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Commercial Leases: COVID-19 Legislative Update

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Article | Commercial Leases: COVID-19 Legislative Update

April 2020

Business continuity for landlords and tenants is a critical economic issue in the face of the COVID-19 pandemic. The effect of COVID-19 on businesses, and its consequent effect on commercial leases, has given rise to complex issues for both landlords and tenants alike.

This article will consider the rights and obligations of landlords and tenants in light of the emerging legislation and relief packages.

IN BRIEF

  • The emergency measures made necessary by COVID-19 apply to all commercial leases from 30 March 2020 and will continue for at least 6 months.
  • Landlords cannot take action against tenants for non-payment of rent or outgoings where the tenant is suffering financial hardship due to COVID-19.
  • Landlords and tenants need to negotiate in good faith to achieve outcomes fair to both parties and to ensure that the financial impacts of the pandemic are shared.

HOW WE CAN HELP

For landlords:

  • It is critical that landlords seek legal advice before taking action against a tenant. Terminating a lease without any entitlement to do so, or where prohibited by legislation, can have serious implications.
  • We can help you negotiate and properly document compliant arrangements with tenants. Failure to do so may have unintended consequences for your lease.

For tenants:

  • We can advise tenants on their rights in this difficult and uncertain time, and ensure that their landlords are acting in compliance with the measures which have been legislated.
  • We can assist with negotiations with your landlord and the drafting of associated documentation to protect your rights.

COVID-19 EMERGENCY RESPONSE BILL 2020

The COVID-19 Emergency Response Bill 2020 (Bill) was introduced on 7 April 2020 and passed by Parliament on 8 April 2020.

Temporary Operation

The COVID-19 Emergency Response Act 2020 (Act) will come into operation on the day it is assented to by the Governor. However, section 7 of the Act – the section applicable to commercial leases, will be taken to have applied from 30 March 2020.

The Act will expire on the earlier of:

  • the day on which all relevant declarations relating to COVID-19 within SA have ceased; and
  • the day 6 months after the commencement of the Act.

Essentially, the Bill anticipates that these emergency measures will be in place for a maximum of 6 months.

Application

Section 7 of the Bill contains the measures applicable to commercial leases. The Act will apply to leases subject to the Retail and Commercial Leases Act 1995 (SA) (RCLA), as well as any other agreement which grants a right to occupy premises for the purpose of carrying on a business. As a result, these provisions will capture a wide range of commercial occupancy rights including licences and is not limited to small and medium enterprises.

Moratorium on evictions

A key provision of the Bill is the moratorium on enforcement action where the tenant is unable to fulfil financial obligations as a result of the COVID-19 pandemic.

Section 7(3) provides that if a tenant is suffering financial hardship as a result of COVID-19 and fails to pay rent or outgoings or operate the business during the hours required by the lease as a result, a landlord cannot take any action or issue legal proceedings for:

  • eviction, re-entry or recovery of land;
  • termination of the lease;
  • distraint of goods;
  • damages;
  • recovery of a security bond;
  • interest on unpaid rent;
  • performance by the tenant or any guarantor; or
  • any other remedy available to the landlord.

Where a tenant is suffering financial hardship as a result of COVID-19, landlords will also be prohibited from:

  • increasing the rent (except a component determined by reference to turnover); or
  • recovering land tax (this protection is already afforded to tenants with the benefit of the RCLA, but will now be extended to all commercial leases covered by the Bill).

Other Breaches

Any act or omission of a tenant which is required by law in response to the COVID-19 pandemic will not constitute a breach of any lease or be grounds for termination. For example, this may provide protection where a tenant is required to keep leased premises appropriately staffed for the operation of the business or to conduct the business to a high standard of excellence, but the tenant is required by law to temporarily close the business.

Financial Hardship

The Bill does not set out the circumstances in which a tenant will be taken to be suffering ‘financial hardship as a result of the COVID-19 pandemic’. At this stage, it appears that the phrase will take its ordinary meaning and be considered on a case-by-case basis. However, the Governor is expressly empowered to make regulations relating to this issue. The Code of Conduct considered below includes a definition of financial hardship and may provide some guidance.

Either party to the lease can apply to the Small Business Commissioner for a determination on this issue. The determination can then be appealed to the Magistrates Court.

Disputes

A party to a lease can also apply to the Commissioner for mediation of a dispute in relation to the operation of these provisions, or otherwise related to the COVID-19 pandemic and the lease or the occupation of the leased premises for the relevant business.

CODE OF CONDUCT

On 7 April 2020, the National Cabinet announced a Mandatory Code of Conduct for small and medium sized commercial tenants impacted by COVID-19 (Code). The Code seeks to share the burdens faced by the property sector and to ensure that there are sufficient protections in place for impacted tenants.

The Code will be implemented through state and territory legislation or regulation with the Code to take effect from a date after 3 April 2020 as determined by the state or territory.

We are yet to see how the South Australian Parliament will seek to implement the Code, whether it be incorporated into the Act through the Regulations or implemented by subsequent legislation. Some of the measures provided by the Code have already been included in the Bill (for example the moratorium on evictions). The Bill does allow for the Regulations to apply or incorporate a code, standard or policy. However, we consider that carefully drafted legislation or Regulations will be required to implement the complex bilateral negotiations necessitated by the Code.

How long will the Code apply for and who does it apply to?

The Code is intended to remain in place during the ‘COVID-19 pandemic period’ which is defined as the period that the JobKeeper program is operational.

The Code will apply to commercial leases where the tenant is both:

  • a small or medium enterprise with an annual turnover of less than $50 million; and
  • suffering financial stress and hardship – defined so that any tenants which are eligible for the JobKeeper payment are automatically included.

It is stated that the principles should ‘nevertheless apply in spirit to all leasing arrangements for affected businesses’.

Code Principles

The overarching principle is that landlords and tenants should negotiate in good faith to achieve the outcomes intended by the Code.

The Code provides the following key leasing principles to be applied on a case-by-case basis:

  1. Landlords must not terminate leases due to non-payment of rent.
  2. Tenants must still abide by the terms of their lease subject to any agreed rental amendments and a tenant’s ‘material failure to abide by substantive terms of their lease’ will forfeit any protections under the Code.
  3. Tenants should be able to extend the lease for a period equivalent to the period of any rent reduction.
  4. Any reduction in statutory charges or benefit from deferral of loan payments received by the landlord should be proportionately shared with the tenant.
  5. Landlords should seek to waive recovery of outgoings where appropriate and may reduce services where appropriate.
  6. No fees, default interest or penalties may be imposed by a landlord with respect to rent reductions or any reduction in trading and landlords must not draw on securities for non-payment of rent.

Rent reductions in detail

Landlords must provide reductions in the rent payable by a tenant proportionate to the reduction in the tenant’s turnover during the course of the pandemic and a reasonable recovery period thereafter. This will require tenants to provide sufficient information about their financial position.

Waivers should account for at least 50% of the total reduction of rent unless waived by the tenant and should account for a higher proportion where failure to do so would compromise the tenant’s capacity to fulfil its obligations. Any rent waived cannot be recovered by the landlord.

The balance of any rent reduction should be deferred and amortised over the balance of the lease term or 24 months, whichever is the longer period (unless otherwise agreed). This causes difficulty where the remaining lease term is less than 24 months and is likely to result in payment arrangements extending past the term of the lease. No repayments should commence until the end of the pandemic period.

For example:

  • An eligible tenant experiencing a 60% reduction in turnover as a result of COVID-19 would be entitled (in principle) to a 60% reduction in the corresponding rent, with at least half of this amount to be permanently waived.
  • If the monthly rent was $10,000, the tenant would pay $4,000 a month ($3,000 waived and $3,000 deferred).
  • The $3,000 deferred would be split over the remaining months of the lease term once the pandemic has ended.

Binding Mediation

If the parties are unable to reach an agreement in accordance with the Code a binding mediation is to be made available in each state and territory.

LANDLORDS

Landlords should familiarise themselves with the requirements of the Bill and heed the recommendation to enter into good faith negotiations with their tenants, having regard to the principles set out in the Code.

Landlords should give careful consideration to securing any appropriate relief from financiers, whether through direct negotiations with their financier or the Australian Banking Association deferral scheme.

TENANTS

For many tenants these measures come as a relief. The Bill will afford an element of protection to those tenants that are suffering financial hardship as a result of COVID-19. However, for many tenants, the protections in the Bill will not be enough.

It is critical that tenants approach their landlord as soon as possible to negotiate a commercial compromise.

CONSIDERATIONS

  • How will any rent variation be calculated and what information is required to determine the percentage reduction in turnover?
  • Regard should be had to ensuring any agreement is sufficiently structured and documented. Any agreement should be recorded in writing, preferably through a deed.
  • How should the benefit of any financial assistance through deferred loan payments be calculated so that it can be shared with a tenant? Parties need to take into account that interest will likely continue to accrue and repayments will be capitalised.
  • Do any securities need to varied where lease terms are extended or repayment arrangements continue after expiry of the lease?
  • The Bill and Code do not deal with complex leasing arrangements involving subleases. We urge parties involved in complex leasing arrangements to commence negotiations as soon as possible to adequately deal with their specific circumstances.
  • What rights and obligations do landlords and tenants have under their insurance and does the cover extend to business interruptions or loss of rent in these circumstances?
  • How should tax and GST obligations be managed and are there any adjustments or deferrals available that could assist with cash flow?

SUMMARY

These are difficult times for landlords and tenants alike and the rapidly changing legal landscape we are currently experiencing adds another layer of complexity.

The key message is for all parties to communicate and work towards a solution which will support continuity of business after this crisis. Ensuring commercial leases can endure through this period will benefit both landlords and tenants in the long term.

Any arrangement should be considered on a case-by-case basis and the ideal outcome will depend on your individual lease and circumstances. It is important that you obtain appropriate legal advice and ensure that any agreement is properly documented.

MORE INFORMATION

We are available to help our clients deal with this challenging time and the rapidly shifting commercial and legal environment.

If you are a landlord, tenant or property manager and want to understand the potential implications and your options, our Key Contacts below can assist you. 

Disclaimer

The content of this newsletter is for general information purposes only and should in no way be treated as formal legal advice.