Commercial leases in the aftermath of COVID-19

This article was published in the Hire and Rental News on 9 Sept 2021.

On 28 March 2021, the operation of the Retail and Other Commercial Leases (COVID-19) Regulations 2020 (Regulations) came to an end.

This means that the relief and protections afforded to retail and commercial tenants by the Regulations is no longer available.

However, this has opened up a whole other layer of complexities for parties to consider when dealing with retail and commercial premises over the next 12 to 24 months.

The Past - the Code and the Regulations

The National Cabinet Mandatory Code of Conduct (“the Code”) was introduced on 7 April 2020 – see our earlier article: Mandatory Code of Conduct – SME Commercial Leasing Principles

The purpose of the Code was to create a set of good faith leasing principles against which landlords and tenants could renegotiate their leases to assist the tenant through the period of the COVID-19 pandemic.

Interestingly, a number of the leasing principles set out by the Code are expressed to apply to the pandemic period and a reasonable subsequent recovery period. 

On 24 April 2020, New South Wales passed the Retail and Other Commercial Leases (COVID-19) Regulations 2020. Those Regulations placed an obligation on the parties to renegotiate the terms of the lease, having regard to:

• the economic impacts of the COVID-19 pandemic

• the leasing principles set out in the National Code of Conduct.

Whilst those Regulations have now gone through three different iterations, the emphasis has always been to provide tenants and landlords with a set of good faith leasing principles to govern their negotiations.

We set out below some of those principles which we think will continue to have effect, long after the Regulations cease:

• Leasing Principle 1 – Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or reasonable subsequent recovery period);

• Leasing Principle 5 – Payment of rental deferrals by the tenant 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; and

• Leasing Principle 9 – If negotiated arrangements under this Code necessitate repayment, this should occur over an extended period in order to avoid placing 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.

The Present - cases and early complexities

There was and remains some level of complexity as to the practical interpretation of the Code and the Regulations; what prescribed actions could be taken, when proceedings could be brought and what was a reasonable subsequent recovery period were just some of the questions we were asked on a regular basis.

In August 2020, the Supreme Court of New South Wales in the matter of Sneakerboy helpfully gave some guidance on those issues and in particular what a reasonable subsequent recovery period was. Whilst it is important to note that the reasonable subsequent recovery period is fluid and will need to be determined on a case by case basis depending on the industry, Justice Robb has determined that a period of six months following the end of the pandemic period to be a reasonable period -  see our earlier article: Sneakerboy - Running headfirst into COVID-19 lease issues

It is likely that there will continue to be arguments between landlords and tenants in relation to the application of the Code and the Regulations for months to come. By way of example, just recently, proceedings were commenced by Kiss Kiss Bang Bang Pty Ltd, a small bar in Sydney, against its landlord for taking possession of its premises four days after the cessation of the Retail and Other Commercial Leasing (COVID-19) Regulation (No 2) 2020.

The Future – practical issues arising from deferred rents and the reasonable subsequent recovery period

From a practical perspective for landlords and tenants, the deferral of rental payments coupled with the inability to take a prescribed action for a circumstance arising from the COVID-19 pandemic, will no doubt add a greater level of complexity and consideration for property transactions.

In this regard, it is likely that deferred rent and or negotiated settlements will, over the next year or two, impact at least the following areas:

Subleases

In most leases, a landlord will have the ability to withhold its consent to a tenant subletting the premises in circumstances where there are arrears.

Consideration will need to be given as to whether the deferred rent, which is often invoiced at the time it would ordinarily become due, is technically in arrears. This would provide a basis for a landlord to potentially withhold consent.

Although inconsistent with the spirit of the Code, we expect to see opportunistic landlords, seeking as a condition to the grant of a sublease, the payment of all deferred amounts upfront.

Assignment of interest in lease

Similar to the issues raised in respect of subleases, the deferred rent will cause significant complexity when parties are looking to assign their interest in a particular lease.

Some of the issues we expect to see over the next 12 to 24 months will surround the commercial negotiations and terms of the assignment, including whose obligation it will be to pay the deferred rent.

In circumstances where the obligations remain with the outgoing tenant, this creates further risk for the landlord recovering the deferred rent in circumstances where they do not have the same rights that would be available under a lease to retake possession of the property and call on existing bank guarantees.

Sale of retail or commercial premises subject to existing tenancies

The sale and purchase of retail and commercial premises will require a consideration of whether the vendor and tenant entered into any agreement to defer the repayment of rent.  Similar to an assignment of lease, how will a vendor recover abated rent when it is no longer a party to the lease?

Further, an existing tenancy, which once provided some certainty of income, could now present uncertainty for prospective purchasers especially in circumstances where:

1. arrangements between the existing landlord and tenant may be over an exponential period of time limiting the ability for the purchaser as incoming landlord to increase rents or take prescribed actions;

2. arrangements between the existing landlord and the tenant may not be in writing and it may not be clear how much rent has been abated and when it will be payable;

3. the reduced rental payments over a long period of time may ultimately result in a lower valuation for the premises and create serviceability issues and/ or lending issues for the acquiring party.

As a key takeaway, we recommend that any party who is interested in acquiring an interest in a property, either by acquisition or lease, undertake their due diligence as to the arrangements which may have been agreed (either in writing or verbally) during the pandemic period as the terms of those agreements may ultimately affect the legal entitlement and commercial deal which might be struck.

Authors: Adam Cutri, Melissa Potter & Gabrielle Ellis