COVID-19: Leasing in precarious times
During these precarious times, landlords and tenants alike should be aware of a number of risk management measures that can be implemented to mitigate the impact of the COVID-19 pandemic on their leasing arrangements.
Below are a number of items which both landlords and tenants should consider in relation to their leases. Given that each lease is usually subject to bespoke negotiations, it is important that the terms of each individual lease are reviewed.
Measures to mitigate risk
Issue
Landlords
Tenants
Incentive arrangements
Bring incentives forward (noting the risk if any tenants become insolvent the incentive cannot be recouped).
Review incentive arrangements to ensure that any closure of the building which amounts to a breach under the terms of the lease does not result in forfeiture of any incentive.
Payment of rent
Consider providing temporary rent relief or entering into an arrangement with tenants agreeing to cash in any security (if any) provided under the terms of lease.
Consider abatement/deferral rather than rent free, noting that insurance payouts in the event of damage could be compromised where rental has been reduced rather than deferred.
Engage in discussions with landlords if paying rent becomes difficult. Some options include:
- entering a moratorium to delay the payment of rent;
- requesting a rent free period in exchange for agreement to extend the term of the lease by a period equal to the rent free requested;
- temporary utilisation of some or all security or
- requesting a temporary conversion to turn-over rent.
Insurance
Focus on Business Pack and Industrial Special Risk (ISR) policies as these are most likely to provide cover for lost revenue or lost profits arising from shutdowns or customer or supply chain disruptions.
There has not been a unified approach by insurers. Review insurance policies to determine whether loss of rent income is recoverable.
As for landlords.
Other measures in respect of mitigating the effects of COVID-19
Issue correspondence to tenants in relation to:
- proactive measures being adopted
- notification requirements of any suspected cases of COVID-19; and
- compliance with all laws that impact use and possession of the premises (such as health and safety related laws).
If new leases are being negotiated or leases extended, request a force majeure clause be inserted which includes public health pandemics
Some other considerations
Can the tenant stop trading?
Payment of rent is an essential term under any lease. In the absence of an express provision allowing a tenant to cease trading in the event of a disease pandemic, it is unlikely tenants can simply stop trading or paying rent during any closure period. Most leases do not have an express provision that can be relied on.
Retail shop leases usually require tenants to continue trading, as well as requiring tenants to be fully stocked and staffed.Accordingly, a tenant's decision (without the landlord's approval) to close the premises could amount to a breach of the lease.If a tenant pays turnover rent, the lease should be reviewed to consider the consequences of a closure.
Commercial leases do not necessarily contain a positive obligation on tenants to continue trading. In essence, provided the tenant keeps paying rent in accordance with the terms of the lease, there is no requirement to keep the premises open.
Building closure
Most leases require the parties to comply with all laws affecting the use of the premises, and to comply with any order by a government authority.
However, if the closure of the building is based merely on a government recommendation and not an order, the closure could amount to a breach by the landlord.
Rent reduction
Unless the lease contains a specific rent reduction clause, the tenant does not have legal grounds to request a rent reduction if the building is closed or access is restricted.
The parties should also consider the specific wording of any rent reduction clause as it may or may not cover a public health pandemic. Whether the landlord takes the commercial view in the prevailing circumstances to reduce rent is at the landlord's sole discretion.
Force majeure
Some leases may contain a force majeure clause. These clauses have the effect of relieving a party of its obligations if circumstances outside its control make it impossible to perform them.
Ultimately, the consequences of such a clause depends on how the force majeure event is defined. Terms such as 'pandemic' or 'disease' could cover COVID-19. Similarly, clauses referring to 'acts of government' or 'impacts from the exercise of governmental powers' could qualify as force majeure events and permit a party to the lease to be excused from performing their obligations under the lease.
If the lease does not contain a force majeure clause, it is unlikely that there are grounds for either party to be excused from their leasing obligations.
Further insurance considerations
For the business interruption section of an ISR or Business Pack to respond, usually there first needs to be 'damage' to insured property. There are limited extensions of this requirement for damage and two of those are closure by regulatory authority and closure by infectious diseases.
The closure of your business by a public authority can constitute 'damage' under certain ISR policy wordings. However, many ISR policies will go on to exclude damage caused by pandemics or communicable diseases from business interruption cover, regardless of the fact that the business has been ordered to close by a public authority.
If your business does have infectious diseases cover there are usually significant restrictions of this cover, including a significantly lower limit of indemnity.
As COVID-19 has been declared a pandemic by the World Health Organisation, the reality is that most ISR policies will not respond to business interruption sustained as a result of COVID-19.
Again, as all insurance policies are not the same, it is important to consider that each policy will turn on its own wording. In particular, the exclusions and individual endorsements need to be considered in detail.
Changes in legislation / updates
At the date of this article, NSW had passed amendments which gives the NSW Minister wide ranging powers in relation to leasing. These powers include the capacity to issue regulations to prevent landlords terminating leases in particular circumstances. Further details are yet to be disclosed and the other States are expected to follow suit.
In addition to this, Scott Morrison announced on 29 March 2020 that the National Cabinet had agreed on a set of principles relating to leases, both commercial and residential, to protect renters during the COVID-19 pandemic. These included a moratorium on evictions for unpaid rent if it was a result of severe financial distress due to the coronavirus.
We recognise that things are moving quickly and we encourage you to keep following our updates as we will share further information when known.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
