Update 5 – (the Commercial Leases Regulations) - effects of Covid-19 on commercial tenancies

Current to 11am 4 May 2020

This is update 5 of 9 - for our latest article on this topic see here.

In our Update 3 we gave a summary of the Mandatory Code of Conduct for commercial leases. You can read our Update 3 here: https://www.easternbridge.com.au/post/covid19-and-commercial-tenancies. On 1 May 2020 the COVID-19 Omnibus (Emergency Measures) (Commercial Leases and Licences) Regulations 2020 (“the Regulations”) were brought into effect in Victoria by Government Gazette S216. A copy of the Regulations is here: https://content.legislation.vic.gov.au/sites/default/files/2020-05/20-031sra authorised.pdf (if clicking this link does not work try copying and pasting in your browser).

Contrary to expectations the Regulations do not bring into effect the “Mandatory” Code of Conduct published 7 April and upon which all leasing negotiations have taken place since. Instead the Regulations create their own set of rules in relation to the landlord and tenant relationship during the period 29 March 2020 – 29 September 2020 (“the relevant period”).

We will publish a separate article being an ‘editorial’ of sorts – for now this article aims to convey just the effect of the Regulations. The very brief summary is that the Regulations remove the stringent requirements on landlords in relation to rental reductions proportional to turnover reductions. In this regard our view is that the regulations place significantly more power in the hands of landlords.

Who will the Regulations apply to

Read together with the enabling Act (see our Update 4 here in that regard: https://www.easternbridge.com.au/post/update-4-covid-and-commercial-tenancies) the Regulations apply to “eligible leases” being, subject to exceptions below, any lease or “commercial licence” in effect on 29 March 2020 where the tenant is an SME with a turnover of less than $50,000,000 that qualifies for and is a participant in the federal government’s JobKeeper program.

The Regulations clarify how grouped entities will be treated and specifically exclude from the ambit of the Regulations leases where the tenant is controlled by an entity with an aggregated turnover of more than $50 million (generally, the threshold for control under the relevant legislation is at least 40% ownership of the shares of the company, or otherwise receipt of at least 40% of income or capital distribution). Moreover, leases where the tenant could reasonably be expected to act at the direction of an entity with a turnover of $50 million will also be excluded (although this does not generally extend to franchise situations merely as a consequence of the franchise agreement). Please contact our office if you think this exclusion may apply and need more detail.

A number of leases for specific uses are excluded, principally leases for agricultural purposes.

The Act defines “commercial licence” unusually (referring to licenses of a “part” only of a broader premises). That warrants further consideration but this article is not the place for that.

General obligations

The Regulations insert into every eligible lease an obligation on landlord and tenant to “cooperate and act reasonably and in good faith” in relation to matters to which the Regulations apply. A failure to comply with that obligation would constitute a breach of the lease but no other specific penalty or remedy is imposed.

Protection in respect of defaults

Non-payment of rent

A tenant under an eligible lease will not be in breach of its lease if it does not, during the relevant period, pay the rent otherwise required by the lease provided it has:

• requested rent relief in writing;

• provided the landlord with a statement that the lease is an eligible lease;

• provided information evidencing that the tenant is an SME entity and participant in the JobKeeper scheme; and

• negotiated in good faith with the landlord.

If a tenant has negotiated with its landlord and reached agreement (by way of variation of lease or otherwise) then that protection will no longer apply (and the tenant must comply with the terms of lease as varied).

The protection does not extend to outgoings – a tenant is required to pay outgoings in accordance with the terms of lease and is offered no protection in that regard by the Regulations (some more on outgoings below). The protection does not extend to non-payment of rent outside the relevant period.

It is important to note the commencement of the relevant period is 29 March 2020. The Code had stated that it would come into effect “from a date following 3 April 2020”. The difference is important – the Regulations will provide protection to tenants who have failed to pay rent otherwise due from 29 March (including, relevantly, rent due 1 April 2020).

Closing premises or reducing hours

A tenant under an eligible lease will not be in breach of its lease if it reduces opening hours or closes the premises. A landlord will not be entitled to evict or re-enter or purport to do so on the basis of a failure to open the business or a reduction of hours.

The vast majority of leases require tenants to continue to conduct business from the premises. Particularly in shopping centres, tenants are generally required to maintain hours consistent with the centre. The Regulations protect tenants who have been required to or who have chosen to close or reduce hours.

Negotiations

Once a tenant has made a request for rent relief in writing (which must be accompanied by a statement that the lease is an eligible lease and by evidence that the tenant is an SME entity and participant in JobKeeper) a landlord must, within 14 days or such other time as agreed with the tenant, offer rent relief to the tenant.

There is no prescribed formula as to the offer. The offer of rent relief must be “based on all the circumstances” of the lease and must [the following extracted from the legislation with emphasis added in bold and comments added in square brackets]:

(a) relate to up to 100% of the rent payable under the eligible lease during the relevant period; and (b) provide that no less than 50% of the rent relief offered by the landlord must be in the form of a waiver of rent, unless a landlord and a tenant otherwise agree in writing; and (c) apply to the relevant period; and (d) take into account—

(i) the reduction in a tenant's turnover associated with the premises during the relevant period; and (ii) any waiver given pursuant to regulation 14(2) [being a waiver of outgoings]; and (iii) whether a failure to offer sufficient rent relief would compromise a tenant's capacity to fulfil the tenant's ongoing obligations under the eligible lease, including the payment of rent; and (iv) a landlord's financial ability to offer rent relief, including any relief provided to a landlord by any of its lenders as a response to the COVID-19 pandemic; and (v) any reduction to any outgoings charged, imposed or levied in relation to the premises.

These provisions are starkly different to what was contemplated by the Code. Most relevantly a landlord no longer has to offer rent relief “proportional to” the tenant’s loss of turnover, the landlord must simply “take into account” that loss of turnover.

The provisions would seem to prevent a landlord from offering relief of more than 100% of rent (for instance payment of incentives or provision of fitout) and would seem to prevent a landlord from offering relief extending out beyond 29 September 2020 (being the end of the relevant period).

The provisions draw on the concept introduced in the Code of relief being offered by way of waiver and deferral, requiring at least 50% of the relief to be offered by way of waiver (the balance assumedly to be deferred). We re-iterate, unlike the Code, the Regulations do not set a minimum requirement for relief (and without any reference in the Victorian law to proportionality our view is that ordinary contractual principles would apply – there would not be any assumption that rent relief need be proportional and it is well established that a contractual obligation of good faith does not require a party to act in the interests of the other party or to subordinate its own legitimate interest to the interests of the other party).

Following a landlord’s offer the parties must negotiate in good faith with a view to agreeing on rent relief.

If the position of a tenant changes after agreement is reached the tenant can request further relief and the landlord must follow the process set out above but any further relief need not include the 50% waiver element noted at (b) above.

We note that there is no guidance or restriction in relation to the scope of information a tenant should provide or a landlord is entitled to request.

Deferral of rent and extension of term

Where a landlord and tenant agree to a deferral of some part of the rent the landlord must not (without the tenant’s consent) require repayment of the deferred amount until the expiry of the relevant period or the end date of the lease (whoever is earlier) and repayments must (save with the tenant’s consent) be made over a period being the greater of 24 months and the balance of the lease term.

Interestingly (and this extends beyond what the Code contemplated) if the parties agree to a deferral of the rent payable the landlord must offer the tenant an extension to the term of the lease.

Two possible interpretations of Regulation 13 (dealing with the extension of term) have been raised - the Regulation states that the landlord must offer an extension of term "equivalent to the period for which rent is deferred" (emphasis added). The alternate interpretation effectively treats that regulation as though it says "...the period in respect of which rent is deferred". The difference is significant - if rental for one month is deferred for the minimum 24 month period the plain interpretation would see an extension of the term by 24 months; the alternate interpretation would see an extension of only one month.

Although it reads words into the regulations that are not there that alternate interpretation appears to us to be the preferred interpretation - the first interpretation imposing a very significant commercial barrier to negotiation and causing conflict with the provisions of Regulation 16.

The provisions in relation to deferral and extension of term, however, lose a lot of their impact in circumstances in which there is no requirement for a landlord to reduce rent proportionally to the tenant’s lost income (a landlord might simply offer a lower rent waiver amount with no deferral).

Dispute resolution

Parties to a lease may refer any dispute arising in relation to a matter to which the Regulations apply to the Victorian Small Business Commissioner but must not do so to prolong or frustrate the process of reaching agreement (although it must be asked how that could ever be the case if the party referring the dispute is otherwise unwilling to agree).

The parties may be represented by a legal practitioner at mediation.

VCAT’s jurisdiction over retail leases is expanded to include any dispute arising under the Regulations (whether in respect of a retail lease or otherwise) but its jurisdiction in that regard will not be exclusive (so in respect of a non-retail lease the parties may proceed through VCAT or through the courts as they see fit).

Save in respect of proceedings for an order in the nature of an injunction, parties may not proceed with litigation at VCAT or in a Court unless the SBC has certified that mediation has failed or is unlikely to resolve the dispute (or, in the case of the Supreme Court, otherwise with the leave of the Court).

Other provisions

Fees and interest

Where a landlord allows a deferral of rent the landlord must not require the tenant to pay any interest or other fee or charge in relation to the deferral (this differs from the Code which contemplated a landlord charging “non-punitive” interest on deferred rent).

Rent increases

A landlord is not entitled, without the consent of the tenant, to increase rent throughout the relevant period. This prohibition does not apply to the extent rent is determined by reference to volume of trade of a tenant’s business (commonly known as ‘turnover rent’ but also including where any variation is agreed by reference to a tenant’s reduction in revenue).

Outgoings

A landlord must “consider” waiving recovery of outgoings. There is no obligation on a landlord to actually waive outgoings and any outgoings waived may factor into the landlord’s decision making in relation to the offer for reduction of rent. In our view this provision is almost entirely without effect.

Landlords should ensure they keep a note that they considered waiving outgoings. If they determine not to waive outgoings they should keep a record of that.

Any outgoings that are reduced need to be passed proportionally to a tenant (so if a tenant usually pays 50% of the landlord’s land tax and the landlord receives a 25% land tax waiver the tenant will be entitled to the benefit of 50% of that waiver).

Recourse to security

A landlord under an eligible lease must not have recourse to any security (which includes any bank guarantee or personal guarantee) in respect of tenant’s non-payment of rent (provided the tenant has requested rent relief in the manner contemplated above) or closure of the premises as details above under our heading “protection in respect of defaults”.

It is important to note the prohibition on recourse to security does not extend, for instance, to non-payment of outgoings or to any other default under the lease.

We are aware of at least one major bank last week refusing to honour guarantees on the basis that the Code (which has no force in Victoria) might prohibit the landlord from calling on the security. In our view this is a significant overstep by the bank, is in breach of the bank’s obligations and would make the bank liable to the landlord (we recommend any landlord in a similar position contact our office (no landlord in that position should sign any ‘indemnity’ or similar given to them by the bank)).

Confidentiality

The Regulations impose confidentiality provisions preventing the parties from disclosing personal or sensitive information (including in relation to the trade of a business) save for obtaining professional advice, discussing with financiers or otherwise as required by law or the Small Business Commission.

Summary

The Regulations are a far cry from what had become a new status quo following publication of the Code. Please contact our office for any specific advice you may need in these circumstances. Paul Nunan Director Accredited Specialist | Commercial Leasing Jack Kelly Lawyer