15 April 2020
Stuart Dixon-Smith, Simone Menz, Carl Black, Chris Wheeler, Mark Bayliss, Francesca Giorlando, Chris Mitchell, Julia Nikolic and Tristan Howes.
On 7 April, the National Cabinet announced a Mandatory Code of Conduct (Code) for COVID-19 impacted small and medium sized commercial tenants. The good faith leasing principles imposed by the Code stand to radically alter the rights of affected landlords and tenants, and we would anticipate that their implementation will require careful legislation from States and Territories and complex bilateral negotiations between landlord and tenant parties. The Code seeks to share the burden of the challenging conditions faced by the property sector (including through a sharing of benefits provided to landlords by their banks) and to ensure commensurate protections are in place to support Australian businesses. Whilst the Code was prepared after consultation with stakeholders in the commercial property sector, many aspects will require further development by both State and Territory government and industry participants to ensure clear and successful outcomes.
This alert sets out the changes to existing commercial leasing arrangements required by the Code, and considers the implications and opportunities for landlords and tenants.
Whilst the Code has been developed to enable a consistent national approach and application, the States and Territories will each separately introduce legislation to give effect to the Code. Commencement will be determined by each State and Territory and the Code is intended to apply for as long as the Commonwealth JobKeeper program is operational (COVID Period). Regardless of the dates on which individual States achieve legislative adoption of the Code, the Code proposes commencement of the measures from a date after 3 April, within individual State legislation to define the date.
The Code applies to commercial tenancies where the tenant is both:
The principles espoused in the Code are also intended to apply “in spirit” to the leasing arrangements of all businesses affected by the COVID-19 pandemic, regardless of whether they meet the specific eligibility criteria. The below rules will not strictly apply to ineligible tenancies, but nonetheless may provide guidance for negotiations which might occur as a result of the COVID-19 pandemic.
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”:
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.
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, 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 Period 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.
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.
Landlords must not increase the rental amounts payable by commercial tenants during the COVID Period 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.
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.
There was an initial indication that tenants would be provided with an arbitrary right to terminate their lease, unless landlords signed up to the Code. However, this has not materialised.
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 extending to cover the deferred rent.
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 by the law) would then generate an automatic 100% decrease in turnover as a result and would then be entitled to a comparable rent reduction.
If statutory changes result in a reduction of the land tax, council or Territory 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 separate State and Territory Government commitments to provide direct waivers or deferrals of land tax. This appears to reflect the standard provisions of most net lease arrangements, although further reductions may be required for gross lease arrangements.
The expectation is that States and Territories will be passing complementary laws to provide this tax relief. Indeed the ACT has already made those announcements.
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 Period. The additional prescribed factors which should be taken into account by parties in arriving at their individual arrangements include:
Given the detailed nature of the Code, a number of implications are clear at this stage:
However, many details within the Code will require further clarification, including:
The Code presents landlords and tenants with the flexibility to agree the terms of any variations to their existing commercial leasing arrangements, in line with the stated principles, rather than seeking to provide a one size fits all solution. This creates both opportunities and challenges to reach mutually beneficial commercial arrangements.
We are on hand 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.
Thank you to King and Wood Mallesons for letting us reproduce this article.
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