This article was written by Chris Wheeler, Benita Ainsworth and Rhys Mitchell
The National Cabinet announced on 7 April the Mandatory Code of Conduct (National Code) for leases to COVID-19 impacted small and medium sized commercial tenants.
We analysed the National Code in our alert: "Mandatory Code of Conduct and the ACT Government's rent relief package for commercial tenancies" (8 April Alert). The States and Territories have since been preparing their own legislation to implement the National Code within their own jurisdictions.
Prior to the introduction of the National Code, the ACT Government through the COVID-19 Emergency Response Act 2020 (COVID-19 Act) had already taken preliminary steps to create a legislative framework to regulate some aspects of the landlord and tenant relationship for commercial tenancies financially impacted by COVID-19. The details were outlined in our client alert on 3 April 2020: "COVID-19: ACT Government's rent relief package for commercial tenancies" (3 April Alert).
The ACT Government announced on 11 May 2020 its regime to implement the National Code through the Leases (Commercial and Retail) COVID-19 Emergency Response Declaration 2020 (Declaration).
The Declaration has been made pursuant to the declaration making powers of the Leases (Commercial and Retail) Act 2001 (Leases Act) which were given to the Attorney General in the COVID-19 Act. The Declaration aims to implement the overarching principles and leasing principles contained in the National Code and places great emphasis on parties negotiating in good faith in determining appropriate leasing arrangements.
The ACT Government has also released guidance notes for tenants and landlords which provides a summary of the key elements of the ACT Government's approach to implementing the National Code (Guidelines). The Guidelines essentially provide a commentary on application of the Declaration as well as seeking to answer by way of example some frequently asked questions. The Guidelines do not, however, have the force of law and are not intended to change the legal interpretation of the Declaration itself. Nevertheless, the Guidelines are of significance as they will likely be taken into account initially by the parties in negotiations and in any mediation process facilitated by the Local Business Commissioner. Where the Guidelines may be at odds with a legal interpretation of the Declaration this will not be able to be formally resolved except through proceedings in the Magistrates Court.
- In this article we will examine the key features of the Declaration and the Guidelines and potential gaps and issues that may depart from the principles espoused in the National Code.
The Declaration at a glance
- To be able to enforce a relevant lease, a landlord must first negotiate with the COVID-19 financially impacted tenant having regard to the overarching principles and leasing principles set out in the National Code (Good Faith Negotiations).
- Unless the requirement to undertake Good Faith Negotiations has been complied with, a landlord will not be permitted to issue a termination notice, terminate the lease or pursue other remedies against the tenant that would usually be available (such as enforcement of a guarantee, recovery under a bond, imposition of 'penalty' interest or seeking damages).
- The Local Business Commissioner will have a role in facilitating negotiations between the landlord and tenant if the parties cannot independently reach a binding agreement to amend leasing arrangements.
Application and limitations:
- Applicable only to leases:
- primarily subject to the Leases (Commercial and Retail) Act 2001; and
- entered into before 7 April 2020.
- Applicable only if the tenant qualifies for the JobKeeper regime and has a turnover for the 30 June 2019 financial year less than $50 million (and is not part of a broader corporate group with aggregate turnover greater than or equal to $50 million).
- A landlord is not prohibited from taking legal enforcement action against a tenant for breaches that are unrelated to requirements to: pay rent; pay outgoings or other money; or to operate the tenant's business during specified hours.
- Effective from 1 April 2020 until the first day no COVID-19 emergency exists in the ACT
The Declaration adopts the overarching principles and leasing principles of the National Code and places great emphasis on landlords and tenants engaging in good faith negotiations to agree on rent relief arrangements.
These principles taken together align more closely philosophically with the Victorian commercial leases relief scheme than the more narrow NSW scheme.
The overarching principles of the National Code seek to share the economic impact in a proportionate manner and at the same time balance the interests of both parties. The principles are as follows:
- landlords and tenants share a common interest in working together, to ensure business continuity, and to facilitate the resumption of normal trading activities at the end of the COVID-19 pandemic during a reasonable recovery period.
- landlords and tenants will be required to discuss relevant issues, to negotiate appropriate temporary leasing arrangements, and to work towards achieving mutually satisfactory outcomes.
- landlords and tenants will negotiate in good faith.
- landlords and tenants will act in an open, honest and transparent manner, and will each provide sufficient and accurate information within the context of negotiations to achieve outcomes consistent with this Code.
- any agreed arrangements will take into account the impact of the COVID-19 pandemic on the tenant, with specific regard to its revenue, expenses, and profitability. Such arrangements will be proportionate and appropriate based on the impact of the COVID-19 pandemic plus a reasonable recovery period.
- the parties will assist each other in their respective dealings with other stakeholders including governments, utility companies, and banks/other financial institutions in order to achieve outcomes consistent with the objectives of this Code.
- all premises are different, as are their commercial arrangements; it is therefore not possible to form a collective industry position. All parties recognise the intended application, legal constraints and spirit of the Competition and Consumer Act 2010.
- the parties will take into account the fact that the risk of default on commercial leases is ultimately (and already) borne by the landlord. The landlord must not seek to permanently mitigate this risk in negotiating temporary arrangements envisaged under this Code.
- all leases must be dealt with on a case-by-case basis, considering factors such as whether the SME tenant has suffered financial hardship due to the COVID-19 pandemic; whether the tenant's lease has expired or is soon to expire; and whether the tenant is in administration or receivership.
- leases have different structures, different periods of tenure, and different mechanisms for determining rent. Leases may already be in arrears. Leases may already have expired and be in "hold-over." These factors should also be taken into account in formulating any temporary arrangements in line with this Code.
- as the objective of this Code is to mitigate the impact of the COVID-19 pandemic on the tenant, due regard should be given to whether the tenant is in administration or receivership, and the application of the Code modified accordingly.
The leasing principles of the National Code are as follows:
- landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period (or reasonable subsequent recovery period).
- tenants must remain committed to the terms of their lease, subject to any amendments to their rental agreement negotiated under this Code. Material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under this Code.
- landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals of up to 100% of the amount ordinarily payable, on a case-by-case basis, based on the reduction in the tenant's trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.
- rental waivers must constitute no less than 50% of the total reduction in rent payable under principle #3 above over the COVID-19 pandemic period and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise the tenant's capacity to fulfil their ongoing obligations under the lease agreement. Regard must also be had to the Landlord's financial ability to provide such additional waivers. Tenants may waive the requirement for a 50% minimum waiver by agreement.
- payment of rental deferrals by the tenant must be amortised over the balance of the lease term and for a period of no less than 24 months, whichever is the greater, unless otherwise agreed by the parties.
- any reduction in statutory charges (e.g. land tax, council rates) or insurance will be passed on to the tenant in the appropriate proportion applicable under the terms of the lease.
- a landlord should seek to share any benefit it receives due to deferral of loan payments, provided by a financial institution as part of the Australian Bankers Association's COVID-19 response, or any other case-by-case deferral of loan repayments offered to other Landlords, with the tenant in a proportionate manner.
- landlords should where appropriate seek to waive recovery of any other expense (or outgoing payable) by a tenant, under lease terms, during the period the tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.
- if negotiated arrangements under this Code necessitate repayment, this should occur over an extended period in order to avoid placing an undue financial burden on the tenant. No repayment should commence until the earlier of the COVID-19 pandemic ending (as defined by the Australian Government) or the existing lease expiring, and taking into account a reasonable subsequent recovery period.
- no fees, interest or other charges should be applied with respect to rent waived in principles #3 and #4 above and no fees, charges nor punitive interest may be charged on deferrals in principles #3, #4 and #5 above.
- landlords must not draw on a tenant's security for the non-payment of rent (be this a cash bond, bank guarantee or personal guarantee) during the period of the COVID-19 pandemic and/or a reasonable subsequent recovery period.
- the tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period outlined in item #2 above. This is intended to provide the tenant additional time to trade, on existing lease terms, during the recovery period after the COVID-19 pandemic concludes.
- landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period, notwithstanding any arrangements between the landlord and the tenant.
- landlords may not apply any prohibition or levy any penalties if tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.
The Declaration does not depart from the above principles contained within the National Code.
Rather than a specific clear relief formula, the National Code principles apply a broad menu of factors that the parties should take into account in their good faith relief negotiations. While fairer, the broad principles do create a degree of uncertainty and leave a lot of room for possible disagreement. If the negotiations are undertaken in the correct spirit with shared transparency and accountability, then the prospects of coming to an agreed and quick position will be enhanced.
Period of application
The Declaration was made on 11 May 2020 but will have retrospective effect so that the 'prescribed period' (as defined in the Declaration) of application will commence from 1 April 2020. The Declaration will remain in force until:
- the first day no COVID-19 emergency is in force; or
- any later day notified by the Minister under the section 177(3)(b) of the Leases Act,
This is a contrary to the National Code, which is intended to operate no sooner than 3 April 2020 and for the duration of the Commonwealth's JobKeeper program (which is due to end on 27 September 2020). At the time of this article, the prescribed period ends on 7 July 2020. The Guidelines, however, indicate an intention on the part of the ACT Government to extend the application of the declaration to 30 September 2020, to align with the expiry of the JobKeeper program and the ACT Government's rates relief package (as described in our 3 April Alert).
The Declaration applies to an 'impacted tenant' which is a tenant under a 'prescribed lease' who:
- at any time during the Prescribed Period qualifies for the JobKeeper scheme under the Coronavirus Economic Response Package (Payments and Benefits) Rules 2020 (Cth) sections 7 and 8; and
- has a turnover for the 2018-2019 financial year of less than $50 million for –
- if the tenant is a franchisee in a business – the business conducted at the premises or land under the lease; or
- if the tenant is a member of a corporate group (meaning a corporation and all its related bodies corporate) – the group; or
- in any other case – the business conducted by the tenant.
This definition is essentially the same as the NSW scheme.
The financial impact of COVID-19 on a tenant's turnover will be required to be established to inform negotiations for temporary rent reductions. The Guidelines indicate that the tenant must be prepared to provide evidence substantiating the financial impact it has experienced as a result of COVID-19 and that a letter from an accountant merely stating the level of impact will not be sufficient. It is suggested in the Guidelines that the method used for calculating reduction in turnover should follow those publicised on the Australian Taxation Office website and be derived from recognised accounting systems. Eligibility for JobKeeper will likely substantiate impact on turnover of at least 30% (subject to verification), but additional information will be required to evidence any greater impacts and will be essential for a tenant who seeks rent relief greater than 30%.
Notably, (and as acknowledged in the Guidelines) the financial position of the landlord will also be relevant to the level of any rent relief that can ultimately be offered to a tenant.
An unintended consequence of the Declaration drafting is that new businesses that do not have turnover figures for the 30 June 2019 financial year will not be entitled to the relief. Landlords should not seek to take advantage of this loop hole as the ACT Government will be closely monitoring the Declaration outcomes and will be quick to amend if there is perceived incompatible behaviour by the parties.
A 'prescribed lease' is intended to be any lease subject to the Leases Act that was entered into before 7 April 2020 (including leases usually excluded from application of the Leases Act under section 12(2)(a) and (b)).
Therefore, the Declaration will not apply to any lease:
- which is not subject to the Leases Act, common examples being leases to:
- (contrary to the intention of the Declaration) incorporated charitable organisations that do not carry on a "business" (other than those incorporated under the Associations Incorporation Act 1991, or an entity eligible to be incorporated under that Act); or
- a listed public company or a subsidiary of a listed public company for more than 1,000 square metres; or
- a warehouse operator with no retail services; or
- which was entered into from 7 April 2020.
It is assumed that the parties to any lease entered into from 7 April 2020 would have been aware of the National Code and so the parties would have addressed how to deal with the COVID-19 crisis.
With respect to charitable organisations, the Declaration attempts to include provision for leases to charitable organisations within its ambit by including in the definition of 'business' any "business conducted for a not-for-profit basis". However, the definition of 'business' is only used in the context of 'turnover' and 'prescribed breach'. While the intention is to pick up leases to incorporated charities, it would have been preferable to put this issue beyond doubt through a regulation under section 12(1)(k) of the Leases Act to specifically include leases to incorporated charitable organisations under the ambit of the Leases Act for the purpose of the Declaration.
An unfortunate drafting issue has arisen in the definition of a 'prescribed lease' and the related definition of 'lease to which the Act applies', which could mean that only a handful of leases are actually subject to the Declaration. Again the intent seems clear that a 'prescribed lease' should be one to which the Leases Act applies. Hopefully this definitional issue is resolved without requiring a direction from the Courts.
For leases not subject to the Declaration (particularly those where to the tenant is not an SME), landlords and tenants will be able to negotiate any rent relief arrangements independently, but will not be obliged to and will not be required to comply with the terms of Declaration or the National Code.
Enforcement of leases
Under the Declaration, a landlord is permitted to issue a termination notice to an impacted tenant provided:
- they have engaged in Good Faith Negotiation with the impacted tenant (i.e. the landlord has genuinely attempted to negotiate in accordance with the overarching principles and leasing principles of the National Code); and
- the impacted tenant has committed a 'prescribed breach'.
The Declaration defines a 'prescribed breach' to be a failure by the impacted tenant:
- to pay rent; or
- to pay outgoings or other amounts due under the lease; or
- to operate the business on the premises under the lease during the hours required under the lease.
Therefore, if an impacted tenant has committed a 'prescribed breach' from 1 April 2020, a landlord will need to demonstrate that they have complied with the Declaration and have engaged in Good Faith Negotiations with the impacted tenant in order to issue a termination notice. It is therefore important for landlords to continue to engage with impacted tenants in an open, honest and transparent manner to avoid losing any enforcement rights otherwise available under the respective lease.
Further, the Declaration does not preclude a landlord from engaging in enforcement action under the lease (i.e. terminating the lease or calling on a bank guarantee or bond) for unremedied conduct of the impacted tenant that:
- occurred prior to the commencement of the prescribed period (i.e. before 1 April 2020); or
- is unrelated to a 'prescribed breach' (e.g. is a breach of the purpose clause or repair and maintenance obligations).
It is notable that the Declaration does not provide any right for tenants to unilaterally terminate a lease for reasons related to COVID-19 financial hardship. There are no protections provided for tenants that seek to walk away from a lease for these reasons without the mutual agreement of the landlord. As noted in the Guidelines, the normal operation of the Leases Act will apply in such circumstances.
Is the Declaration mandatory?
At one level the Declaration is not mandatory – it does not expressly oblige a landlord to reduce the rent. Rather it is more nuanced, in that it prevents the landlord from enforcing the lease for non-payment of rent unless Good Faith Negotiations have been undertaken.
If a tenant does not approach the landlord to seek rent relief, then strictly speaking a landlord is not obliged to provide the relief. In practice, however, most landlords and tenants have already been in discussions regarding rent relief and in many cases already have relief agreements in place.
Also, if a landlord wishes to qualify for the ACT Government's rates relief scheme then in most circumstances the landlord will need to provide rent relief to qualify for the rates concessions. As such, the ACT Government has deliberately sought to incentivise landlords to adopt the Declaration principles.
So the distinction in practice between whether the Declaration is mandatory or not is more academic.
What about existing relief agreements?
Existing rent relief agreements between landlords and tenants are not necessarily secure.
Rather they will need to be reviewed to see if they are compatible with the Declaration. If so, then the agreement can stand. If not, then the agreement can be challenged (by either party).
As described in our 8 April Alert, the ACT Government has officially confirmed the appointment of Brendan Smyth as the Local Business Commissioner.
The Guidelines indicate that if independent agreement cannot be reached by the parties, the Local Business Commissioner will be available to assist in mediating lease negotiations between landlords and tenants that are affected by the economic impact of COVID-19. However, the role of the Local Business Commissioner is limited to the extent that they cannot compel the parties to mediate nor are they able to make a binding decision (which will mean that their actions are not subject to review by the ACT Civil and Administrative Tribunal (ACAT)). Any opinion given by the mediator as to whether negotiations were attempted in good faith will be relevant to a landlord's decision whether to proceed with termination or other enforcement action against the tenant. Only the Magistrates Court however will be able to determine if the Good Faith Negotiation requirement was met.
It is therefore incumbent on the landlord and tenant to reach an agreed outcome which is then intended to be recorded as a binding agreement. The Guidelines indicate that it is likely that any breakdown in the relationship between the landlord and the tenant will need to be resolved by a formal meditation process or through usual Magistrates Court proceedings. The Magistrates Court will not permit proceedings to commence unless there is evidence that mediation had been undertaken. As such, either party cannot run off directly to the Court without embarking on a mediation exercise. The ACT Government is particularly minded not to clog up the ACT justice system with rent relief disputes.
It is more likely the Local Business Commissioner will act more as a facilitator than a mediator and their role will be to facilitate landlords and tenants determine an agreed outcome between themselves. The Guidelines indicate that further guidance on this mediation process is to be provided by the ACT Government.
This mediation service does not intend to replace or affect any mediation process that may be referred under the Leases Act. Hopefully that does not lead to the duplication of mediation processes for rent relief disputes headed to the Court.
How does this work with the ACT Government's rates relief package?
As noted in our 3 April Alert, the ACT Government 'Economic Survival Tranche 2' (Stimulus Package) prescribed a tiered category system which indicated the level of support afforded to landlords through a reduction in general rates payable on commercial properties (subject to the landlord providing rent reductions to impacted tenants).
The tiered categories are as follows:
- Category 1 – those who have been partially or not affected (up to 30% reduction in tenant business income - it is anticipated that tenants will continue to pay the rent required under the lease and no rates rebate is offered to the landlord);
- Category 2 – those who have been significantly affected (more than 30% but less than 80% reduction in tenant business income - rates rebate provided at 25% of the rent reduction – capped at the lower of $5,000 per quarter or the total quarterly rates bill); and
- Category 3 - those who have effectively shut-down operations due to COVID-19 health restrictions (at least 80% reduction in tenant business income - rates rebate provided at 50% of the rent reduction – capped at the lower of $8,000 per quarter or the total quarterly rates bill).
The Guidelines indicate that landlords wanting to access the rates concessions will be required to make a declaration that they have negotiated in good faith with regard to the National Code with respect to leasing arrangements and agreed rent reductions.
The rates rebate assistance will be available to landlords (owners) of commercial property with an average unimproved value of no more than $2 million. The reduction to general rates will apply from 1 April 2020 and will continue for a period up to 6 months. The level of assistance offered to landlords is dependent on which above category applies to the business being conducted from the commercial property and the level of rent reduction that is agreed.
For landlords of commercial property with an average unimproved value greater than $2 million, an application for rates relief can still be made to the ACT Revenue Office, however, each application will be assessed on a case-by-case basis and there is no guarantee that assistance will be provided.
Take away items
The Declaration will require landlords who seek to enforce their leases that are subject to the Declaration, to adhere to the overarching principles and leasing principles of the National Code and engage in Good Faith Negotiations for rent relief.
However, parties to commercial leases that are not subject to the Leases Act or not otherwise bound by the Declaration and the National Code may proceed independently with negotiations and usual lawful enforcement action for any breach.
Landlords who do not follow the Declaration principles will largely not be entitled to the ACT Government's rates concessions.
We are continuing to advise our clients on their lease arrangement strategies as they work through and beyond the COVID-19 crisis. Now the Declaration has been revealed and is in force, landlords and tenants will quickly look to:
- formerly engage (or re-engage) to negotiate adjustments to their leases and to formalise binding relief agreements; or
- pursue their rights to seek to finalise such an agreement by mediation or in the Courts.