In the meantime, it’s important for clients to be aware of core aspects of the Code, and this note sets out the scope of application of the Code and considerations landlords and tenants will need to factor into negotiations with each other.
Scope of Application
The Code is mandatory for commercial leases (including retail, office and industrial) where:
- The tenant’s annual turnover is less than $50 million, and
- The tenant is eligible for the JobKeeper Program.
While many commercial leases do not fit into this category, the National Cabinet has indicated that the Code should nevertheless apply ‘in spirit’ to all leasing arrangements for affected businesses, having fair regard to the size and financial structure of those businesses.
Tenant Turnover Threshold
For franchises and retail tenancies, the tenant turnover threshold will be applied at the franchisee or group level, rather than at the individual tenant level. It is not clear whether office and industrial tenants will also be assessed at the group level.
Tenants/employers (including not-for-profits, charities and self-employed individuals) will be eligible for the JobKeeper Program if:
- their business has a turnover of less than $1 billion and their turnover will be reduced by more than 30% relative to a comparable period a year ago (of at least a month), or
- their business has a turnover of $1 billion or more and their turnover will be reduced by more than 50% relative to a comparable period a year ago (of at least a month), and
- the business is not subject to the Major Bank Levy (i.e. a levy on banks with total liabilities over $100 billion).
Core Considerations for Landlords
1. Rent relief (Leasing Principles 3, 4, 5, 9 and 12)
The Code sets out a series of principles to guide tenant and landlord discussions for appropriate rental relief. Landlords are expected to agree to tailored, bespoke and temporary arrangements for each tenant, taking into account their particular circumstances.
Importantly, tenants are required to act in an open, honest and transparent manner, and must provide the landlord with sufficient and accurate information to prove their financial stress is a direct result of COVID-19. This includes accounting data and information received from a financial institution.
Landlords must offer tenants proportionate rent reductions of up to 100% of the amount that is ordinarily payable, based on the reduction in the tenant’s trade during the COVID-19 pandemic period, and reasonable recovery period.
Unless the parties agree otherwise, at least 50% of the rent relief must be in the form of a rent waiver. This means that at least 50% of the rent relief offered is not recoverable from the tenant. The remaining 50% may be made up of rent deferrals or other forms of rental relief. Rent deferrals are to be amortised over: (a) the balance of the lease term; or (b) a period of no less than 24 months, whichever is longer. No repayment may commence until whichever comes earlier: the COVID-19 pandemic is over or the existing lease expiring.
By way of example:
- Tenant A leases a café from the landlord.
- There are 3 years remaining on the term and rent is $1000 per month.
- Tenant A’s trade for April 2020 has reduced by 60% as compared to its trade for April 2019.
- Under the Code, the landlord must offer a 60% reduction in rent payable for April 2020. At least half of this reduction must be in the form of a rental waiver.
- Of the $1000 ordinarily payable for the month of April:
- Tenant A must pay $400 as usual
- $300 is waived and is non-recoverable
- $300 may be deferred and Tenant A must repay this amount over the balance of the lease term once the COVID-19 pandemic has ended.
The Code also stipulates that tenants should have an opportunity to extend their lease terms for an equivalent period of the rent relief granted. If a tenant requests an extension to its lease term, landlords should consider reducing the length of any option terms by a commensurate amount.
2. Termination and drawing on security (Leasing Principles 1 and 11)
The Code introduces a moratorium on lease termination due to non-payment of rent during the COVID-19 pandemic period and a reasonable subsequent recovery period. It is not clear if the moratorium applies to termination for non-payment prior to the pandemic period. However, as the Code requires the parties to act in good faith, it is likely that a tenant could not dispute a termination for failure to pay rent prior to the effects of the pandemic.
The Code also prevents landlords from drawing on tenants’ security for non-payment of rent during the COVID-19 pandemic and a reasonable subsequent recovery period. However, this should not preclude a landlord from drawing on a bank guarantee that is about to expire, provided it holds the funds as a cash security deposit.
Landlords should review the expiry dates of the bank guarantees that they hold and any obligations to hand back security by a certain date.
As outlined above, the payment of rental deferrals by the tenant must be amortised: (a) over the balance of the lease term; or (b) for a period of no less than 24 months, whichever is longer. This means that if there is less than 2 years remaining on the lease term, the tenant may continue to have payment obligations after the lease has expired.
Landlords should be aware of this when negotiating rent relief with tenants and ensure that the lease is varied appropriately to allow them to hold security until the tenant’s payment obligations cease. This will ensure that they are not left without security while the tenant owes rent.
3. Rent increases (Leasing Principle 13)
The Code stipulates that landlords agree to a freeze on rent increases (except where rent is based on turnover rent) for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period.
Notably, this is not expressed as a freeze on rent review. As such, market rent review provisions may still apply. Depending on the state of the market at the relevant review date, this may result in a decrease in rent payable.
Landlords should review their leases to confirm if there are any upcoming market-rent reviews. If so, the landlord may wish to negotiate with their tenant to delay the review until after the COVID-19 pandemic has passed. This avoids the situation where the market rent review results in a lower rent becoming payable.
Landlords should also consider negotiating variations to their rental agreements to allow for rent review immediately following the COVID-19 recovery period.
4. Outgoings, default interest and other expenses and services (Leasing Principles 6, 7 and 8)
The Code requires that any reduction in statutory outgoings (such as land tax and council rates) or insurance be passed on to the tenant in the appropriate proportion. This suggests that tenants must continue to pay their outgoings, even if rent is deferred or waived.
By contrast, the Code specifies that landlords should seek to waive recovery of any other expenses from a tenant during the period the tenant is unable to trade. This would include, for example, cleaning costs. For such expenses, landlords reserve the right to reduce services as required.
Importantly, if rent is deferred, the landlord may not apply any fees, interest, punitive interest or other charges to the deferred rent. This seems to prohibit landlords passing on any capitalised interest which they incur on their own loans, notwithstanding the fact that landlords are required to share any benefit they receive from their bank regarding deferral of loan repayments with the tenant in a proportionate manner.
5. Tenant obligations (Leasing Principle 2)
While the Code places relatively few obligations on tenants, tenants are required to remain committed to the terms of their lease as amended (except for any mandatory operating or trading requirements that it is unable to fulfil because of the COVID-19 pandemic). Material failure to abide by the substantive terms of the lease will result in the forfeit of any protections provided to tenants under the Code.
We are yet to see what will be considered a ‘substantive term’. For example, would a failure to pay the proportionately reduced rent be a failure to abide by a substantive term? We will provide a further update on this once the State and Territory legislation has been released.
6. Reasonable subsequent recovery period
Landlords should note that the majority of the principles embodied in the Code apply both during the COVID-19 pandemic period and for a reasonable subsequent recovery period. It is not clear what length of time a “reasonable subsequent recovery period” is intended to cover. Indeed, this will likely depend on the length of the pandemic itself. We expect to see more guidance on how this will be determined in the State and Territory legislation and regulation.
What if the parties do not agree?
Where landlords and tenants cannot reach an agreement on leasing arrangements (where the arrangements have been impacted directly by the COVID-19 pandemic), either party may refer the dispute to applicable retail/commercial leasing dispute resolution processes for binding mediation. This may include the Small Business Commissioner, Small Business Champion or Ombudsman in the relevant State or Territory.
How can we help?
In speaking with clients over the past several weeks, our Property Team has accumulated significant insights into the challenges being experienced by commercial landlords and tenants. Our priority is to represent and help our clients as you navigate the unprecedented challenges triggered by COVID-19.
Clearly, there are still many aspects of the Code that require further detail – rest assured that we will keep you updated. In the meantime, if it would be helpful to you to have a more detailed briefing on the information contained in this newsletter, please don’t hesitate to make contact with one of us.