Commercial Leasing and COVID-19

  • COVID-19
  • Published 21.04.2020

Summary

The National Cabinet has, on 7 April 2020, approved a legally enforceable Mandatory Code of Conduct that will apply to SME commercial leasing during the period of the COVID-19 pandemic (including a reasonable subsequent, but as yet unspecified recovery period).

The purpose of the Code is to impose a set of good faith overarching and leasing principles for application to commercial tenancies (including retail, office and industrial) between landlords and eligible tenants.

Application of the Code 

The Code applies to all commercial tenancies (including retail, office and industrial) where the tenant is eligible for the Federal Government’s JobKeeper Program and has an annual turnover of $50 million per annum or less (SME tenants). The $50 million turnover limit will apply at the retail group level for retail tenants and at the franchisee level for franchises.

The Code will apply to eligible tenants, even though they may have entered into pre Code agreed rental reductions or other lease variations with their landlord. If these agreed lease variations provide for rent relief or other repayment obligations which are not as favourable as those under the Code, tenants will be able to renegotiate these lease variations in accordance with the terms of the Code.

The Code will apply whilst the JobKeeper program is operational – initially six months. To be eligible for the JobKeeper program, a tenant will have to have suffered at least an estimated 30% decline in turnover over a corresponding BAS period 12 months earlier as a result of the COVID-19 pandemic and be otherwise eligible for the program. Governments and their agencies are not eligible for the program. 

The Code will be given effect through relevant State or Territory legislation or regulation, yet to be introduced in Victoria. It is unclear whether the Code will be adopted as is, or whether uncertainties present in the Code will be dealt with in the legislation or regulations. It is possible that any such legislation or regulation would be retrospective in its operation.

We also note that the Victorian Premier, Daniel Andrews, on 21 March 2020 in the State Government’s Economic Survival Package to Support Businesses and Jobs press release, announced that “Commercial tenants in government buildings can apply for rent relief – a move private landlords are also being encouraged to undertake – and 2020 land tax payments will be deferred for eligible small businesses.” It is not clear how this proposal will dovetail with the Code.

Overarching Principles

The intention of the Code is to aid the management of cash flow for tenants and landlords on a proportionate basis as a result of the impact of COVID-19, whilst seeking to appropriately balance their interests. 

The main Overarching Principles can be summarised as:

  • landlords and tenants must engage to achieve satisfactory temporary leasing outcomes;
  • each lease must be dealt with on a case-by-case basis;
  • parties are required to engage in good faith negotiations, with transparency and honesty;
  • landlords and tenants are to assist each other in dealing with other stakeholders, including utility service providers and banks;
  • the commercial positions of each party are to be recognised.

Leasing Principles

The Code confirms that the following leasing principles should be applied in negotiations between landlords and tenants on a case by case basis:

  1. Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or a reasonable subsequent recovery period).
  2. Tenants must remain committed to the terms of their lease, subject to any amendments to their rental agreement negotiated under this Code. Material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under this Code.
  3. Landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals of up to 100% of the amount ordinarily payable, on a case-by-case basis, based on the reduction in the tenant’s trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.
  4. Rental waivers must constitute no less than 50% of the total reduction in rent payable under principle #3 above over the COVID-19 pandemic period and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease agreement. Regard must also be had to the landlord’s financial ability to provide such additional waivers. Tenants may waive the requirement for a 50% minimum waiver by agreement.
  5. Payment of rental deferrals by the tenant must be amortised over the balance of the lease term and for a period of no less than 24 months, whichever is the greater, unless otherwise agreed by the parties.
  6. Any reduction in statutory charges (e.g. land tax, council rates) or insurance will be passed on to the tenant in the appropriate proportion applicable under the terms of the lease.
  7. A landlord should seek to share any benefit it receives due to deferral of loan payments, provided by a financial institution as part of the Australian Bankers Association’s COVID-19 response, or any other case-by-case deferral of loan repayments offered to other landlords, with the tenant in a proportionate manner.
  8. Landlords should where appropriate seek to waive recovery of any other expense (or outgoing payable) by a tenant, under lease terms, during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.
  9. If negotiated arrangements under this Code necessitate repayment, this should occur over an extended period in order to avoid placing an undue financial burden on the tenant. No repayment should commence until the earlier of the COVID-19 pandemic ending (as defined by the Australian Government) or the existing lease expiring, and taking into account a reasonable subsequent recovery period.
  10. No fees, interest or other charges should be applied with respect to rent waived in principles #3 and #4 above and no fees, charges nor punitive interest may be charged on deferrals in principles #3, #4 and #5 above.
  11. Landlords must not draw on a tenant’s security for the non-payment of rent (be this a cash bond, bank guarantee or personal guarantee) during the period of the COVID-19 pandemic and/or a reasonable subsequent recovery period.
  12. The tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period outlined in item #2 above. This is intended to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the COVID-19 pandemic concludes.
  13. Landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period, notwithstanding any arrangements between the landlord and the tenant.
  14. Landlords may not apply any prohibition on levy any penalties if tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.

Leases not covered by the Code

The Code provides that its principles should apply in spirit to all leasing arrangements for affected businesses of otherwise non eligible tenants, having regard to the size and financial structure of those businesses.

Notwithstanding, where the Code does not apply, landlords and tenants will be subject to their existing leasing arrangements and general legal principles which apply. 

Most commercial leases will not contain force majeure provisions (events beyond the reasonable control of a party which would prevent them from fulfilling their obligations under the lease) allowing the lease to be terminated due to an event such as the COVID-19 pandemic, nor would standard rent abatement clauses apply. Additionally, we would not expect that the legal doctrine of frustration (where through no fault of either party to the lease, it becomes impossible to perform the obligations under the lease) would apply to allow termination of a lease. This should be the case, even where State or Federal Governments exercise statutory powers requiring closure of premises for the duration of the pandemic.

Accordingly, whilst non-eligible Code tenants will not, as a matter of course, be entitled to relief from the payment of rental or outgoings under the lease, issues of rental relief or deferral will remain a matter for negotiation between landlords and tenants.

Mediation 

Where landlords and tenants are unable to agree on amendments to their leasing arrangements under the Code, either party may refer the matter for binding mediation by the applicable State or Territory dispute resolution process.

Rent Relief

The Code’s approach to the issue of rental relief is on the basis of proportionality, seeking to balance the financial risk and cash flow of the impact of the pandemic between landlords and tenants. Both parties will need to deal with confidentiality and privacy issues regarding any exchange of information between them in order to facilitate compliance with the Code.

The Code requires that landlords offer tenants proportionate reductions of up to 100% in rent based on the reduction in the tenant’s trade, without any real guidance as to how this reduction in trade is to be measured.

In order to determine the impact of the COVID-19 pandemic on tenant’s trade, tenants will need to provide landlords with financial information (turnover figures) for a comparable period from the prior year. This information must be sufficient and accurate and generated from an accounting system, and information provided to and/or received from a financial institution. 

Likewise, landlords will need to provide tenants with details of any reduction in statutory outgoings or insurance and the benefit of any loan deferrals that they receive.

Rental reductions will consist of a combination of waivers and deferrals in accordance with requirements as follows:

  • rental waivers are to comprise not less than 50% of the total rent reduction allowed to the tenant under the proportionality principle, unless waived by the tenant;
  • rental deferrals are to be amortised over the balance of the lease term and for a period of not less than 24 months, whichever is greater, unless otherwise agreed by the parties;
  • negotiated repayments are to avoid placing any undue financial burden on tenants and should not commence until the earlier of the pandemic period ending or the lease expiring after taking into account a reasonable subsequent recovery period;
  • tenants are to be provided with an opportunity to extend the lease for an equivalent period of the rent waiver and/or deferral period, so as to provide the tenant additional time to trade on existing lease terms, during the recovery period after the pandemic concludes;
  • no fees, interest or other charges are to be applied to waived or deferred rent;
  • rental waivers must constitute no less than 50% of the total reduction in rent payable, and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease agreement (while having regard to the landlord’s ability to provide such waivers). Rental waivers are unable to be recouped by the landlord over the term of the lease.

Rent Relief Example

The following example draws on the Leasing Principles noted above:

  • rental waivers must constitute no less than 50% of the total reduction in rent payable;
  • rental deferrals are to be amortised over the balance of the lease term and for a period of not less than 24 months, whichever is greater.

An eligible tenant that suffers a 60% loss in turnover would receive a guaranteed 60% cash flow relief. Half of the relief is to be provided as a rent-free/rent waiver and up to half could be through a deferral of rent with this to be recouped over at least 24 months in a manner to be negotiated.

Current rental $10,000 per month. Cash flow relief will be a guaranteed $6000 per month.

At a minimum, half of this amount, $3000 will be provided as rent free/rent waiver, with a deferral of the balance of $3000 to be repaid over the balance of the lease term or at least a 24 month period, whichever is greater.

Repayments are not to commence until the earlier of the COVID-19 pandemic ending (as determined by the Federal Government) or the existing lease expiring and taking into account a reasonable subsequent recovery period.

Outgoings, Other Expenses and Savings

The Code requires that a landlord pass on to the tenant any reduction in statutory outgoings or insurance and the benefit of any loan deferrals that it receives, in the appropriate proportion applicable under the terms of the lease. Further, landlords are required to waive recovery of any other expense payable by a tenant during a period that the tenant is unable to trade. It is noted that landlords reserve the right to reduce services as required.

Rent Reviews

The Code makes it clear that landlords must agree to a freeze on rent increases (except for retail leases based on turnover rent), for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period. Given there is no equivalent freeze on rent reductions which may occur following market rent reviews, landlords may seek to defer or waive rent reviews by agreement until the Code is no longer in force.

Lease Evictions

Under the Code, it is clear that landlords are not to terminate leases due to non-payment of rent (including renegotiated rent) during the COVID-19 pandemic and a reasonable subsequent recovery period. That said however, landlords are still able to terminate leases for breaches of material terms (other than non-payment of rent) in accordance with the default provisions in the lease.
The Code prevents landlords from making a claim on a bank guarantee, cash deposit, personal guarantee or other security for non-payment of rent, however, claims on these securities for other breaches of the lease by the tenant may be made in the usual way.

Legal Advice

It would be prudent for the parties to appropriately document any agreed variations to the terms of their lease (rental/outgoings reductions and waivers/deferrals, payment arrangements and services reductions) after obtaining legal advice.
 

Stephen Teale

Partner

P: 03 8600 5008

Email Stephen