Mandatory Code of Conduct – SME Commercial Leasing Principles

This article is current as at 9 April. We will update you with the latest developments as they occur.

On 7 April 2020, Prime Minister Scott Morrison announced the National Cabinet’s new Code of Conduct for commercial tenancies.  The Code will become law once it is enacted by each of the States and Territories shortly.

The Code imposes a set of leasing principles, which must be applied when negotiating amendments to existing leasing arrangements for certain tenancies.

The objective of the Code is to share, in a proportionate, measured manner, the financial risk and cashflow impact during the COVID-19 pandemic.  Landlords and tenants are encouraged to tailor their agreement to their particular situation (noting some tenants have obviously been harder hit than others), to ensure businesses can recover on the other side of this crisis.

In what situations will the Code apply?

The Code only applies:

• to commercial tenancies, including retail, office and industrial tenancies;

• where the tenant is suffering “financial stress or hardship” as a result of the COVID-19 pandemic as defined by their eligibility for the Commonwealth Government’s JobKeeper programme, with an annual turnover of up to $50 million (to be applied at the franchisee level for franchises, and the group level for retail corporate groups); and

• for the duration of the COVID-19 pandemic period (as defined by the government, estimated to be 6 months, and being tied to the period during which the JobKeeper programme is operational).

The Code defines “financial stress or hardship” to be “an individual, business or company's inability to generate sufficient revenue as a direct result of the COVID-19 pandemic (including government-mandated trading restrictions) that causes the tenant to be unable to meet its financial and/or contractual … commitments.  SME tenants which are eligible for the federal government’s JobKeeper payment are automatically considered to be in financial distress under the Code.

Who is eligible for the JobKeeper programme?

Businesses (including not-for-profit entities and self-employed individuals) will be eligible for the JobKeeper program if:

• they have a turnover of less than $1 billion and their turnover has fallen by more than 30% (of at least a month) when compared to the same month last year; or

• they have a turnover of $1 billion or more and their turnover has fallen by more than 50% (of at least a month) when compared to the same month last year.

Note, that the Code only applies to enterprises that have an annual turnover of up to $50 million – therefore, the Code will not apply to all businesses that qualify for the JobKeeper programme.

While the Code only applies to SME tenants who are eligible for the JobKeeper programme, parties involved in negotiations relating to tenancies that do not strictly fit the criteria are encouraged to follow the Code.

What does the Code require landlords and tenants to do?

The Code provides that negotiated agreements must follow these principles:

1. Landlords must not terminate leases due to non-payment of rent during the pandemic period (or reasonable subsequent recovery period).

2. Tenants must remain committed to the terms of their lease, subject to any amendments negotiated under the Code. Tenants who fail to abide by substantive terms of their lease will lose any protections provided under the Code.

3. 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. This is on a case-by-case basis, based on the reduction in the tenant’s trade as a result of the COVID-19 pandemic during the pandemic period, plus a subsequent reasonable recovery period (consistent with assessments undertaken for eligibility for the Commonwealth’s JobKeeper programme). A ‘waiver’ or ‘deferral’ could also include other forms of agreed variations to the lease (such as deferral, pausing and/or hibernating the lease), or any other commercial agreement reached between the parties.  Any amount of reduction provided by a waiver may not be recouped by the landlord over the term of the lease.

4. Rental waivers must constitute at least 50% of the total reduction in rent payable under principle #3 above during the pandemic period, and should constitute a greater proportion in cases where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease. Regard must also be had to the landlord’s financial ability to provide such additional waivers.  Tenants may waive the requirement for a 50% minimum waiver by agreement.

5. Payment of rental deferrals by the tenant must be amortised (ie. spread) 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). This means that the parties may have an ongoing contractual relationship (ie. ongoing repayment of deferred rent), even after the lease term ends – we understand that the term of the lease does not need to be extended to accommodate the repayment period.

6. Any reduction in statutory charges (e.g. land tax, council rates) or insurance will be passed on to the tenant in the appropriate proportion applicable under the terms of the lease.

7. A landlord should seek to share any benefit it receives due to deferral of loan repayments with the tenant in a proportionate manner.

8. Landlords should where appropriate seek to waive recovery of any other expense or outgoing payable by a tenant, under lease terms, during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.

9. If negotiated arrangements under the Code necessitate repayment, this should occur over an extended period in order to avoid placing an undue financial burden on the tenant. No repayment should commence until the earlier of the pandemic ending or the existing lease expiring, and taking into account a reasonable subsequent recovery period.

10. No fees, interest or other charges should be applied with respect to rent waived in principles #3 and #4 above and no fees, charges or punitive interest may be charged on deferrals in principles #3, #4 and #5 above.

11. Landlords must not draw on a tenant’s security for the non-payment of rent (be this a cash bond, bank guarantee or personal guarantee) during the pandemic period and/or a reasonable subsequent recovery period.

12. The tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period outlined in principle #2 above. This is intended to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the pandemic concludes.

13. Landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the pandemic and a reasonable subsequent recovery period (unless the landlord and tenant agree otherwise).

14. Landlords may not apply any prohibition or impose any penalties if tenants reduce opening hours or cease to trade due to the pandemic.

Examples of ‘proportionality’

The Code provides some examples of how the proportionality principle works:

• If the tenant’s revenue has fallen by 100%, then at least 50% of total cash flow relief provided by the landlord must be a rent waiver and the remainder is a rent deferral. The deferred rent is to be recouped over at least 24 months in a manner that is negotiated by the parties.

• If the tenant’s revenue has fallen by 30%, then the landlord must guarantee a 30% cash flow relief under the lease. At a minimum, half must be provided by way of rent waiver, and the remainder may be provided as a rent deferral.  The deferred rent is to be recouped over at least 24 months in a manner that is negotiated by the parties.

All leases must be dealt with on a case-by-case basis, considering factors such as whether the SME tenant has suffered financial hardship due to the COVID-19 pandemic; whether the tenant is already in arrears; whether the tenant’s lease has expired, is soon to expire or has already expired and is on holdover; and whether the tenant is in administration or receivership.  For example, the Code should not apply in the same way if a tenant was already in administration or receivership.

The parties must negotiate in good faith, and act in an open, honest and transparent manner.  They must provide sufficient and accurate information to each other.  Such information includes information generated from an accounting system, and information provided to and/or received from a financial institution, that impacts the negotiations and relates to the parties’ current financial stress caused as a direct result of the COVID-19 event.  The parties should assist each other in their dealings with other organisations, such as banks, government authorities, utility providers, etc.

Does the Code encourage the parties to mediate their differences?

Yes.  If the parties are not able to agree on an outcome, either party can apply to have the matter referred to binding mediation, using existing services (such as the services offered by the Small Business Commissioner).  The parties must not use the mediation process as an opportunity to prolong or delay resolution of the matter.

Who will administer the Code?

The Code will be administered by state based Industry Code Administration Committees, comprising representatives from relevant industry bodies representing the interests of landlords, tenants and small to medium enterprises.  Committee members must promote awareness of, encourage application of, and monitor the operation of the Code.

Conclusion

Overall, the Code offers a reasonable set of principles which will give parties some clarity around what their negotiated agreement should entail.  However, many landlords, particularly those whose tenants have seen a 100% drop in revenue due to government-imposed closures, will be left to bear the brunt of these measures – as they will not be collecting any rent, and will be waiting at least 24 months before all rent deferrals are repaid. 

Although landlords may gain some relief by pausing mortgage repayments and accessing some benefits that have been announced – such as deferral (not waiver) of land tax payments, and deferral of other payments (which must largely be negotiated with each provider, including strata levies, council rates and other rates and taxes) – it seems landlords will ultimately be responsible for ‘holding the fort’ in relation to any payments that still need to be made.  Landlords are not likely to be afforded a 24 month period within which to repay such deferred expenses.

If parties have already come to an agreement, they may like to review such agreement in light of the new Code to see whether a more suitable arrangement could be struck.

The Commonwealth Government is acting as a model landlord by waiving rents for all its SME and not-for-profit tenants within its owned and leased property across Australia.

Note that the code does not apply to residential tenancies, with such tenancies to be dealt with by each of the State and Territory governments.  The Prime Minister stated “we have a moratorium on evictions, and then individual measures beyond that … are best addressed within each individual jurisdiction”.

Authors: Melissa Potter and Kristie Carlile

 

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