revenue is lower than usual. Under such circumstance, enterprise A does not have solid ground to get the leasing fee exemption.
However, if the revenue is reduced greatly by the lockdown, based on the principle of fairness, the renter can negotiate the leasing fee reduction with the landlord, then try to reach a consensus of the leasing fee reduction.
Can the lessee unilaterally pay a reduced leasing fee?
The scenario here is that the lessee has asked the landlord a reduction and such reduction has been denied. What happen if the lessees unilaterally pay a reduced leasing fee?
When the lessee pays a reduced leasing fee without the consent of the lessor, the lessor may sue the lessee to court and the court will decide a proper amount for the leasing fee based on the actual situation. In a case decided by Shanghai Second Intermediate People's Court in 20218, the lessee hoped to reduce the leasing fee but failed to reach an agreement with the lessor, then the lessee stopped paying the leasing fee and sued by the lessor. Based on fair principle, the court decided that the lessee should get a 50% percent of reduction due to the business difficulty caused by Covid19.
Is the lockdown which bring no business a just cause for termination?
Some tenants, under the pressure of no sales, might wish to trigger the termination clause. Will the lockdown lead to the termination of the leasing contract? It depends on the purpose of contract if no relevant clause is stipulated in the contract.
According to Article 563 of the P.R.C Civil code, if it is impossible to achieve the purpose of the contract due to force majeure, then the parties involved may rescind the contract. In another case decide by Shanghai Second Intermediate People's Court in 20229, the lessee rented a commercial property for children art training. Due to the Covid19 emergency, the lessee cannot run its business. The lessee hoped to get the exemption for leasing fee of 3 months but the lessor did not agree, so the lessee sent the termination letter to the lessor.
Based on the above facts, the court supported the lessee's behavior of contract termination and decided that the lessor does not need to bear the liability of breach of contract.
To conclude, during lockdown the government, the court and relevant authorities have announced many measures and regulations to help the enterprises overcome relevant difficulties, including the exemption or reduction of leasing fees. The following picture can be referenced if the lessee hopes to get exemption or reduction of the leasing fee, or hopes to terminate the contract.
Meanwhile, negotiating with the landlord and providing necessary materials for the leasing fee exemption or reduction will be a way worth trying. With thorough negotiation, the dispute of leasing contract may be settled more efficiently. Last but not least, please take care during the Omicron pandemic and hope the Shanghai lockdown will ends soon.
Footnotes
1 Article 42: When an infectious disease breaks out and prevails, the local people's government at or above the county level shall immediately get people organized to control and treat the disease in accordance with its preliminary plan for prevention and control and cut off the route of transmission; and when necessary, they may take the following emergency measures, subject to reporting to and decision by the people's government at the next higher level, and make the measures known to the public: (1) restricting or suspending fairs, cinema shows, theatrical performances and other types of mass gathering; (2) suspension of work, business and school classes; (5) closing the places where the spread of infectious diseases may be caused.
2 See article 590 of the P.R.C Civil Code.
3 For more details, please check the following link of the wechat official account for Shanghai High People's court https://mp.weixin.qq.com/s/vUOCY8HROP_TbkL4I3hRaw
4 For more details, please check the following link of the wechat official account for Shanghai government https://mp.weixin.qq.com/s/K17QghQXjqmMeu0TxgTQaw
5 State-owned Assets Supervision and Administration Commission
6 Same as footnote 4.
7 For more details, please search the case number "(2021)沪01民终12484号".
8 For more details, please search the case number "(2021)沪02民终9332号".
9 For more details, please search the case number "(2022)沪02民终881号".
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
