After weeks of scrambling amongst commercial landlords and tenants about options for rent relief during the COVID-19 crisis, the Morrison Government last week released the National Cabinet Mandatory Code of Conduct (Code).
The Code secures rental waivers for tenants and immediate cash flow relief together with benefits for landlords to assist in offsetting the loss to their turnover. You can read the Prime Minister's media statement here.
Although the Code will not become law until it is implemented through legislation by each of the states and territories in the coming weeks, there are steps landlords can take now to ensure current and new agreements will comply with the intention of the Code.
To help you navigate these significant changes, partner Kristy Dorney answers your key questions about how the Code applies and provides some tips for landlords on documenting rent relief agreements and what steps they can be taking now.
The Code captures all commercial tenants and is not limited to retail.
The Code applies to any tenant who is an eligible business under the Federal Government JobKeeper program and has a turnover of $50 million or less. While the rules for JobKeeper eligibility are still in draft you can click here for the latest Government factsheets.
Eligibility under JobKeeper requires a business to estimate and demonstrate a decline in projected GST turnover of at least 30 percent for any month in the period March to September 2020 or in either the June or September 2020 quarter.
Even if the Code is not triggered, landlords may think about complying with it. Both the Queensland and New South Wales Governments have announced they are offering a three-month rebate of land tax for 2019-20, followed by a three-month deferral of land tax for 2020-21. However, to be eligible for this relief, landlords must agree to adopt the Code for all tenancies at the property, whether the Code applies or not. It is expected any relief packages announced moving forward will be tied to compliance with the Code. You can view the Palaszczuk Government's media statement here.
For a lease to fall under the Code, the tenant's annual turnover must be $50 million or less.
For retail corporate groups, the $50 million threshold will apply at the group level rather than the individual retail outlet level. The Code is silent on whether non-retail corporate groups are tested at the group level. However, we see no reason why they would be treated any differently from retail.
Where a franchise is operated from the tenancy, the $50 million annual turnover threshold is to be applied 'at the franchisee level', even if the lease is in the name of the franchisor and not the franchisee.
While the Code sets out several 'leasing principles', one of the more important is the principle of 'proportionality' which is described as:
Landlords must offer tenants proportionate reductions in rent payable in the form of waivers and deferrals of up to 100 percent 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.
Proportionate means the amount of rent relief proportionate to the reduction in trade as a result of the COVID-19 pandemic.
The Code includes a basic example – where the tenant suffers a 60 percent loss in turnover as a result of the COVID-19 pandemic the rent payable during the period of the COVID-19 pandemic, and for a reasonable recovery period, is reduced to 40 percent of the usual rent. The 60 percent rent relief is dealt with by a combination of waiver and deferred payment agreement.
Therefore, parties will need to agree by what percent the tenant has suffered a reduction in trade as a result of the COVID-19 pandemic.
Good question! Unfortunately, the Code does not include a prescriptive formula. Instead, the Code's 'good faith' principles are expected to be applied by the landlord and tenant to reach agreement about the percentage fall in turnover due to the COVID-19 pandemic.
Tenants seeking the benefits of the Code need to disclose sufficient information about their turnover to show what their turnover was for the last few years to set a fair base, what the turnover is now, and the turnover moving forward. This will be easier for landlords who regularly collect turnover data from their tenants. However, this information is not commonly shared outside of the retail tenant space.
Tenants not comfortable with disclosing their financials may look to strike a deal with their landlord outside of the Code. This should be done in writing and reflect the tenant's election to waive their rights under the Code in exchange for the alternative arrangement.
The Code does not limit the turnover assessment to turnover generated from the premises. The turnover of all businesses operated by the tenant or franchisee is relevant to assessing the extent of the financial hardship suffered by the tenant and the rent relief the tenant genuinely requires. Turnover from telephone or online sales and through third party platforms which may have no connection to the premises will be particularly relevant.
Once a fall in turnover is identified, an assessment should be made about whether the cause of the fall is entirely 'as a result of the COVID-19 pandemic'. Each tenant's circumstances will be different and there may be other reasons at play for a downturn. It is unclear how the Code will deal with a situation where a tenant is not subject to a direction to cease trading but has voluntarily decided to close its doors.
If agreement cannot be reached between the landlord and tenant about the percentage reduction in trade, the Code foreshadows a 'binding mediation' service will be made available.
It is unclear whether this is intended to be a mediation in the traditional sense, where an independent third party assists the parties to reach an agreement (if they can), which is then documented and becomes binding, or whether the mediator will hold power to make binding determinations. It is also unclear what recourse a tenant will have where they believe the landlord is not adhering to the Code.
Steps we think will aid in reaching an agreement and avoid the need for mediation include:
Tenants should be given sufficient time to consider any proposal and to seek their own advice.
The starting point is the Code requires 50 percent of any relief agreed must be waived (ie forgiven entirely). However, the Code states waivers 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. This is another acknowledgement that some businesses will be more affected than others and even when social distancing restrictions are lifted, it is simply not possible for some tenants to recover revenue lost during this period. In those cases, it may be appropriate to waive a greater proportion of the rent.
The balance of the rent relief amount is the 'deferred component'.
However, the above is simply the starting point. The Code allows a tenant to waive the requirement for a 50 percent minimum waiver if they reach alternative commercial arrangements with their landlord. There is a whole range of other agreements landlords and tenants might agree on which fall outside the Code or provide the tenant with other benefits that can be secured in lieu of the 50 percent minimum waiver.
Repayment of the deferred component must be amortised over the balance of the lease term or for a period of no less than 24 months, whichever is the greater, unless otherwise agreed by the parties. Practically speaking, this means if the tenant's lease ends within 24 months of the end of the COVID-19 pandemic, then the landlord will need to negotiate an early repayment or negotiate security for repayment of any outstanding amount. Payment of the deferred rent is not to commence until the earlier of the end of the lease or the date the COVID-19 pandemic is declared to have ended.
The Code states landlords are not permitted to charge 'punitive interest' on the deferred component, which suggests some interest can be charged. In our view, it would be appropriate for a landlord to charge interest based on its own cost of funds or an alternative reasonable commercial rate of interest.
Another good question! No one knows, but it is clear it will not be acceptable for rents to immediately revert to the rent agreed in the lease as soon as the Federal Government declares the COVID-19 pandemic is at an end. Therefore, depending on the nature of the business, landlords and tenants could be living with whatever rent relief they agree for some time in the future. So, it is important whatever arrangement you agree is properly documented and can be administered effectively, including if relevant, an opportunity for review and adjustment at appropriate intervals in the months to come.
The Code accepts that each tenancy is different and there cannot be a prescribed approach. Landlords are encouraged to agree 'tailored, bespoke and appropriate temporary arrangements for each SME tenant, taking into account their particular circumstances on a case-by-case basis'.
Looking back at the example given in the Code, 60 percent rent relief is given during the COVID-19 pandemic and for a reasonable recovery period. Of that 60 percent, 30 percent is required to be waived as unrecoverable (to meet the 50 percent minimum requirement) and the other 30 percent is deferred for later payment. This example assumes a rate of rent relief is agreed upfront and applies for the life of the rent relief period. Practically, there may be several reasons during the period of the COVID-19 pandemic, the rate of rent relief could trigger a review, including a change in consumer trends or the Government's directives.
Subject to each tenant's circumstances, below are some examples of alternative arrangements that could be reached following the principles of the Code:
Where a landlord has already agreed a relief package with a tenant, then it should be assessed against the Code and the legislation (once available) to ensure it complies. If it does not comply there is a risk of it being unwound once the legislation is finalised.
Here is a list of things landlords should consider when negotiating the terms of any rent relief under the Code:
The impact of the COVID-19 pandemic is so profound and so sudden that there are many examples of tenants simply advising their landlord they are not paying rent, as though their lease does not exist or is no longer legally binding. This is not the case (the Code makes it clear leases continue to be binding) and is not something landlords can allow to persist.
The proper administration of this process will help to manage cashflows and preserve the value of assets throughout the COVID-19 pandemic and possibly into the future. It is important landlords give proper care and attention to the details surrounding these upcoming negotiations to preserve the value of assets.
We recommend landlords take the following steps:
If you have any questions or require assistance in preparing any of the documents or communications we have discussed above, please contact Kristy Dorney or a member of our Real Estate team. We are here to help you.