Mandatory Code of Conduct for commercial tenancies released

The much-vaunted National Cabinet Mandatory Code of Conduct for commercial leasing was released by the Prime Minister on 7 April 2020. The purpose of the Code is to set out good faith leasing principles which will apply to commercial tenancies (retail, office and industrial).

Who does it apply to?

The Code applies to all tenancies that are suffering financial stress or hardship as a result of the COVID-19 pandemic, where the tenant is eligible for the JobKeeper programme and has an annual turnover of up to $50 million (SME Tenant).

The turnover threshold will be applied to franchises at the franchisee level and in respect of retail corporate groups at the group level (rather than the retail outlet level).

However, while not mandatory for tenancies which do not meet the JobKeeper eligibility and turnover criteria, landlords are encouraged to apply the Code to all leasing arrangements for affected businesses, having fair regard to the size and financial structure of those businesses.

How long does it apply for?

It applies from a date after 3 April 2020 (to be defined by each jurisdiction) for the period during which the JobKeeper programme is operational (i.e. until the end of the pandemic period). The JobKeeper programme is currently in place for 6 months, subject to any appropriate extension or reduction.

How will it be enforced?

The Code will be given effect through relevant state and territory legislation or regulation as appropriate. There is no detail yet regarding the timing or language of such legislation or regulation. It is possible that regulations (or declarations in some jurisdictions) will be made in relation to retail leases for the enforcement of the code of conduct for retail tenancies, but there is no comparable existing legislation for office or industrial leases and so it remains to be seen how such legislation will work.

It is also intended that there will be State- or Territory-based Industry Code Administration Committees, comprising representatives from relevant industry bodies representing landlord, tenant and SME interests, with an independent chair appointed by the relevant State or Territory Government. The role of the committee will be primarily to encourage application of the Code.

What are the principles?

The overarching principles set out in the Code include:

• landlords and tenants share a common interest to preserve the lease and facilitate the resumption of normal trading activities;
• landlords and tenants are required to negotiate and work towards achieving mutually satisfactory outcomes and negotiate in good faith;
• landlords and tenants will act in an open, honest and transparent manner and provide sufficient and accurate information to enable the parties to reach agreement consistent with the Code;
• the arrangements must be proportionate to the impact of the COVID-19 pandemic on the tenant;
• landlords and tenants will assist each other in their respective dealings with other relevant third parties such as government, utilities and financiers in order to achieve outcomes consistent with the Code;
• landlords must not seek to permanently mitigate their risk in relation to default in negotiating the temporary arrangements; and
• each lease must be dealt with on a case-by-case basis having regard to the hardship suffered by the SME tenant (including any insolvency) and the terms of the lease.

What can be agreed between the landlord and the tenant?

The Code provides that the following leasing principles should be applied as soon as practicable on a case-by-case basis:

• landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or reasonable subsequent recovery period);
• tenants must continue to comply with the lease terms, subject to any temporary arrangements agreed with the landlord. A material breach will mean that the tenant is not protected under the Code;
• landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals of up to 100% of the rent ordinarily payable, on a case-by-case basis, based on the reduction in the tenant's trade for the pandemic period and a subsequent recovery period;
• rental waivers must constitute no less than 50% of the total reduction in rent and may be greater where necessary to allow the tenant to fulfil its ongoing obligations, but regard must also be had to the landlord's financial ability to provide such waivers. Tenants may waive the 50% minimum waiver requirement;
• any remaining relief may be in the form of a waiver or a deferral;
• deferred rent must be paid over the balance of the lease term, but if the balance of the lease term is less than 24 months, then the tenant may pay the deferred rent over a 24 month period, commencing after the end of the pandemic period (i.e. deferred rent could continue to be paid after the lease expiry);
• any reduction in statutory charges or insurance costs incurred by the landlord will be passed on to the tenant in the appropriate proportion under the terms of the lease;
• if the landlord receives any benefit due to the deferral of loan payments by its financier, the landlord should seek to share that benefit with the tenant in a proportionate manner;
• landlords should seek to waive recovery of any other expense (such as cleaning costs or marketing levies) or outgoings payable by a tenant during the period the tenant is not trading and landlords may reduce services provided to the premises in these circumstances;
• if the agreement between the landlord and tenant requires any repayments, then the repayment should be made over an extended period of time and should not commence until the earlier of the end of pandemic period or existing lease expiry, and taking into account a reasonable recovery period;
• no fees or other charges should accrue on waived or deferred rent;
• no interest is payable on waived rent although interest may accrue on deferred rent provided it is not punitive;
• landlords must not draw on a tenant's security for the non-payment of rent during pandemic period or a reasonable recovery period;
• tenants should be given the option to extend their lease term for a period equivalent of the rent waiver and/or deferral period;
• landlords will not apply rent increases (except for retail leases based on turnover rent) during the pandemic period; and
• tenants will not be in breach of the lease if they reduce opening hours or cease to trade during the pandemic period.

These principles offer a starting point for landlords and tenants when seeking to negotiate rent relief due to COVID-19. While they are binding on leases with SME Tenants, they also provide good guidance for landlords seeking to provide relief and for other commercial tenants experiencing hardship.

What if no agreement is reached?

If landlords and tenants cannot reach agreement, the matter may be referred by either party to applicable leasing dispute resolution processes for binding mediation. It is unclear what will happen if the parties cannot reach agreement at mediation; presumably there will be a right to escalate the matter through the relevant Courts and tribunals. Alternatively, the "binding mediation" may take the form of an arbitration where the arbiter determines the resolution without a further escalation regime.

Landlords and tenants must not use mediation to prolong or frustrate the process.

How will it work in practice?

It is intended that landlords will agree bespoke, temporary agreements with each SME Tenant documenting the rent relief and which takes into account the particular circumstances on a case-by-case basis.

Landlords and tenants who are not bound by the Code can use the principles set out in the Code as a framework for agreeing and documenting any relief which may be necessary and appropriate for those leases.

To demonstrate hardship, tenants will need to provide "sufficient and accurate information", which, as specified in the Code, includes information generated from an accounting system and information provided to and/or received from a financial institution. See here for a suggested list of the sorts of information which tenants may be required to provide.

Case study

The tenant has experienced a 60% reduction in turnover since 1 March, attributable to COVID-19. The tenant's usual turnover is less than $50 million. The lease is therefore subject to the mandatory code. The tenant seeks rent relief from the landlord and provides relevant information to support its position.

In accordance with the Code, the landlord and the tenant agree:

• 30% waiver of rent during the pandemic period;
• 30% deferred rent to be repaid over the remaining three years of the lease term;
• tenant will continue to pay 40% of the rent during the pandemic period;
• the landlord will not terminate the lease due to non-payment of rent or call on the bank guarantee; and
• a fixed rent increase which was scheduled to take place on 1 May will not occur.

This agreement complies with the Code because:

• the total cash flow relief is proportionate to the loss in turnover;
• half the rent relief is in the form of a rent waiver with the remainder as a rent deferral;
• there is a moratorium on termination and calling on security during the pandemic period; and
• the scheduled rent review during the pandemic period will not take place.

What is the difference between a waiver and a deferral?

A waiver means the amount of rent payable is waived and may not be recouped by the landlord at a later time. A failure to pay the waived rent will not be a breach by the tenant.

A deferral means the amount of rent payable is deferred and must be paid by the tenant at a later time. A failure to pay the deferred rent at the later time would be a breach by the tenant.

What next?

We will need to see the terms of the relevant State- and Territory-based legislation to understand the full implications of the Code. However, the Code will enable parties to commence negotiating appropriate rent relief in line with the principles set out in the Code.

See here for the types of matters which parties could consider including in their agreements.