Courts Leave Landlords in the Lurch on Guaranty Law

Recently, two important court decisions ruled that a New York City local law known as the Guaranty Law, which rendered unenforceable certain guaranties of commercial lease obligations, was unconstitutional. One month later, the New York Supreme Court declined to follow it.

Conflicting rulings, however, left the issue unsettled and landlords without clear guidance.

In 2020, during the midst of the Covid-19 crisis, the New York City Council adopted N.Y.C. Local Law No. 55 of 2020 – commonly referred to as the Guaranty Law – to alleviate the pandemic’s effects on small business. The law was intended to relieve individual, personal guarantors of a tenant’s obligations under a commercial lease of liability if the tenant was required to either close to members of the public or significantly reduce its regular business operations due to one or more of the then governor’s Executive Orders. The Guaranty Law rendered unenforceable those personal guaranties during the period from March 7, 2020 to June 30, 2021.

Article I, Section 10 of the U.S. Constitution, commonly known as the Contract Clause, prohibits any state from passing any “law impairing the Obligations of Contracts.” Thus, it can be argued that the Guaranty Law violates those constitutional prohibitions on impairing contract obligations because the New York City Council had retroactively caused a guaranty agreement entered into in good faith and at arm’s length to become unenforceable. But, while the Contract Clause is written in absolute terms, case law has developed several limitations on it, not unlike the First Amendment, where recent events made clear that free speech rights also are not absolute or without exception.

In Melendez v. City of New York, certain New York City commercial landlords challenged the Guaranty Law in federal court. The District Court stated that, in determining whether a law violates the Contract Clause, courts inquire “(1) whether the contractual impairment is substantial and, if so, (2) whether the law serves a legitimate public purpose… and (3) whether the means chosen to accomplish this purpose are reasonable and necessary”. The District Court’s decision in this case found that the Guaranty Law did impose a substantial contractual impairment on these landlord plaintiffs, while at the same time it determined that the de Blasio Administration’s effort to blunt the economic impact of the Covid-19 shutdown of all but essential businesses during this period did in fact serve a legitimate public purpose. However, with guidance from the appellate Second Circuit Court, the Melendez court decided that the City’s measures were unreasonable, for the following reasons:

1. The Guaranty Law was not a temporary impairment or mere suspension of lease guaranty agreements. Instead, it made amounts due landlords under guaranties of lease obligations during the March 7, 2020 to June 30, 2021 period permanently uncollectable.
2. The Guaranty Law was based on faulty assumptions, among them (a) that all individual lease guarantors were owners of the affected business, (b) that these individuals would be financially ruined if their guaranties were enforced and (c) the owners were not likely to re-open these businesses once the pandemic ended.
3. The burden of loss associated with the Guaranty Law was placed exclusively on landlords. Unlike other cases where courts permitted an impairment of contract rights on the party causing some public harm, obviously, New York City landlords, as a class, bore no responsibility for the economic crisis associated which the spread of the Covid-19 virus brought about.
4. Application of the Guaranty Law is not conditioned on need. For example, unlike the federal CARES Act stimulus payments, which were based upon an individual’s income, all tenants, without regard to their financial ability to sustain loss or succumb to the shutdown, received the benefit of the Guaranty Law.
5. Finally, the Guaranty Law had no provisions to compensate the economic loss it would cause landlords, many of whom were small businesses as well.

But unfortunately, the uncertainty about the Guaranty Law continues. Less than one month after the District Court’s decision, the New York Supreme Court for New York County in Mansion Realty LLC v. 656 6^th Ave Gym LLC correctly ruled that it was not obligated to follow the federal District Court’s decision in Melendez and declined to do so. The judge in the Mansion Realty case noted that, while decisions by federal courts may be persuasive and provide guidance, state courts are bound only by U.S. Supreme Court rulings on constitutional and other federal law issues.

There is a silver lining however, in the Mansion Realty case. The owner of the 6^th Avenue fitness center permanently shut down his facility, and the lease guarantor sought to be completely relieved of all liability to the landlord under the guarantor’s contract of guaranty. Importantly, the court held that the Guaranty Law rendered lease guaranties unenforceable only for a tenant’s lease obligations during the limited March 7, 2010 to June 30, 2021 timeframe, and the guarantor was personally liable to the owner for rent and associated lease obligations for all other periods.

With these conflicting rulings, the issue remain unsettled, and future federal and state court cases will determine ultimately whether the Guaranty Law violates Article 1, Section 10.