29 April 2020

National Code of Conduct for commercial leases – New South Wales’ mandatory regime comes into force

This article was written by Stuart Dixon-Smith, Chris Wheeler, Simone Menz, Carl Black, Mark Bayliss, Francesca Giorlando, Chris Mitchell and Tristan Howes.

Since the National Cabinet announced the Mandatory Code of Conduct (National Code) for COVID-19 impacted small and medium sized commercial tenants in early April, States and Territories have been preparing their own legislation to implement the National Code within their own jurisdictions. While several States have now passed enabling legislation, New South Wales has moved ahead of the pack as the first jurisdiction to introduce comprehensive implementation regulations. 

This alert sets out the key details of the New South Wales regulations, and what is now clear and unclear for affected lessees and lessors.

NSW Regulations in force

The Retail and Other Commercial Leases (COVID-19) Regulation 2020 (NSW Regulations) was passed on Friday 24 April, creating new regulations under the Retail Leases Act 1994 (for affected retail leases) and amending the Conveyancing General Regulation 2018 (for other affected commercial leases).

The NSW Regulations are to operate for six months from 24 April 2020 to 24 October 2020 (prescribed period), with no automatic shortening or extension mechanisms (any extension would require Parliament to legislate, and cannot be done by regulation). The NSW Regulations are repealed by clause 12 of the NSW Regulations on 25 October 2020, and there is uncertainty about whether the NSW Regulations would apply to alter leases and lessors’ rights after that date.  The prescribed period of six months is the same as the six month JobKeeper program duration, but starts and ends later than the JobKeeper program (which ends on 27 September 2020) and so represents a departure from the National Code that lessors under affected leases should be mindful of.

Who qualifies?

The qualification criteria for relief under the NSW Regulations closely follow the National Code, with certain clarifications, and some less clear provisions.

The NSW Regulations apply to commercial leases for premises within the State entered into before 24 April 2020 (and option renewals after that date) excluding leases under the Agricultural Tenancies Act 1990. The NSW Regulations will only apply to an “impacted lessee”, who:

  • qualifies for the Jobkeeper scheme (and in this respect lessors should be mindful that the prescribed period ends after the date on which the Jobkeeper scheme is currently scheduled to end); and
  • has 2018-2019 financial year turnover of less than $50 million, calculated on the total business of the lessee (presumably not limited to that generated in NSW alone), except:
    • for a lessee who is a franchisee, in which case the calculation will only be on the business conducted on the premises or land concerned. Whilst analogous, this allows a franchisee operating multiple franchises at different locations to measure the turnover of their franchise premises separately, rather than as a whole; or
    • where the lessee is a member of a group of related bodies corporate under the Corporations Act 2001, in which case the calculation will be on a whole of group basis,

including turnover from internet sales in any case.

Unlike the National Code, there is no reference to “in spirit” application to non qualifying lessees, providing clarity (but not the protection and relief) for larger lessees and their lessors. Parties to those leases will need to negotiate their own arrangements without the imposition of an obliging law.

Key updates from the National Code

Whilst the general faithfulness of the NSW Regulations to the National Code will be welcomed by parties who have concluded, or are continuing, negotiations under the broader National Code principles, there are a number of areas in which the NSW Regulations refine and supplement the National Code principles.

Area

Comment

Requirement to renegotiate rental and lease terms

 

If requested by either party to the lease, impacted lessees and their lessors are required to renegotiate in good faith the rent payable and other provisions of their lease, having regard to the economic impacts of COVID-19 and the leasing principles in the National Code.

The NSW Regulations do cross refer to relevant leasing principles in the National Code, but do not enact them.  Therefore, the NSW Regulations do not impose strict mandatory requirements for the form of rent relief or lease amendments. The notes to the Regulations reference in particular the requirement in National Code Principle 3 that rent waivers and deferrals are proportional to reductions in turnover. However, parties are not strictly required to comply with those National Code principles. For example, the reference in National Code Principle 4 to at least 50% of rental reductions being waivers (rather than deferments) is not replicated as a mandatory requirement. There is also no mandatory minimum repayment period for deferred rent, as required by the National Code.

If a rent relief position was not agreed, however, between an impacted lessee and lessor, a mediator, and likely a court, would first consider the application of the leasing principles under the National Code and ask why they could not be applied.

Whilst stipulating that a lessor cannot enforce or pursue rent for the prescribed period unless the lessor has first complied with the renegotiation obligations, the NSW Regulations are not prescriptive on the duration of any rent relief. However, there is an underlying assumption in the drafting that the rent relief will at least be referable to the prescribed period.

Prohibitions on rent increases

 

The NSW Regulations impose a blanket prohibition on rent increases for impacted lessees taking effect or being enforced during and after the prescribed period, excluding any rent payable on the basis of turnover. This effectively suspends all fixed, consumer price index, market review and other rent increases from coming into effect during the prescribed period.  The mechanics of the suspension of the rent review are unclear and we advise lessors and lessees to address these mechanics specifically in the renegotiation of the terms of any lease with a rent review that falls within the prescribed period.

This largely reflects National Code Principle 13. If a rent review date falls due during the prescribed period, lessors will not be able to apply the outcome of the review until the prescribed period has ended and cannot “back date” the review or apply it retrospectively.

Fixed contributions to charges

 

Where an impacted lessee is required to make fixed contributions to land tax, other statutory charges or insurance costs, and those charges payable by the lessor are reduced, the amount of those charges payable by the impacted lessee must be reduced in a corresponding manner.

This does not expressly apply to standard net rental arrangements, where reductions in outgoings will automatically flow on to lessees.  Although not entirely clear, we believe that the NSW Regulations are intended to ensure lessees under gross leases are to receive an appropriate share of any land tax concessions (we also believe it is likely a lessors’ entitlement to a land tax concession will, when legislated, be conditional on it being passed through to lessees in a corresponding manner).  Most likely rent relief arrangements involving reductions and waivers of gross rents will ordinarily satisfy this requirement (it being understood that such rents include components to cover such outgoings).

Enforcement restrictions

One of the more noteworthy aspects of the NSW Regulations is the broad restrictions on almost all lessor enforcement actions against impacted lessees for breaches during the prescribed period. The restrictions are mandatory, apply immediately and reach significantly further than the National Code principles.

Lessors are prohibited from taking any “prescribed action” against impacted lessees during the prescribed period for failure to pay rent, failure to pay outgoings or not being open for business during required hours (holy trinity breaches). Prescribed action is very broadly defined to include any terminations, evictions, enforcement of guarantees, damages, various other actions and any other common law or statutory remedies. The intention appears to bar almost all enforcement proceedings.

As discussed below, enforcement action generally speaking for non-holy trinity breaches are not prohibited by the NSW Regulations. Maintaining the theme in National Code Principle 2 that the parties should continue to respect the sanctity of the terms of the lease other than in relation to the specified relief areas.

In addition, if an act or omission of an impacted lessee is required under the law of the Commonwealth or the State in response to the COVID-19 pandemic, a lessor must not treat this as a breach of lease or as grounds for termination or other prescribed action. For example, if a tenancy is required to close or change its services to comply with a public health order, a lessor cannot treat such action as a breach of lease.

There are three exceptions to the prohibitions on prescribed action:

  • actions are permitted where they are agreed between the lessor and lessee under the NSW Regulations, including agreed termination of the lease. The acceptable scope of this is unclear, although possible uses could include withdrawing rent relief if agreed conditions are breached or allowing the lessor’s debts to be proved if the lessee is subject to insolvency proceedings during the prescribed period. In the absence of express agreement, these scenarios are not exempted from the blanket prohibition of prescribed actions;
  • actions are also permitted on grounds unrelated to COVID-19. The NSW Regulations specify breaching a lease by damaging premises or failing to vacate at the end of a term as examples of breaches that can still be actioned by a lessor during the prescribed period (including by eviction and termination).  Rent arrears predating the prescribed period can also be a basis for termination, recourse to bank guarantees or other enforcement action; and
  • the lessor may become entitled to take enforcement action if it has complied with the renegotiation requirements and been through the mandatory mediation dispute resolution process provided for in the NSW Regulations.  The lessor must first obtain a certificate from the relevant dispute resolution tribunal that the mediation has failed.  The lessor could then take any enforcement action not requiring a court order (such as cashing a bank guarantee or terminating the lease).  If the enforcement action requires a court order (such as an order for possession), the court now has discretion to refuse to grant orders enforcing the lease, having regard to the leasing principles of the National Code, the reasons for the failure of the mediation and the result of the enforcement orders sought.

Dispute resolution

 

The National Code called for binding mediations to resolve disputes arising under it. A slightly different approach is taken by the NSW Regulations, which varies depending on whether the relevant lease is a retail lease:

  • where the lease is a retail lease, any disputes in respect of the liabilities and obligations of impacted lessees during the prescribed period, including disputes in relation to rent negotiations, are characterised as “impacted commercial lease disputes” and will be treated as a retail tenancy dispute under the Retail Leases Act. In most instances they will be subject to mediation with the Office of the NSW Small Business Commissioner and then application to the NSW Civil & Administrative Tribunal; and
  • where the impacted lessee is not a retail lessee, the NSW Regulations set out freestanding mediation requirements with the Office of the NSW Small Business Commissioner, which must be complete or have failed before relevant recovery, termination or enforcement proceedings are taken unilaterally or commenced in court. The NSW Regulations do not accommodate up front mediation to resolve rent and lease negotiations in the absence of pending enforcement proceedings. It is not clear at this stage how the Commissioner intends to properly resource and manage the myriad of complex commercial issues between sophisticated commercial parties that could present themselves in this forum.  

For retail and non retail leases alike, tribunals and courts considering recovery, termination or enforcement proceedings against impacted lessees must have regard to the National Code Principles. It is not entirely clear at this stage how this will impact upon court and tribunal decision making.

 

Action Points

Many will welcome the NSW Regulations and the clarity they provide, especially impacted lessees who now qualify for immediate protection from COVID-19 related enforcement proceedings and will be entitled to renegotiate their rent and lease terms with reference to the National Code, with the lessee having a strong bargaining position because the lessor is prevented from enforcing the lease.  Lessors of impacted lessees also have far greater clarity on their obligations inresponse to COVID-19, apart from the above uncertainties in relation to the enforcement prohibitions and rent increases.

Lessors under commercial leases with lessees that do not qualify as impacted lessees under the NSW Regulations have been left to their own commercial negotiations with those lessees. Despite the absence of regulation around such commercial leases, we are seeing many examples of careful negotiations between lessor and lessee parties to those leases to support the viability of office, industrial and retail operations.

We are continuing to advise lessors and lessees as they work through and beyond COVID-19.

 

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