Covid Emergency Measures for Commercial Leases
5 June 2020: New Covid Emergency Laws – Alert to Landlords and Tenants
New laws have been passed by the WA Government setting out the principles for rent relief and rent deferrals during the Covid 19 pandemic.
The State Government has adopted a Code which sets out the principles for rent relief and rent deferrals for commercial leases during the Covid 19 emergency (Commercial Tenancies (COVID-19 Response) Regulations 2020 (WA)). This came into force over the weekend.
Set out below is a rushed summary of the principles which will enable you to get started on the process and any negotiations. I am on leave this week but Anna Dunn and Melanie Lynn from my office are available to assist with any queries that you might have this week. As you will see below there is no rush with the procedure so I do not expect you will need anything urgent. If you read this and you are still confused then talk to Anna or Melanie but be warned that some aspects of the Code are confusing and there are no clear answers so we are just going to have to work through it for a while to figure out how it works.
The WA Code is significantly different to the National Code that was published by the National Cabinet in early March. The WA Code is a significant improvement on the National Code and provides much better certainty and clarity around the principles and the procedures to be followed. The WA Code is significantly different and you cannot rely on anything you have read about the National Code or how it applies in other States. Interstate tenants and landlords will need to apply different laws in dealing with rent relief for WA premises.
Qualifying Requirements – Small Commercial Lease and Eligible Tenants
The rent relief principles only apply to Eligible Tenants of Small Commercial Leases.
An Eligible Tenant must have a turnover of less than $50m in the 30 June 2019 year (i.e. LAST FINANCIAL YEAR) and qualify for Jobkeeper or meet the Jobkeeper turnover decline tests. The $50m turnover threshold test for franchisees is applied at the premises in question and for corporate members of a corporate group is applied to the whole group, in other cases the test is applied at the premises in question. Note this principle operates at a number of places in the Code – the focus is on the business and the turnover at the premises in question.
The Eligible Tenant must have a Small Commercial Lease which is defined as:
- A retail shop lease under the Retail Shops Act;
- A lease where the tenant owns or operates a small business and uses the land or premises for carrying on that business;
- A lease where the tenant is an incorporated corporation (set up under the Associations Incorporation Act); or
- Any other lease set out in the Regulations.
A lease is widely defined to include sub-leases, licences or other agreements and does not require exclusive possession or writing but does not apply to residential tenancies, long stay residential park tenancies, pastoral leases, mining tenements and anything else set by regulations. A small business is defined under the Small Business Development Corporation Act as a business that has a relatively small share of the market in which it competes and is managed personally by the owner or directors and is not a subsidiary of a larger business or enterprise, and can be a sole trader, partnership or corporation under the Corporations Act.
Note that I have paraphrased a number of these definitions in order to convey the principles and avoid clutter. If your situation is close to the edge of a definition then it will be necessary to consider the precise wording of the regulations. So do not rely on the summaries above alone.
The discussion below assumes that the situation meets the requirements of an Eligible Tenant of a Small Commercial Lease.
The Code then sets out a number of overarching principles for the negotiation for rent relief. The first few are pretty standard – the landlord and tenant must cooperate, act reasonably and in good faith, and act in an open honest and transparent manner. But then the next two are out of the ordinary and are contradictory – the landlord and tenant must provide each other with sufficient and accurate information that is reasonable for them to provide in the circumstances for the purposes of the negotiations but must not make onerous demands for information from each other.
The Code then sets out a procedure for requesting rent relief. The tenant must request rent relief in writing and the request must be accompanied by:
- A statement by the tenant that the tenant’s lease is a small commercial lease and that the tenant is an eligible tenant in relation to the small commercial lease;
- Sufficient and accurate information that evidences that the tenant is an eligible tenant in relation to the small commercial lease; and
- Sufficient and accurate information that evidences the reduction in the tenant’s turnover that is associated with the business conducted at the premises and that the tenant has experienced during the emergency period.
These are very precise and onerous requirements and it is highly unlikely that any of the requests for rent relief that have already been made satisfy all of these requirements. So I anticipate that any tenant that wishes to take advantage of the Code in WA will have to restart the process and meet these requirements. Note that in relation to information, the Code requirements use strict language by referring to evidence which suggests a relatively high standard of documentation to verify the validity of the tenant’s claim for relief.
The Code then sets out a very strict procedure for negotiating rent relief. After a landlord receives a valid request for rent relief from an eligible tenant that meets all of the requirements set out above then within 14 days the landlord must offer rent relief. The landlord’s offer must be in writing and consistent with the principles set out further below. After the landlord’s offer, the parties must negotiate over the principles set out below with a view to agreeing on rent relief to apply during the emergency period.
The Rent Relief Principles
Note that rent relief can either be a waiver which appears to mean a permanent release of that obligation to pay rent or a deferral which appears to mean putting off the payment to a later time. The principles set out below accommodate either a waiver or a deferral. Outgoings are dealt with differently.
In relation to rent, the landlord’s offer must be at least proportionate to the reduction in the tenant’s turnover that is associated with the business conducted at the premises in question and that the tenant has experienced during the emergency period. The Code incorporates the principles of the decline in turnover test which apply to the Jobkeeper rules but modified as appropriate to apply to that business at the premises in question during the emergency period.
The offer of rent relief must be at least 50% of rent and up to 100% of the rent. The offer of rent relief must be more than 50% if failure to provide more than 50% would compromise the tenant’s capacity to meet the tenant’s obligations under the lease and the landlord has financial capacity to provide more than 50% of the rent relief in the form of a waiver. Note this is a significant deviation from the National Code and effectively brings in the concepts that lack of rent relief would compromise the tenant’s capacity to pay, and the concept of the landlord’s financial capacity to offer that rent relief. This will involve a balancing of the landlord’s and the tenant’s financial capacity to pay and probably invite some analysis of past profitability and balance sheet health of both landlords and tenants.
In addition, if the landlord is a head tenant and the landlord has got rent relief then the landlord must pass on some of the rent relief to the tenant under the small commercial lease.
Note that some of these principles can be otherwise agreed in writing. So, for instance, even though the Code says the offer of rent relief must be not less than 50% of the rent, the parties can otherwise agree in writing. So there is some freedom to deviate from these principles even though at first glance they appear to be quite strict.
If agreement can be reached then the parties may enter into a written variation or any other written agreement. So probably a deed would be best but a letter would probably be sufficient.
If the parties agree on a deferral then there are rules for the deferral. The landlord must not request payment of the deferred rent until after the emergency period ends or the lease ends (whichever is first). The minimum period for paying the deferred rent is either the balance of the term of the lease or two years unless otherwise agreed. The landlord must offer an extension of the term equivalent to the period for which the rent is deferred and otherwise on the same terms unless otherwise agreed in writing or unless the landlord is a head tenant and the head lease will expire or there is some other contractual obligation that prevents the landlord from doing so.
In relation to outgoings, slightly different principles apply. The principles in relation to outgoings only appear to apply if for part of the emergency the tenant was not able to conduct their business at the premises in question. This appears to suggest that it will only apply to businesses that were required to close during the emergency period. The landlord is required to consider waiving recovery of any outgoing, which is not difficult to satisfy, and the landlord may cease to provide services if it is reasonable in the circumstances or in accordance with any reasonable request of the tenant.
The Code then mandates that any outgoing savings which the landlord has enjoyed during the emergency period must be passed on. So if any outgoings are reduced in respect of the emergency, then the landlord must not require the tenant to pay any amount of money in respect of the outgoing based on the reduced outgoing payable and the tenant’s proportional share. If the tenant has already paid then the landlord must reimburse the excess as soon as possible.
If parties have already negotiated binding agreements to give effect to rent relief, and it now appears that the Code is more favourable to the tenant than that agreement, then the tenant may request that the process restart. Also, if the financial circumstances of the tenant materially change then the tenant may make a further request and the parties must follow the process set out above. This appears to give the tenant the best of all worlds – either the agreement or the Code if it’s more favourable.
There is a general obligation of confidentiality in relation to information provided pursuant to the Code. Note the comments above that the tenant’s initial letter requesting rent relief must provide evidence just satisfy the requirements of the Code. This information must be kept confidential.
Note that there is a procedure under the Act to go to the State Administrative Tribunal to resolve disputes about Rent Relief. I will not go into those details at this stage because there is plenty here to absorb and this procedure will only apply if the parties cannot agree.
At the time of writing (2pm Friday 24 April) the supporting Regulations have not been signed into law and are not on the official website of State legislation (www.legislation.wa.gov.au) but it is to be expected that the supporting Regulations will adopt the Commonwealth SME Commercial Leasing Principles during Covid 19 issued by the National Cabinet as a Mandatory Code of Conduct.
The main effects of the Act are:
- Prohibit enforcement action under small commercial leases – no evictions, terminations, claiming on bank guarantees, security deposits or personal guarantees, or other enforcement rights – for certain defaults relating to the Covid 19 emergency.
- Adopts the ‘Code of Conduct SME Commercial Leasing Principles During Covid-19’ for adjustment of rent and outgoings between landlords and tenants based on reduction in trade of tenants due to the Covid 19 emergency.
- Allows for disputes in relation to the Act to be mediated in the Small Business Development Corporation or heard and determined by the State Administrative Tribunal.
- The Act is backdated to have effect from 30 March – note this is EARLIER than 3 April specified in the SME Commercial Leasing Principles – and with some special rules around prohibited action which has been partially completed.
Prohibited Enforcement Action
The banning of Prohibited Action only applies:
If it is a small commercial lease then the landlord cannot take prohibited action of eviction, re-entry, possession, recovery of the land, distraint of goods, forfeiture, termination, damages, payment of unpaid rent or other unpaid money including operating expenses, recovery of any security including a security bond, performance of obligations under a guarantee including making a demand on the bank guarantee and any other remedy otherwise available to the landlord against the tenant at common law or under a written law. So that pretty well covers everything. Also, the rent cannot be increased during the emergency period.
The landlord cannot take the prohibited action under a small commercial lease where there is:
- A failure to pay rent or any other amount of money payable, including operating expenses; or
- The land not being open for business at hours or times specified in the lease; or
- Anything else set out in the Regs; AND
- Anything a tenant is required to do under a written law in response to the Covid 19 pandemic is not regarded as a breach of the lease, grounds for termination or grounds for taking prohibited action.
So if the tenant commits a breach for something else, the Landlord may take action even though it involves prohibited action. But effectively there is immunity for failure to pay or trade or complying with emergency laws which put the tenant in breach of the lease. So there will not be many types of lease defaults that a landlord can take action for because these defaults and the immunity given to actions under other Covid 19 emergency law will cover most of the typical things that give rise to terminations.
The Act came into force on 24 April but is backdated to have effect from 30 March. Basically, things that happened between 30 March and 24 April are still effective but ongoing things that remain incomplete are stayed or suspended until the end of the emergency period. Any rent increase is still effective but stayed until the end of the emergency period.
Code Of Conduct – SME Commercial Leasing Principles
This Code was issued by press release on 7 April 2020 but relies on State laws to have legal effect. The Act refers to the Code of Conduct and adopts it by Regulation. Note that at the time of writing the Regulations have not been issued but it is expected the Code will be adopted in full and the commentary below assumes that there are no changes to the Code as issued on 7 April.
The Code applies to any tenant who qualifies for Jobkeeper, relevantly a loss of turnover of 30% or 15% for most ACNC registered charities, with an annual turnover of up to $50m. Note that this is different to the defined category of small business lease in relation to prohibited action. So the rules in relation to the Code may apply to different leases than the rules on prohibited action.
The Code contains numerous motherhood statements and general principles about balance, fairness and hardship and to negotiate in good faith. Amongst these appear to be some firmer statements as follows:
- 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 the Code.
- The parties will take into account 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 under this Code.
It is difficult to summarise the effect of these motherhood statements but I will try:
“Each side has to openly and fully disclose their true financial position as a result of the Covid 19 pandemic (which for tenants means revenue, expenses and profitability) and account to each other for savings or benefits received from other sources (such as government, utilities or banks) to arrive at a temporary leasing arrangement that is proportionate and appropriate and achieves a mutually satisfactory outcome (neither side becomes insolvent) during the period of the pandemic plus a reasonable recovery period but landlords cannot use this process to permanently mitigate the risk of lease default.”
The Code then states a set of principles which appear to have a harder focus. Some of those harder principles are reflected in the Act in relation to prohibited actions (see above).
In relation to rent reductions the Code requirements appear to be:
- Rent reduction made up of waivers and deferrals based on reduction in tenant’s trade;
- Rent reduction in the range of 50% rent to 100% rent;
- Of the total rent reduction, at least 50% must be a waiver which is a permanent release or forgiveness of this component of the rent, and the remainder by a rent deferral amortised over the balance of the lease term and for at least 24 months.
The first Code example then states that a 60% loss in turnover would result in a guaranteed 60% cash flow relief, with a minimum of half as a rent waiver and half through a deferral recouped over at least 24 months to be negotiated. The second Code example then states that if the tenant’s revenue has fallen by 100% then at least 50% of total cash flow relief is rent waiver and the remainder is a rent deferral. The third Code example states that if the tenant’s revenue has fallen by 30% then at least 15% of total cash flow relief is rent waiver and the remainder is rent deferral.
In relation to the concept of deferrals, the Code principles state that rent deferrals must be amortised over the balance of the lease term and for a period of no less than 24 months, whichever is the greater, unless otherwise agreed by the parties. The Code also states that any repayment (not the same word as deferral but apparently the same concept) should occur over an extended period, to avoid placing an undue financial burden on the tenant and no repayment should commence until the Covid 19 pandemic ends or the lease expires and taking into account a reasonable recovery period. This suggest that for the component of rent deferral:
- If the balance of the term is, say, 10 years, then the amortisation is over 10 years, paid monthly, starting when the Covid 19 pandemic ends plus a reasonable recovery period;
- If the balance of the term is, say, 1 year then the amortisation is over 2 years, paid monthly, starting when the lease ends plus possibly a reasonable recovery period. However, note below the possibility of extending the term to allow for repayment.
If you think this is confusing and contradictory then you are right. I cannot reconcile the different statements and their application to different examples.
In relation to Outgoings, the Code says the landlords should, where appropriate, seek to waive recovery of outgoings during the period the tenant is not able to trade. This suggests that outgoings are only waived if the tenant is unable to trade – so if the tenant is able to trade then presumably it should pay outgoings in full. None of the Code examples address outgoings and there is no discussion of proportions of waiver or deferral, or terms of deferral in relation to outgoings. There is a general statement that any reductions in statutory charges (land tax, council rates) or insurance will be passed on to the tenant in the appropriate proportion applicable under the lease.
In relation to waivers and deferrals, landlords are not to charge fees, interest, penalty interest or other charges.
In relation to the Landlord’s debt obligations, the Code states that landlords should seek to share any benefit they receive due to deferral of loan repayments in a proportionate manner.
In relation to the term of the lease, the Code states that the tenant should be provided with the opportunity to extend its lease for an equivalent period of the rent waiver and deferral period, to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the Covid 19 pandemic concludes.
Rental waivers must constitute no less than 50% of the total reduction in rent payable
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 recovery period.
For more information, please contact Stephen Hicks (firstname.lastname@example.org) or Anna Dunn (email@example.com).