This article was written by Chris Wheeler, Benita Ainsworth and Rhys Mitchell.
On 7 April 2020, the National Cabinet announced a Mandatory Code of Conduct (Code) to apply to small and medium sized commercial tenancies impacted by the COVID-19 pandemic.
The Code aims to alter the rights of affected landlords and tenants for commercial tenancies and is intended to have nationwide application. However, it is incumbent on the individual States and Territories to introduce legislation or regulation to adopt, implement and enforce the Code within their respective jurisdiction.
The ACT Government has already taken preliminary steps to address the issue of affected landlords and tenants for commercial tenancies, as outlined in our previous email alert on 3 April 2020: "COVID 19: ACT Government's rent relief package for commercial tenancies" (3 April Alert).
This article examines some of the key principles in the Code and how these interact with the ACT Government's previously announced rent relief package for commercial tenancies.
Mandatory Code of Conduct
What is the Code?
The Code was devised and prepared following consultation with key stakeholders in the commercial property sector. Commencement of the Code is to occur after 3 April 2020, at a specific date to be determined by each State and Territory. The application of the Code to commercial tenancies will continue for as long as the Commonwealth's JobKeeper program is operational.
The Code applies to:
- small or medium sized commercial enterprises (including retail, office and industrial tenancies) with an annual turnover of less than $50 million per year (measured at the franchisee level for franchises and at the group level for retail corporate groups). It is thought the intent is for the grouping to apply to all corporate tenants, not just retail groups; and
- that are eligible for the Commonwealth's JobKeeper program.
The key requirements
The Code is based on good faith leasing principles and is designed to encourage parties to reach mutually agreeable outcomes. However, its "principles" include the following guidance, to be applied on "a case by case basis":
- the Code includes several express positive obligations required of negotiated outcomes:
- Rent reductions: landlords must reduce rent proportionately to the decline in the tenant’s business, measured by the reduction in turnover during the period of the COVID-19 pandemic and a reasonable recovery period. The reduction is to be a combination of waivers and deferrals of rent. Alternate outcomes such as deferral, pausing or hibernating may also be used to reach commercially agreed outcomes; and
- Lease obligations remain on foot: tenants must remain committed to the terms of the lease and continue to pay rent where possible;
- the Code also imposes a number of restrictions that apply during the COVID-19 Period and a reasonable recovery period:
- Rent increases: landlords must not impose rent increases (except in the case of retail turnover rent);
- Terminations: landlords must not terminate leases for the non-payment of rent;
- Securities: landlords must not draw on tenant securities (including personal guarantees) for the non-payment of rent;
- Penalties: landlords are prohibited from imposing penalties for tenants who stop trading or reduce opening hours; and
- Interest: landlords must not charge interest on any unpaid rent;
- despite the level of prescription, the Code seeks to promote flexibility for landlords and tenants in several respects:
- the Code includes a number of broad overarching principles encouraging tenants and landlords to work together to share the financial burden during the COVID-19 pandemic;
- landlords and tenants are encouraged to negotiate in good faith amendments to their existing arrangements that are bespoke and appropriate to their particular circumstances; and
- an expectation that landlords will work with their banks to share the burden, and share any benefits provided to them with tenants; and
- the arrangements will be overseen by a binding mediation process coordinated by each State and Territory. It will be interesting to see how this will be resourced.
The Changes in detail
Tenants must continue to observe the terms of the lease, subject to any agreed amendments. This is expressed as a prerequisite to the applicability of the Code, with any material disregard of the lease by the tenant to result in forfeiture of the specific protections set out in the Code.
Landlords must provide reductions in the rent payable by the tenant, proportionate to the reduction in the tenant's turnover, during the course of the pandemic and a reasonable recovery period thereafter. Rent reductions may provide up to a 100% reduction of the rental amounts normally payable by the tenant.
Rent waivers must account for at least 50% of any rent reduction (unless waived by the tenant), and should make up a higher proportion where the tenant would otherwise be unable to fulfil their lease obligations and having regard to the financial ability of the landlord. Any such rent waivers may not be recovered by landlords during the remaining term of the lease. This will lead to the requirement for tenants to be very transparent to landlords about their financial position, including both their cashflow position and their financial reserves (cash, loan facilities and equity positions).
The balance of the rent reduction should be made up of rent deferrals, repayable over the greater of the balance of the term and 24 months after the COVID-19 pandemic and a reasonable recovery period (except as otherwise agreed). It is not immediately clear how a 24 month repayment period would be implemented where the balance of the term is less than 24 months. The expectation is that the relief agreement would be an enforceable enduring arrangement potentially well past the term of the lease in some cases.
The rent reductions are likely to apply only to net rent. Outgoings can still be recovered, although landlords are asked to seek to waive recovery whilst tenants are unable to trade.
Landlords must not impose any fees, interest or charges in relation to any agreed rent waivers and deferrals. This contrasts to the position of many loan deferral arrangements with the banks.
- a tenant experiencing a 40% decrease in turnover as a result of measures taken to deal with the COVID-19 pandemic would be entitled (in principle) to a reduction in the corresponding rent by 40%, with at least half of this reduction being a permanent waiver;
- if the monthly rent was $10,000, the tenant would pay $6,000 each month; and
- $2,000 each month is deferred (and payable over a period of at least 24 months after the reasonable recovery period), whilst $2,000 each month is permanently waived by the landlord.
Tenants should be provided with the opportunity to extend lease terms for an equivalent period of the rent waiver and deferral period. This would provide them with an opportunity to trade during the eventual period of recovery, whilst providing time to repay any deferred rent.
Landlords must not increase the rental amounts payable by commercial tenants during the COVID-19 pandemic and a subsequent reasonable recovery period. The duration of the recovery period has not been defined, and it is likely that further detail will be provided by States and Territories. If this detail is not forthcoming, allowances for a reasonable recovery period will need to be negotiated between landlords and tenants.
The prohibition on rental increases applies regardless of any arrangements between tenants and landlords in their existing commercial leases, but excludes increases due to turnover rent provisions of retail leases.
Landlords may not terminate leases due to the non-payment of rent during the COVID-19 pandemic and a subsequent reasonable recovery period, regardless of the terms of the existing lease. This does not prevent the lease being terminated for reasons other than the non-payment of rent, taking into account the overarching principles of the Code.
There was an initial indication that tenants would be provided with an arbitrary right to terminate their lease, unless landlords signed up to the Code. However, this has not materialised.
In addition to the termination restrictions, landlords are precluded from drawing down tenant securities such as bank guarantees, security deposits, bonds or personal guarantees, due to the non-payment of rent by tenants. Again, this does not prevent landlords drawing on these securities in other circumstances permitted under the lease, taking into account the overarching principles of the Code.
Nor is there a restriction on landlords when entering into relief agreements from requiring those securities be extended to cover the deferred rent.
Landlords may not penalise tenants who reduce operating hours or cease trading by reason of the COVID-19 pandemic. It is not clear, however, whether a tenant which elects to close (rather than being forced to by law) would then generate an automatic 100% decrease in turnover as a result and would then be entitled to a comparable rent reduction.
Land tax and other outgoings
If statutory changes result in a reduction of the land tax, council or Territory government rates or other charges payable by a landlord, or insurance costs, the landlord must pass a proportion of these savings to the tenant as required by the terms of the lease. This will include the pass through of separate State and Territory Government commitments to provide direct waivers or deferrals of land tax. This appears to reflect the standard provisions of most net lease arrangements, although further reductions may be required for gross lease arrangements.
The expectation is that States and Territories will be passing complimentary laws to provide this tax relief. Indeed the ACT has already made those announcements.
Parties are expected to formally document their arrangements to ensure the agreed variations to their existing commercial leasing arrangements are recorded, and may be referenced and amended as required during, and after, the COVID-19 pandemic. The additional prescribed factors which should be taken into account by parties in arriving at their individual arrangements include:
- the revenue, expenses and profitability of the tenant;
- the specific impact of the COVID-19 pandemic on the tenant;
- the commercial arrangements applicable to the specific premises;
- whether the tenant's lease has expired, is due to expire or is in "hold-over";
- whether the tenant is in receivership or administration;
- the structure, period of tenure, and mechanism for determining rent in the existing lease; and
- whether the tenant was in arrears prior to the COVID-19 pandemic.
ACT Government's rent relief package
The ACT Government's position regarding relief arrangements for commercial tenancies was discussed in our 3 April Alert. In summary, the ACT Government announced relief would be implemented through the Covid-19 Emergency Response Act 2020 (Act) and the ACT Government's 'Economic Survival Tranche 2' (Stimulus Package). Under the Act, the Minister would be afforded declaration making powers in connection with the enforcement and termination of commercial tenancies. The Stimulus Package introduced a tiered category system to determine the level of support afforded to landlords (and passed onto tenants) by the ACT Government.
Analysis of the Code and the ACT Government's current position
This section provides a comparative analysis of the key issues addressed by the Code in contrast to the ACT Government's Stimulus Package announcements. At the time of this article, the ACT Government has not announced any details regarding how the Code will be implemented in the ACT.
Is the Code enforceable in the ACT right now?
No, the Code is not currently enforceable in the ACT and will not be enforceable until the ACT Government introduces and passes legislation or regulation to adopt, implement and enforce the Code.
The expectation, however, is that the ACT Government will adopt the Code with enabling legislation to be introduced in the next week or so. We anticipate that the legislation or regulation introduced by the ACT Government will address the principles in the Code by either referring back to a requirement to comply with the Code, or providing its own interpretation on how the Code is to be implemented.
Will the Code apply to all commercial tenancies in the ACT?
Broadly speaking, the Code will only apply to commercial tenancies where the tenant is a small or medium sized enterprise with an annual turnover of less than $50 million per year and is eligible for the Commonwealth's JobKeeper program.
In contrast, the Act, and the Minister's ability to make declarations in connection with the enforcement and termination of leases, applies to commercial leases that are subject to the Leases (Commercial and Retail) Act 2001 (Leases Act). To recap, the Leases Act is applied broadly to retail and commercial premises, as well as leases to specified business and tenants (such as incorporated associations). The primary exemption applies to leases to a listed public company or a subsidiary of a listed public company for more than 1000m2. Most ACT office leases are captured by the Leases Act as well as more obvious retail leases.
Further, the rate relief measures provided in the Stimulus Package only apply to those landlords and tenants who can prove that their business falls within one of the prescribed categories in the ACT Government's tiered category system.
As such, there is an apparent inconsistency regarding the application of the Code and the ACT Government's relief measures for commercial tenancies. We anticipate that the ACT Government's position regarding the application of the Code will be addressed in the legislation or regulation it introduces, however, whether the application of their current measures, provided by the Act and the Stimulus Package, will change in response to the Code remains unclear. This is something being pursued by the Property Council.
It is therefore important that landlords consider the nature of their tenant's business and their leasing documentation to determine whether the Code or the ACT Government's measures will apply to their commercial tenancy.
How will the rate reductions to be apportioned in the ACT?
The Code prescribes that landlords should seek to reduce rent payable by the tenant, proportionate to the reduction in the tenant's trading activities, during the course of the Covid-19 pandemic and a reasonable recovery period following. If required, rent reductions may provide up to a 100% reduction of the rental amounts usually payable by a tenant under a commercial tenancy.
Under the Stimulus Package, the rate reduction to be afforded to landlords is contingent on which "category" of application has been made to the ACT Revenue Office. If Category 2 applies and the landlord receives a rates waiver, 25% of that waiver is to be passed onto tenants. If Category 3 applies and the landlord receives a rates waiver, 50% of that waiver is to be passed onto tenants. Both the Code and the Stimulus Package prescribed that relief is only to be granted on the basis that a tenant can prove there has been a reduction in their revenue as a result of the Covid-19 pandemic. It is therefore important for landlords to clearly set out with the tenant what information they require the tenant to produce (i.e. sales reports or financial statements) in order to justify the rent reduction.
What dispute resolution process will apply in the ACT?
Where landlords and tenants cannot reach agreement on relief arrangements, the Code prescribes that parties should refer to a binding mediation process implemented by the State or Territory to resolve the impasse.
The ACT Government has already announced in the Stimulus Package that it intends to appoint a 'Commercial Tenancy Mediator (Business Commissioner)' to assist landlords and tenants to engage and negotiate mutually agreeable relief arrangements.
Reportedly, Brendan Smythe will take on the role of the Commercial Tenancy Mediator in his new role of Local Business Commissioner. However, given the number of commercial tenancies in the ACT that will potentially fall within the jurisdiction of the mediator, it seems unlikely that any dispute or disagreement between landlords and tenants over relief arrangements will be resolved in a timely and efficient manner.
Further, there is a question over the enforceability of the decision made by the mediator. If one party determines to disregard the mediator's decision, the other party may have to apply to the ACT Civil and Administrative Tribunal (ACAT) to have the decision enforced. Due to Covid-19, the ACAT is operating on a limited schedule and their capacity to hear and resolve cases is contingent on the resources available to them. However, it should be noted that applications in relation to rental property disputes (i.e. termination and possession orders, rent increases and modifications) will have priority, but it is unclear whether this directive extends to commercial tenancies.
As such, we consider that the mediation process should only be sought by parties as a last resort. It is, therefore, imperative that landlords and tenants continue to engage in constructive dialogue and negotiate in good faith to reach a mutually beneficial relief arrangement. This will mitigate any potential delays or issues that may arise through the mediation process.
So what's next?
Both landlords and tenants should continue to negotiate in good faith with regards to any relief arrangements.
Tenants should also gather and be prepared to provide to their landlord sufficient information to verify:
- that they are eligible for the Commonwealth Government's JobKeeper program;
- what their usual turnover is; and
- the specifics of reductions in turnover caused directly by the COVID-19 pandemic.
We will continue to watch for any further developments from the ACT Government or the National Cabinet regarding commercial tenancies and will update you once available. Otherwise, we will continue to help our clients deal with this difficult time and the constantly changing commercial and legal landscape.