COVID-19: the impact on commercial leases

Almost all businesses that operate out of physical premises have been impacted by the COVID-19 pandemic. If you are a commercial tenant or landlord, you will be understandably concerned about your rights and obligations under your commercial lease.

Tenants are mainly concerned about costs and cashflow. For many small businesses rent is the biggest overhead cost after salaries. Many tenants are faced with having to run their business remotely, meet rent payments on time and also consider their ability to access premises as and when needed including during deep clean processes and if changing their services offering having to establish whether they are impacted by change of use rules.

Commercial landlords are mainly concerned about costs and cashflow, their obligations to continue providing services to tenants and also to meet financial obligations to lenders especially where the property is used as security. Many tenants have had to close physical premises and have had their income drastically reduced or extinguished and so cannot pay their rent at all. Landlords may want to ensure some level of payment and/or to secure enhanced future repayment to recoup losses they will suffer as a result. Equally they will need to consider mitigating their losses, clear in the knowledge that finding an alternative, fully paying, tenant in this market is unlikely to be a realistic way forward.

Some businesses have already dealt with these issues, others are operating the best they can but may become unstuck going forward. Understanding the other party’s position and concerns is key to the success of any negotiations in order to move forward together to reach a workable outcome for both parties.

We are currently advising clients on leasehold negotiations including putting in place deeds of variation or side letters to vary the terms of their current leases. This briefing note covers key considerations and options for both sides.

We start by identifying the main documents to review, and which clauses in particular need attention. We will look at the key points you may want to negotiate, followed by how you can practically implement the agreed variations. We touch upon landlord remedies for non-payment – including the recently enacted suspension of forfeiture as a remedy and what this all means for both tenants and landlords.

We have also compiled a short Q&A also addressing some additional questions which we have seen arise.

What documents should I review and what should I be looking out for?

· Lease
· Rent deposit deed
· Insurance policies

As either a tenant or a landlord, the starting point is to review the terms of the lease.

First check the key terms of the lease: rent, rent review, covenants, term of the lease, any break clauses and obligations of the other party. It is important to be absolutely clear on the detail. For example, rent:

1. Where does rent stand for this period and beyond?
2. How much is it?
3. How is it paid? Standing order or direct debit (or other)?
4. When is it paid? Monthly or quarterly?
5. When is the next payment date? Is there a rent review? If so, when is the rent review date?
6. What is the lease termination date?
7. What is the value of the rent deposit?

Make a note of these as they will be important when negotiating.

Other key provisions should also be reviewed including services to be provided under the lease, are tenants being permitted access and whether a break clause exists (and if so, its date). There are also other provisions which may not immediately come to mind, or you may not be sure how they apply to current circumstances. This requires a more detailed review. If you need guidance on these, we would be happy to assist.

The rent deposit deed is also important and you should take note of the key provisions including the amount, how the deposit is held (as a charge or on trust), in what circumstances the landlord can withdraw from the deposit and how it should do so (the process to be followed), and how the obligation to top up is dealt with.

Insurance policies should be checked for any appropriate cover. It is helpful to consider different scenarios. For example, if the landlord is forced to close the building and stop services and unlawful entry by a third party causes damage to the property or loss who is responsible? If you ae unable to pay rent is this situation covered? It is important to speak to your insurers. We also return to insurance considerations in the Q&A (see Q3 below).

Varying lease terms – what can be negotiated?

Below are some of the matters that landlords and tenants should consider in advance of their discussions.

· Can a rent holiday be agreed? What is the minimum and maximum length each party could agree to? The landlord may be more agreeable if these payments are to be spread over a period on return to business as normal.
· Can a rent reduction be agreed? If so, what is considered “fair” to both parties?
· Can the tenant commit to a lease extension in order to cover rent holidays or reductions? Agreeing not to reclaim unpaid rent could also be exchanged for renewed commitment down the line.
· Would monthly rental instalments instead of quarterly payments be possible? This type of payment plan may assist with the tenant’s cashflow and increase chances of payment for the landlord.
· Can the rent deposit be used temporarily and an extended period to top it back up be agreed?
· Could the terms of the rent be changed temporarily – for example to a turnover-only basis?
· Can any rent reviews be delayed? Or, if a rent review has been undertaken, is the landlord willing to agree to forego claiming the increase temporarily?

These are ultimately commercial decisions. In the present circumstances, both parties should have a heightened appreciation of the alternatives in failing to reach agreement.

What are the landlord’s options when facing non-payment?

Where the tenant has not paid its rent: what can the landlord do and are there any limitations?

· Draw down on rent deposit. Subject to the terms of the rent deposit deed, the landlord can withdraw sums from the rent deposit. This is helpful in the short-term and guarantees a certain amount of recovery. The landlord would then ask for the rent deposit to be topped up by the tenant.
· Issue court proceedings for rent arrears (for losses/payment). This can be a lengthy and expensive process; a court hearing may not be set for several months. However, because of this length of time, if the landlord wants to give the tenant time to get its financial affairs in order and pay the arrears, preserving the landlord and tenant relationship, court proceedings may be an appropriate way of taking action to obtain the unpaid rent. This is subject to courts being open and having the staff to process any issued claims (here is the list of courts which are currently open).
· Pursue guarantor or former tenant. The range of parties the landlord may pursue for any rent arrears will depend on whether a guarantor is available. Landlords could then issue claims against guarantors, subject to court operations as discussed above. However, given the far-reaching impact of this pandemic, the guarantor or former tenant may be in no better a position to pay any arrears.
· Commercial Rent Arrears Recovery (CRAR). This method of enforcement can be used to seize goods in order to cover main rent due. If this method is available, the landlord can also recover from the undertenant (which may be useful if the undertenant is better placed to pay). It is not however clear whether bailiffs/enforcement agents will be operating within the lockdown.
· Issue a petition for winding up. The landlord may wish to consider commencing insolvency proceedings. Where there is no dispute as to the amount of the debt, the landlord can serve a statutory demand on the tenant. If this remains unpaid after 21 days, and it is more than £750 (for commercial tenants), then this would be deemed evidence of inability to pay a debt and therefore give grounds to present a winding up petition. Again, this is subject to any disruptions to court operations.
· Forfeiture. The landlord may want to take back possession of the property (evict the tenant), and the lease will often provide for this remedy. However, the government has passed emergency legislation to prevent landlords from either effecting forfeiture or enforcing a possession order (where an order has already been obtained) until 30 June 2020. This applies for forfeiture being effected for non-payment of rent.

What does this mean in present circumstances?

Landlords will usually have the upper hand in negotiations particularly due to their limited obligations under the lease and a wide array of remedies. . At present – with forfeiture being unavailable (and any threats of imminent forfeiture empty), replacement tenants being hard (or near impossible) to come by, and many enforcement options being more difficult to exercise than usual – the negotiating position of landlords has been impacted.

The practical response to this is both sides will be encouraged to negotiate, rather than pursue strict enforcement of their rights, given the enhanced difficulties in doing, obligations to mitigate and time and expense. Of course many tenants cannot see a way forward regardless of rent concessions and are returning their keys forcing an altogether different set of circumstances.

There are reports of landlords, such as Argent and Network Rail, offering businesses rent-free periods, but others (big and small) are unable to take such a financial hit. The Grosvenor Estate, one of the UK’s wealthiest landowners, reportedly offered a deferral of rent as a “first step”, with a view to discussing a rent holiday with more vulnerable tenants. Many smaller landlords will be unable to apply a blanket holiday and may have to approach each negotiation separately, taking into account a tenant’s individual circumstances.

What are the next steps and how do I vary the lease?

Understanding the key the lease provisions provides a good basis for negotiations. Here is a quick link back to review the negotiation points: Negotiating rent concessions: key considerations.

We would advise that any tenants and landlords should seek independent legal advice before accepting and formalising any agreements. Much of our commercial property work over the last few weeks has consisted of reviewing leases and implementing deeds of variation and side letters amending contractual lease terms. We can also assist in drafting or responding to requests or offers for rent concessions.

A lease can be varied by a side letter which is a personal agreement to vary the terms of a lease, for example by way of rent reduction. They may offer a more attractive solution than varying the lease itself (using a deed of variation), because of their personal and specific application. As the rights granted are usually personal, subsequent tenants will not benefit from the terms avoiding the need to vary the terms again, when situations change.

Summary

1. Look at the key lease provisions which need amendment such as the rent, any break clause or rent review.
2. Consider what may be a satisfactory solution.
3. Review what remedies may be available and present limitations.
4. Negotiate changes
5. Document the agreed terms to vary the lease.

Commercial leases and COVID-19 Q&A

The following Q&A addresses some other questions that we have recently seen arise:

Q1 Do I still have access to the premises?

This will depend on whether the landlord has closed the central building and common parts. Any landlords facing this decision should review the provisions relating to their obligations and of course government requirements. There will also likely be provisions for restricting access to the common parts in an emergency. If there has been a confirmed case of COVID-19 in the building, then the landlord may be able to rely on this to close the building.

Subject to the terms of the lease and agreed services, landlords are generally able to suspend the provision of services. Depending on the circumstances, the service charge payments if services are not provided arguably should be reduced or suspended. Failure to do so may lead to subsequent claims from tenants for breach.

Q2 Does the lease contain an obligation to remain open? If so, are there exceptions?

These types of provisions appear in many retail and leisure leases and affect businesses which have been ordered to close. It is likely that any such provision will allow closure where required by law, but this needs to be checked. If it is not provided for in the lease, there may be a separate provision requiring tenants to comply with legal requirements, which would take precedence.

In reality, even if the above protections are missing, keep open covenants are difficult to enforce and landlords should seek legal advice.

Q3 Does the lease contain rent suspension provisions?

Modern commercial leases usually only provide for rent suspension in relation to property-only matters (for example damage to the property) which are insured risks. It is very unlikely that these lease insurance provisions will apply to these circumstances, but they should be reviewed.

It is also important to look at business interruption insurance and any other policies (for example, crisis management insurance, general liability insurance and/or mitigation insurance). Some policies do cover compulsory closure caused by notifiable infectious diseases; however, the vast majority list specifically the diseases they cover. As coronavirus was unknown until recently, as most businesses have discovered, there will be very few policies that cover it.

Q4 Is COVID-19 a force majeure event? Or, failing this, can the lease be frustrated?

It is unusual for modern commercial leases to contain force majeure provisions (which allow parties to be excused from obligations due to events outside of their control). If the lease does provide for force majeure, the clause should be reviewed to see if coronavirus would be covered by a provision. Specific references are unlikely, so the key will be whether it is the type of event that would fall under general force majeure wording, or whether there has been a government decision or administrative action preventing performance. If there is a provision, it may also carve out certain obligations, e.g. state that payment of rent is not covered.

Frustration of a contract (discharging a party from its contractual obligations) occurs if a change in circumstances makes it physically or commercially impossible to perform the contract or would render performance radically different. It is unlikely that a tenant will be able to successfully argue that the lease has been frustrated as a result of the pandemic, especially as any inability to occupy the premises is likely to only be temporary. To our knowledge, there are no reported cases in England where a lease has ever been held to be frustrated.

Q5 Is there any provision allowing for early termination?

If there is a break clause, depending when the break date is, a tenant may seek to exercise that break. The formalities contained within the clause should be followed carefully, otherwise the landlord may argue that the break notice is invalid (leaving the tenant unable to rely on it). It is also common for break rights to require all rents to be satisfied as at the break date and all covenants to have been performed. If a tenant is considering exercising a break, then it must comply with its obligations under the lease unless negotiated otherwise.

Q6 Can the landlord recover costs associated with “deep cleaning”?

Many landlords have been taking pragmatic steps in order to prevent COVID-19 spreading; supplying extra cleaning services, in particular for more thorough cleaning of common parts of their building(s), as well as extra provision of hand sanitiser and other supplies. Responsibility for these extra costs will depend on the lease terms.

The landlord should review whether the service charge provisions allow it to recover extra costs incurred as a result of complying with, for example, “applicable laws” or for “good estate management”. Reliance on either may be disputed and parties should seek independent legal advice.

If you would like to discuss any of the decisions you are making in these challenging times, or have any other questions, you can contact us via 020 3709 9670 or enquiries@fortunelaw.com

See the links below to our COVID-19 related articles which may be a useful read in these stressful times,

What you need to know about Directors’ duties

What you need to know about furloughing

Remote working? Practical advice for small businesses

Coronavirus; practical guidance for small businesses