April 2020
On 7 April 2020 the much-anticipated Mandatory Code of Conduct for SME commercial leases was released by the Prime Minister. The Code of Conduct (Code) imposes a set of good faith leasing principles which fundamentally modify the terms of commercial leases (including retail, office and industrial) to aid the management of cashflow by sharing the burden on a proportionate basis due to the impact and financial disruption caused by the virus and government response to contain the pandemic.
The Code was developed after consultation with stakeholders in the commercial property sector and will be supported by state-based Committees comprising of representatives from relevant bodies including landlord, tenant and SME interests. Committee members will meet fortnightly and their role is to promote, monitor operation, and encourage use of the Code.
Whilst the Code will be given effect through relevant state and territory legislation or regulation as appropriate it is not intended to supersede such legislation, but aims to complement it during the COVID-19 crisis period.
Applicable Tenancies
This Code applies to all tenancies that are suffering Financial Stress or Hardship as a result of COVID-19 as defined by their eligibility for the Commonwealth Government’s JobKeeper programme, with an annual turnover of up to $50 million (SME tenants). The threshold for franchises will be determined at the franchisee level and retail corporate groups at the group level.
Financial Stress and Hardship is defined as 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 (including retail leasing) commitments. SME tenants which are eligible for the federal government’s JobKeeper payment are automatically considered to be in financial distress under this Code.
The principles adopted in the Code are also intended to apply to leasing arrangements of businesses affected by COVID-19 regardless of whether they meet the specific eligibility criteria.
Commencement
This Code comes into effect in all states and territories from a date following 3 April 2020 (being the date that National Cabinet agreed to a set of principles to guide the Code to govern commercial tenancies as affected by the COVID-19 pandemic) to be defined by each jurisdiction, for the period during which the Commonwealth JobKeeper program remains operational, currently in place for 6 months.
Overarching Principles
As mentioned earlier, the objective of the Code is to share, in a proportionate, measured manner, the financial risk and cashflow impact during the pandemic, whilst seeking to appropriately balance the interests of tenants and landlords.
It is intended that landlords will agree tailored, bespoke and appropriate temporary arrangements for each SME tenant, taking into account their particular circumstances on a case-by-case basis.
The following overarching principles of this Code will apply in guiding such arrangements:
- Landlords and tenants share a common interest to ensure business continuity, and to facilitate the resumption of normal trading activities.
- Landlords and tenants will be required to negotiate in good faith and work to achieve mutually satisfactory outcomes.
- Landlords and tenants will act in an open, honest and transparent manner, and will each provide sufficient and accurate information during negotiations to achieve outcomes consistent with the Code.
Sufficient and accurate information includes information generated from an accounting system, and information provided to and/or received from a financial institution, that impacts the timeliness of the Parties making decisions with regard to the financial stress caused as a direct result of COVID-19. Examples of such information might include bank statements, audited or certified financial statements by a chartered accountant, profit and loss statements, balance sheet, and register printouts.
- Arrangements will take into account the tenant’s revenue, expenses, and profitability.
- The parties will assist each other in their respective dealings with governments, utility companies, and banks/other financial institutions in order to achieve outcomes consistent with the Code.
- The landlord must not seek to permanently mitigate this risk in negotiating temporary arrangements envisaged under this Code.
- Each lease must be dealt with on a case-by-case basis having regard to the SME tenant suffering financial hardship including expiration of the lease and in “hold-over” or is soon to expire; and if the tenant is in arrears or insolvent.
Leasing Principles
The Code should be applied as soon as practicable on a case-by-case basis. However, the Code imposes a number of mandatory restrictions during the pandemic and a reasonable recovery period including:
1. Landlords must not terminate leases for the non-payment of rent.
2. Landlords must not impose rent increases (except for retail leases based on turnover rent).
3. Landlords must not draw on a tenant’s security (cash bond, bank or personal guarantee) for the non-payment of rent.
4. Landlords may not apply any penalties if tenants reduce opening hours or cease to trade.
5. Landlords must not charge any fees, interest or other charges on any unpaid rent, rent waivers and deferrals.
The Code also includes express positive obligations on the parties:
6. 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.
A waiver means the amount of rent payable is abandoned and may not be recovered by the landlord at a later stage. In contrast, a deferral means the amount of rent is payable by the tenant at a later time.
Any reference to waiver and deferral also includes alternative outcomes such as deferral, pausing and/or hibernating the lease or any other agreements 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.
7. Waivers must constitute no less than 50% of the total reduction in rent payable with regard to the Landlord’s financial ability to do so. Tenants may waive the requirement for a 50% minimum waiver by agreement.
8. Payment of 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.
9. Tenants must remain committed to the terms of their lease and pay rent where possible otherwise a material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under this Code.
10. 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.
11. A landlord should seek to share any benefit it receives due to deferral of loan payments, provided by a financial institution with the tenant in a proportionate manner.
12. Landlords should waive recovery of any other expense (or outgoing payable) by a tenant during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.
13. If negotiated arrangements under this 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 COVID-19 pandemic ending (as defined by the Australian Government) or the existing lease expiring and taking into account a reasonable subsequent recovery period.
14. The tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the COVID-19 pandemic concludes.
Case Study 1
A tenant is experiencing a 60% decrease in turnover since March 2020 as a result of the COVID-19 pandemic. The lease period is 10 years with 6 years remaining. Rent is $20,000 per calendar month and a rent review is scheduled on 1 May 2020. The tenant’s usual turnover is less than $50 million.
This lease is subject to the mandatory Code. The tenant would be entitled to a proportionate rent reduction of 60%, with at least half of this reduction being a permanent waiver which applies as follows.
The tenant would pay $8,000 each month (40% rent); where $6,000 each month is deferred (30% deferred) and payable over a period of at least 24 months after the reasonable recovery period, with the remaining $6,000 each month permanently waived (30% waived) by the landlord. The lease period remains the same with no extensions. The rent review would not occur and would be postponed until after the reasonable recovery period.
Case Study 2
A tenant is experiencing a 100% decrease in turnover since March 2020 as a result of the COVID-19 pandemic. The lease period is 5 years with 1 year remaining. Rent is $20,000 per calendar month and a rent review is scheduled on 1 May 2020. The tenant’s usual turnover is less than $50 million.
This lease is subject to the mandatory Code. The tenant would be entitled to a proportionate rent reduction of 100%, with at least half of this reduction being a permanent waiver which applies as follows.
The tenant would make no rental payments each month (0% rent); where $10,000 each month is deferred (50% deferred) and payable over a period of at least 24 months after the reasonable recovery period. The lease agrees to extend the tenants lease term for another 12 months (period of non-trading plus a reasonable time to recover). The remaining $10,000 each month permanently waived (50% waived) by the landlord. The rent review would not occur.
Mediation
Where landlords and tenants cannot reach agreement on leasing arrangements the matter should be referred and subjected (by either party) to applicable state or territory retail/commercial leasing dispute resolution processes for binding mediation, including Small Business Commissioners, Champions and Ombudsmen where applicable.
Landlords and tenants must not use mediation processes to prolong or frustrate the facilitation of amicable resolution outcomes.
Comments and Observations
Until the states and territories pass legislation in support of the Code, we will not know the full extent and implications for landlords and tenants. Despite this, there is no reason why parties are unable to commence negotiations for rent relief within the principles outlined in the Code.
The operation and ultimate success of the Code is based solely on the good faith of landlords and tenants. A level of trust is required for the parties to resolve their rent payment dispute. Tenants must be completely transparent to landlords regarding their current financial position, both cash flow and savings. This also means landlords are required to provide information regarding their financial obligations to banks and lenders so that if a waiver or deferral is given to them, then in the spirit of Code, it is passed onto the tenant.
However, outgoings are still recoverable although landlords are asked to waive these expenses if tenants are not trading. If a tenant is not required by law to close but chooses to do so, then an automatic 100% decrease in turnover would entitle the tenant to a proportionate rent reduction of 100%. Alternatively, in cases where landlords and tenants come to an agreement, what happens if there is a monthly fluctuation in the tenant’s turnover? An increase in turnover would not complicate matters, but if there is a decrease, what are the parties rights regarding breach and enforcement of their agreement? Do the parties enter into further negotiations to reach a new agreement?
Tenants must remain committed to all other terms of their lease otherwise they do not have the protections afforded to them under the Code. A landlord cannot terminate a lease for non-payment of rent but the Code provides no protection from termination for reasons other than a failure to pay rent, which may give rise to a landlord accessing securities. This scenario would be subject to the overarching principles in the Code.
Although rent increases are forbidden, increases due to turnover rent provisions of retail leases, such as those usually found in shopping centres including Westfield, are allowed.
The Code does not provide for an automatic arrangement between landlord and tenant. For any agreement to be effective, the parties must formally document their arrangement and any variations to the lease.
The existence of a binding mediation procedure will provide an avenue for the resolution of any dispute or bad faith negotiations. Where a tenant is unable to pay rent and having regard to the financial resources of the landlord, it is likely that many tenants who receive only a 50% rent waiver might seek more at mediation. That said, how will the mediation process and enforcement mechanisms operate in each state or territory and what powers will mediators possess?
With respect to agreements reached before 3 April 2020, one may assume that those arrangements can be revisited to the extent of any inconsistency at mediation.
The Code presents landlords and tenants with numerous tests, the main being logistical challenges for landlords with extensive property portfolios being able to meet and agree with their tenants in a reasonable and timely manner. The Code should, however, provide a level of comfort to landlords and tenants as opportunistic behaviour and bad faith is completely rejected and will not be tolerated. The Code provides real opportunities for the parties especially when negotiations are honest, genuine and transparent so that the solution becomes purely mathematical with touches of reasonableness, if required.
We understand that you are focused on more important matters during this pandemic. Ensuring the continued well-being of your family and loved ones is paramount. We are available to assist landlords and tenants with Code based negotiations to protect business interests and place you in the best position to financially recovery once this pandemic is over.