On 7 April 2020 the Federal Government announced a mandatory code of conduct setting out principles to govern commercial and retail tenancies affected by the COVID-19 pandemic (Code) had been agreed by National Cabinet. The Code was prepared with input from industry bodies and will be made enforceable by incorporation into the State and Territory legislation or regulation.
Landlords and tenants will need to comply with the Code where:
- the tenant has annual turnover of $50 million or less;
- the tenant is suffering financial hardship as a result of the COVID-19 pandemic to the extent that it has experienced at least a 30 per cent drop in revenue; and
- the tenant is a participant in the Federal Government’s JobKeeper program.
The Code clarifies that the $50 million annual turnover threshold:
- in respect of franchises, will be applied at the franchisee level; and
- in respect of retail corporate groups, will be applied at the group level, rather than at the individual retail outlet level.
Landlords should ask tenants for:
- evidence that the tenant is eligible for the JobKeeper program and has a turnover of less than $50 million;
- a statement of the tenant’s financial position, outlining income, expenses, assets and liabilities pre and post COVID-19;
- details of business interruption insurance and whether the payment of rent and outgoings is covered and if so, whether a claim has been triggered and the status of any claim;
- a report from an accountant or financial adviser with evidence that the business has experienced a substantial reduction in its ability to pay rent due to the impacts of COVID-19;
- a summary of the tenant’s debt obligations and whether the lender has granted any repayment deferments; and
- details in relation to the ongoing operation of the tenant’s business, such as work from home or stand-down arrangements.
Tenants seeking rent relief will need to be able to show landlords that the relief sought is reasonable and proportionate to the impact of COVID-19 on the tenant’s business. Tenants who are upfront and can demonstrate the impact of COVID-19 on their business are more likely to be successful in their claim for rent relief.
Landlords should also ascertain if their business interruption insurance will respond and determine what steps they need to take to be able to claim on their insurance. Where possible, landlords should implement this Code in the way that has the least adverse impact possible on this insurance.
Commencement and Expiry
The Code came into effect on 7 April 2020 and will continue for the period of operation of the Federal Government’s JobKeeper program.
In negotiating appropriate temporary arrangements for eligible tenants, the following principles are to be applied as soon as practicable on a case-by-case basis. The principles have not been prepared by parliamentary drafters but rather are intended to form the basis on which landlords and tenants will agree specific arrangements to apply to their situation.
Our analysis and commentary are included under each of the principles from the Code:
- Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or reasonable subsequent recovery period).
In the Code the term COVID-19 pandemic period refers to the period during which the JobKeeper program is operational.
The moratorium on termination is to apply for the COVID-19 pandemic period or for a reasonable subsequent recovery period. Whilst the COVID- 19 pandemic period will have a definite end (i.e. when JobKeeper comes to an end), there are no parameters on how long the reasonable subsequent recovery period will be.
These periods are expressed as alternatives to each other and not considered in aggregate.
- 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.
Tenants must abide by the terms of their leases as varied by any agreement reached pursuant to the Code. A material breach of a key term of the lease would mean that the protections of the Code would no longer apply.
For example, if following agreement in relation to rent waiver and deferral pursuant to the Code, the tenant failed to pay that portion of rent not waived or deferred, the protections of the Code would be forgone.
- Landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals as outlined in the Code 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.
In order to calculate the proportionate rent reduction to be applied, the landlord will need to consider the impact on the tenant’s trade at the commencement of the operation of the Code and at intervals during the COVID-19 pandemic period and a subsequent reasonable recovery period.
Any agreement reached pursuant to the Code will need to record the process by which sufficient and accurate information evidencing the tenant’s trade is to be reviewed and the rent adjusted or where the rent has been paid in advance, credits for reductions moving forward with a reconciliation at the end of the COVID-19 pandemic period and a subsequent reasonable recovery period.
There is no distinction made between a tenant required to cease trade by government order, for example a gym or beauty therapist, and a business that is able to operate but on a limited basis and ceases to operative because it is economically not viable to do so, eg a café in an office building where most of the tenants have employees working from home.
- 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.
A minimum of 50% of the reduction calculated under principle 3 needs to be waived by the landlord (ie written off). It would be difficult to see a scenario where a tenant might waive this minimum requirement.
- 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.
Unless agreed otherwise, the portion of the rent reduction calculated under principle 2 and not part of the waiver the subject of principle 4, is to be amortised over a period of no less than 24 months.
This means that the tenant may have repayment obligations in respect of deferred rent that continue past the expiry of the lease. In this case the landlord will need to consider if the security provided by the tenant (such as a bank guarantee) must continue until the payment obligations have been discharged by the tenant.
Principle 9 additionally provides that no repayment can commence until the earlier the Australian Government determining that the COVID-19 pandemic has ended or the expiry of the lease, and taking into account a reasonable subsequent recovery period.
- 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.
This is a direct proportionate pass through to the tenant and is separate and additional to the rent reduction.
- 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.
This principle is problematic. It is not clear what this means and how it can be shared.
Most relief from lenders is the form of capitalisation of interest. This interest still needs to be paid by the landlord but there is some cash flow relief. What is the quantifiable benefit to the landlord, how is this calculated and how can it then be shared with the tenant or tenants in a proportionate matter?
- 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.
A waiver of outgoings where a tenant is not able to trade, raises the question as to what “not able to trade” means. Was there a choice by the tenant or was it dictated by government directive or some other circumstance? Is this only to apply where the tenant is subject to a shut down?
Where a landlord seeks to reduce services, careful consideration needs to be given to any flow on impact of performance criteria provisions in the lease.
- 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.
No repayment of any deferred obligation 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. The reference to a reasonable subsequent recovery period adds uncertainty to when repayment can be required.
The parties should try and agree what a reasonable recovery period would be.
- 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.
This is straightforward, no fees, interest or other charges can be applied to the negotiated concessions.
- 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.
The period that this is to apply for is unclear.
There reference to the ‘period of the COVID-19 pandemic’ is not the same as the use of the expiry of the COVID-19 pandemic period concept. Is the relevant period the period that JobSeeker is operational and/or a reasonable subsequent recovery period or until the COVID-19 pandemic ends (as defined by the Australian Government) and/or a reasonable subsequent recovery period.
Again, there are no parameters on how long the reasonable subsequent recovery period would be.
Care needs to be taken where the security held is in the form or a bank guarantee. When does the bank guarantee expire? Does the landlord have a right to require a replacement bank guarantee with an expiry date beyond the term of the lease as varied by these negotiations? What if the tenant is unable to procure the replacement? Provision should be made in the negotiated arrangements under the Code for the landlord to call on the bank guarantee (before it expires) and to hold the cash received to be applied if the tenant does not perform its obligations under the lease as varied.
- 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.
This principle is unclear. There is no waiver or deferral period referred to in principle 2.
Given the intention is for the tenant to have the opportunity to operate after the pandemic concludes, we think this means an offer to extend the lease term for the period equivalent to the period of the negotiated rent relief provided to the tenant.
- 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.
No rent increases for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period. Again, is this for the period where JobSeeker is operational or until the COVID-19 pandemic ends (as defined by the Australian Government) and a reasonable subsequent recovery period?
This is not a waiver so once the relevant period has passed (unless the lease provides otherwise) the rent increases will apply. This could result in rent reviews happening within a relatively short space of time (i.e. the frozen rent review and the next following rent review).
Where a market rent review applies and results in a rent decrease, the rent decrease must still be implemented.
- 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.
This is straightforward.
Negotiated relief under the Code
The Federal Government acknowledges that there are many ways relief can be provided and accordingly the Code is not overly prescriptive on the form of relief, but rather gives landlords and tenants an avenue to negotiate in good faith and agree a way forward which takes into account their particular circumstances.
Examples of rent reduction
Grant’s Gym Pty Ltd (Grant’s Gym) is a tenant paying $10,000 per month in rent. Grant’s Gym has closed due to a government directive. Grant’s Gym’s turnover reduces by 100%. The relevant lease has a term of 5 years of which 2 years have expired. On the basis that Grant’s Gym is an eligible tenant under the Code, Grant’s Gym and its landlord agree:
- 100% rent reduction ($10,000 per month) is to apply for the COVID-19 pandemic period and a subsequent reasonable recovery period of 3 months (Agreed Relief Period).
- 50% of the rent reduction ($5,000 per month) is waived and not recoverable by the Landlord.
- 50% of the rent reduction ($5,000 per month) is deferred for the Agreed Relief Period and becomes repayable in equal instalments over the balance of the term (on the basis the balance of the term exceeds 24 months) commencing on the COVID-19 pandemic ending (as defined by the Australian Government).
- To extend the lease term for the Agreed Relief Period.
- Any reduction in statutory charges (e.g. land tax, council rates) or insurance ordinarily payable will be passed on to Grant’s Gym.
- For the period where Grant’s Gym is unable to trade due to a government directive, the Landlord agreed to a waiver of outgoings. When the government directives are lifted, outgoings are payable.
ABC Engineering Pty Ltd (ABC) is an office tenant paying $20,000 per month in rent. ABC has implemented work from home protocols for its staff but continues to operate a skeleton staff at the premises. Due to projects being postponed indefinitely as a result of COVID-19, ABC’s turnover reduces by 70%. The relevant lease has a term of 3 years of which 2 years have expired. On the basis that ABC is an eligible tenant under the Code, ABC and its landlord agree:
- 70% rent reduction ($14,000 per month) is to apply for the COVID-19 pandemic period and a subsequent reasonable recovery period of 3 months (Agreed Relief Period).
- 50% of the rent reduction ($7,000 per month) is waived and not recoverable by the Landlord.
- 50% of the rent reduction ($7,000 per month) is deferred for the Agreed Relief Period and becomes repayable in equal instalments over 24 months (as the balance of the term is less than 24 months) commencing on the COVID-19 pandemic ending (as defined by the Australian Government).
- To extend the lease term for the Agreed Relief Period.
- Any reduction in statutory charges (e.g. land tax, council rates) or insurance ordinarily payable will be passed on to ABC.
- On the basis that ABC’s decision to work from home was not an inability to trade, the Landlord did not agree to a waiver of outgoings.
Any agreements reached between landlords and tenants should be documented formally.
Parties should take care to ensure there is no inadvertent waiver of rights and/or the creation of express or implied representations/warranties in their negotiations. The impacts of the changes on the whole lease need to be carefully considered.
In a retail context, if the term is extended commensurately with the time of any forced shutdown or rent abatement, consideration needs to be given as to whether a new disclosure statement is required.
If you have any questions or require assistance, please do not hesitate to get in touch with any member of our experienced Property and Leasing team.