Commercial Leasing Principles for SME During COVID-19 – Analysis

Commercial Leasing: Sharing the pain in a “Proportionate, measured manner”

The National Cabinet Mandatory Code of Conduct – SME Commercial Leasing Principles During COVID-19.

Without a doubt, the impacts on the commercial leasing sector brought on by the coronavirus pandemic have been extreme.

With ever-changing restrictions impacting on foot traffic and patronage, many businesses who rely on customer traffic have seen severe reductions in cash flow, often impacting on their ability to pay fixed expenses, including lease payments.

Tenants are suffering cash flow problems by reduced turnover and wages for any retained staff, and the obligations on landlords to maintain mortgage repayments and outgoings will continue despite the pandemic.

Consequently, it is unavoidable that commercial leasing rent payments under leases are at risk.

The Commonwealth Government should be applauded for the roll-out of the JobSeeker and JobKeeper incentives. This first tranche of economic assistance focused on assisting those that have lost jobs (JobSeeker), and the other aimed at helping businesses to retain staff (JobKeeper).

The National Cabinet has now released next tranche being the National Cabinet Mandatory Code of Conduct – SME Commercial Leasing Principles During COVID-19 (the “Code”).

The Code is to apply through each state and territory legislation and is not intended to override the legislation of each jurisdiction but “…aims to complement it during the COVID-19 crisis period.”

That said, the Code does not apply to all tenancies. The Code will apply to landlords and tenants who are eligible for the JobKeeper program and who have an annual turnover of less than $50 million. It appears that the intent is for the Code to capture small to medium business.

One of our recent articles noted that it is crucial for landlords and tenants to openly discuss these issues that are affecting both to seek a commercial outcome. Maintaining an honest and open dialogue should never be discouraged. As a result, commercial agreements with respect to moving past the pandemic may be achieved.

Types of Conduct

This type of conduct is also reflected in the Overarching Principles of the Code where landlords and tenants are to generally:

• discuss relevant issues, to negotiate appropriate temporary leasing arrangements, and to work towards achieving mutually satisfactory outcomes;
• negotiate in good faith;
• act in an open, honest and transparent manner, and will each provide sufficient and accurate information within the context of negotiations to achieve outcomes consistent with this Code;
• consider the duration and expiry of the lease; and
• consider the structure of the leases.

Without wanting to sound sceptical, the Code does contain some cuddly language to support this position, by using terms such as negotiate in good faith, achieving mutually satisfactory outcomes and applying the Code in spirit to all leasing arrangements. However, experience tells us that when people become desperate, those goals only get you so far.

Accordingly, the Code does provide for a list of mandatory principles to guide that negotiation.

Key Leasing Principles Outlined in the Code

Accordingly, the Code provides for several leasing principles that should be applied as soon practicable, the most critical being that:

1. Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or 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. However, 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 so that the cash flow relief is in the commensurate to the turnover reduction suffered by the tenant where, at a minimum, half of the assistance must be provided for by way of a rent waiver. For example, if the tenant experiences a 60% turnover reduction then at least 30% of the relief must be by way of rent waiver, and 30% must be by way of rent deferral;
4. 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 longer unless otherwise agreed by the parties;
5. 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;
6. 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;
7. Landlords must not draw on a tenant’s security for the non-payment of rent during the period of the COVID-19 pandemic and/or a reasonable subsequent recovery period; and
8. Generally, landlords must freeze rent increases for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period.

What may be of concern to some is point 2 above where any material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under this Code. This raises the question that if a business is suffering financial hardship and is unable meet its rent obligations and is then ultimately unable to pay for the costs of repair to the premises to the satisfaction of the landlord will any agreement negotiated pursuant to the Code by negated. As any tenant will know, financial obligations extend well beyond the payment of rent.

Deferred Rent Regime

What may concern landlords is the deferred rent regime. The end of the pandemic does not require the tenant to immediately repay any and all deferred rent payments, which may be paid through the recovery period. The Code states that tenants should be provided with an opportunity to extend the lease for a period equivalent to the rent wavier and deferral period. This is not mandatory. Accordingly, a lease may expire before all of the deferred rent has been paid to the landlord. Therefore, landlords should be wary that deferred payments of rent may be at risk, particularly when leases expire not long after the crisis has concluded or the tenant’s business recovers at a slow rate.

If the landlord and the tenant are unable to agree on terms applying the principles set out above, then the parties are to refer the matter to the relevant State or retail leasing dispute resolution process. Unfortunately, for most leasing matters, the relevant referee in determining disputes is the Queensland Courts and the Queensland Civil and Administrative Tribunal.

Increased Commercial Leasing Disputes

Only time will tell as to how well Queensland will cope with a potential influx of leasing disputes seeking to be determined through any dispute resolution process and what will happen to those parties whilst waiting for any dispute resolution to occur. Given the obvious effect on businesses in Queensland as a result of the pandemic, every minute will count.

Will it work? Only time will tell with many factors at play, including the overall length of downtime due to government restrictions and the resilience of business against growing economic uncertainty.

The implementation of the Code (which must be legislated for by the State Government) is nothing short of a positive step forward in preventing the economic ruin of small business.

If any landlord and tenant require assistance in negotiating commercial leasing relief, then please contact Bill Purcell or Daniel Ronan in our Property and Real Estate team.

Individual liability limited by a scheme approved under professional standards legislation (personal injury work exempted).
This article was co-authored by Jacob Duane while under employment of Bennett & Philp Lawyers.