On 7 April 2020 the Federal Government introduced the Mandatory Code of Conduct which will apply to commercial leases of certain eligible small to medium enterprise (SME) tenants (the Code). Once the new Code is implemented and takes effect, eligible tenants will be entitled to receive rent reductions in the form of waivers or deferrals to enable them to navigate the uncertain waters of the Covid‑19 pandemic. The Code sets out several ‘good faith’ leasing principles, to be separately legislated and regulated by each State and Territory.
The Code will apply to all SME tenancies that are suffering “financial stress or hardship” (as that term is defined) as a result of the Covid‑19 pandemic, where the tenant:
- is eligible for the Commonwealth Government’s JobKeeper programme; and
- has an annual turnover of up to $50 million,
(referred to as SME tenants).
Financial stress or hardship is the inability of a tenant (whether individual, business or company) as a direct result of the Covid-19 pandemic to generate sufficient revenue, with the effect the tenant is unable to meet its financial and /or contractual commitments. SME tenants who are eligible for the JobKeeper payment are automatically subject to the Code.
Overview of the Code
The purpose of the Code is for parties under commercial tenancy arrangements to share, in a proportionate, measured manner, the financial risk and cashflow impact during the Covid-19 pandemic period. The Code imposes a set of ‘good faith’ principles for application to commercial tenancies (including retail, office and industrial) between owners/ operators/ other landlords and tenants. The Code has not yet been legislated and each State and Territory will need to incorporate the Code in its legislation and regulations, by complementing (rather than superseding) legislation. Once in effect, it will apply during the period in which the JobKeeper programme is operational.
The Code distinguishes between:
- ‘overarching principles’ – where the parties have an obligation to negotiate in good faith and act in an ‘open, honest and transparent manner’. Parties must also provide each other with sufficient and accurate information within the context of such negotiations; and
- ‘leasing principles’ – the Code sets out 14 leasing principles as follows:
- landlords must not terminate a lease for non-payment of rent during the pandemic period or the subsequent recovery period;
- tenants must comply with the terms of their lease subject to the negotiated changes. A material failure to comply with substantive lease terms will result in a forfeit of the protections provided by the Code;
- landlords must not draw on a tenant’s security (whether this be cash bond, bank guarantee or personal guarantee) for the non-payment of rent during the pandemic period or the subsequent recovery period;
- landlords must offer proportionate rent reductions in the form of waivers and deferrals up to 100% of the amount ordinarily payable. The reductions are assessed on a case‑by‑case basis and are to be based on the reduction in the tenant’s turnover during the Covid‑19 pandemic period and the subsequent recovery period;
- “Proportionate” is defined as the amount of rent relief proportionate to the reduction in trade as a result of the Covid‑19 pandemic plus a subsequent reasonable recovery period. Any amount of reduction provided by waiver may not be recouped by the landlord over the term of the lease;
- any rental waivers must constitute no less than 50% of the total rent reduction during that period. Tenants may waive the 50% waiver requirement by agreement with the landlord;
- unless otherwise agreed by the parties, rental deferrals must be amortised over the greater of:
- the balance of the lease term; and
- 24 months.
- tenants should be given the opportunity to extend their leases for an equivalent period of the rent waiver and/ or deferral period;
- any reduction in land tax, council rates or insurance granted to the landlord will be proportionally passed on to the tenant;
- landlords should seek to share with the tenant in a proportionate manner any benefit the landlord receives due to a deferral of loan payments, provided by a financial institution as part of the Australian Bankers Association’s Covid‑19 response;
- 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 may reserve the right to reduce services as required in such circumstances;
- no fees, interest or other charges should be applied with respect to the waived rent, and no fees, charges or punitive interest may be charged on deferrals;
- the tenant should be provided with an opportunity to extend the lease for an equivalent period of the rent waiver and/ or deferral period;
- 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; and
- landlords are prohibited from applying any penalty if a tenant reduces its opening hours or ceases to trade due to the Covid‑19 pandemic.
If negotiations guided by the Code’s principles are unsuccessful, the matter should be referred and subjected to the applicable State or Territory retail/ commercial leasing dispute resolution processes for binding mediation.
Key considerations for commercial SME tenants:
- Eligibility – the Code will be mandatory for tenancies where the tenant is an eligible business for the purposes of the JobKeeper programme.
- Rent waiver or deferral – rent waivers or deferral principles offered to tenants are only required to be proportionate to the reduction of the tenant’s trade during the applicable period. This means that if your business is still trading, albeit at a limited capacity, a landlord is only required to offer a waiver or deferral proportionate to the trading reduction of your business.
- Tenant obligations – tenants must honour and uphold their obligations under the lease. For example, where a tenant is still trading it will not be protected under the Code if it does not comply with the substantive terms of the lease. Tenants must remain committed to the terms of their lease.
- Obligation to negotiate in good faith and accurate provide information – tenants are required to act in an open, honest and transparent manner and provide accurate financial information for the purposes of negotiation with their landlord. Under the Code is it your duty as a tenant to provide accurate turnover figures and other relevant financial statements indicating evidencing your financial position.
- Insurance – tenants should consider whether their business interruption insurance policy will apply in the current circumstances before offering any sort of lease extension in return for a short‑term rent deferral or waiver. Early indications are that COVID-19 issues are unlikely to be covered by insurance. We suggest you contact your insurance provider to discuss your options.
- FIRB – where a tenant has foreign ownership an extension of the lease term or substantial variation of the lease may attract the operation of the Foreign Acquisitions and Takeovers Act 1975, having regard to the recent reduction of the thresholds applicable under the Act to zero. In limited circumstances this may require the tenant to make application for a no objection letter, approval or exemption under the Act.
Key considerations for commercial landlords:
- Eligibility – the Code will be mandatory for tenancies where the tenant is eligible for the JobKeeper programme and has an annual turnover of up to $50 million.
- Restrictions on security drawdowns and termination – landlords are prohibited from drawing on a tenant’s security or terminating a lease for non-payment of rent during the Covid‑19 pandemic and the subsequent recovery period. It is important to note that if a landlord has cash flow issues, it will not be able to call on any cash deposits, bonds or bank guarantees provided as security by the tenant under the lease. Under the Code, it is unclear whether there is a blanket prohibition on drawing on security for non-payment of rent (for reasons not related to the pandemic) during the pandemic period and the subsequent recovery period.
- Obligation to negotiate in good faith – landlords are required to act in an open, honest and transparent manner when negotiating with tenants.
- Implications for offering rent deferral or waiver – if there is a rent concession provided by the landlord to the tenant during the pandemic, care should be taken in the drafting to ensure that it does not affect a later market rent determination. Landlords should note that they must not impose fees, interest or charges on rent waivers or fees, charges or punitive interest on rent deferrals.
- Protection of security interests – until legislated by each of the States and Territories, it is unclear under the guiding principles of the Code whether landlords are permitted to record their interests to the security under the lease on the Personal Property and Securities Register. However, if a significant security deposit has been provided, landlords should consider whether this is an option to be explored to protect their interests.
- Landlords must pass on outgoings relief – if landlords are granted any relief from their obligations to pay land tax, council rates or insurance premiums, these savings are required to be proportionately passed on to their tenants.
- Tenant turnover figures – although tenants have an obligation to act in good faith and provide accurate information, there is a significant degree of honesty required of tenants when disclosing financial statements evidencing their revenue figures. Given tenants would not necessarily have up-to-date financial statements, landlord should carefully review any financial statements provided by their tenant indicating a loss of revenue.
- Financing arrangements and underlying asset valuation – if landlords are agreeing and formalising lease variations and rent concessions, they should consider any restrictions or provisions in the terms of their financing arrangements that may need to be complied with. Landlords should also consider the impact that any rent concession or lease variations may have on the market valuation of their asset or the relevant portfolio.
If you are unsure of your rights and obligations as a SME tenant or a landlord the subject of an SME tenancy during this period of uncertainty, please take a moment to consider these points to ensure you understand the full extent of your entitlements and obligations under the Code as well as your lease during this period of widespread disruption.
Tenants & Rent Abatement
Our recommendation is that SME tenants should commence discussions with their landlords as soon as possible in accordance with the Code, with a view to agreeing a reduction or deferral of rent payable under the tenancy agreements during the COVID-19 pandemic and a subsequent recovery period.
Tenants should ensure that any approaches to landlords are framed under the guiding principles of the Code, as a request to agree a rent waiver or deferral, without any suggestion that they intend to stop paying rent. This is important to avoid the possibility of anticipatory breach or their actions being considered a repudiation of the lease.
SME Tenants should proactively and clearly communicate with their landlords regarding any decisions they make about full or partial closure of their premises, whether they are offices, industrial or retail. This will ensure that the landlord is aware that its tenant’s decision to cease or reduce occupation is a step to mitigate risk until the COVID-19 outbreak abates, not a decision to abandon the premises. Tenants should also ensure that they continue to maintain all insurances required under their leases during any period of premises closure.
If you are a SME tenant and think you may be entitled to rent relief under your commercial lease or the Code, we are happy to assist with drafting or reviewing letters to your landlord on these issues, together with formal arrangements to vary the lease in respect of the rent relief arrangements. For tenants who do not fall within the Code, landlords and tenants may still make commercial arrangements in relation to an appropriate level of rent abatement (if any) under a lease.
If you are a landlord the subject of an SME tenancy, you should carefully consider the key items listed above. The Code as it currently stands is largely tenant friendly. There will be both flow-on issues and practical issues for landlords to carefully consider in the coming months. If you need assistance with navigating these foreseeable issues or assistance with negotiating or documenting any agreed variations to leases, we can assist you in this regard.
We suggest that landlords:
- request tenants to provide relevant information and evidence to demonstrate that the tenants are eligible for relief under the Code. Landlords may pay particular attention to tenant’s online sales and may seek comfort from the tenant’s accountants and bankers about the information provided by tenants;
- give their bank visibility on their discussions with tenants and request that the bank give the landlord relief from their financial covenants and payment obligations;
- get on the front foot by preparing a pro forma variation of lease or side deed which protects the landlord’s interests, while still complying with the requirements of the Code. Issues to consider before commencing negotiations with tenants are:
- whether there are tax or accounting consequences in deciding to give a rent waiver or a deferral;
- if the lease contains an incentive which has not been utilised or foregone, whether this can be used to implement the rent relief;
- whether the agreement can be drafted by way of a deed which is not registered on title to protect confidentiality;
- whether any consequential changes need to be made to the lease, such as an extension of the term, an increase in security, confirmation that the variations must not affect any market rent review under the lease, changes to trading hours or other operational issues;
- be alive to the fact that an extension of the lease term or substantial variations of the lease may have implications for tenants with foreign ownership. In limited circumstances, the Government’s reduction of the thresholds applicable under the Foreign Acquisitions and Takeovers Act 1975 to zero may require those tenants to make application for approvals or exemptions under the Act.
- requiring regular reporting from tenants on trading;
- consider whether any changes should be agreed to the rent relief arrangements if the tenant’s trading improves before the pandemic ends, or the government introduces additional measures to support tenants or landlords; and
- whether any provisions can be incorporated in the agreement to ensure the tenant is not relieved from any breaches of the other provisions of the lease and the landlord has the ability to exercise its rights in respect of such breaches.
Generally, it is recommended that landlords take a pragmatic approach giving consideration to the long-term benefits of reaching an agreement with their tenants, which will allow the tenants to re‑commence trading under the existing lease terms after the Covid‑19 pandemic and the reasonable recovery period. Ultimately, this would be preferable to vacant premises where a tenant’s business does not survive the pandemic.