COVID-19 AND ITS EFFECT ON COMMERCIAL LEASES - FAQS
Thanks to our friends at Fox Law -
On 29 March 2020, Prime Minister Scott Morrison made it clear he wants commercial landlords and tenants to work something out to survive the Covid-19 period.
The starting point is that nobody should assume their lease (or any contract for that matter) automatically ends because of Covid-19.
In fact, for the reasons discussed in more detail below, most landlords and tenants will remain in a binding lease which will not automatically come to an end due to Covid-19. There may, as with most things in law, be exceptions. Every lease and every situation is different. Before taking action, please get specific advice.
The best approach for most parties will be to seek to agree on a commercial arrangement which is mutually acceptable to both the landlord and the tenant. I encourage everyone to approach these negotiations with a sense of empathy for the other party’s situation. Covid-19 is neither party’s fault and both parties will have their own set of financial pressures at this time. Now is the time for a commercial approach, cool heads and pragmatism (and collegiality between solicitors).
I have considered some frequently asked questions (from a landlord’s and tenant’s perspective) below. I hope this serves as a useful starting point for understanding the issues involved, but I cannot stress enough the importance of obtaining specific advice. For example, it may be that your particular lease has a specific clause in it which changes the ‘answer’ to a question entirely.
For commercial and residential tenants, a 6-month moratorium on evictions has been announced, along with a set of commercial tenancy principles (as set out in the Prime Minister’s media statement on 29 March 2020) as follows:
- a short term, temporary moratorium on eviction for non-payment of rent to be applied across commercial tenancies impacted by severe rental distress due to coronavirus;
- tenants and landlords are encouraged to agree on rent relief or temporary amendments to the lease;
- the reduction or waiver of rental payment for a defined period for impacted tenants;
- the ability for tenants to terminate leases and/or seek mediation or conciliation on the grounds of financial distress;
- commercial property owners should ensure that any benefits received in respect of their properties should also benefit their tenants in proportion to the economic impact caused by coronavirus;
- landlords and tenants not significantly affected by coronavirus are expected to honour their lease and rental agreements; and
- cost-sharing or deferral of losses between landlords and tenants, with Commonwealth, state and territory governments, local government and financial institutions to consider mechanisms to provide assistance.
Q1: Can the tenant ask for a rent reduction/abatement or a deferment of rent?
A: Yes, the tenant can ask. This is what Scott Morrison has encouraged a discussion on. No, the tenant is not, in most cases, entitled to a rent reduction/abatement or a deferment of rent (unless the Government take further actions to provide for this). Parties may choose to begin negotiations by talking with each other directly, by the tenant dealing with the landlord’s property manager/agent, or via their respective solicitors. Once an agreement is reached, this should be evidenced/documented. Depending on what is agreed, your solicitor will guide you as to how best to document the arrangement.
Q2: Will additional costs I incur due to Covid-19 be recoverable as outgoings? For example, more frequent cleaning of common areas and bathrooms, provision of hand wash, hand sanitiser, etc.
A: This will depend on whether any outgoings are payable by the tenant under the existing lease and the definition of “Outgoings”. Where cleaning costs/consumables are currently recoverable (by the landlord from the tenant), it is likely these costs will be recoverable from the tenant (provided the landlord acts reasonably in the circumstances). In respect of areas maintained by the landlord (e.g. common areas), the landlord may have an obligation to take additional steps in the interest of the safety of those that use the building. In that case, where outgoings are recoverable from tenants, it would be appropriate to pass on any additional or increased costs (in most cases).
Q3: Can I force a tenant to continue trading?
A: No. While many leases do contain a clause requiring the tenant to trade or operate, it is very unlikely a court would grant an injunction (an order compelling action in this case) to force a tenant to trade. You may, however, have a damages claim against the tenant. However, in circumstances where the tenant is closing to comply with the law, and there is an inconsistency between the obligation to trade/operate and the obligation to comply with any ‘official requirements’ (as they are often described in commercial leases), it is likely the obligation to comply with official requirements would prevail.
Q4: Can the tenant argue frustration of contract and that the lease is now at an end?
A: No, in most cases. The doctrine of frustration of contract is part of the common law (the body of case law that has developed over many years, outside of specific legislation). Frustration occurs when, through no fault of the parties, an intervening unforeseen event happens which makes performance of the contract either radically different or impossible. It is usually very difficult to establish frustration of a contract. Typically, a temporary closure will not frustrate a lease. The length of the existing lease would likely be a relevant factor to consider. For example, a 3-month closure, in the context of a 10-year lease is unlikely to constitute frustration. However, it may be arguable that a 5-month closure in the context of a 6-month lease may well frustrate that contract.
Q5: Can the tenant argue you’ve breached your covenant (promise) to provide quiet enjoyment?
A: No, in most cases. Under most leases the tenant is obligated to comply with ‘official requirements’ (laws/regulations/orders from an authority etc). Even without an ‘official requirements’ clause, if the tenant’s closure is compelled by law, rather than the closure being caused by a voluntary decision to disrupt the tenant’s quiet enjoyment, it is unlikely a tenant could argue any breach of quiet enjoyment. The situation may, however, be different where you voluntarily close the premises or centre before the law requires it. If you are a landlord considering this, please seek legal advice specific to your own circumstances. If the premises is a ‘retail shop’, see the comments below at Q6.
Q6: What if I have a ‘retail shop’ – will I be liable to compensate my tenant?
A: Queensland legislation (s43(1) of the Retail Shop Leases Act 1994) provides that compensation is payable to a retail shop tenant if the landlord (rather than a virus):
- substantially restricts the tenant’s access to the premises;- takes action (other than under a lawful requirement) that substantially restricts or alters the flow of potential customers past the premises; or- causes a significant disruption to trading.
Note that s43 is focused on actions taken by the landlord.
Further, under s43AB, there is also an emergency ‘exception’, which may absolve the landlord from liability for compensation. A landlord is not liable to pay compensation under s43(1) where their action is a reasonable response to an emergency or in compliance with any duty imposed under (or under the authority of) an Act.
Therefore, it is unlikely a tenant would succeed in claiming compensation where the landlord closed a centre due to a legal requirement to do so. Where a landlord closes a centre pre-emptively/voluntarily, the answer is a little more uncertain and landlords will need to exercise care and document their decision well. Landlords may need to balance their obligation to provide access to the premises with other risks/considerations (e.g. negligence, public relations, etc). For example, if there was an outbreak of cases in a particular shopping centre, it might be reasonable/appropriate for the landlord to close the centre, despite the fact the Government had not yet made closure mandatory. Again, in most cases these issues will be better resolved by good communication and negotiation of a solution, rather than through the Courts (where there will likely be limited access and delays during the Covid-19 period).
Q7: Are there any special considerations if I hold the property as trustee for a self-managed super fund (SMSF)?
A: Yes, there are, but the ATO has now said, in short, that granting rent relief is okay (and they won’t require strict compliance with the usual SMSF rules for the financial years 2020 and 2021). There was some initial concern regarding the ability of SMSF landlords to grant rent relief (especially to a related party tenant), given that under the ‘sole purpose test’ a SMSF landlord would usually need to be acting to benefit its members’ retirement benefits, not acting to benefit a tenant. Although, one might argue that helping the tenant survive (rather than become insolvent) and to be able to continue to pay rent in the future, is in the interests of the members of the SMSF. Fortunately, the ATO has now put out guidance to make it clear that granting rent relief in connection with Covid-19 will not be the subject of compliance action. Despite this ATO reassurance, if your tenant is a related party, it is recommended that you approach rent relief in a similar way to how you would approach the situation with an arms-length tenant.
Q8: Do I owe a duty of care to tenants’ employees?
A: You may owe a duty of care to take reasonable steps to protect the tenants’ employees from harm/loss etc. Typically, an employer (the tenant) will have the primary duty of care to look after the health and safety of their employees. However, especially in areas where you exercise a level of control (e.g. common areas), you may have a duty to take reasonable steps to prevent harm/loss which is reasonably foreseeable.
Q9: If required to close my business by the Government, will I have to comply?
A: Yes, the Governments (at a Federal and State level) have broad powers to deal with events like this (Covid-19).
Q10: Can I rely on the rent abatement clause in my lease?
A: No, in most cases. Typically, rent abatement (reduction) clauses apply where there is an inability to use or access the premises due to physical damage or destruction. The Covid-19 situation involves no physical damage or destruction to the premises, so it is unlikely these types of clauses will apply.
Q11: What options are there in terms of dealing with rent at this time?
A: When negotiating with a landlord, essentially any workable, mutually agreeable, arrangement is open to you. Here are some of the possibilities (not exhaustive):
(a) Discounted rent (e.g. 30%, 50%, etc) for an agreed period of time (e.g. 3 months).
(b) No rent (rent free) with lease extension – no rent is payable for an agreed period (e.g. 6 months), but the lease term is extended by the period of time the ‘rent free’ applies for.
(c) Deferred rent amortised over the remaining term – this is where you might agree to defer rent (e.g. no rent payable for 3 months), but the total deferred rent is then amortised (divided up into, usually equal, payments) over the remaining term of the lease.
(d) Resort to a security bond (cash) or bank guarantee held – the landlord may (either under the terms of the lease or by mutual agreement) resort to accessing a cash security bond or a bank guarantee. The security bond can be applied to rent owed. In the case of a bank guarantee, while this will allow the landlord access to the money to apply to rent, this will then mean the tenant has a liability to repay the bank, in accordance with the terms of your bank guarantee facility.
You might also consider some hybrid of the above, or some other creative solution. Parties may need to talk to their accountant about any tax or other consequences of these arrangements.
Q12: What if my landlord is not agreeable to having a discussion (about rent or other things)?
A: Most landlords will be watching the news and hearing all the same updates and information you are and hopefully it will be unlikely your landlord (or landlord’s property manager/agent) will be unwilling to have a discussion. However, in the event you have initial difficulty, you may be able to highlight the dispute resolution provisions in your lease, which usually provide a mechanism/process to bring about a meeting, either with or without a mediator. In relation to dispute resolution, it is worth noting that a number of mediators now offer services remotely (e.g. using platforms like Skype or Zoom or similar).
Q13: Can I make the call myself to stop trading, due to being worried about Covid-19?
A: Strictly speaking, no. Until the Government makes it mandatory for you to cease trading, you are obliged to comply with any requirements in your lease to trade/operate. However, see Q3 above, as the issue of forcing a tenant to trade. The decision to stop trading will not absolve you from the obligation to continue to pay rent.
Q14: Can the landlord decide to close my shop or the centre, due to being worried about Covid-19 (before any Government requirement to close)?
A: Strictly speaking, no. However, it is possible some landlords may move to do this at some stage. This may be able to be achieved by discussion, negotiation and mutual agreement with affected tenants. Alternatively, a landlord may choose to take action in light of certain circumstances (e.g. a Covid-19 outbreak in their centre). In that case, it is possible a tenant may have rights, to damages or otherwise. This would be a fairly tricky/complex situation, and specific legal advice should be obtained if you are a tenant in this position.
Q15: Can I argue frustration of contract and that the lease is now at an end?
A: No, in most cases. See comments above at Q4.<>
Q16: Is this an “act of God”/”force majeure” event which allows me to walk away from the lease?
A: No, in most cases. Unlike with frustration, there is no common law doctrine of ‘force majeure’. If force majeure rights exist, it will be because there is a force majeure clause in the lease. However, it is quite unusual for a commercial lease to include a force majeure clause. If your lease does have a force majeure clause, it will be important to look at what constitutes a force majeure event (e.g. it might cover a fire, flood, war, etc, but may not cover a virus/pandemic situation), what happens (e.g. suspension of obligations) and whether a termination right arises if the event continues for a specified period. You may need to seek advice to ensure any notice you are required to give to invoke the operation of the force majeure clause is effective.
Q17: Can I argue the landlord has breached its covenant (promise) to provide quiet enjoyment?
A: No, in most cases. Particularly where the landlord has closed a centre or premises as required by law, the landlord will not have breached its covenant to provide quiet enjoyment. In most cases, the tenant will need to close to comply with the law, which the tenant is obligated to do under most leases, often due to an obligation to comply with ‘official requirements’ or similar. If the landlord has closed the centre or premises pre-emptively/voluntarily, see the comments at Q5 above.
Q19: Will my ‘business interruption’ or other insurance cover this?
A: Your insurance could, potentially, cover some or all losses incurred due to Covid-19. This this may be because you have specific coverage for losses related to a viral pandemic or because you have more general “business interruption” insurance. You would need to check your policy for any exclusions (e.g. disease outbreak, epidemics, pandemics, etc). I expect many policies will exclude cover for diseases such as Covid-19. Cover is often linked to physical damage to the business premises or business property. Your policy should be reviewed carefully. You may wish to initially seek guidance/advice from your broker/insurer. If not satisfied with their response, I recommend you seek further advice from a solicitor experienced in insurance law.
Stay safe and be kind out there!
Source - Fox Law | 31st March 2020 |