By Kendra McKay & Maged Jebeile
On 24 April 2020, the Retail and Other Commercial Leases (COVID-19) Regulation 2020 (NSW) (Regulation) commenced, affecting both retail and commercial leases in New South Wales. The Regulation gives effect to the National Cabinet Mandatory Code of Conduct – SME Commercial Leasing Principles During COVID-19 (Code) which was adopted by the Federal Government on 7 April 2020.
The recall of the NSW Legislative Assembly on 12 May 2020 also provided for some further fine-tuning in relation to the State Revenue and Planning Legislation and associated business affecting the NSW Property industry.
HWL Ebsworth has been engaging with its property industry colleagues, major landholder and tenant networks to navigate through the practical application of the Regulations.
The Regulation applies the Code to certain impacted lessees, it is not an automatic relief for all commercial leases. Impacted lessees must demonstrate financial tests (i.e.: be small to medium enterprise significantly impacted by the COVID-19 pandemic).
For those impacted lessees, landlords are prohibited from the exercise or enforcement of rights under the commercial or retail lease (such as termination of lease, or drawing on security, requiring interest on rent arrears) for certain breaches occurring during the prescribed period (i.e.: failure to pay rent, failure to pay outgoings, not opening for business during the hours required under the lease).
If requested by an impacted lessee, the landlord must renegotiate the rent in good faith having regard to the Leasing Principles of the Code. The Regulation does not formalise the Code per se, just direct parties to the good faith set of principles as a framework for negotiation. Some argue this still leaves it open to interpretation of the parties.
The Regulation does not prevent a landlord exercising rights / taking action in relation to a breach arising prior to the prescribed period, or a breach that is not COVID-19 related (such as damage to the premises / failure to make-good at end of lease term).
However, recognition is given to the overriding commercial interests in maintaining the commercial leasing arrangements through to recovery.
The Regulation applies to the exercise or enforcement of rights under a lease in relation to circumstances occurring during a prescribed period. The prescribed period is now the six-month period that the Regulation is in force, being 24 April 2020 to 24 October 2020. This differs from the Code (which mirrored the JobKeeper program (for six months commencing on 30 March 2002 to 30 September 2020)).
Breaches that arise prior to the prescribed period (an example being period of 30 March until 23 April 2020 (arguably during COVID-19 Pandemic)) may not be afforded the same protections.
CLASSES / TYPE OF LEASES
The Regulation applies to leases in existence before the commencement the prescribed period, being 24 April 2020, and any subsequent renewal or extension of an existing lease, being a lease that is a:
- A ‘retail shop lease’ under the Retail Leases Act 1994 (NSW) which extends to licence agreements (typical to franchise businesses) and other informal retail tenancy arrangements covered by the Act; and
- A commercial lease pursuant to the new Schedule 5 Conveyancing (General) Regulation 2018 (NSW), which relates to leasing of premises or land for a commercial purpose, it does not include agricultural leases.
On the face of it, the Regulation does not extend to commercial licence agreements or informal commercial tenancy arrangements, such as the shared-workspace environment.
It doesn’t apply to new leases entered into after 24 April 2020 unless it is a renewal or extension of an existing lease. Parties to those leases are free to negotiate terms outside the scope of the Code.
CRITERIA FOR AN IMPACTED LESSEE
The Regulation applies to small to medium enterprise (SME) tenants who meet both of the following criteria:
- Qualify for the Commonwealth Jobkeeper program which generally requires:
- the lessee operated a business since 1 March 2020;
- the business has suffered (or likely to suffer) a decline in turnover by 30% or more;
- the lessee is not in liquidation or under bankruptcy; and
- the lessee is not an excluded entity (being major banks, government or local government entities or sovereign entities).
- Annual turnover in the 2018/2019 financial year was less than $50 million:
- for franchisees – the turnover of the business conducted at the premises or land concerned;
- for members of a corporate group – the turnover of the group (which includes a subsidiary tenant or related party tenant); and
- in any other case – the turnover of the business conducted by the lessee.
- Turnover of a business includes any turnover derived from internet sales, which for retail groups can be significant where they have a significant e-commerce presence; and
- Corporations constitute a group if they are ‘related bodies corporate’ under the Corporations Act 2001(Cth).
Impacted lessees should substantiate turnover loss by providing financial information such as 2018/2019 BAS, and other audited sets of accounts / statements to the landlord. Confidentiality / Non-Disclosure Agreements should be sought as part of the negotiations.
Landlords are not required to apply the Code with regard to those tenants that do not meet the financial criteria of “impacted lessees”.
Impacted lessees can contract out of the protections, if they choose to.
RESTRICTIONS ON ENFORCEMENT OF LEASES
Landlords are prohibited from taking prescribed action against an impacted lessee during the prescribed period under the terms of the lease, or seeking orders from a court or tribunal for breaches because of:
- A failure to pay rent;
- A failure to pay outgoings;
- A failure to open for business during the hours specified in the lease; or
- Breaches of the lease in order to comply with Commonwealth or NSW State Government COVID-19 legislation (public health orders etc).
Prescribed action generally includes:
- Termination of the lease, evicting the tenant, and exercising a right of re-entry to the premises;
- Call on a bank guarantee or rental bond or pursuing a guarantor;
- Charging interest or fees on unpaid rent;
- Recovering damages; and
- Any other remedies available.
Tenants must comply with all their other (non COVID-19 related) obligations under the lease.
Landlords can still terminate a lease on expiry of a fixed term, or holdover period (e.g. month-to-month tenancy).
In the absence of a commercial agreement with the landlord, the wording of the Regulation indicates that impacted lessees are still liable for pre 24 April 2020 rent arrears (March/April rent), However, it is unclear whether the landlord is prohibited from taking prescribed action given the breach mentioned did not arise during the prescribed period but could still be COVID-19 related. Further complications arise where there are multiple breaches.
The Regulation also provides with respect to impacted lessees:
- Rent (other than turnover rent) must not be increased during the prescribed period. After the prescribed period, landlords must not take any prescribed action (such as drawing down on bank guarantee) in respect of non-payment of a rent increase due during the prescribed period; and
- Landlords must pass on the benefit of any reductions to statutory charges (such as land tax or council rates) or insurances where the lease requires fixed outgoings to be payable, or leases that pass on such holding costs.
There is a freeze on base rent increases (fixed, CPI, market) over the prescribed period.
Where impacted lessees pay fixed monthly outgoings, lessors must pass on the benefit of any outgoings reductions proportionally to the monthly amount rather than as an adjustment at the end of the financial year end cycle.
RENEGOTIATIONS OF THE LEASE
Where an impacted lessee is a party to a commercial lease to which the Regulation applies, either party can request to renegotiate the rent payable and any other terms of the lease.
If requested, both parties must renegotiate in good faith and have regard to:
- The economic impacts of the COVID-19 pandemic; and
- The Leasing Principles (3-5, 7-10 and 12) of the Code.
During the prescribed period, a landlord cannot take any prescribed action against an impacted lessee for failure to pay rent unless the lessor has complied with a request and participated in good faith negotiations.
Some key renegotiation concepts contained in the Leasing Principles include:
- Lessor to offer reductions in rent proportionate to the lessee’s reduction in turnover during the COVID-19 pandemic and reasonable recovery period;
- The reduction in rent must be in form of rent waivers (abatement) and rent deferral (repayable at a later time) during the COVID-19 pandemic and a reasonable recovery period;
- Rent waivers must constitute at least 50% of the total rent reduction;
- Rent waivers should constitute a greater portion where an impacted lessee would be compromised to fulfil their ongoing obligations under the lease subject to the lessor’s financial ability to provide the additional waiver;
- Rent deferrals must be amortised over the greater of the balance of the lease term or 24 months unless otherwise agreed;
- Waiver of outgoings where tenants are unable to trade / or reduction in services could be considered;
- Such rent relief amount must include a reasonable subsequent recovery period for the tenant after the COVID-19 pandemic; and
- Lessees should be provided with an opportunity to extend the lease for an equivalent period of the rent reduction period with the intent to provide additional trading time on existing lease terms during the recovery period after the COVID-19 pandemic concludes.
The landlord isn’t liable for 100% of the tenant’s losses, i.e. where a closure relates to a loss of 100% of the business of a tenant. It needs to be proportionate and have regard to the landlord’s capacity. Example: subject to the landlord’s loan repayment deferrals (linked to ABA announcement for deferrals of repayments of < $10m).
If the lease expires before the end of the 24-month deferral period then the deferral repayments would continue until repaid.
The concept of reasonable recovery period (in respect of deferred rent repayments) in the Code is not brought into the Regulation (other than with a reference to the Leasing Principles). This is a matter for commercial negotiations between the parties.
A landlord should consider reviewing the expiry dates of existing bank guarantees or security held under the lease and the current lease terms to ensure that the security remains current and can be retained by the Landlord for the deferral period. Any necessary changes to security or the lease terms should be considered as part of the negotiations. Except for simple matters like a short-term rent reduction, which can be agreed by letter or email, anything complicated or longer term should be recorded in a variation of lease.
Example:- commercial lease with a current rent of $100,000 per month:
- Where the tenant met the definition of ‘impacted lessee’, and requested a rent reduction from the landlord based on a 55% reduction in turnover (and substantiated such loss of income with audited financials);
- The parties must renegotiate in good faith, and could agree, by way of example, to a proportionate reduction in rent, to be an amount of $45,000 per month payable; and
- The tenant must pay the reduced amount agreed, otherwise in accordance with the lease terms.
In accordance with the Code, 50% of the agreed reduction (being an amount of $27,500) must be waived and the remaining 50% (being an amount of $27,500) must be deferred as gradual payments over greater period of balance of the lease term or at least 24 months. No fees, interest, charges can be applied to these deferred amounts during the prescribed period.
Where attempts to renegotiate in good faith with an impacted lessee have failed, the Regulation provides for mandatory mediation before the action can be taken in the tribunal/court.
The Regulation adopts separate dispute resolution mechanisms for retail leases and commercial leases, however both retail and commercial leases must refer to the NSW Small Business Commissioner (with some exceptions) and the Commissioner needs to certify the mediation failed before initiating proceedings in a court or tribunal.
The Regulation requires a court or tribunal to have regard to the Leasing Principles of the Code when considering a decision or order enforcement action.
Before a landlord can draw on the tenant’s bank guarantee and/or terminate the lease for non-payment of rent during the prescribed period, the landlord must first attempt mediation to resolve the dispute.
The requirement for mediation with respect to commercial (non-retail) lease, appears to apply broadly to any commercial lease dispute (not just impacted lessees). However, when this provision is read in conjunction with other clauses of the Regulation, it may be intended that the requirement for mediation only applies to disputes involving impacted lessees relating to circumstances occurring during the prescribed period. Given the uncertainty, a landlord should carefully consider application of the Regulation to any given dispute during the prescribed period before taking any enforcement action.
The Regulation does not prevent enforcement action on grounds not related to the economic impacts of the COVID-19 Pandemic.
The existing rules of equity and common law continue. For example, tenant’s seeking relief against forfeiture (which gives the tribunal/court broad discretion to prevent a landlord from terminating a lease on grounds of equity and fairness) is unaffected.
LANDLORDS MAY BE ELIGIBLE FOR LAND TAX RELIEF
The NSW Government is introducing land tax relief measures to support landlords to manage their tenancies including reductions of up to 25% on the land tax payable for 2020.
To be eligible for the land tax support package:
- You must have a land tax liability in 2020;
- Have a COVID-19 affected tenant (according to the impacted lessee criteria outlined above);
- You reduce the rent (or outgoings) of the affected tenant by at least as much as the tax reduction; and
- The land tax must directly relate to the property for which rent has been reduced.
The application process is now available through the Revenue NSW web site.
Supporting documents may be required to show the lessee is in financial distress for the application including BAS statements, or a letter from the lessee’s accountant.
Revenue NSW may also require evidence that the lease was reduced in response to this financial distress, such as copies of the current lease terms and subsequent agreements (such as a variation of lease) that indicate the rent reduction.
Our Stamp Duty Partner John Caravousanos is advising clients on these updates.
REINSW thanks HWL Ebsworth Lawyers for this article.
Kendra McKay is a Partner and Maged Jebeile a Special Counsel at HWL Ebsworth.
Important Disclaimer: The material contained in this publication is of general nature only and is based on the law as of the date of publication. It is not, nor is intended to be legal advice. If you wish to take any action based on the content of this publication we recommend that you seek professional advice.
Retail and Other Commercial Leases (COVID-19) Regulation 2020 (NSW)
National Cabinet Mandatory Code of Conduct – SME Commercial Leasing Principles During COVID-19
Retail Leases Act 1994 (NSW)
Conveyancing (General) Regulation 2018 (NSW)
Corporations Act 2001