On October 28, 2021, in Melendez v. City of New York, the United States Court of Appeals for the Second Circuit held that New York City's Guaranty Law (Section 22-1005 of the New York City Administrative Code) permanently renders unenforceable any personal guaranties of rent obligations arising under certain commercial leases for the period covered by the legislation and may be an unconstitutional impairment of a landlord's contract rights under the Contracts Clause of the US Constitution. The ruling allows the plaintiffs to pursue a constitutional challenge to the Guaranty Law, including injunctive and declaratory relief from its enforcement. ( (2d Cir. Oct. 28, 2021.)

On May 26, 2020, New York City enacted the Guaranty Law suspending the enforcement of personal guaranty provisions in certain commercial leases affected by COVID-19. The law's intent is to protect owners and third-party guarantors of small businesses, including restaurants and bars, retail establishments, and barbershops, hair salons, and other personal care service providers, impacted by state-mandated closures and limitations related to COVID-19. Section 22-902 of the New York City Administrative Code was also amended to make it a form of tenant harassment for a landlord to attempt to enforce a personal guaranty in a commercial lease that it knows (or should know) is unenforceable under the Guaranty Law.

The Guaranty Law extinguishes a landlord's right to enforce a personal guaranty under a covered commercial lease for unpaid rent from March 7, 2020 through June 30, 2021. For more information on the Guaranty Law including the types of commercial leases covered by the law, see Legal Update, COVID-19: NYC Suspends Enforcement of Lease Guaranties for Restaurants, Retail Establishments, and Other Small Businesses.

Owners of small commercial buildings in Brooklyn, Queens, and Manhattan impacted by the legislation sued the City alleging violations of the United States Constitution Contracts Clause that prohibits state law impairing contract obligations. On November 25, 2020, the Southern District of New York upheld the Guaranty Law. The owners appealed.

The Second Circuit disagreed with the district court, finding that the Guaranty Law substantively impairs a landlord's contract rights when a covered commercial lease agreement is secured by a personal guaranty. Although the relevant obligation period is temporarily limited to approximately 16 months, the unenforceability of the guaranty for unpaid rent for the period is permanent.

The court majority agreed that in determining whether an impairment is substantial for the purposes of running afoul of the Contracts Clause is the extent to which reasonable expectations under the contract have been disrupted. Personal guaranties are critical to inducing landlords to rent to new, small businesses lacking established revenue. The court remanded the case back to the district court, allowing the plaintiffs to proceed with their constitutional challenge and to seek injunctive and declaratory relief.

The ruling revives hope for affected commercial landlords who have been unable to take efforts to collect unpaid rent. One point of clarity in the decision is that making lawful, routine rent demands, including against a guarantor, is not unlawful tenant harassment under the legislation. However, the decision only revives the plaintiffs' causes of action based on the Guaranty Law and does not fully adjudicate them.

A landlord faced with a tenant who defaulted during the period covered by the Guaranty Law should continue to monitor the case and closely examine the facts and circumstances before seeking recourse under any personal guaranty provisions.

For a collection of resources related to COVID-19, pandemics, and business interruption content, see Real Estate Global Coronavirus Toolkit.