One of the toughest issues for businesses trying to survive the economic fallout of the COVID-19 pandemic has been that of the premises lease. For most businesses it is the largest fixed cost. For landlords, of course, it IS the business.

Tenants have looked to Federal and State Governments for assistance such as rent relief and protection against evictions, whilst landlords have simultaneously hoped for Government assistance to mitigate the effects of lost rental income.

At the same time, there has been substantial noise emanating from media outlets about commercial leasing over the past few months, compounding the issue for already confused tenants and landlords. So in this article we will take a look at the Government announcements to date, and what they mean for tenants and landlords at the time of writing.

The Timeline So Far

6 April

The NSW Government announced $220 million in land tax relief on premises where the tenants qualify under the Mandatory Code. Landlords who enter into agreements under the Code with their tenants will be entitled to apply for a 25% land tax concession for the 2020 calendar year. In addition they will be entitled to a further three months deferral of the balance of the land tax.

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7 April

The Federal Government released a “Mandatory Code of Conduct” for landlords and tenants. This lays down broad “Leasing Principles” that are to apply during the period of the COVID-19 pandemic and its consequential impact on businesses.

However, leases are governed by State and Territory legislation, so in order to give effect to the “mandatory” part of the Code, the states and territories need to provide the formal legal force.

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24 April

The necessary empowering Regulations were issued in NSW. These Regulations simply adopt the Code as part of NSW law, and do not provide any greater procedural detail.

 

What does the Mandatory Code outline?

The Mandatory Code requires landlords and tenants to negotiate in good faith and enter into agreements based on the Code’s principles. The people most affected by the Code will already be familiar with its contents, but may be wondering what it really means in their own particular situation. Below we take a look at some of the contents and how it will impact the relevant parties:

  • The Code applies to all tenancies suffering “financial stress or hardship” with an annual turnover up to $50m. Tenants eligible for the Federal Government’s JobKeeper Payment (i.e. those who experiencing a 30% decline in turnover) are “automatically” eligible under the Code.
  • The principles under the Code are to apply during “the COVID-19 pandemic plus a reasonable recovery period”. What does this mean? The Code is expected to come into effect from a date “following 3 April 2020” (being the date the National Cabinet agreed the Code’s principles) “to be defined by each jurisdiction”.However, the Code is also expressed to apply during the period of the JobKeeper scheme, which commences the 31st of March. However, the NSW Regulations are expressed to terminate 6 months after the date they became effective, i.e. on 24 October 2020. That may reflect an optimistic view of the duration of the pandemic – presumably the Regulations will be renewed if these 6 months are insufficient to cover the pandemic plus recovery period.
  • What is a “reasonable recovery period” – weeks, months, even years? No one can know in advance, as this is something that will be determined by circumstances as they unfold. This will vary across individual cases, inevitably creating uncertainty and dispute.
  • Landlords must offer “proportionate reductions in rent … up to 100% of the amount ordinarily payable”, based on “the reduction in the tenant’s trade”. Let’s say the tenant’s turnover is down 60% – so also is the rent the landlord can collect. If the tenant is forced by law to close completely, such as pubs and bars, the rent reduction is 100%. But what if the tenant chooses to close, simply because there are not enough customers during the period of social isolation? Can a landlord argue that the tenant should have continued to trade, in order to reduce the amount of the rent reduction?
  • Will the reduction in trade, and proportionate rent reduction, be calculated on a month-by-month basis, or over an extended period such as the quarterly BAS period applicable to most small businesses? Rent is normally paid monthly in advance, but the reduction in trade will be known only after the event. Does this mean that the landlord and the tenant must go through a reconciliation process each month to credit back the tenant’s reduction entitlement? That could get messy – lots of work for accountants!
  • Will the reduction be calculated on a month-by-month basis, or over the whole pandemic (plus recovery) period? What happens if the tenant qualifies for the 30% reductions in some months, but not others?
  • The landlord will bear the entire reduction during the pandemic (and recovery) period. The rent reduction is in two equal parts:
    • The first 50% of a rent waiver, so the landlord loses that forever; and
    • The second 50% is a deferral, which is rolled forward, interest free, presumably for the pandemic period plus reasonable recovery period.

The deferred half of the rent is still payable by the tenant, but is amortised over the balance of the lease term (or for at least 24 months). Suppose that the reasonable recovery period ends on 31 March 2021, and the lease then terminates and the tenant vacates on 30 June 2021.

The balance of the deferred rent (7/8 of the total) will then be payable by the tenant over the next 21 months. In many cases, if not most, the landlord will never see the money and it will cost too much in legal expenses to be worth chasing through the courts.

  • The rent reduction (waiver + deferral) applies only to rent, and not to outgoings (such as council rates, land tax, strata levies, insurance etc). In the case of “gross” leases (i.e. where the tenant simply pays a single rental amount, inclusive of outgoings) it makes no difference – the proportional reduction applies to the whole amount. However, in the case of “net” leases, where the tenant pays a rental amount plus a share (often 100%) of the landlord’s actual outgoings, the proportionate reduction applies only to the rental component. However, the Code requires that any reduction in “statutory charges” (e.g. rates, land tax) and insurance premiums payable by the landlord must be passed on to the tenant.
  • Landlords also “agree” (so the Code says!) to a freeze on rent increases, whatever the lease itself may provide. This freeze should apply during the pandemic emergency plus a reasonable recovery period. So, even if the lease provides for a 4% increase on 1 May 2020, that simply won’t apply. What is not clear is whether that increase is lost forever, or if it can be brought to account after the pandemic is over.
  • Landlords cannot claim on any security held – such as cash bonds or bank guarantees – during the period of the rent reduction.
  • Disputes should be referred to “the applicable state or territory retail/commercial leasing dispute resolution processes for binding mediation. In NSW this would most likely be the NSW Commercial and Administrative Tribunal (NCAT).
  • The NSW Government’s announcement of a 25% land tax concession is available only if it is passed on to the tenant. In the case of a net lease this will mean that the land tax component of the outgoings will be reduced, in additional to the proportionate rent reduction. In the case of a gross lease the position is less clear – but it seems likely that the concession will be applied as a further reduction of the rent. Which all means one thing: that the land tax relief will go straight to the tenant, and not do anything to assist the landlord.

Despite is inherent ambiguities, the Mandatory Code will provide significant benefit to tenants, and in many cases it may be the crucial difference between these businesses surviving through the economic crisis caused by COVID-19, or closing down permanently, resulting in an enormous amount of job losses.

But at the same time, it’s worthwhile considering the landlords, as the burden on them is immense. Most will be looking at a substantial, or even total, loss of rental income for a period of months to potentially more than a year. Many landlords are themselves individuals or small businesses that will be unable to survive financially, particularly if they have mortgages to service.

Compounding their burden is the fact that there is no certainty that lenders will provide any relief to landlords. And if they do, it may be in the form of a deferral, with the full principal amount plus compounded interest payable down the track. In those circumstances some landlords may be forced to sell their properties into a steeply falling market.

Whichever way the issue of commercial property is looked at in the current COVID-19 climate, it is a topic that is fraught with complexity, lack of clarity and uncertainty. We can only hope that the forthcoming detailed procedures will ensure that both tenants and landlords can survive these challenging economic times without losing their livelihoods – whether that is their business, their investments or for others, their jobs.

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Antcliffe Scott Lawyers