On 7 April 2020 National Cabinet announced a mandatory code (‘Code’) for commercial leases of small and medium sized Australian business (‘SMEs’). As we predicted, in just over one month the Code has profoundly impacted retail, office and industrial leasing arrangements across Australia, with tens of thousands of SMEs re-negotiating their leases under these principles.

In NSW, the Code was given legislative force by the Retail and Other Commercial Leases (COVID-19) Regulation 2020 (NSW) (‘Regulation’) on 24 April 2020. The NSW Parliament was recalled yesterday on 12 May 2020 to potentially fine-tune the legislation, however no adjustments to the Regulation were made.

General

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 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. If requested by either party to the lease, the parties must re-negotiate the terms of the lease in line with the leasing principles set out in the Code. It seeks to appropriately balance their respective interests and proportionately share the financial risk and cashflow impact of COVID-19.

One month on….some thoughts from Edwards + Co

One matter that the Regulation has clarified is the type of sales turnover should be included for the purposes of the 30% test.  The Regulation states that:

“To avoid doubt, in this clause, turnover of a business includes any turnover derived from internet sales of goods or services.” (emphasis added)

This means that a retail shop that is selling online must count revenue from their online sales channels, and cannot look only at lost revenue from the bricks and mortar store.

More difficult to assess is the position of a professional services firm, where most advice is provided through email. Whilst these services are delivered online, should they be regarded, for the purposes of relevant law, as being “sold” online?

In our first-hand observations, and from discussions with other professional advisors, the first month after the introduction of the Code has given rise to some interesting matters in practice. For example, it has quickly become a common practice for landlords to ask for more than they are strictly entitled to under the Code.  This includes requests for detailed financial information about costs and in some cases information about whether the tenant has stopped paying utility bills or enrolled in Government grant schemes. This goes well beyond the strict turnover test set out in the Code.

Further, some landlords are also seeking to use negotiations as an opportunity to try and lock in longer leases. COVID-19 has cast a shroud over the future of the rental market. With more and more businesses having been forced to trial working from home, many of these may find they don’t need as much commercial space as they currently hold, or indeed, in some cases, any at all.

Other questions still remain, which the introduction of the Regulation has not resolved. These include:

• 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?
• 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?
• 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?

What’s next?

Edwards + Co Legal is a commercial law firm assisting businesses 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.

This article is part of our “law in the time of corona” series of business law articles.