COVID-19: COMMENTARY ON COMMERCIAL LEASING PRINCIPLES
- April 15, 2020
- April Peterson
- Comments Off on COVID-19: COMMENTARY ON COMMERCIAL LEASING PRINCIPLES
On 7 April 2020 the Federal Government announced a mandatory Code of Conduct (‘Code’) setting out Leasing Principles to govern commercial tenancies affected by the COVID-19 pandemic.
WHAT ARE THE LEASING PRINCIPLES?
The Code sets out the following Leasing Principles to be applied in negotiating and enacting appropriate temporary arrangements. Our comments are included under each of the principles.
Principle 1: Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or reasonable subsequent recovery period).
Whilst this restriction on termination relates only to the non-payment of rent, it is expected that a landlord will also be prevented from terminating a lease for breach of a trade or keep open covenant, this being consistent with other statements in the Code. Presumably a landlord’s rights (including a right to terminate) for a breach of any other lease covenant will remain unaffected.
It remains unclear whether the Code will limit or prohibit a landlord from taking action, including terminating a lease, in respect of arrears arising prior to the commencement date of the Code.
Principle 2: Tenants must remain committed to the terms of their lease, subject to any amendments to their rent negotiated under the Code. Material failure to abide by substantive terms of their lease will forfeit any protections provided to tenants under the Code.
The protections afforded to a tenant under the Code is subject to the tenant’s compliance with the terms of their lease as varied by any rent relief arrangement pursuant to the Code. As such if a tenant fails to pay rent (as reduced and/or deferred) or comply with any of its other obligations, the protections of the Code would be waived.
Principle 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, but generally using the principle of ‘proportionality’ to reduce the rent proportionately to the reduction of a tenant’s trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.
There is no distinction made between a tenant that closes their business voluntarily as opposed to those forced to cease trade by government order. There is also no guidance as to how online sales should be taken into consideration where a tenant closes physical outlets.
A key issue for landlords will be determining whether a tenant’s turnover is less than $50 million per annum and what percentage the tenant’s turnover has reduced. While the Code requires a tenant to provide “sufficient and accurate information” it is silent on what that information comprises and how it is to be provided. A tenant may be reluctant to provide certain information and confidentiality and privacy issues may create challenges.
Principle 4: Rental waivers must constitute at least 50% of the total rent reduction granted over the COVID-19 pandemic period and should constitute a greater proportion of the total rent reduction in cases where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease. Regard must also be had to a landlord’s financial ability to provide such additional waivers. Tenants may waive the requirement for a 50% minimum waiver by agreement.
No guidance is provided for landlords or tenants on:
- the circumstances in which it is appropriate that the rent waived should exceed 50%; or
- determining the amount and extent to which rent should be waived as compared to deferred,
save that care should be taken to ensure that any agreed reduced payment and/or deferral of rent arrangement does not compromise the ability of the affected tenant to recover from the crisis.
Principle 5: Repayment of deferred rent 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.
The minimum instalment period of 24 months means that the tenant may have repayment obligations in respect of deferred rent that continue past the expiry of the lease. The expiry date for any lease security should therefore be reviewed and considered in any deferred rent arrangements.
Principle 6: Any reduction in statutory charges (e.g. land tax, council rates) or insurance must be passed on to the tenant in the appropriate proportion applicable under the terms of the lease.
This principle is separate and in addition to any rent relief arrangement and is regarded as a direct proportionate pass through by the landlord.
Principle 7: Landlords should seek to share any benefits received 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 tenants in a proportionate manner.
How this principle is required to be implemented is unclear. Benefits and relief from lenders remain subject to change, are undefined and may be difficult to quantify or share with a tenant.
Principle 8: Landlords should, where appropriate, seek to waive recovery of any other expense (or outgoing payable) by a tenant under their lease, during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.
This principle raises similar questions to those identified in Leasing Principle 3 with no distinction between a tenant who voluntarily ceases trade as opposed to one forced to cease by government order.
Principle 9: If rent is deferred, repayment by tenants 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.
The parties are encouraged to seek agreement around what a reasonable recovery period would be by taking into account their particular circumstances on a case by case basis.
Principle 10: No fees, interest or other charges should be applied with respect to rent waived and no fees, charges nor punitive interest may be charged on rent deferred.
Principle 11: Landlords must not draw on a tenant’s security (be this a cash bond, bank guarantee or personal guarantee) for the non-payment of rent during the period of the COVID-19 pandemic period and or a reasonable subsequent recovery period.
The Code does not refer to any restriction on a landlord drawing or calling on a lease security for a breach of a term of the lease other than non-payment of rent. In taking such action a Landlord is however required to consider the Overarching Principles of the Code.
It remains unclear whether the Code will prohibit a landlord from drawing or calling on a lease security, in respect of rent arrears arising prior to the commencement date of the Code.
Principle 12: Tenants should be provided with an opportunity to extend their lease for an equivalent period of the rent waiver and or deferral period as outlined in principle 2. 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.
Principle 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.
This principle is not a waiver for the rent increases. Rent increases can and will apply immediately upon the end of the “reasonable subsequent recovery period”. This could result in multiple rent reviews taking place within a relatively short space of time to account for the frozen rent review and the next rent review immediately following. In circumstances where a market rent review applies and results in a rent decrease, the rent decrease will still need to be implemented unless a valid rachet provision applies.
Principle 14: Landlords may not apply any prohibition or levy any penalties if tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.
We are available to assist landlords and tenants to work through these complex requirements and negotiate outcomes to protect their businesses through the COVID-19 pandemic and best position them for recovery.
All information is current as of 4:00pm on 14 April 2020, based on publicly available information.
Disclaimer: This update does not intend to provide legal advice and should not be relied upon as such. If you require independent legal advice or would like to discuss any of the issues raised that may be applicable to your situation, please do not hesitate to contact our team.
Liability limited by a scheme approved under Professional Standards Legislation.
Prepared by Darryl Kipping and Dora van der Westhuyzen