GENERAL INFORMATION FOR LANDLORDS RE COVID 19 AND TENANTS RENT REDUCTIONS

06 May GENERAL INFORMATION FOR LANDLORDS RE COVID 19 AND TENANTS RENT REDUCTIONS

disclaimer/use of this information
this information is general in nature and does not constitute legal advice. you must not rely on it. legal advice based on your specific circumstances should be sought by you.

On 7 April 2020, the National Cabinet announced a Mandatory Code of Conduct (Code) to apply to small and medium sized commercial tenancies impacted by the COVID-19 pandemic. The Code aims to alter the rights of affected landlords and tenants for commercial tenancies and is intended to have nationwide application. However, each State needs to introduce legislation or regulation to adopt, implement and enforce the Code.

What is the Code?

The Code applies from 7 April 2020. It will apply to commercial tenancies for as long as the Commonwealth’s JobKeeper program operates.

The Code applies to:

• small or medium sized commercial enterprises (including retail, office and industrial tenancies) with an annual turnover of less than $50 million per year (measured at the franchisee level for franchises and at the group level for retail corporate groups). It is thought the intent is for the grouping to apply to all corporate tenants, not just retail groups; and
• that are eligible for the Commonwealth’s JobKeeper program.  

The key requirements

The Code is based on good faith leasing principles and is designed to encourage parties to reach mutually agreeable outcomes. However, its “principles” include the following guidance, to be applied on “a case by case basis”:

• the Code includes several express positive obligations required of negotiated outcomes:
  • Rent reductions: landlords must reduce rent proportionately to the decline in the tenants business, measured by the reduction in turnover.
  • This applies during the period of the COVID-19 pandemic plus a ‘reasonable recovery period’.
  • The reduction is to be a combination of waivers and deferrals of rent.
  • Alternate outcomes such as deferral, pausing or hibernating may also be used to reach commercially agreed outcomes; and
  • Lease obligations remain on foot: tenants must remain committed to the terms of the lease and continue to pay rent where possible.

The Code also imposes a number of restrictions that apply during the COVID-19 Period and a reasonable recovery period:

• Rent increases: landlords must not impose rent increases (except in the case of retail turnover rent);
• Terminations: landlords must not terminate leases for the non-payment of rent;
• Securities: landlords must not draw on tenant securities (including personal guarantees) for the non-payment of rent;
• Penalties: landlords are prohibited from imposing penalties for tenants who stop trading or reduce opening hours; and
• Interest: landlords must not charge interest on any unpaid rent.

Despite the level of prescription, the Code seeks to promote flexibility for landlords and tenants in several respects:

• the Code includes a number of broad overarching principles encouraging tenants and landlords to work together to share the financial burden during the COVID-19 pandemic;
• landlords and tenants are encouraged to negotiate in good faith amendments to their existing arrangements that are bespoke and appropriate to their particular circumstances; and
• an expectation that landlords will work with their banks to share the burden, and share any benefits provided to them with tenants; and
• the arrangements will be overseen by a binding mediation process coordinated by each State.

The Changes in detail

Lease obligations

• Tenants must continue to observe the terms of the lease, subject to any agreed amendments. 
• This is expressed as a prerequisite to the applicability of the Code, with any material disregard of the lease by the tenant to result in forfeiture of the specific protections set out in the Code.

Rent reductions

• Landlords must provide reductions in the rent payable by the tenant, proportionate to the reduction in the tenant’s turnover, during the course of the pandemic and a reasonable recovery period thereafter.  Rent reductions may provide up to a 100% reduction of the rental amounts normally payable by the tenant. 
• Rent waivers must account for at least 50% of any rent reduction (unless waived by the tenant), and should make up a higher proportion where the tenant would otherwise be unable to fulfil their lease obligations and having regard to the financial ability of the landlord.
• Any such rent waivers may not be recovered by landlords during the remaining term of the lease. 
• This will lead to the requirement for tenants to be very transparent to landlords about their financial position, including both their cashflow position and their financial reserves (cash, loan facilities and equity positions).
• The balance of the rent reduction should be made up of rent deferrals, repayable over the greater of the balance of the term and 24 months after the COVID-19 pandemic and a reasonable recovery period (except as otherwise agreed). 
• It is not immediately clear how a 24 month repayment period would be implemented where the balance of the term is less than 24 months.
• The expectation is that the relief agreement would be an enforceable enduring arrangement potentially well past the term of the lease in some cases.
• The rent reductions are likely to apply only to net rent. Outgoings can still be recovered, although landlords are asked to seek to waive recovery whilst tenants are unable to trade.
• Landlords must not impose any fees, interest or charges in relation to any agreed rent waivers and deferrals. This contrasts to the position of many loan deferral arrangements with the banks.

For example:

• a tenant experiencing a 40% decrease in turnover as a result of measures taken to deal with the COVID-19 pandemic would be entitled (in principle) to a reduction in the corresponding rent by 40%, with at least half of this reduction being a permanent waiver;
• if the monthly rent was $10,000, the tenant would pay $6,000 each month; and
• $2,000 each month is deferred (and payable over a period of at least 24 months after the reasonable recovery period), whilst $2,000 each month is permanently waived by the landlord.

Extended terms

• Tenants should be provided with the opportunity to extend lease terms for an equivalent period of the rent waiver and deferral period.
• This would provide them with an opportunity to trade during the eventual period of recovery, whilst providing time to repay any deferred rent.

Rent increases

• Landlords must not increase the rental amounts payable by commercial tenants during the COVID-19 pandemic and a subsequent reasonable recovery period.  The duration of the recovery period has not been defined, and it is likely that further detail will be provided by States and Territories.  If this detail is not forthcoming, allowances for a reasonable recovery period will need to be negotiated between landlords and tenants.
• The prohibition on rental increases applies regardless of any arrangements between tenants and landlords in their existing commercial leases, but excludes increases due to turnover rent provisions of retail leases.

Terminations

• Landlords may not terminate leases due to the non-payment of rent during the COVID-19 pandemic and a subsequent reasonable recovery period, regardless of the terms of the existing lease.
• This does not prevent the lease being terminated for reasons other than the non-payment of rent, taking into account the overarching principles of the Code.

Securities

• In addition to the termination restrictions, landlords are precluded from drawing down tenant securities such as bank guarantees, security deposits, bonds or personal guarantees, due to the non-payment of rent by tenants.  Again, this does not prevent landlords drawing on these securities in other circumstances permitted under the lease, taking into account the overarching principles of the Code.
• Nor is there a restriction on landlords when entering into relief agreements from requiring those securities being extended to cover the deferred rent.

Penalties

• Landlords may not penalise tenants who reduce operating hours or cease trading by reason of the COVID-19 pandemic. It is not clear, however, whether a tenant which elects to close (rather than being forced to by law) would then generate an automatic 100% decrease in turnover as a result and would then be entitled to a comparable rent reduction.

Land tax and other outgoings

• If statutory changes result in a reduction of the land tax, council or State government rates or other charges payable by a landlord, or insurance costs, the landlord must pass a proportion of these savings to the tenant as required by the terms of the lease. This will include the pass through of State Government commitments to provide direct waivers or deferrals of land tax.

Individual arrangements

• Parties are expected to formally document their arrangements to ensure the agreed variations to their existing commercial leasing arrangements are recorded, and may be referenced and amended as required during, and after, the COVID-19 pandemic. The additional prescribed factors which should be taken into account by parties in arriving at their individual arrangements include:
• the revenue, expenses and profitability of the tenant;
• the specific impact of the COVID-19 pandemic on the tenant;
• the commercial arrangements applicable to the specific premises;
• whether the tenant’s lease has expired, is due to expire or is in “hold-over”;
• whether the tenant is in receivership or administration;
• the structure, period of tenure, and mechanism for determining rent in the existing lease; and
• whether the tenant was in arrears prior to the COVID-19 pandemic.

Recommendations

We suggest that landlords:

• request tenants to provide relevant information and evidence to demonstrate that the tenants are eligible for relief under the Code.  
• Landlords may pay particular attention to tenant’s online sales and may seek comfort from the tenant’s accountants and bankers about the information provided by tenants;
• give their bank visibility on their discussions with tenants and request that the bank give the landlord relief from their financial covenants and payment obligations;
• prepare a pro forma variation of lease or side deed which protects the landlord’s interests, while still complying with the requirements of the Code.  Issues to consider before commencing negotiations with tenants are:
  • whether there are tax or accounting consequences in deciding to give a rent waiver or a deferral;
  • if the lease contains an incentive which has not been utilised or foregone, whether this can be used to implement the rent relief;
  • whether the agreement can be drafted by way of a deed which is not registered on title to protect confidentiality;
  • whether any consequential changes need to be made to the lease, such as an extension of the term, an increase in security, confirmation that the variations must not affect any market rent review under the lease, changes to trading hours or other operational issues;
  • requiring regular reporting from tenants on trading;
  • consider whether any changes should be agreed to the rent relief arrangements if the tenant’s trading improves before the pandemic ends, or the government introduces additional measures to support tenants or landlords; and
  • whether any provisions can be incorporated in the agreement to ensure the tenant is not relieved from any breaches of the other provisions of the lease and the landlord has the ability to exercise its rights in respect of such breaches.

We recommend that whilst you must negotiate with your tenants you do not enter into a long term agreement since the cessation of the pandemic or its impact on your tenants business may diminish or change from month to month.

Accordingly you should consider reviewing the impact on your tenants business on a regular basis and every 2 to 3 months.  

Ultimately, this would be preferable to vacant premises where a tenant’s business does not survive the pandemic.

If you are a landlord the subject of an affected commercial tenancy, you should carefully consider the key items listed above.  The Code as it currently stands is largely tenant friendly.  There will be both flow-on issues and practical issues for landlords to carefully consider in the coming months.  If you need assistance with navigating these foreseeable issues or assistance with negotiating or documenting any agreed variations to leases, we can assist you in this regard. Please call us on 8212 1322 to discuss your unique case with us.