COVID-19 Commercial Leasing Code of Conduct – Application in South Australia

“What happens to my commercial lease during Covid-19?” has been one of the most regularly asked questions by both tenants and landlords since the outbreak of the Coronavirus across Australia.

In times of unprecedented disruption to business practices and downturn in economic activity, this question has no simple answers, and it is therefore no surprise that the National Cabinet took close to two weeks to consider all options before the release of the Covid-19 Commercial Leasing Code of Conduct.

In this article, Eckermann Lawyers have summarised the application of the Covid-19 Commercial Leasing Code of Conduct in South Australia, and answered the following key questions:

• How does the Covid-19 Commercial Leasing Code of Conduct work?
• Who does the Covid-19 Commercial Leasing Code of Conduct apply to?
• Does the Covid-19 Commercial Leasing Code of Conduct apply to residential tenancies?
• What can I do as a commercial tenant?
• What can I do as a commercial landlord?
• How long will the Covid-19 Commercial Leasing Code of Conduct apply?

What we know

• The Code of Conduct (Code) can be found here.
• The Code is not binding in itself. Instead, the principles within the Code (plus hopefully a lot more clarifying detail) needs to be legislated by each State Government. The Code is a set of principles that will obviously shape the legislation to be enacted. It will be the legislation that must be complied with, and the Code will then simply complement that legislation, and not supersede it. However, the Code does give direction now to the parties it applies to, which will enable them to progress negotiations and manage expectations.
• The Code does not apply to residential tenancies. Other than an eviction moratorium recommended by the National Cabinet (which needs to be legislated by each state and which is separate to the Code), residential tenancies are not being dealt with (at this stage anyway) by the National Cabinet, and are being left to each state to deal with.
• The Code does apply to leases meeting all of the following criteria (Eligible Leases):
  • a) The premises is a commercial tenancy (including retail, office and industrial);
  • b) The tenant has a turnover of $50m or less;
    • this threshold will be applied at the franchisee level for franchises, and at the group level for retail corporate groups (and not the individual retail outlet level); and
  • c) Either:
    • the tenant is eligible for the Federal Government’s Job Keeper programme (i.e. turnover has reduced by 30% or more); or
    • the tenant is suffering financial stress or hardship as a direct result of the COVID-19 pandemic which makes it unable to meet its financial and/or contractual (including leasing) commitments.
• The Code does apply to landlords and tenants of Eligible Leases.
• The Code does not apply to banks, utility companies, local government etc. (However, we understand the landlord’s ability to access assistance being provided by those bodies is (or will be) predicated on the landlord complying with the Code).
• While this Code will be embedded within legislation, it is clear that the intention is that landlords and tenants negotiate and agree appropriate temporary arrangements on a case-by-case basis, where the Code effectively acts as a backstop.
• The ‘COVID-19 Pandemic Period’ is defined by the period during with the Job Keeper programme is operational (currently 30 March 2020 to 27 September 2020, effectively 6 months). The period covered by the Code is the COVID-19 Pandemic Period, plus a ‘reasonable recovery period’, which we understand will be determined by the Federal Government. Together, we’ll call this the “Code Period”.
• Notwithstanding the Code Period above, the Code will officially come into effect on a date following 3 April 2020 (to be determined by the South Australian Government) and continue for as long as the Job Keeper programme remains operational. It is worth nothing that the legislation will more clearly clarify the commencement and expiry dates of the assistance provided under the Code.
• For Eligible Leases, the following leasing principles are set out in the Code:

#1: Landlords must not terminate leases due to non-payment of rent during the Code Period;

#2: Tenants must remain committed to the terms of their lease (as renegotiated – if applicable, and subject to the minimum changes set out in the Code), otherwise the tenant will not be able to rely on the protections under the Code;

#3, #4 and #5: Landlords must offer tenants proportionate reductions in rent as follows:

• • • • • The rent must be reduced by at least the same percentage as the reduction in turnover experienced by the tenant throughout the Code Period (Rent Reduction);
        • This Rent Reduction must be comprised of at least a 50% waiver of the rent altogether (Rent Waiver). The remaining balance can be deferred (Rent Deferral);
        • The Deferred Rent must be amortised over the balance of the lease term or for 24 months, whichever is the greater (unless otherwise agreed by the parties);
        • Subject to the landlord’s financial ability, the Rent Waiver should constitute greater than 50% of the Rent Reduction, where failure to do so would compromise the tenant’s capacity to fulfil their ongoing obligations under the lease; and
        • The tenant can waive the minimum 50% Rent Waiver requirement by agreement.

#6: Any reduction in statutory charges or insurance (if recoverable under the lease), must be passed on to the tenant in the same proportion as the reduction received by the landlord.

#7: Landlords should seek to share any benefit they receive due to the deferral of loan payments with the tenant in a proportionate manner.

#8: Landlords should where appropriate seek to waive recovery of any other expenses or outgoings payable by a tenant during the period the tenant is not able to trade. The landlords can reduce those services as required in the circumstances.

#9: No repayments [presumably mainly comprising Rent Deferrals] arranged under the Code should commence until the earlier of the ‘COVID-19 pandemic ending’ (as defined by the Federal Government) taking into account a reasonable subsequent recovery period [we think this is the same as the Code Period] or the existing lease expiring.

#10: There can be no fees, interest or charges applied to Rent Waivers, and no fees, charges or punitive interest charged on Rent Deferrals [but presumably non-punitive interest can be charged on Rent Deferrals].

#11: Landlords must not draw on tenant’s security (cash bond, bank guarantee or personal guarantee) for non-payment of rent during the Code Period.

#12: The tenant should be provided the opportunity to extend their lease for the period that they are entitled to the Rent Reduction.

#13: Except for retail leases based on turnover rent, all rent increases are frozen for the Code Period (notwithstanding any arrangements between the landlord and tenant).

#14: Landlords cannot apply any prohibition or impose any penalties if tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.

• Disputes about leasing arrangements as a direct result of the COVID-19 pandemic will be referred to binding mediation with the Small Business Commissioner.

What we don’t know

• As stated above the Code is a set of principles, which needs to be legislated by each State Government to become binding. The principles within the Code will shape the legislation, but there is a lot of detail not covered in the Code, which hopefully the State Government legislation to be enacted will address. Below we have set out the most obvious issues to us that requires further clarification in the legislation.
• What penalties will be applied to landlords who do not comply with the Code?
• Is the proportionality principle to be calculated on a month by month basis, which only kicks in for each given month once a tenant’s reduction in turnover exceeds 30%? Or is a reduction in turnover greater than 30% for any month in the Code Period sufficient, and then the tenant’s drop in turnover over the whole Code Period is taken into account to determine the proportionality principle?
• Are tenants expected to pay full rent each month upfront, with the reduction in rent to be calculated in arrears and a refund or credit applied once calculated?
• Where the tenant uses accrual instead of cash accounting, is the reduction in turnover purely linked to invoiced fees, or is there some consideration of cash recovered?
• What non-punitive interest rate is acceptable on the Rent Deferral amount?
• Does the landlord get any additional security or priority in relation to recovery of the Rent Deferral after the expiry of a lease, for up to 24 months?
• Is the landlord required to seek deferral of loan payments?

What you should do from here if you are a landlord

• Solvent, sustainable and long-term tenants are obviously the lifeblood of any landlord’s business.
• Accordingly, we recommend you engage in open communication with your tenants to see how they are faring in these times, and see how you can best work with them for a win-win solution to the current crisis.
• At a minimum, you will need to comply with the principles in the Code (once they are legislated).
• However, where the short term cash flow relief for tenants set out in the Code is still not sufficient to ensure the financial viability of the tenant, consider renegotiating the current lease (or entering into a ‘new lease’ if the tenant is currently in a holding-over phase and you do not wish to terminate their lease) to provide for some or all of the following:
• • Bringing forward any unused rent incentives;
  • A larger rent waiver or deferral and/or a longer rent waiver or deferral than what is required under the Code;
  • An increase in the length of the current term (for a greater period than just the period that the Rent Reduction applies to);
  • An increase in the amount of the bank guarantee provided under the lease; and/or
  • Adding a personal guarantee to the lease.
• Your willingness to engage in these additional negotiations will obviously depend on the tenant’s conduct and performance prior to the COVID-19 Pandemic Period, and your confidence in their ability to return to profitable trading following this period.

What you should do from here if you are a tenant

• While it might seem tempting, now is not the time to ‘take advantage’ of the COVID-19 crisis and see what you can get away with. To minimise the likelihood of getting into a dispute situation with your landlord (which will take up valuable mediation time and create uncertainty while unresolved), we recommend open and honest communication with your landlord so you can reach a win-win solution for the both of you.
• Remember, a landlord will have financial obligations that they need to meet, and so it’s in the interests of both parties that both you and the landlord remain solvent and sustainable for the long term.
• You will only be able to rely on the base principles in the Code (once they are legislated).
• However, where the short term cash flow relief for tenants set out in the Code is still not sufficient to ensure your financial viability, consider renegotiating the current lease (or entering into a ‘new lease’ if you are currently in a holding-over phase and you do not wish to terminate your lease) to provide for some or all of the following:
• • Bringing forward any unused rent incentives;
  • A larger rent waiver or deferral and/or a longer rent waiver or deferral than what is required under the Code;
  • An increase in the length of the current term (for a greater period than just the period that the Rent Reduction applies to);
  • An increase in the amount of the bank guarantee provided under the lease; and/or
  • Adding a personal guarantee to the lease.
• The landlord’s willingness to engage in these additional negotiations will obviously depend on your conduct and performance prior to the COVID-19 Pandemic Period, and the landlord’s confidence in your ability to return to profitable trading following this period. Accordingly, the earlier you start discussions with your landlord and the more open you are to a win-win situation for them and you, the better off your chances will be of negotiating amended terms to see you through this challenging period.

How we can help

Understanding your minimum rights and obligations under the Code (and the imminent legislation) is essential.

So too is documenting any agreed variations for all parties to maximise certainty in these uncertain times, and to reduce the risk of future disputes occurring due to misunderstandings or miscommunications.

Eckermann Lawyers is a specialised property and commercial law firm, acting for both landlords and tenants, regardless of the type of properties or the amount of rent involved. If you would like to discuss your current arrangements and receive advice on how best to proceed in the circumstances, then please contact Eckermann Lawyers.

We look forward to assisting you.

Eckermann Lawyers

image: by sincerely meida via Unsplash