Mandatory code of conduct for commercial and retail leases on the way as part of COVID-19 response

On Friday, the Prime Minister Scott Morrison foreshadowed the creation of a mandatory code of conduct in relation to commercial and retail leases.

Key points:

• there will be a mandatory code of conduct in relation to commercial and retail leases which is currently being finalised by industry stakeholders and the National Cabinet;
• the mandatory code of conduct will apply if the tenant is a small and medium enterprise (turnover of less than $50m and is eligible for the JobKeeper assistance);
• the mandatory code of conduct will be enforced under State and Territory laws;
• parties should negotiate in good faith to reach a mutually agreed outcome;
• the proportionality principle should apply – any reduction in rent should proportionally reflect the reduction in turnover, but how that is documented and structured is up to the individual landlords and tenants;
• if a tenant has not experienced a reduction in business turnover, there should be no entitlement to rent relief – rent should be paid where it can; and
• the mandatory code will provide for:
  • a prohibition on termination of leases for non-payment of rent;
  • a freeze on rent increases;
  • a prohibition on penalties for tenants who stop trading or reduce opening hours;
  • a prohibition on landlords passing land tax to tenants (if not already legislated against);
  • a prohibition on landlords charging interest on unpaid rent;
  • prohibition on landlords from making a claim on a bank guarantee or a security deposit for non-payment of rent;
  • removal of any legislative barriers or administrative hurdles to lease extensions are removed (so that a tenant and landlord could agree a rent waiver in return for a lease extension);
• for landlords and tenants that sign up to the code of conduct, State and Territories have agreed to look at providing the equivalent of at least a 3 month land tax waiver and 3 month land tax deferral on application for eligible landowners, with jurisdictions to continue to monitor the situation. Landlords must pass on the benefits of such relief to tenants;
• it appears that the National Cabinet is stepping away from its previous position that would have allowed tenants to terminate leases for financial distress (as previously announced by the Prime Minister following the National Cabinet meeting on 29 March 2020); and
• mediation in the event that landlords and their retail and commercial tenants were unable to reach agreement will be provided as needed through existing State and Territory mechanisms.

It is unclear how the code of conduct will be enforced and how parties will be bound by the code of conduct, particularly in relation to commercial leases. It may be that landlords and tenants will need to sign up to the code It is possible that regulations will be made in relation to retail leases for enforcement of the code of conduct for retail tenancies.

The Prime Minister acknowledged that both tenants and landlords need each other and that this mutual dependence should drive the parties to come to a sensible arrangement to get through this period. There needs to be "give and take". The key take-away message was for landlords and tenants to "do the right thing".

For tenancies which do not fall within the mandatory code of conduct, landlords and tenants will be free to make their own commercial arrangements in relation to an appropriate level of rent abatement (if any) and the consequences which will flow from that.

How should a landlord determine if a tenant has experienced a reduction in business turnover?

In order to obtain rent relief, tenants will need to be willing to "open their books" to the landlord to demonstrate a reduction in business turnover.

Landlords should ask for relevant information which allows the tenant to demonstrate how their circumstances have changed as a result of COVID-19, with comparative data for pre and post 1 March 2020.

Such information might include:

• evidence that the business is eligible for the "JobKeeper" assistance and has a turnover of less than $50 million (in which case the mandatory code will apply);
• a statement of financial position, outlining income, expenses, assets and liabilities (preferably audited or certified by a chartered accountant), currently and pre-1 March 2020;
• year to date and recent financial year financial statements for the impacted location, and guarantor entity:
  • P&L or Income Statement;
  • Balance Sheet;
• report from an accountant or financial adviser with evidence that the business has experienced a substantial reduction in its ability to pay rent due to the impacts of COVID-19;
• summary of major debt obligations and whether any repayment holidays has been offered by the financier;
• other relevant information depending on the nature of the business, for instance, evidence of a decline in sales or loss of clients/projects and the consequential anticipated turnover for the current quarter, which shows how circumstances have changed as a result of COVID-19 since 1 March 2020;
• what arrangements are currently in place for the ongoing operation of the business, such as work from home arrangements and whether staff have been stood down; and
• whether the tenant holds business interruption insurance that covers the payment of rent and outgoings and if the circumstances for a claim on that insurance have been triggered.

Tenants seeking rent relief will need to be able to justify the relief sought with reference to this information so that the relief is proportionate and reasonable. Tenants who are transparent and provide compelling information are more likely to be persuasive in their claim for rent relief.

How will the rent relief be structured?

The way in which the rent relief is structured is up to the parties. It will no doubt depend on the particular circumstances of the tenant and the extent of financial hardship being experienced.

The Prime Minister said today that "how that is done inside the lease is up to the landlord and the tenant. There are many different ways you can achieve this. If, for example, there was a three or six-month rental waiver because a lessee, a tenant would have had to closed their doors and there is simply no money coming in, one way to achieve that is to extend the overall lease by six months on the other side if they're going to give a rental waiver. Similarly, they could agree to a different amount of the lease for the period of time. These are things we do not wish to be prescriptive about."

Options to consider when negotiating rent relief include:

• Will there be a rent free period or merely a rent reduction?
• Will the abatement apply to other costs like outgoings and cleaning charges or only rent? In relation to outgoings, where the mandatory code of conduct applies, there will be a prohibition on landlords passing land tax to tenants (if not already legislated against).
• Will there be any circumstances for the unpaid rent to be recouped, for instance, will there be a subsequent repayment plan or if the tenant is subsequently in default?
• Will there be any changes to the way in which any existing incentive may be applied?
• Will there be any consequential permanent changes to the lease? For example:
  • an extension of the term;
  • an increase in bank guarantee or provision of corporate or personal guarantees, which would needed to be documented in a formal registered variation of lease; or
  • a change to the rent review mechanism.
• If rent payments are deferred rather than waived, will the unpaid rent component bear interest? The right to interest will not apply in circumstances where the arrangements are governed by the mandatory code of conduct.
• Are there any other conditions attached to the rent relief, such as participation in the "JobKeeper" program or other government assistance?
• If insurance proceeds or government assistance become available, will the tenant be required to use those funds to repay the unpaid rent?
• How long will the arrangement be in place for?
• Is there scope to review the arrangement and in what circumstances?
• Will there a relaxation of other lease obligations, such as an obligation to keep trading? In this regard, arrangements governed by the mandatory code of conduct will have protections for tenants who stop trading or reduce opening hours.

The rent relief agreement should be formally documented. Any permanent changes to the lease (such as an extension of the term) will need to be documented by way of a variation of lease, which can be registered on title if the lease is registered or required to be registered.