The following article has been written to assist commercial landlords and tenants to better understand the application of commercial lease rent reductions in light of the recently released COVID-19 regulations.
Currently, there is a degree of uncertainty amongst both landlords and tenants as to how and when the various instruments of the Federal Government will apply to commercial lease arrangements here in South Australia. Below is a short guide as to the current position in SA, as at 4 May 2020, and how best to apply the available guidelines.
In South Australia, the COVID-19 Emergency Response Act 2020 (Act) became law on 9 April 2020 and the National Cabinet Mandatory Code of Conduct (Code) has been released by the Federal Government and exists as a set of “guiding principles” in respect of commercial leasing practices and appropriate rent reductions, deferrals and waivers. The Code has not been made law in South Australia, and it is unknown if or when this will occur (and in what form).
At present, it is necessary to apply the Act, and it is best practice to apply the Code.
Importantly, parties to a lease may agree on terms which fall outside of the Act and the Code, so long as it is by mutual agreement (and does not breach the Act).
Here is an example of what may be considered best practice in South Australia when a commercial tenant requests a rent reduction:
- Obtain from the tenant reasonably sufficient and accurate evidence of their Financial Hardship** as a result of COVID-19. Including:
- the tenant’s successful application for the national JobKeeper Program (eligibility requires a 30% reduction in turnover for a business with a turnover less than $1 billion or a 15% reduction in turnover for a charity); and
- evidence which shows the decreased turnover experienced by the tenant (e.g. a gross sales reports or financial statements).
- The landlord should consider whether the relevant information provided relates to the tenant entity. For example, a group of companies may be experiencing financial hardship whilst the particular limb of the business which trades from your premises may be continuing to trade successfully in this period despite COVID-19. Each circumstance will require individual consideration and a % of rent waiver or deferral may still be appropriate to ensure the viability of the tenancy long-term.
- Advise the tenant that they must continue to comply with the terms of the lease until such time as a rent waiver or deferral can be agreed.
- Apply the Code minimum requirements (using examples A and B below) and seek to arrive at a mutual agreement with the tenant in respect of an appropriate waiver or deferral of rent – including the amount of the deferral and the subsequent repayment terms (amount and duration).
Minimum requirements of the Code include:
- a rent reduction proportionate to the tenant’s decrease in turnover (e.g. an 80% reduction in turnover equates to an 80% reduction in rent);
- at least 50% of the reduction is a non-recoverable waiver (unless agreed otherwise by the parties); and
- the balance of the reduction is a recoverable deferral of rent which can be recovered over the balance of the term of the lease or 24 months (whichever is the greater amount of time). Unless the parties agree otherwise.
- Further, due to the Act, the landlord must not, in circumstances where the tenant is experiencing financial hardship as a result of COVID-19:
- terminate the lease;
- seek damages;
- undertake a distraint of goods;
- enforce any guarantees;
- require payment of default interest;
- evict a tenants; or
- essentially taking any action that is adverse to the tenant’s interests.
[See the Act here]
Examples of application of the Code:
The following example relates to a tenant whose current rent is $10,000.00 per month and who is able to establish a turnover loss as a result of COVID-19 of 80%, based on the assumption the COVID-19 crisis continues for four months.
The tenant will be entitled to a proportionate rent reduction equivalent to the turnover loss established (80%), in the following form:
- a rent reduction of 80% (i.e. $8,000,00 per month), therefore making the current rent payable at $2,000.00 per month;
- of that rent reduction of $8,000.00 per month, 50% must be a rent waiver – therefore $4,000.00 per month for four months (total of $16,000.00) – this amount is not recoverable;
- the balance of the reduction can be a rent deferral ($16,000.00) to be repaid by the tenant on a monthly basis over the duration of the remainder of the lease term or 24 months (whichever is the greater amount of time). For example:
- if the remainder of the term is 36 months the monthly repayment will be the amount of $444.44 per month in addition to the going rent of $10,000.00 per month; or
- if the remainder of the lease term is 18 months, the repayment timeline will be extended to 24 months and the monthly repayment will be the amount of $666.66 per month in addition to the going rent of $10,000.00 per month. Whilst the Code is not clear, it is presumed that this $666.66 per month will continue on being payable for the additional 6 months after the end of the lease term; or
- parties can always mutually agree to terms which are outside of the Code and the Act.
The following example relates to a tenant who’s current rent per month is $75,000.00 and who is able to establish a turnover loss as a result of COVID-19 of 50%, based on the assumption the COVID-19 crisis continues for three months.
The tenant will entitled to a proportionate rent reduction equivalent to the turnover loss established (50%), in the following form:
- a rent reduction of 50% (i.e. $37,500.00 per month), therefore making the current rent payable at $37,500.00 per month;
- of that reduction of $37,500.00 per month, 50% must be a rent waiver – therefore $18,750.00 per month for three months (total of $56,250.00) – this amount is not recoverable;
- the balance of the reduction can be a rent deferral ($56,250.00) to be repaid by the tenant on a monthly basis over the duration of the remainder of the lease term or 24 months (whichever is the greater amount of time). For example:
- if the remainder of the term is 40 months the monthly repayment will be the amount of $1,406.25 per month in addition to the $75,000.00 per month; or
- if the remainder of the lease term is 18 months, the repayment timeline will be extended to 24 months and the monthly repayment will be the amount of $2,343.75 per month in addition to the $75,000.00 per month. Whilst the Code is not clear, it is presumed that this $2,343.75 per month will continue on being payable for the additional 6 months after the end of the lease term; or
- parties can always mutually agree to terms which are outside of the Code and the Act.
It is advisable that any agreement reached is documented to ensure the tenant is bound to make repayment of the deferral and the landlord can establish the loss of income for the waiver period.
In the event the term of the lease is to expire within an expected timeframe which may not allow for any deferred rent to be repaid, for example, should a deferral be necessary for six months due to COVID-19 and the lease term remaining is less than 12 months, the parties may agree to document the deferral via a Deed of Extension and Variation of Lease in order to allow for an extension of the lease term and therefore an extension of the time allowable for repayment of the deferred rent.
Please note that the above commentary and examples are based on the assumption that SA will apply the Code in its current form. However, there is no guarantee that this will happen, and it may be that what SA enacts, if anything, is different to the Code. In which case, a landlord who may follow the good faith principles of the Code may end up offering a greater or lesser rent relief than what it is legally be required to. It is therefore important that any agreement that a landlord and tenant agree to now is a fair and reasonable outcome for both parties, such that any subsequent change in law should have minimal effect on that agreement – or, alternatively, any agreement reached now between the landlord and tenant could be made subject to any change in law which may be made in SA as a consequence of the Covid-19 pandemic.
Continued uncertainties and practical considerations
Whilst the Act and the Code have attempted to consider a wide variety of circumstances, there are still various grey areas, such as:
- the recovery of deferred rent in the event of lessee termination during the 24 month recovery window;
- the appropriateness of termination of an existing lease on grounds which do not relate to COVID-19;
- whether it may be appropriate to complete an adjustment at the end of the month, which may then be applied as a credit for the following month’s rent; and
- whether rent reductions should be applied as a fixed percentage or adjusted in line with the JobKeeper scheme, i.e. to consider it on a month by month basis, or a quarter by quarter basis (when compared with the prior year).
In light of the above, and acknowledging that circumstances are ever-changing, it is recommended to seek legal advice to ensure your position, as either tenant or landlord, is protected and you can move through this COVID-19 period with confidence.
The COVID-19 Emergency Response (Commercial Leases) Regulations 2020 provide the following further definitions:
- Financial Hardship: “a lessee will be taken to be suffering financial hardship as a result of the COVID‑19 pandemic if the lessee is eligible for, or receiving, a JobKeeper payment in respect of the business of the lessee (whether in their capacity as an employer or on their own behalf).”
- JobKeeper payment: “means the fortnightly wage subsidy announced by the Prime Minister on 30 March 2020 due to the COVID‑19 pandemic to employers for the purposes of employers continuing to pay their employees.”
The COVID-19 Emergency Response Act 2020 (Act) can be found here.
The National Cabinet Mandatory Code of Conduct can be found here.
Should you require assistance in negotiating a rent reduction specific to your leasing situation please contact the team at Eckermann Lawyers.