Personal Guarantors Back on the Hook as New York City’s “Guaranty Law” is Ruled Unconstitutional
The saga continues now that a federal district court judge has ruled that N.Y.C. Local L. No. 55 of 2020 (also known as the Guaranty Law) is unconstitutional.
The Guaranty Law, which sought to provide immediate monetary relief to personal guarantors of commercial leases during the COVID-19 pandemic, permanently barred landlords from collecting unpaid rent from individual guarantors between March 7, 2020 and June 30, 2021, provided the tenant whose lease was the subject of the guaranty met one of the following three conditions:
- the tenant was required to stop serving patrons food or beverage for on-premises consumption under Executive Order 202.3,
- the tenant was a non-essential retail establishment subject to in-person limitations pursuant to Executive Order 202.6,
- the tenant was required to close to the public under Executive Order 202.7, which required “personal care services” and related businesses to close.
However, the United States District Court for the Southern District of New York, on remand from the United States Court of Appeals for the Second Circuit, has held that the Guaranty Law violates the Contracts Clause of the United States Constitution.
In deciding whether the Guaranty Law violated the Contracts Clause, the Court applied the three-prong test from Sullivan v. Nassau Cty. Interim Fin. Auth. The Court found that although the law substantially impaired contractual arrangements, it nonetheless served a legitimate public purpose since it prevented “business owners from being pushed into both business and personal bankruptcy”. However, the law also was not a “reasonable” and “necessary” means to accomplish the City’s goal of alleviating the financial burdens of small businesses caused by the pandemic (and, therefore, failed the Sullivan test).
The Court addressed five “serious” issues identified by the Second Circuit regarding the Guaranty Law:
- The Guaranty Law did not temporarily relieve guarantors from their contractual obligations, but rather, permanently extinguished these obligations. As a result, landlords were forever barred from collecting accrued but unpaid rent from a guarantor for that 16-month period.
- The City wrongly assumed that all small businesses are owned by the same individuals guaranteeing their leases and did not condition rent relief on the continued operations of a business.
- In an effort to save small businesses from permanently shuttering, the Guaranty Law shifted the financial burdens onto landlords. The City argued that shifting the financial burden was meant to encourage landlords to renegotiate leases (however, since the Guaranty Law prohibited landlords from collecting under these guaranties, tenants had little incentive to negotiate.)
- The relief afforded by the Guaranty Law was not conditioned on a guarantor demonstrating financial hardship.
- The City did not provide landlords with a means to be compensated for losses resulting from the Guaranty Law.
As swiftly as the Guaranty Law shifted the financial burden onto landlords, this decision has now shifted that burden back to guarantors who may face liability for unpaid rent that accrued between March 7, 2020 and June 30, 2021, and has re-opened the door for landlords to seek payment from those guarantors.
The City has not yet announced whether it will seek to appeal the decision but, if it does file an appeal, it will likely request that the ruling be stayed pending the outcome of that appeal.
As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.
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