On 7 April 2020 the National Cabinet unveiled the Mandatory Code of Conduct (Code) for commercial and retail property leases. Office and industrial leases are included as well as premises leased by not-for-profit entities.
The Code is intended to provide a “good faith” framework for landlords and tenants to negotiate variations to the terms of their property leases that will assist tenants to stay at the premises and commence operating its business once the COVID-19 crisis is dissolved.
The Code is effective from 3 April 2020 and will be effected by each State and Territory introducing complementary laws. At this stage, NSW is the only state that has brought in new laws, but it is expected that Victoria will follow suit sooner rather than later. The Code will apply for the same period the JobKeeper scheme is available which at this stage, is scheduled to end on 27 September 2020 (Moratorium Period).
Businesses with an annual turnover of $50 million or less and who are eligible for the JobKeeper scheme can access the protections available under the Code. Refer to this article to determine if you are eligible for the JobKeeper scheme.
A summary of the principles
During the Moratorium Period and/or for a subsequent reasonable recovery period:
- Landlords must not terminate the lease due to non-payment of rent.
- Landlords must not enforce their rights on any security provided by tenants for the lease. That is, a landlord is prohibited from drawing on security deposits or bank guarantees or seeking recovery from guarantors for non-payment of rent
- There will be a freeze on rent increases (except for retail leases based on turnover rent)
- Reductions to charges such as tax, council rates or insurance will be passed to the tenant in the same proportions as under the lease
- Landlords should consider waiving recovery of any expense such as outgoings from a tenant for a period where the tenant is unable to trade
- Any benefits the landlord receives with respect to the premises (eg. reductions or deferrals of mortgage repayments, rates or land tax) should be passed on to the tenant proportionately
- Landlords must not apply penalties where the tenant has reduced opening hours or ceased trading due to COVID-19
- Landlords must offer tenants rent reductions (whether a waiver and/or deferred rent arrangement) proportionate to the reduction in trade experienced by the tenant as a result of the COVID-19 crisis. Rental waivers must be at least 50% of the total reduction of rent payable. For example, a tenant’s business has suffered a downturn of 40%, the landlord must offer a rent reduction of at least 20% in the form of a waiver and payment of the balance of 20% to be deferred.
- If a landlord cannot financially sustain a rent waiver then a tenant may agree not to enforce the requirement for the landlord to waive 50% of the total reduction of rent, in part or whole
- If the parties agree to an arrangement to defer the rent over an extended period the financial obligation to repay the deferred rent must not cause an undue burden on the tenant
- Rent deferrals must be for a period of the balance of the lease term but not less than 24 months, whichever is period is greater. For example, if there is 3 years left on the lease then the deferral period will be for 3 years. However, if there is only 1 year left then tenant will have 24 months to pay the rent deferral
- Interest, fees or charges should not be applied on any rent that is deferred
- Tenants should be provided with an option to extend the lease for the period that is equivalent to the waiver or deferral period
What should tenants do to access the protections available under the Code?
- Tenants will need to substantiate the financial impact the COVID-19 crisis has had on its business and share this information with its landlord. Tenants must demonstrate that any down turn in its turnover occurred over at least one month. We suggest tenants use the same or similar assessment it made with respect to its application for the JobKeeper scheme.
- The Code implies that the tenant must act reasonably in requesting rent (and/or outgoings) relief for a period beyond the Moratorium Period. In order to decide whether you will need relief to continue into a recovery period, if it is reasonably practicable, prepare a forecast of the business with respect to the revenue, expenses and profitability.
Your accountant should be involved in this process and in our view, the forecast should assume that if your business is non-essential the business will be largely non-operational up to 27 September 2020. Tenants should be prepared to share the forecast and any supporting documents with its landlord.
- Ask the landlord whether it has or will receive the benefit of any incentives offered by its mortgagee and any authorities (eg. The council with respect to rates levied on the premises, utility providers, the Commissioner of State Revenue for land tax).
- If your landlord claims that it will be unable to sustain any reduction in the rent and/or outgoings (whether in the form of a waiver or deferral of rent) ask the landlord to substantiate this claim with evidence from third parties (eg. An accountant or the bank).
What should landlords do during negotiations with the tenant?
- Contact your financier and negotiate changes to your mortgage repayments. Landlords must share the benefit of any reduced mortgage repayments or similar benefits with the tenant.
- Check your loan and mortgage documents to see whether you need your mortgagee’s consent to any changes you make to the lease.
- Landlords should insist that any financial statements provided by the tenant is certified by a qualified accountant.
- Taking into account the financial circumstances of the landlord and tenant, consider if it would be reasonable to request security for payment of the part of the rent you have agreed to defer. The security could be in the form of a cash security deposit, bank guarantee or director guarantees.
It would be sensible to consider an arrangement where the security will only be provided if the tenant’s business is fully operational and a material improvement in turnover is sustained over say, a 3 or 6 month period.
- If the lease provides for a market rent review within the next 6-12 months consider obtaining the tenant’s consent to waive the market rent review – this would be sensible as the COVID-19 pandemic is likely to cause a downturn in the property in the short term and result in a lower valuation.
What if the tenant defaults in paying the deferred rent?
The Code states that other than any variations agreed by the parties:
- the terms of the lease still apply and tenants are expected to comply with their obligations; and
- tenants may lose the protection of the Code if a tenant defaults or breaches any obligations under the lease.
The Code does not provide clear guidance on what a landlord can or cannot do if a tenant fails to pay the rent payable under a deferral arrangement agreed by the parties (that is, the post Moratorium Period). It is our view that it would be unreasonable to prohibit a landlord from terminating the lease and finding another tenant where the current tenant has failed to pay the deferred rent – in such circumstances, the landlord would be bearing the full financial burden and will be unable to mitigate its loss by leasing the premises to another business.
In order to avoid the scenario described above, tenants should be conservative in estimating when its business is expected to fully recover from the COVID-19 crisis. From a landlord’s perspective insisting on a reporting arrangement with trigger points linked to monthly trading results could be considered.
What if I do not qualify for the Code?
The Code expressly encourages all landlords and tenants to negotiate arrangements to provide tenants with rent relief where a tenant’s business has been impacted by the COVID-19 pandemic. If you are a tenant whose business has been impacted by COVID-19 but for you’re not eligible for the Code we suggest that you forecast your revenue, expenses and profitability six months ahead and share this information with the landlord to request rent relief on the basis that you will not be able to sustain the current level of rent if your business continues to suffer a downturn and does not recover by specific point in time.
Next Steps – Deed of Variation of Lease
While the Victorian government has not yet enacted the legislation to complement the Code, you should start the process now by doing the following:
- Determine whether you or your tenant is eligible, preferably by requesting forecasts, budgets or other financial information;
- Start your negotiations and put forward the critical commercial points to the other party; and
- Agree who will document the variations and that the parties will share these costs equally.
Regardless of whether you are a landlord or tenant, you must accurately document the agreed arrangement in a Deed of Variation. In the absence of a clear and binding Deed of Variation you will risk a potentially costly dispute arising as the parties may have different expectations of what was agreed in the prior months.
For advice on the Code or negotiating an arrangement that will protect your commercial interests and not fall foul of the Code, contact Sotheary Bryant.