NYC's Guaranty Law Violated the Contracts Clause of the U.S. Constitution

Last summer, we wrote about New York City Administrative Code Section 22-1005, known as the Guaranty Law.¹ This was a pandemic-era prohibition on enforcement of personal guaranties supporting commercial leases for defaults that occurred between March 7, 2020, and June 30, 2021. At the end of that article, we pointed out that landlords had challenged the Guaranty Law under the Contracts Clause of the U.S. Constitution.² Now, the U.S. District Court for the Southern District of New York has decided the Contracts Clause dispute in favor of the landlords.³

The District Court had previously dismissed the landlords' Contracts Clause claim.⁴ Deciding the appeal of that decision, the U.S. Court of Appeals for the Second Circuit instructed the District Court, on remand, to address five specific concerns "about that law being a reasonable and appropriate means to pursue the professed public purpose."⁵

In its recent decision, the District Court recognized "the Guaranty Law advanced a legitimate general interest of mitigating a staggering economic crisis brought about by a once-in-a-lifetime pandemic."⁶ However, the city failed to show the Guaranty Law was a reasonable and appropriate means to achieve "the City's legitimate public purpose," and the court decided that the Guaranty Law violated the Contracts Clause.⁷

First, the Second Circuit was concerned that the Guaranty Law did not merely defer guaranty obligations, but permanently and entirely extinguished them. As it had to – given the clear terms of the Guaranty Law – the city conceded that the Guaranty Law permanently extinguished personal guaranties for the relevant period.⁸ This concession weighed in favor of finding that the Guaranty Law violated the Contracts Clause.

Next, the Second Circuit reasoned the Guaranty Law was based on three assumptions: 1) shuttered small businesses are usually owned by the same person who guarantees the lease; 2) the owner-guarantors would face financial ruin if they had to pay business rent arrears; and 3) financially ruined owners would be unlikely to reopen the business. For the Second Circuit, the city's solution addressed the second concern about financial ruin, but the relief was not conditional on the small business owner also being the guarantor with at least the intention of reopening the business. Ultimately after examining the evidence, the District Court decided that because the Guaranty Law did not apply only to those able to demonstrate need based on a pandemic-related hardship, the city did not show that the Guaranty Law provided a solution to its assumptions, which weighed "in favor of a finding that the Guaranty Law violated the Contracts Clause."⁹

Third, the Second Circuit was concerned that the burden of the Guaranty Law fell exclusively on landlords. The District Court determined that small business tenants were able to access other pandemic assistance and that guarantors had no incentive to renegotiate their obligations because they had been released from any obligation to pay rent on commercial leases during the relevant period. Having rejected these arguments from the City to justify the Guaranty Law, the District Court held that there was no justification for allocating the burden exclusively to landlords.

The Second Circuit's fourth concern was that business-lease guarantors were absolved from their responsibility for paying rent during the 16 months at issue, regardless of their ability to pay.¹⁰ The city argued that hearing testimony showed the need for relief, but it could not provide any evidence that the Guaranty Law targeted only those people in need of relief. The District Court held that the lack of any needs-based conditions to the Guaranty Law weighed against it being a reasonable impairment of contracts.

Last, but likely not least for the landlords, the Second Circuit was concerned that the Guaranty Law did not provide for landlords to be compensated for the losses resulting from the law. The city did not dispute that the Guaranty Law provides no assistance to landlords but pointed to the availability of pandemic relief loans and other business ventures that helped the plaintiff landlords survive the pandemic. The District Court was unpersuaded, explaining that unpaid rent remained unpaid and that pandemic relief loans incurred interest and had not been forgiven. The city failed to provide a "record-based position" that would allow the court to conclude that the "lack of compensation to landlords … was a reasonable and appropriate means of advancing the legislation's purpose."¹¹ Thus, the landlords prevailed in every area raised as a concern by the Second Circuit.

Conclusion

Not surprisingly, the decision has been appealed. In the meantime, it has had an immediate effect on those involved in commercial lease disputes in New York. One New York State Court judge declined to follow the federal court's decision, noting that New York courts are bound only by U.S. Supreme Court rulings on federal law and not by any other lower federal courts.¹² However, other New York State Court decisions have allowed landlords to dismiss affirmative defenses that relied on the Guaranty Law¹³ or to amend the complaint to assert a claim previously omitted based on the Guaranty Law.¹⁴

With the appeal pending and other commercial lease guaranty claims in litigation, issues raised by the Guaranty Law have still to be determinatively resolved. Stay tuned for those decisions.

Notes

¹ N.Y.C. Admin. Code § 22-1005.

² U.S. Const. art I, § 10, cl. 1.

³ Melendez v. City of New York, No. 20-CV-5301(RA), 2023 WL 2746183 (S.D.N.Y. Mar. 31, 2023).

⁴ Melendez v. City of New York, 503 F. Supp. 3d 13, 18 (S.D.N.Y 2020).

⁵ Melendez v. City of New York, 16 F. 4th 992, 1047 (2d Cir. 2021).

⁶ Melendez v. City of New York, 2023 WL 2746183 at *10.

⁷ Id.

⁸ Id. at *11.

⁹ Id. at *13.

¹⁰ Id. at *14.

¹¹ Id. at *16.

¹² Mansion Realty LLC v. 656 6th Ave Gym LLC, 2023 N.Y. Slip Op. 23113, n.4 (N.Y. Sup. Ct. 2023).

¹³ 1325 Fifth Ave., LLC v. Yuryeva, 2023 WL 3304213 (N.Y. Sup. Ct. May 3, 2023).

¹⁴ Kensington House NY LLC v. Accardi, 2023 N.Y. Slip Op. 31673(U) (N.Y. Sup. Ct. 2023); 128 Second Realty LLC v. Toscana Pizza Inc., 2023 N.Y. slip Op. 31954(U) (N.Y. Sup. Ct. 2023).