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Commercial Leases and COVID-19

24 March 2020

With the UK Government imposing previously unseen peacetime sanctions, we take a look at the potential implications for commercial landlords and their tenants during these unprecedented times.

Landlords

It is understandable that landlords will be extremely concerned at this time as to whether their tenants are going to be able to pay their rent. This concern will be even more pressing for landlords who have mortgages over their properties, even with the potential for landlords to be able to request three-month mortgage holidays from their mortgagees.

Landlords are likely to be concerned about the recourse some tenants may take at this time to enable them to keep their heads above water. We explore some of these issues below:

COVID-19 and frustration of leases?

One potential argument, from a tenant’s perspective, may be to try and get out of their obligations to pay their rent and comply with their other obligations in a lease by arguing that their lease has become ‘frustrated’ as a result of the pandemic.

Arguments for frustration of commercial leases have been in the media in the past eighteen months as a result of Brexit. In the case between Canary Wharf (BP4) T1 Limited & the European Medical Agency, the High Court held that the European Medical Agency’s (“EMA”) lease had not been frustrated as a result of Brexit. They found that, as the lease contained alienation provisions (as is standard with most commercial leases), the EMA could look to dispose of its interest in the lease, even if the EMA could no longer operate in the UK as a result of Brexit.

In light of this ruling, it would seem unlikely that Courts would rule in favour of tenants who are seeking to argue the frustration of their leases as a result of the COVID-19 pandemic. This is particularly so given that ‘frustration’ occurs when an event happens which renders performance of a contract impossible, or performance of the contractual obligations ends up substantially different from both parties’ expectations (one basic example would be when an employee is convicted and sent to prison). The argument frustration could occur as a result of a pandemic would seemingly be weaker than that of Brexit.

Are you covered by insurance?

Another option for landlords would be to look at their insurance policy in more detail to see if there is any cover should tenants fail to pay their rent. Such insurance policies are known to exist in the market, but these are often issued on a bespoke basis with much higher premiums.

It is also worth noting that insurers may not pay out if an exclusion means they do not have to. For example, the general trend has been for insurers not to pay out on business interruption policies if closures are voluntary and not forced by the UK Government.

Does your lease contain a keep open clause?

Retail leases, particularly those that reserve a ‘turnover rent’, often contain a keep open clause requiring the tenant to trade from its property on certain days and between certain hours.

Given the recent challenging times that the retail sector has faced, pre COVID-19, ‘turnover only’ leases have become increasingly common as consumers move away from the High Street to the internet.

If a lease contains turnover rent provisions only, and the lease does not reserve a base rent, landlords may be concerned that they could receive no income from their commercial property investment.

Such a concern is even more prudent with the shutdown yesterday evening of all shops (other than shops who sell basic necessities) in the face of the COVID-19 pandemic; however, if leases do contain keep open clauses, landlords may be entitled to seek damages from tenants in respect of any losses which the landlord can prove.

It is worth noting that the Courts have historically ruled that a tenant cannot be forced to open and that a landlord’s remedy in this scenario would be to seek damages. Given the UK Government’s decision on 23^rd March 2020, it is yet to be seen whether the Courts would award damages to landlords where tenants of non-basic necessities shops have been forced to close.

Tenants

It is understandable that tenants will be concerned as to whether they are going to be able to keep their heads above water during the COVID-19 pandemic.

As more people work from home following the UK Government’s decision on the 23^rd March, footfall in the leisure and retail sectors will be non-existent other than for those retail outlets selling basic necessities. With the forced closure of pubs, bars, cafes, restaurants, cinemas, gyms, clothing shops etc, many tenants will be frantically putting in place contingency plans to enable them to ride out this pandemic as best as possible.

Paying the rent

Tenants are going to be hugely concerned about their ability to pay the rent and other payments due under their leases to landlords. Many commercial leases contain rent suspension provisions (i.e. circumstances where payment of the rent can be suspended) for when damage occurs to a property as a result of insured and/or uninsured risks; however, it is unlikely that a pandemic will fall under either of these risks.

Moreover, such clauses are unlikely to have been drafted in a way that would cover rent suspension in the face of a pandemic, as the majority of rent suspension clauses relate to events directly attributable to the property in question.

If you are a tenant and you are struggling to pay the rent, it would be advisable to speak to your landlord to see if a temporary arrangement is able to be drawn up (e.g. you ask pay the rent monthly and not quarterly, you ask for a rent free period, you request a reduction in your rent, you ask if any arrears of rent can be deferred for a set period of time etc).

If any temporary arrangements are agreed with a landlord, It is vital that these are documented in writing with the document stating:-

• the length of time arrangement is to last;
• the amount of the reduction; and
• confirmation from the landlord that they will not pursue the tenant for any breach of the tenant’s lease as a result of the documented arrangement.

It is always advisable for a landlord or tenant to seek legal advice when making permanent changes to a lease, to ensure that such changes are documented as the parties intend.

It would be advisable to take the above steps as soon as possible as it could help prevent a landlord from taking steps to exercise its right to forfeit the lease (i.e. terminate the lease) or prevent the landlord from taking other steps such as issuing winding-up proceedings, or seeking orders from either the County Court or High Court to recover their monies, all of which would result in further costs for the tenant.

Break clauses?

If a tenant has a break clause within its lease (most rights to break require at least six months’ written notice and often contain other pre-conditions e.g. there is no arrears of base rent), a tenant should carefully consider whether exercising the break and operating from a different property on a more informal basis could solve any short term cash flow issues. It is unlikely that tenants will be able to terminate their leases in any other way, unless provided for in their leases.

Insurance?

Tenants should check their insurance policies to establish whether they are covered in the event of a pandemic. Recent publications by insurance companies appear to indicate that a pandemic would not be covered by a tenant’s insurance policy unless expressly mentioned within the insurance policy (albeit there may be an argument for a claim if an insurance policy covers ‘Acts of God’).

Business rates

To assist tenants, the UK Government has announced a twelve-month business rates holiday for all retail, hospitality, leisure and nursery businesses in England. The Welsh Government has also announced similar holidays for business in Wales (as business rates have been devolved in Wales).

Ongoing transactions

Any ongoing lease transactions from a tenant’s perspective should contain provisions permitting tenants to close and for rents payable under the leases for a set amount of time in light of the current and any future pandemic(s).

Working together

As we have seen in the media, the key to getting through this is working together. Many sectors and people on opposing sides are uniting to reduce the risks to the economy and people’s health that the COVID-19 pandemic is causing.

Landlords and tenants are therefore likely to enter into more dialogue than usual and reach never-before-seen compromises to enable each to preserve their own position. Such dialogue should strive to achieve a workable but fair balance for both landlords and tenants to enable both to protect their businesses as much as possible.

Need more guidance?

If you require bespoke advice on the detail of your commercial lease contact our Commercial Property specialists Lucy Hollis on 01267 239 018 or Paul Farthing on 01792 952 967.