EFFECTS OF COVID-19 ON THE BRAZILIAN REAL ESTATE AND CONSTRUCTION SECTORS

Introduction

In response to the COVID-19 pandemic, governments around the world are implementing unprecedented measures to slow the spread of the virus. In Brazil, the first South American country to report a COVID-19 case, the Ministry of Health reports 1,546 confirmed cases and 25 deaths, with plans to screen 10 million people in the coming weeks.¹ São Paulo, the most populous and worst-affected Brazilian state, declared a public emergency on March 17, 2020.  São Paulo subsequently closed schools, parks, and most other public facilities and offices through April 30, 2020, and it urged residents to avoid leaving their homes. In addition, on March 20, 2020, São Paulo instituted a 15-day quarantine requiring the closure of all non-essential services. Sao Paulo is not alone in their response to COVID-19. Other state and municipal-level governments within Brazil have imposed similar restrictions. Brazil has also closed its land borders, and its currency, the real, has hit a new nominal low against the U.S. Dollar. 

These measures and a burgeoning nationwide economic crisis have had enormous impact on many business sectors in Brazil. The real estate and civil construction sectors, which rely on consumer activity, contractual agreements, public permits, and functioning supply chain mechanisms, look to be particularly hard-hit.

COVID-19’s Impact on the Real Estate Sector in Brazil

Shopping Centers and Other Non-Residential Leasing Operations

The COVID-19 pandemic, the extraordinary measures instituted by the Brazilian government, and the resulting economic uncertainty will likely have a substantial impact on Brazil’s real estate sector. For example, São Paulo’s recent closure of all shopping centers in its metropolitan region from March 23 to April 30, 2020 will negatively impact both retailers and shopping center owners, alike. Retail revenues will suffer as store owners are forced to close their stores and landlords’ rental revenues will decline because retail lease agreements commonly provide for variable rent based on store revenues. There is also no certainty revenues will return to normal once shopping centers are allowed to reopen.  Consumers may be anxious to leave their homes or return to public places if they continue to fear exposure to COVID-19.  The effect of these closures may render many retail store owners and their landlords unprofitable or unsustainable.  The impact of the COVID-19 pandemic is not limited to shopping centers, however. Even now, other non-residential real estate properties in Brazil that remain open are suffering decreased activity and cash flow difficulties that, at a minimum, may impact their timely payment of rent. Prudent landlords and tenants are reviewing their contractual obligations and many may be questioning how they will perform their obligations if their business is impacted by COVID-19. 

The COVID-19 pandemic could constitute an “act of God” or a force majeure event under Brazil law that may excuse a party’s performance of its contractual obligations.  Article 393 of the Brazilian Civil Code defines an “act of God” or force majeure event as an unavoidable or unforeseeable event, rendering the debtor not liable for any resulting damages (assuming that the debtor is not responsible for the event). Under Brazilian law, contractual parties are free to negotiate provisions establishing what qualifies as an “act of God”/force majeure event and how they will be addressed by the parties. Contractual arrangements regarding “act of God” or force majeure would supersede Article 393 of Brazilian Civil Code.

The language of Article 393 is quite broad and generic, so there is no bright line as to when an “act of God” or a force majeure event exists. What separates an “act of God” or force majeure event from any other rare event that does not trigger the application of Article 393, is in practice tenuous and, often, subjective. There are, however, certain events that are commonly understood to fall within the scope of Article 393, including natural phenomena, general strikes and wars. Furthermore, when public authorities establish actions or omissions (e.g. restriction of circulation), it is easier to prove an “act of God” or force majeure event exists. A pandemic might qualify as an “act of God” or force majeure event under Article 393 if it prevents the fulfillment of a contractual obligation in full, without any other alternative for the fulfillment of the obligation by the party seeking relief. The pivotal issue under Brazilian law is not only whether the event is unpredictable and unforeseeable, but also that the event’s effect on contractual performance be inevitable.

It is much too early to know whether the COVID-19 pandemic ultimately will be interpreted by Brazilian courts as constituting an “act of God” or force majeure event. But the severity and seriousness with which the pandemic is being addressed worldwide, and the drastic measures taken by the city and government of São Paulo and other state and municipal governments in Brazil – measures unseen since World War II –  provide a strong argument that the pandemic  constitutes an “act of God” or force majeure event under Article 393. Nonetheless, whether the COVID-19 pandemic will excuse performance under a specific contract is not determined by a bright line test and will depend largely on the particularities of each case and how the law develops in the wake of these unprecedented circumstances.

In addition to Article 393, parties to a non-residential lease may seek relief under Brazilian Lease Law (Federal Law No. 8,245 / 91) from the impacts of COVID-19, depending on the specific case.  For example, Article 22 of the Brazilian Lease Law obligates a landlord to guarantee the peaceful use of the property. A non-residential tenant may argue that Article 22 entitles it to suspend its obligation to pay rent during the period of time when the leased premises is closed, even if the landlord is acting according to the recommendations or, as the case may be, determinations of Public authorities. However, Article 22 is unlikely to provide relief as long as the building remains open and the tenant is allowed to use its leased premises. Additionally, if a landlord closes its building due to legal mandate or to protect the larger community, the landlord may attempt to seek relief under Article 393 from its obligations to the tenant, as described above.

Simply put, the COVID-19 pandemic is an extraordinary situation without equal in recent Brazilian history. There are no precedents in past national case law or even classification in the applicable legislation.  In the short term, parties to non-residential real estate contracts should seek a creative solution under the existing contract in order to avoid a drawn-out judicial dispute.

Real Estate Development

Real estate development deals have been roiled by the impact of COVID-19 and the governmental response, as parties raise critical questions about how – or even if – to proceed with planned transactions. With the hours of notary and registry offices severely curtailed in most of the major states and municipalities in Brazil, obtaining project approvals, acquiring necessary permits, and the settlement of in rem rights over real estate has become burdensome. Those curtailments may cause real estate transactions or development projects to suffer delay.

In addition, the uncertain economic outlook means that it will likely be more challenging for real estate developers to raise capital for land acquisitions and for future development. For real estate developers, difficulties getting a project approved or securing adequate fundraising may lead to a determination not to proceed with the project because its unfeasible.  That may prove challenging for existing land purchase and sale agreements, as most such agreements in Brazil contain an “irreversible and irrevocable” clause that does not provide for unilateral termination.

Real estate developers with existing projects for the construction of autonomous units may see unit buyers impacted by the COVID-19 pandemic, seek to terminate their purchase and sale agreements.  Like lessees, unit buyer’s may argue they should be excused from their obligations to purchase the unit because the COVID-19 pandemic constitutes an “act of God”/force majeure event. Brazilian law would require the buyer to demonstrate that the COVID-19 pandemic made it impossible for them to proceed with the acquisition. However, a lack of funds to close the deal may not be sufficient; especially if it results from the buyer’s unemployment caused by the pandemic. Brazilian law may conclude that in such a situation a reasonable, diligent buyer would have assured the availability of necessary funds through savings or insurance. Buyer’s argument becomes even more challenging if it seeks to exempt itself from applicable statutory penalties imposed on its termination of the purchase and sale agreement.

On the other hand, real estate developers that suffer project delays resulting from the COVID-19 pandemic are likely to invoke an “act of God”/force majeure theory in order to extend the 180-day tolerance regarding delivery of a purchaser’s unit so the developer will be exempt from statutory delay and termination penalties, particularly if existing or new measures by government authorities render it impracticable or even impossible to satisfy the requirements for closing.

The Construction Industry

The COVID-19 pandemic also raises significant issues for the Brazilian construction sector, particularly if the supply chain for raw materials and equipment is complicated. For instance, border closures and trade restrictions with other affected regions such as China, Europe, and the United States could negatively impact the supply chain. The workforce, too, may be paralyzed by spreading illness or by increased governmental restrictions.

Construction agreements commonly include “act of God”/force majeure event clauses. Even in the absence of such clauses, however, Article 625 of the Brazilian Civil Code provides for the suspension of construction activities “due to force majeure.” For Article 625 to apply, the affected construction company must demonstrate that delays and other issues are directly linked to the force majeure event.

Conclusion

The COVID-19 pandemic has created unprecedented complications in the Brazilian real estate and construction sectors, and equally unprecedented issues for the Brazilian legal system. The economic consequences of the pandemic on these sectors – and their downstream effects on the securitization market for real estate receivables and other financing instruments – are unknown, but likely to be considerable.

Our Real Estate Transactions and Investments team stand ready to advise on any legal issues arising from the pandemic. Certainly, parties negotiating any new real estate and construction contracts should consider including an express clause addressing pandemic-related issues. With respect to existing contracts, if shopping center managers, retailers, developers and their customers and suppliers, construction companies, and contractors/subcontractors hope to work together in the future, good-faith negotiation is critical.

This is a dynamic situation, and as circumstances change, we will be updating our conclusions and sharing thoughts on related issues.