Read our Next Normal Q&A guide here which summarises some of the most common queries from our clients with our brief guidance.
How does COVID-19 impact commercial lease obligations?
As the UK continues to tackle the challenges caused by the spread of Coronavirus/COVID-19, Walker Morris continue to receive a number of enquiries from landlord and tenant clients as to how this may affect their property arrangements and obligations.
We have already seen the challenges faced and in light of the Government's announcement that the current restrictions will continue, it is essential that land owners and occupiers in all sectors understand the implications for their real estate-related rights and liabilities.
So, what are the key issues and concerns facing commercial landlords and tenants?
Can a tenant withhold rent or terminate a lease?
Given the potential adverse financial impact on tenants, a common question is whether tenants can refuse to pay rent, pay less rent and/or seek to terminate the lease prematurely.
The starting point is to review the terms of the particular lease. The relevant provisions to consider include:
- Any break clause that may enable the tenant to terminate the lease early;
- Any turnover rent provisions that are dependent upon the income generated from the premises; and/or
- Any force majeure clause (although these are rarely found in commercial leases and there is no common law right to terminate for force majeure).
Most modern commercial leases will provide for rent to be payable without deduction or set off. In those circumstances a tenant is unlikely to be able to withhold payment of rent for Coronavirus-related reasons unless any specific provision in the lease enables it do so, or unless it reaches an agreement with the landlord.
Rent suspension clauses generally only apply where premises have been damaged or destroyed. Tenants may therefore struggle to argue for a rent suspension in reliance on such provisions.
Tenants may look to the common law doctrine of frustration where the lease provides no express option for early termination. To terminate a lease or any other commercial contract by frustration, a party has to prove that there is some form of illegality or failure of common purpose that renders performance of the lease/contract impossible or so radically different from the parties' expectations that termination is justified. Importantly, however, the doctrine operates within very narrow confines. The courts will not lightly relieve parties of their contractual obligations and the bar for a successful frustration claim is high.
It is possible, in light of the scale of the outbreak and the unique underlying economic context, that the impact of the Coronavirus could, depending on the facts of individual cases, found successful frustration claims. However, potential claimants could face arguments that public health issues were not so far outside the parties' contemplation at the time the lease was granted that they could not have negotiated lease terms to allocate any associated risks; and that any inability to occupy premises would be for a short period of time only (when compared with the term of the lease), rather than a permanent arrangement. In addition, it is especially difficult to successfully argue for frustration in the case of a lease, because a lease affords a tenant the benefit of the demised premises whether or not the tenant wishes to make use of it, plus there usually remains the possibility of the tenant assigning or subletting1.
Can a Landlord forfeit the lease and evict the tenant for non-payment of rent?
Along with other unprecedented measures to protect the public and the economy, the UK government announced on 23 March 2020 that commercial landlords are to be precluded from forfeiting commercial leases 2and evicting the tenant for non-payment of rent. This measure has been extended from 30 June 2020 and will remain in place until 30 September 2020.
These measures form part of the emergency Coronavirus Act 2020 which was enacted on 25 March 2020.
For our full note on Government's announcement on the moratorium on Coronavirus-related commercial forfeiture see here.
Where a tenant is unable to pay its rent in full, the Government is encouraging Landlords to follow its recently introduced, voluntary, Code of Practice that is designed to 'promote good practice amongst landlord and tenant relationships.'
Must Tenants Keep Open or Re-open their Premises?
Some modern commercial leases (particularly in the retail sector) contain 'keep open' clauses and/or 'operating/opening hours' clauses.
In light of the restrictions that came into effect on 26 March 2020 under the Health Protection (Coronavirus, Restrictions) (England) Regulations 2020 ("the Regulations"), a large number of premises closed to the public. Although a number of sectors are being permitted to re-open that may prove difficult for some business owners do not wish to expose their staff and customers to potential health risks.
Where a tenant is obliged to "keep open" the premises it is likely that the Regulations will provide a defence to the requirement to "keep open" especially if it can be established that by keeping the Premises open will be unlawful. Further, the courts are generally reluctant to order specific performance of keep open provisions to force tenants to re-open. . However, where the Regulations no longer apply to the tenants business, a tenant is once again likely to become obliged to "keep open" the premises.
Will insurance help?
Landlords and tenants should review their insurance policies and speak with their brokers/insurance companies to understand the cover available to them. Some policies include business interruption cover but this may only be in place where there is a damage to property or where government action has meant that it is illegal for premises to remain open. In many cases, cover for infectious diseases will have been an opt-in extra and most will require the disease to have been classified as 'notifiable'. The UK government's declaration on 5 March 2020 that COVID-19 is a notifiable disease will assist in such cases. Landlords and tenants should note that invoking a force majeure or a frustration claim can impact insurance policies and, in any case where cover may be available, parties should ascertain and carefully comply with any notification requirements.
We are aware that a number of insurers are refusing claims made by both landlords and tenants. As a result, the FCA released a statement on 1 May 2020 announcing the unprecedented step they are taking to obtain a court declaration to resolve uncertainty regarding business interruption insurance and whether certain insurance policies will cover for business interruption related to the current pandemic crisis.
Who will be liable to provide/pay for additional services?
The starting point is that landlords remain liable to provide, and tenants remain liable to pay for, services in accordance with the express service charge provisions in the lease.
Where a lack of staff or materials rendered it impossible for a landlord to provide certain services, whether a landlord's failure amounted to a breach of the lease would depend on whether the lease contained any carve-out for circumstances where a landlord is prevented from complying with its obligations due to circumstances beyond its control.
The ability of a landlord to recover from tenants the costs of the enhanced cleaning regimes that are currently underway in the majority of premises will also depend on the terms of the particular lease. Generally speaking, most service charge provisions include the recovery of cleaning costs and, whilst the costs of enhanced cleaning may exceed usual expenditure, we would anticipate that such costs would be likely to be seen by the courts as reasonably incurred subject to any cap that may apply. Alternatively, a landlord might be able to rely on any 'catch all' provision regarding costs associated with good estate management.
What other options might be available?
There have recently been a number of high profile Company Voluntary Arrangements (CVAs), particularly in the retail sector, that have been used to reduce lease liabilities. This virus has also contributed to a trend towards CVAs in other sectors too such as hospitality.
However, some landlords/creditors may not be amenable to such a proposal. This may leave some tenants with no option but to seek urgent rent concessions, lease surrender by agreement or some form of administration or other insolvency process.
In many cases, it will be sensible for parties to consider commercial and reputational risks, alongside strict legal issues. For example, in such exceptional circumstances, parties may wish to consider being flexible about re-gearing or restructuring rent payment schedules or debts so as to preserve relationships, even where there is no legal right or obligation to do so. If and when any alternative arrangements are agreed, it will be important, from both parties' perspective, to ensure that these are properly documented and accurately reflect the parties' intentions and understanding.
Whether you are a landlord or tenant, it is important to understand your legal obligations and commitments; to act responsibly; and not to assume that you are or will be automatically released from your legal obligations under a lease even in light of current circumstances.
However, regardless of the legal framework, in the majority of cases it will remain in both parties' interests for tenants' businesses to withstand the continued difficulties the Coronavirus outbreak has caused and continues to cause. Given the sudden and negative impact on cash flow for most tenants, the most sensible option may be for landlords and tenants to try and agree practical and commercial solutions to navigate the coming months.
A good tip for when disputes do inevitably arise, is to check whether the particular lease contains any mandatory dispute resolution provisions. An effective dispute resolution clause requires the parties to follow a pre-agreed route to resolution, which can prevent any potential secondary dispute about whether and how the primary issue should be resolved; minimise the scope for any tactical game-playing (thereby helping to preserve commercial relationships); and ensure that the time and costs of dealing with formal litigation are only incurred as a last resort.
In terms of future lease agreements, it will be interesting to see how the market reacts and what sorts of clauses parties seek to negotiate to allocate the commercial risks that may arise from public health crises or other unexpected and significant events.
Finally, please note that this article aims to provide a high level summary of the key issues and concerns facing commercial landlords and tenants in these unprecedented times. Should you require any specific advice – whether from a risk management or a dispute resolution perspective – please do not hesitate to contact David Manda or any of Walker Morris' experienced and expert Real Estate Litigation team.
1 See our earlier briefing on the Canary Wharf v EMA case for further advice and information on frustration in the context of commercial leases
2 See our briefing on the basics of forfeiture for further information about this landlord's remedy
Originally published 29 June, 2020
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.