Under growing pressure to respond to the COVID-19 crisis, on 7 April 2020 National Cabinet announced a mandatory code (‘Code’) for commercial lease tenancies of small and medium sized Australian business (‘SMEs’). The Code will profoundly impact retail, office and industrial leasing arrangements across Australia, with tens of thousands of SMEs set to re-negotiate their leases under these principles.
What’s the Code broadly about?
The Code applies from 3 April 2020 to SME businesses with an annual turnover of $50m or less suffering financial hardship as a result of the COVID-19 crisis. The Code is expressed to be a Mandatory Code of Conduct ‘to be given effect through relevant state and territory legislation or regulation as appropriate’.
The threshold for eligibility for rental relief is a financial hardship test consistent with the eligibility criteria of the Government’s ‘JobKeeper’ program, which requires at least 30% reduction in turnover for the relevant period. Where the test is met, the proportionate reduction in turnover is to be applied against lease payments, in the form of rent waivers and deferrals, with at least 50% of the benefits in the form of rent waivers. E.g., if an SME suffers a 30% loss in revenue for the relevant period, and the lease payment for the period is $10,000, a minimum $1,500 rent waiver for the period should apply.
The main purpose of the ambitious new Code is to assist tenants to continue their business operations and to allow landlords to retain a tenant they might otherwise lose as a result of financial hardship. It seeks to appropriately balance their respective interests and proportionately share the financial risk and cashflow impact of COVID-19.
Some immediate thoughts from Edwards + Co Legal
The Code, and in particular its “Overarching Principles” and “Leasing Principles” (detailed below) raises a number of immediate legal questions. These will require further consideration and development by regulatory authorities in coming weeks.
- What is the exact legal status of the Code and what are the consequences for failing to comply with it?
- For retail groups comprising more than one store, the $50m annual turnover threshold is to be applied at group rather than individual store level. Does this also mean that the ‘financial hardship’ turnover gateway is to be calculated on a group rather than an individual store basis?
- If the relevant business can continue to operate with staff working from home, how are revenues generated from working from home (and not from the leased premises) assessed when assessing loss of turnover from the relevant leased premises?
- As part of the scheme tenants must remain committed to the terms of the lease, so what would constitute a ‘material failure to abide by substantive terms’ of the lease?
- Are reductions in statutory charges or loan deferrals intended to be fully passed on to tenants in additional to the reductions and waivers?
- With respect to the period for the rent relief measures to apply after the main storm of the COVID-19 outbreak has substantially passed, what is likely to be considered a ‘reasonable recovery period’?
- How are parties to determine when a greater than 50% reduction in rent should be applied, given the vagueness of the test of ‘where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease agreement’?
- Payment of rental deferrals must be amortised for no less than 24 months. Does this mean where a lease ends within 24 months AC (after-corona), the lease needs to be extended to cover the repayment period, or does it simply become a debt arrangement?
The detail of the Code – What are the New Principles?
In the Code, National Cabinet has introduced ‘Overarching Principles’ and ‘Leasing Principles’, as set out below:
- Landlords and tenants share a common interest in working together, to ensure business continuity, and to facilitate the resumption of normal trading activities at the end of the COVID-19 pandemic during a reasonable recovery period.
- Landlords and tenants will be required to discuss relevant issues, to negotiate appropriate temporary leasing arrangements, and to work towards achieving mutually satisfactory outcomes.
- Landlords and tenants will negotiate in good faith.
- Landlords and tenants will act in an open, honest and transparent manner, and will each provide sufficient and accurate information within the context of negotiations to achieve outcomes consistent with this Code.
- Any agreed arrangements will. Take into account the impact of the COVID-19 pandemic on the tenant, with specific regard to its revenue, expenses, and profitability. Such arrangements will be proportionate and appropriate based on the impact of the COVID-19 pandemic plus a reasonable recovery period.
- The Parties will assist each other in their respective dealings with other stakeholders including governments, utility companies and banks/other financial institutions in order to achieve outcomes consistent with the objectives of this Code.
- All premises are different, as are their commercial arrangements; it is therefore not possible to form a collective industry position. All parties recognise the intended application, legal constraints and spirit of the Competition and Consumer Act 2010.
- The Parties will take into account the fact that the risk of default on commercial leases is ultimately (and already) borne by the landlord. The landlord must not seek to permanently mitigate this risk in negotiating temporary arrangements envisaged under this Code.
- All leases must be dealt with on a case-by-case basis, considering factors such as whether the SME. Tenant has suffered financial hardship due to the COVID-19 pandemic; whether the tenant’s lease has expired or is soon to expire; and whether the tenant is in administration or receivership.
- Leases have different structures, different periods of tenure, and different mechanisms for determining rent. Leases may already be in arrears. Leases may already have expired and be in ‘hold-over’. These factors should also be taken into account in formulating any temporary arrangements in line with this Code.
- As the objective of this Code is to mitigate the impact of the COVID-19 pandemic on the tenant, due regard should be given to whether the tenant is in administration or receivership, and the application of the Code modified accordingly.
Commercial Leasing Principles
- Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or reasonable subsequent recovery period).
- Tenants must remain committed to the terms of their lease, subject to any amendments to their rental agreements negotiated under this Code. Material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under this Code.
- Landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals of up to 100% of the amount ordinarily payable, on a case-by-case basis, based on the reduction in the tenant’s trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.
- Rental waivers must constitute no less than 50% of the total reduction in rent payable under principle #3 above over the COVID-19 pandemic period and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease agreements. Regard must also be had to the Landlord’s financial ability to provide such additional waivers. Tenants may waive the requirement of a 50% minimum waiver by agreement.
- Payment of rental deferrals by the. Tenant must be amortised over the balance of the lease terms and for a period of no less than 24 months, whichever is the greater, unless otherwise agreed by the parties.
- Any reduction in statutory changes (e.g. land tax, council rates) or insurance will be passed on to the tenant in the appropriate proportion applicable under the terms of the lease.
- A landlord should seek to share any benefit it receives due to deferral of loan payments, provided by a financial institution as part of the Australian Bankers Association’s COVID-19 response, or any other case-by-case deferral of loan repayments offered to other Landlords, with the tenant in a proportionate manner.
- Landlords should where appropriate seek to waive recovery of any other expense (or outgoing payable) by a tenant, under lease terms, during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.
- If negotiated arrangements under this Code necessitate repayment, this should occur over an extended period in order to avoid placing an undue financial burden on the tenant. No repayment should commence until the earlier of the COVID-19 pandemic ending (as defined by the Australian Government) or the existing lease expiring, and taking into account a reasonable subsequent recovery period.
- No fees, interest or other charges should be applied with respect to rent waiver in principles #3 and #4 above and no fees, charges nor punitive interest may be charged on deferrals in principles #3, #4 and #5 above.
- Landlords must not draw on a tenant’s security for the non-payment of rent (be this a cash bond, bank guarantee or personal guarantee) during the period of the COVID-19 pandemic and/or a reasonable subsequent recovery period.
- The tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period outlined in item #3 above. This is intended to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the COVID-19 pandemic concludes.
- Landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period, notwithstanding any arrangements between the landlord and the tenant.
- Landlords may not apply any prohibition on levy any penalties if tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.
Edwards + Co Legal is a commercial law firm assisting SMEs in NSW and across Australia. We are closely following the new business laws and regulations that are being developed in response to the COVID-19 pandemic. Please contact us if you need advice about these new laws, including assistance with re-negotiating your commercial lease arrangements.
This article is part of our “law in the time of corona” series of business law articles.