Mandatory Code for Commercial Tenancies
Details have now been announced of the commercial leasing principles that are to apply during the COVID-19 pandemic and which are included in the National Cabinet Mandatory Code of Conduct (Code). The Code comes into effect from a date following 3 April 2020 to be determined by each jurisdiction and will continue for a period during which the JobKeeper Program remains operational. The Code significantly alters the legal principles which would otherwise regulate the rights and obligations of landlords and tenants under those leases to which the Code applies.
Application of the Code
The Code applies to all commercial tenancies (including retail, office and industrial) where the tenant has signed up to the JobKeeper Program and that have an annual turnover of $50 million per annum or less.
The limitation on turnover means that tenants who are otherwise entitled to participate in the JobKeeper Program, will not be eligible for rent relief under the Code if they have turnover exceeding $50 million.
The trigger for eligibility for the JobKeeper Program is a 30% reduction in turnover relative to the corresponding period 12 months earlier for companies with turnover of up to $1 billion per annum, and a 50% reduction in turnover relative to the corresponding period 12 months earlier for companies with turnover of more than $1 billion per annum.
The $50 million annual turnover threshold will be applied in respect of franchises at the franchisee level, and in respect of retail corporate groups at the group level (rather than at the individual retail outlet level).
For our Victorian readers, the Victorian Government has already announced a rent relief scheme for any commercial businesses that hold a lease or licence on a government property as outlined in its 21 March announcement of its Economic Survival Package to Support Businesses and Jobs. It is not clear if the Code is intended to apply where government is the landlord, and if it is to apply, how the separate schemes will co-exist where they may vary. This will need to be clarified.
The Code will apply to eligible tenants notwithstanding those tenants who may have previously negotiated rent reductions or other variations to their lease terms with their landlords. If those existing arrangements provide for less rent relief or impose repayment obligations which are not consistent with the Code, tenants will be able to renegotiate those arrangements with landlords in accordance with the terms of the Code.
If the Code does not apply to a lease, the legal principles applicable to those leases as described in our eAlert will continue to apply.
Purpose of the Code
The express purpose of the Code is to impose a set of good faith leasing principles for application to commercial tenancies between landlords and tenants where the tenant is an eligible business under the terms of the Commonwealth Government’s JobKeeper Program. The intention is to aid the management of cashflow for tenants and landlords on a proportionate basis as a result of the impact of COVID-19, whilst seeking to appropriately balance the interests of tenants and landlords.
It is intended that landlords will agree to tailored, bespoke and appropriate temporary arrangements for each tenant, taking into account the particular circumstances of the tenant, on a case by case basis.
The Code will be given effect through relevant state or territory legislation or regulation.
Overarching principles of the Code
The Code sets out a number of overarching principles to apply in determining the arrangements between tenants and landlords. In summary, those principles are:
- Landlords and tenants will negotiate in good faith and work towards shared and mutually satisfactory outcomes which are proportionate and appropriate, based on the impact of COVID-19 plus a reasonable recovery period. The intention is to facilitate the resumption of normal trading activities at the end of the COVID-19 pandemic.
- All leases must be dealt with on a case by case basis considering the specific terms and conditions of each lease including where a tenant is already in arrears.
- While due regard should be given to whether the tenant is in administration or receivership and the application of the Code modified accordingly, landlords and tenants will take into account the fact that the risk of default on commercial leases is ultimately (and already) borne by the landlord and the landlord must not seek to permanently mitigate this risk in negotiating arrangements under the Code.
- Landlords and tenants must act in an open, honest and transparent manner and will each provide sufficient and accurate information to achieve the outcomes of the Code.
The following principles apply in negotiations between landlord and tenants and the Code confirms that the 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 remain committed to the terms of their lease, subject to any amendments negotiated under the Code. If tenants don’t abide by the terms of their lease, they will lose the protection provided to them 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 amount ordinarily payable, on a case by case basis, based on the reduction in the tenant’s trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.
Waiver and deferral also includes other forms of agreed variations to existing leases (such as deferral, pausing and/or hibernating the lease), or any such other commercial outcome or agreement reached between the parties.
- Rental waivers must constitute no less than 50% of the total waiver or deferral agreed and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise a tenant’s capacity to fulfil their ongoing obligations under the lease agreement. The landlord’s financial ability to pay such additional waivers should also be considered.
Any amount of reduction in rent provided by a waiver may not be recouped by the landlord over the term of the lease.
Tenants may waive the requirement for a 50% minimum waiver by agreement.
- 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.
- Any reduction in statutory charges (eg land tax, council rates) or insurance will be passed onto the tenant in the appropriate proportion applicable under the terms of the lease.
- A landlord should seek to share any benefit it receives due to deferral of loan payments with the tenant in a proportionate manner.
- 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.
- 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 COVID-19 pandemic ending (as defined by the Australian Government) or the existing lease expiring, and taking into account a reasonable subsequent recovery period.
- No fees, interest or other charges should be applied with respect to rent waived, and no fees, charges or punitive interest may be charged on rent deferrals.
- 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 period of the COVID-19 pandemic and or a reasonable subsequent recovery period.
- The tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period agreed to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the COVID-19 pandemic period concludes.
- Landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period, notwithstanding any arrangements between the landlord and the tenant.
- Landlords may not apply any prohibition or levy any penalties if tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.
Where landlords and tenants cannot reach agreement on amendments to the leasing arrangements in accordance with the Code, either party may refer the matter to applicable state or territory retail/commercial leasing dispute resolution processes for binding mediation. Landlords and tenants must not use the mediation processes to prolong or frustrate the facilitation of amicable resolution outcomes.
Code Administration Committee
The Code will be supported by state based industry code and administration committees, comprising representatives from relevant industry bodies representing landlords, and tenant interests, with an independent chair appointed by the relevant state/territory government.
Practical implications for landlords and tenants
To the extent it applies to their leasing arrangement, the Code now imposes a mandatory set of principles requiring landlords and tenants to renegotiate the terms and conditions of their leases to take into account the impact of tenant turnover caused by the economic impacts of industry and government responses to Covid-19.
As the Code makes it clear that each lease must be dealt with on a case by case basis, landlords and tenants will need to carefully review the terms of their respective leases to determine whether or not the Code applies to the lease, and if so, the specific impact the Code will have on any particular lease.
While the Code provides guidance on a number of matters which remained unclear following earlier announcements by the Prime Minister, there still remain some areas of uncertainty which will need careful review and consideration.
A key issue for landlords will be how to be satisfied that a tenant’s turnover is less than $50 million per annum and to what percentage a tenant’s turnover has actually reduced. Due to confidentiality and privacy provisions, tenants may not be prepared to provide landlords with full details of their businesses. While the Code requires tenants to provide 'sufficient and accurate information' what that information comprises and how it is provided is likely to be a matter for discussion and resolution between the parties. There may need to be mechanism for an independent auditor or other independent process to provide verification of annual turnover and reduction in that turnover.
Another key issue for landlords and tenants will be determining appropriate regimes for reductions in outgoings, reduction in services and mechanisms for repayment of any deferred rent. These will involve careful consideration and detailed drafting to ensure that fair and appropriate outcomes are achieved.
We will separately provide updates on other relevant considerations and issues raised by the Code.
The changes enacted under the Code are broad and impose significant obligations and restrictions on landlords and tenants, and significantly alter the legal principles which would otherwise apply under their leases.
If we can assist you in understanding your rights and obligations under your leases, and the impacts of the Code on those rights and obligations, please contact us.
Maddocks has produced guides to a range of legal issues raised by the coronavirus (COVID-19). You can access these guides here.
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