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The Impact of Covid-19 on Leases

Commercial Law, Property Law

COVID-19 has created a new and difficult environment both for landlords and tenants across New South Wales; both for landlords seeking to enforce their leases as tenants raise arguments of force majeure or frustration or request a rental abatement; and for tenants facing landlords making unreasonable (and most likely illegal) demands. Landlords must be careful to preserve their legal rights when negotiating with tenants during this current period of uncertainty. Recent announcement by government have further complicated the position, although hopefully to the benefit of both parties in this uncertain period.

In this strange new COVID-19 world we’ve already seen the best and worst of many – a few examples:

  • A (healthy) doctor working in a hospital emergency ward was told to vacate her rented premises OR not go in to work because she might present a health risk – even though she was in a fixed term (and in any case an essential services worker).
  • A landlord with a tenant about to fit out new premises for a second gym, reliant on cashflow from the other gym to fund the work (and of course now unable to operate) was offered a lifeline by the landlord with a significant reduction in financial obligations for at least 6 months.
  • A landlord with a number of tenants suffering drastic downturns in cash flow offered significant reductions in rent for at least 6 months provided that the tenants applied for all possible government assistance.

The COVID-19 Legislation Amendment (Emergency Measures) Act 2020 (NSW) (the Act) was assented to on 25 March 2020 to provide for regulatory changes to be made to both retail and residential tenancies. Regulations created pursuant to the Act will expire in no later than 6 months, or such earlier date as determined by Parliament. At the time of writing the regulations have not yet been made; however, as foreshadowed in the Prime Minister’s statement on 7 April 2020, it is likely that landlords may be prohibited from accessing bank guarantees or other types of security where a tenant is in default, and regulations may be made that otherwise exempt tenants from needing to pay rent for a period of time. Certainly, evictions will most likely be prohibited for at least 6 months.

The statement by the Prime Minister on 7 April 2020 about the formulation of a mandatory code for commercial landlords and tenants specifically excluded the operation of residential tenancies which he said is “a matter for the States” – presumably more will come at the state level for that area.  However, for commercial tenancies (including but not restricted to retail) there is now a mandatory code (for Covid-19 distress) applicable to both landlords and tenants – the essential elements of this code are:

  • there is a requirement for good faith in leasing between landlords and tenants who are significantly affected by Covid-19;
  • it will apply to tenants who are JobKeeper participants and have a turnover of less than $50 million;
  • it requires landlords to provide rental relief to qualifying tenants by the same proportion as the loss of revenue experienced by the tenant;
  • half the rent relief must be given in the form of a rent waiver, and the other half can be deferral of rent spread over the life of the lease and not less than a 24-month period;
  • the landlord must not terminate the lease or draw on a tenant’s security (in Covid-19 situations).

A copy of the code (which will be implemented by way of legislation or regulation by state governments) is available here.

What issues should landlords be considering?

It is important that landlords carefully read the terms of their leases to understand how they will respond to impacts of the COVID-19 pandemic, and of course take account of the effect of the code, if the particular lease is governed by it.  Some guidance:

  • Informal discussions with tenants. Landlords will most likely have discussions with tenants regarding rental arrangements or other obligations under the lease. Any informal discussions with tenants may be relied on by the tenant at a later stage to avoid obligations under the lease, particularly if landlords suggest or imply that a reduction of the payment amount is possible or that leniency will be accepted. Landlords should be cautious of any representations made regarding tenants’ obligations during these informal types of discussion to ensure that their position is protected.
  • Rental abatement. Whilst most leases have provisions regarding rental abatement these mostly relate to situations around adequacy of the premises or building and it is unlikely to apply where a business is required to vacate premises for the purposes of cleaning on account of a potential coronavirus contamination. Depending on the terms of the lease, it may be a commercial decision for landlords whether they will agree to a rental abatement.
  • Don’t give up rights. If a landlord considers giving tenants a concession on rent, outgoings or any other payment obligations under the lease, it is important to formalise this in writing and care must be taken to limit (shall we say quarantine) the concessions so they do not entitle the tenant to long term generosity in rent reductions.
  • Market rent reviews. Care must be taken to ensure that if a concession is given it does not affect any later market rent review. It would be worth checking the market rent clauses which often provide for a review based on what would reasonably be expected to be paid if the premises were unoccupied and offered for rent for the same or a substantially similar use. At present, in many industries such as hospitality and travel, comparable rental returns may have been materially reduced in response to coronavirus related shutdowns.
  • Insurance. It’s worth checking landlord’s insurance which may cover loss of rent. Make sure that any such concession does not affect that cover. Checks should also be in place to ensure that a concession does not affect any covenants under mortgage(s), or if there is doubt, get the mortgagee’s consent.
  • Default arising from insolvency. The government has announced significant changes to both the personal and corporate insolvency regimes. Directors have also been given some relaxation on insolvency laws, with directors, in certain circumstances, temporarily being relieved of their duty to prevent insolvent trading. It also seems likely that the Emergency Measures Act 2020 (NSW) may step in to prevent termination of a lease on such grounds.
  • Force Majeure. It is possible that force majeure provisions may entitle a party to be discharged from its obligations under a lease where there has been some overwhelming event, such as war, nuclear events, natural disaster and pandemics. However, the  terms must be expressly set out in the lease and cannot be implied into it, and few leases do include such broad force majeure clauses.
  • Frustration. Frustration of a contract may apply where, without the fault of either party, the contract becomes “impractical” to perform. This may be of benefit or detriment to a landlord depending on the commercial realities of the lease, but most claims of frustration have been difficult to enforce. The event claimed to be frustrating the contract/lease must be such that it makes the contract/lease impossible to be performed – it seems likely that although COVID-19 will create very serious financial difficulties for tenants, that in itself is probably not enough for a court to consider that the contract/lease is itself incapable of being performed.
  • Risk. Landlords and tenants should be very careful not to incorrectly assert frustration or that a force majeure event has occurred as this may amount to repudiation of the lease and require the payment of compensation.
  • Illegality. Some terms of a lease may be rendered void on the basis that they are now contrary to a restriction imposed by an authority, e.g., requirements on minimum trading hours, or the Emergency Measures Act 2020 (NSW). Landlords should take care before enforcing rights under a lease that they are not relying on the non-performance of a now void or otherwise defunct term.

Landlords need to ensure that they keep up to date with the latest regulatory changes as the leasing landscape evolves in response to the challenges of COVID-19. Atkinson Vinden can assist with advice on all aspects of leasing.  Please contact Anne Goodrick of our commercial and Property if you require any further assistance.