COVID-19: Managing Leases 2 – the Code

The National Cabinet met again this week and agreed that States and Territories will to implement a mandatory Code of Conduct (the Code) for commercial leases. The Code reflects the National Principles that were previously agreed by the National Cabinet last week. States and Territories will implement the Code via legislation or regulation. See National Cabinet Mandatory Code of Conduct – SME Commercial Leasing Principles during COVID-19

See the PMs press release about the Code here.

UPDATE – NSW has now made regulations making to make the Code enforceable, see our summary here.

Short story

The short story is that the Code will bring much needed and welcome relief for commercial tenants who have been hit hard by the COVID-19 pandemic. It seems that landlords will shoulder the burden of that relief and it’s unclear whether there will be any assistance for those landlords.

Unfortunately, there’s no legislation or regulation yet setting out the details of how the Code will be implemented. The ground covered by the Code raises some very complex issues. It remains to be seen how the Code will be made into law in the States and Territories and how that regulation / legislation will affect tenants and landlords. For now there are more questions than answers.

In any case, until we see the details, landlords and tenants should seek to negotiate arrangements in a generous and practical way, bearing in mind the Principles in the Code set out below.

Key points about the Code

  • The Code applies to tenants with turnover less than $50m who are suffering financial stress or hardship from COVID-19. Tenants that are eligible for the JobKeeper payment are automatically considered to be suffering financial stress / hardship.
  • Where a tenant’s trade has declined due to COVID-19, their landlord must reduce the rent proportionally to the down turn. At least 50% of the reduction must be a waiver. The rest can be a rent deferral, repaid over the remaining term of the lease or 2 years, whichever is greater.
  • Tenants can’t be evicted for non payment of rent.
  • Landlords must share any benefit they receive by way of loan payment deferral with the tenant.
  • No rent increases during the COVID-19 period and recovery period and tenants should be given the opportunity to extend leases.

Long story

Purpose

The purpose of the Code is to impose a set of good faith leasing principles for commercial tenancies (including retail, office and industrial) between landlords and tenants. The Code will apply to tenancies that are suffering greatly from financial stress or hardship as a result of the COVID-19 pandemic, with an annual turnover of up to $50 million and are an eligible business for the purpose of the Commonwealth Government’s JobKeeper programme.

Overarching Principles

The main objective of the Code is to provide a proportionate and measured burden share between landlords and tenants, whilst still allowing the parties to agree to tailored and appropriate temporary arrangements. The Code requires landlords and tenants to act reasonably, discuss the relevant issues that may impact their leasing arrangements, negotiate in good faith and act in an open, honest and transparent manner.

The Code sets out further overarching principles to guide landlords and tenants in negotiating arrangements:

  • Landlords and tenants share a common interest in working together to ensure business continuity, and to facilitate the resumption of normal trading activities at the end of the COVID-19 pandemic during a reasonable recovery period.
  • Landlords and tenants will be required to discuss relevant issues, to negotiate appropriate temporary leasing arrangements, and to work towards achieving mutually satisfactory outcomes.
  • Landlords and tenants will negotiate in good faith.
  • Landlords and tenants will 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 the Code.
  • Any agreed arrangements will take into account the impact of the COVID-19 pandemic on the tenant, with specific regard to its revenue, expenses, and profitability. Such arrangements will be proportionate and appropriate based on the impact of the COVID-19 pandemic plus a reasonable recovery period.
  • The Parties will assist each other in their respective dealings with other stakeholders including governments, utility companies, and banks/other financial institutions in order to achieve outcomes consistent with the objectives of this Code.
  • All premises are different, as are their commercial arrangements; it is therefore not possible to form a collective industry position. All parties recognise the intended application, legal constraints and spirit of the Competition and Consumer Act 2010.
  • The Parties will take into account the fact that the risk of default on commercial leases is ultimately (and already) borne by the landlord. The landlord must not seek to permanently mitigate this risk in negotiating temporary arrangements envisaged under this Code.
  • All leases must be dealt with on a case-by-case basis, considering factors such as whether the SME tenant has suffered financial hardship due to the COVID-19 pandemic; whether the tenant’s lease has expired or is soon to expire; and whether the tenant is in administration or receivership.
  • Leases have different structures, different periods of tenure, and different mechanisms for determining rent. Leases may already be in arrears. Leases may already have expired and be in “hold-over.” These factors should also be taken into account in formulating any temporary arrangements in line with this Code.
  • As the objective of this Code is to mitigate the impact of the COVID-19 pandemic on the tenant, due regard should be given to whether the tenant is in administration or receivership, and the application of the Code modified accordingly.

Leasing Principles

The Code sets out the following principles that “should” be applied:

1. Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or reasonable subsequent recovery period).

A big question here  – what is the reasonable subsequent recovery period? Is National Cabinet effectively saying “until further notice”?

2. Tenants must remain committed to the terms of their lease, subject to any amendments to their rental agreement negotiated under this Code. Material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under this Code.

It’s unclear whether a defaulting tenant will forfeit the Code protections absolutely or only from the time of the relevant default.

3. Landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals (as outlined under “definitions,” below) of up to 100% of the amount ordinarily payable, on a case-by-case basis, based on the reduction in the tenant’s trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.

When assessing the reduction in the tenant’s trade, what do you compare to: the previous month, year? What if the tenant’s business was declining anyway? What if it was a new business that was growing rapidly? And again, how long is the subsequent reasonable recovery period? Lots of questions here. 

4. Rental waivers must constitute no less than 50% of the total reduction in rent payable under principle #3 above over the COVID-19 pandemic period and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease agreement. Regard must also be had to the Landlord’s financial ability to provide such additional waivers. Tenants may waive the requirement for a 50% minimum waiver by agreement.

This is huge. Half of the rent reduction will not be recoverable. Even more should be non-recoverable if necessary for the tenant to stay in the lease. But regard must be had to the landlord’s financial capacity to do this. It is unclear how it its proposed to assess the tenant’s relevant capacity to meet their obligations under the lease and on the other hand, the landlords capacity to provide waivers. No doubt, in some cases the relative positions of the landlord and tenant will be clear. But for most cases, it will involve a very difficult assessment. And reasonable minds will differ about the assessment. 

For this Principle and Principle 3 above, the parties should be careful to ensure appropriate confidentiality arrangements are agreed before disclosing sensitive financial information. 

5. 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 greater, unless otherwise agreed by the parties.

This will provide excellent relief for long term tenants. However, the effect on landlords will be felt over a long period of time. 

6. Any reduction in statutory charges (e.g. land tax, council rates) or insurance will be passed on to the tenant in the appropriate proportion applicable under the terms of the lease.

Is this in addition to the reduction in rent?

7. 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.

Again, is this in addition to any turnover based rent reduction? 

8. Landlords should where appropriate seek to waive recovery of any other expense (or outgoing payable) by a tenant, under lease terms, during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.

It’s unclear when it will be appropriate to waive recovery of expenses. 

9. 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. No repayment should commence until the earlier of the COVID-19 pandemic ending (as defined by the Australian Government) or the existing lease expiring, and taking into account a
reasonable subsequent recovery period.

It’s unclear what will constitute “undue financial burden”. Reasonable minds will differ about what this means. 

10. No fees, interest or other charges should be applied with respect to rent waived in principles #3 and #4 above and no fees, charges nor punitive interest may be charged on deferrals in principles #3, #4 and #5 above.

It’s unclear what will constitute punitive interest. Can a landlord impose interest on rental deferrals commensurate with a market interest rate for unsecured borrowing? Alternatively, can a landlord pass on their own cost of borrowing where they are required to take a loan to cover their own expenses?

11. Landlords must not draw on a tenant’s security for the non-payment of rent (be this a cash bond, bank guarantee or personal guarantee) during the period of the COVID-19 pandemic and/or a reasonable subsequent recovery period.

It’s unclear whether the landlord will be entitled to draw on the security deposit after the COVID-19 and recovery period passes. 

12. The tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period outlined in item #2 above. This is intended to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the COVID-19 pandemic concludes.

It’s unclear whether this is a mandatory “option to renew” and whether the concessional arrangements in the Code would continue to apply during the option period. 

13. Landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period, notwithstanding any arrangements between the landlord and the tenant.

It’s unclear whether the freeze will apply even where a tenant has returned to normal operations.

14. Landlords may not apply any prohibition or levy any penalties if tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.

Full text of the code here.

It’s clear from the comments above that there is significant uncertainty about how the Code will apply. There is a huge amount of grey area for State and Territory Governments to clear up with legislation and regulation. In the meantime, we recommend landlords and tenants distil the key themes from the Code and negotiate on that basis. Any agreements that are reached can be made subject to review pending new regulations / legislation. Of course, agreements should always be reduced to writing and properly executed by the parties.

See the clip below for how we’re feeling about the Code…

See our round up of other COVID-19 related issues here.