COVID-19 – offsetting the impact on commercial tenants & landlords


Posted By on 22/03/20 at 1:35 PM

Various articles have explored the potential rights that tenants and landlords have under their leases, in the face of the impact of COVID-19.  Most leases do not deal with unprecedented events such as we are currently facing with COVID-19.  In summary, and subject to the specific terms of the relevant lease, landlords and tenants (in particular) are in a no-win position where if they take what may be considered reasonable steps to minimise impacts of COVID-19, they may be in breach of their lease obligations.

Landlords are reluctant to shutdown retail centres, industrial sites and office buildings unless forced to do so by government order or circumstances (eg evidence of an outbreak) given the risk they will breach obligation to provide access, services and quiet possession.  Meanwhile tenants are not generally entitled to rent relief, or to reduce trading hours to deal with highly diminished (or in some cases, highly concentrated) demand.  Force majeure clauses in leases are rare, frustration is a narrowly applied doctrine, rent abatement clause are not generally applicable, and retail tenancies legislation is not particularly helpful in the present circumstances.  Further, it is not generally unconscionable for a party to simply insist upon another party complying with its contractual obligations.  Finally, business interruption insurance is not generally available in relation to the impact of COVID-19.

Tenants may also need to take into account that some outgoings may be higher in the coming months as a result of increased cleaning (sterilisation) and administrative burdens, and later as part of marketing and communications to encourage customers to return.

Accordingly, many tenants are now approaching landlords to discuss arrangements for relief from obligations under their leases.  To their credit, some landlords have been open to these discussions.  Others have seemed more content to let the burden lay where it landed – largely with the tenant.

While landlords may feel entitled to enforce their lease obligations, doing so to the point that tenants (who may already be struggling in the face of retail downturns, bushfires, and global pressures) are pushed to the wall or otherwise decide that despite the talk of “relationships” and “working together” are simply words, may have significant longer term ramifications for the longer term return on their property holdings.  Tenants may reach a point where they decide to take the risk of closing altogether, and defending (if there is any money left) any claims by landlords whose focus may be better directed towards recovery.

KHQ Commercial Property - COVID-19

What are the alternatives?

Rent Relief

The primary alternative is rent relief.  Tenants may be relieved of all or part of their obligations to pay rent for a period while COVID-19 continues to materially impact society.  The extent (percentage) of that relief and long it will be granted will likely depend upon:

  • whether the lease is a net lease (outgoings plus base rent) or a gross rent (rent incorporates outgoings)
  • the nature of the tenant’s business (with discretionary, non-essential sectors such as entertainment, travel and certain personal services particularly hard hit)
  • whether there is a market rent review due shortly.

I have discussed with clients models whereby rent reductions are tied to tenant turnover or customer numbers – both of which have complications, but may be appropriate where there is reliable data.

In addition, parties need to consider what happens if the impacts last much longer or shorter than is currently anticipated.  Landlords will likely be reluctant to grant extensive relief, in case the impacts are dealt with more promptly than expected.  However, given that’s the case, where there are ongoing measurable impacts, it might be preferable for a tenant to be entitled to call on an extension of the relief offered, under agreed arrangements.

Of course, parties can always hold discussions again at a later date, but where minimal relief is offered with a commitment to “act reasonably in considering further arrangements” the offers sound somewhat hollow.  Accordingly, any such arrangements would likely need independently identifiable triggers or good faith negotiation obligations.

Temporary conversion to turnover rent

A further alternative for retail tenants may be to agree to pay only turnover rent for a specified time.  This can represent a genuine sharing of risk – although landlords may be reluctant to agree, since the successful operation of the business is generally more within the control of the tenant.  In addition, if turnover rent is not something a business regularly pays, ensuring that appropriate thresholds and percentages are specified can be a challenge.

Rent deferral

I have seen landlords offer to defer partial payment of rent until a later date.  However, in my view, this is minimal genuine sharing of the burden of the impact of COVID-19.

Surrender of leases

Particularly where a tenant has multiple sites with the same landlord, it might be better to surrender a premises in one or two locations to free up resources to ensure the success in remaining locations.

Incentives for landlords

Apart from a more healthy tenant market, there are other incentives that may persuade landlords to agree to offering rent relief.  Some would include:

  1. Extensions of lease terms.
  2. The early exercise of options.
  3. Releases or resolution of claims in respect of existing disputes.
  4. Bringing forward obligations to refurbish premises.
  5. Inclusion of relocation or demolition clauses in the lease.
Complexities

Some of the complexities of the above arrangements to consider include:

  • How will rent relief impact future rent reviews?
  • Will there be an tax consequences of particular arrangements?
  • How do any arrangements interact with retail tenancy legislation?
  • In what circumstances (if any) might rent relief be clawed back?
Conclusion

I have already received anecdotal evidence of parties turning a blind eye to what are technically breaches of their leases, given the extenuating circumstances.  I trust that in the true spirit of partnership which is sometimes espoused by landlords and tenants alike, arrangements can be reached to appropriately deal with the current crisis, so that the property industry can emerge in a reasonably healthy state.

In England and Wales, the government has reportedly banned landlords evicting residential tenants.  However it is hard to see Australian governments implementing any such arrangements in respect of commercial leasing.  I expect that any legislative steps are likely to only prohibit the most underhanded kind of action.

On that basis, and given action is likely needed sooner rather than later to minimise the impact already being felt, it will be up to landlords and tenants to attempt to navigate their way through the issues.

The options above are only some that might be considered in any discussion between a landlord and tenant.  Arrangements can be complicated, and it is important that they are documented correctly to avoid future disputes.  While parties may be relieved to achieve satisfactory agreement, ensuring the complexities and potentially unexpected consequences of those arrangements do not lead future disputes is an important part of the process.

Our Commercial Property & Development team is ready and willing to answer queries you might have regarding how to deal with the consequences of COVID-19, including advising in relation to your rights and obligations under your lease and any arrangements you are proposing to make with your landlord/tenant.  In the event of any mandated shutdown, we will continue to work remotely and will be available via phone or ZOOM conferencing to support you in these unprecedented times.