Commercial leases and the coronavirus
07 April 2020
It has been a tumultuous time of late for businesses of every nature. Certainly a couple of months ago, few people would have dreamed that they would be able to make it through the day without hearing someone mention Brexit. Enter Covid-19.
As the world gradually locks down its borders, its businesses and, increasingly, its population in a desperate attempt to stem the rise of the coronavirus, the implications for business have been increasingly grave.
As with most upheaval, the markets have destabilised leading to substantial anxiety for businesses the world over. As ever, there remain opportunities in the market but the social distancing and isolation measures imposed on the majority of Europe will inevitably hit the retail and hospitality sectors the hardest.
The increasingly stringent limitations being placed on life in Jersey and the inevitable impact of the UK's market on the local economy mean that landlords and tenants alike will be considering their options.
Jersey leases will normally include a right for the landlord to take steps to cancel the lease where the tenant breaches their obligations and particularly where rent remains unpaid for a specified period (usually 14 – 21 days).
The landlord may only evict a tenant by order of the court (the application for which will come with a high cost in legal fees). In order to reassure tenants, all eviction proceedings in the Petty Debts Court brought about by Covid-19 were adjourned. Although the intended beneficiaries were principally residential tenants, the adjournment has also captured commercial tenants with lower value rents and lease terms of less than nine years.
A landlord that commences proceedings to cancel their tenant's lease is likely to face substantial practical difficulties as the Jersey courts adjust to the new environment, focussing their attention on urgent civil (and certain children and criminal) cases, and postponing or re-arranging other hearings. A landlord that wishes to take action today may find that there is no movement on their case until the island rights itself once again. Even then, as cancellation of a lease is a discretionary remedy of the court, the court may be reluctant to exercise its discretion to cancel a lease during such an unprecedented epidemic and lockdown, given that the events are completely outside of the tenant's control.
Tenants' get-out clauses
It is not unusual for commercial agreements to contain "force majeure" clauses. Force majeure clauses provide for parties to be able to terminate the agreement or escape liability in the event that something happens which prevents that agreement from being performed.
Force majeure clauses are not standard inclusions in Jersey commercial leases but are more likely to be found in the agreements ancillary to them; for example, conditional agreements for leases or building and construction contracts.
It is unlikely that a tenant who has already taken a lease will be able to absolve themselves by virtue of a force majeure clause. Nevertheless, landlords and tenants who have entered into contracts in connection to their lease would be well advised to seek legal advice around their force majeure clauses to be fully appraised of their options.
It is very common for tenants to have the right to terminate their leases on specified dates, subject to giving the landlord advance written notice. The notice periods will vary but normally sit between three and twelve months.
A break option is unlikely to provide instant relief to a tenant. However, a tenant would be well advised to check the exact terms of their break options. The courts have taken a very strict line on the interpretation of conditional break clauses.
A tenant who wishes to operate their break should prepare well in advance to ensure that they comply fully with all of the break clause's requirements. If the tenant does not comply with every aspect of the break clause then it is likely that the break will not be activated and the tenant will remain on the hook for a number of years.
There was a large outcry in the UK when the Prime Minister advised the population not to frequent pubs and restaurants but did not ban hospitality businesses from opening. The hospitality sector argued that, until they were forced to close, they would see their profits fall with no ability to claim against their business interruption insurance. It is unlikely that the business interruption policies will be activated by a pandemic but much will depend on the wording of the insurance itself.
Landlords will generally insure the property that they own. The industry default is for the landlord to have the right to include loss of rent in their insurance and recharge the cost to their tenants. These buildings policies will generally only provide protection against a set of specified risks.
Most loss of rent policies will only pay out where the loss of rent is as a result of a specified insured event. The list of standard insured events is subject to changes in the global market place; for example, across the last 15 years, it has become more common to see the inclusion of terrorism. Whilst it is likely that pandemic will become more popular once the dust has settled on Covid-19, it is unusual to see it in insurance policies currently and it may, therefore, be that landlords struggle to recover monies under their policies if the lapse of rent is as a result purely of the pandemic.
Unfortunately, the disruption to business will be more than some can withstand. We are likely to see a large number of insolvencies as a result of the compounded challenges of an already struggling retail sector and the effect of Covid-19.
Having an insolvent tenant means that the landlord will have to deal with an insolvency professional, appointed to deal with the tenant's affairs. That insolvency professional will benefit from wide-ranging powers allowing them to manage the tenant's business with a view to paying debts and normally winding up the business in due course.
The landlord will almost undoubtedly be owed rent and other sums due under the lease and will be duly paid by the insolvency professional if there are sufficient funds in the tenant's assets. The landlord's full recovery of the sums owed is rare. Nevertheless, a landlord is likely to be able to recover possession of the premises (albeit that the landlord may have to make an application to court to do so) and seek a new tenant in order to maintain their income stream.
Guarantors and rent deposits
The landlord may have negotiated the guarantee of the tenant's obligations under the lease by a third party. The usual provisions of a guarantee clause will allow a landlord to pursue a guarantor for any loss they suffer as a result of the tenant's breach of their obligations. This remedy may be invaluable to a landlord (particularly where the tenant is, or is likely to become, insolvent).
Taking a rent deposit from the tenant is also a popular way of securing the obligations owed to the landlord. As the name indicates, the landlord will be able to withdraw money from the deposit when the tenant fails to pay. However, most rent deposits are unlikely to exceed three months' worth of rent and do not provide a long-term solution for the landlord.
Tenants who are concerned about their ability to pay their rent should approach their landlords in advance and explain their situation. Landlords are likely to be amenable to granting short term concessions in an attempt to avoid tenant insolvency in the future. Commonly, these agreements are documented by a "side letter" which is a relatively informal way of the landlord agreeing to more favourable tenant terms without having to vary the lease.
To a large extent, the terms of the concessions can be whatever the landlord and tenant agree. Business tends to find creative ways around the problems it encounters. Therefore, possibly unsurprisingly, there are a large number of concessions that could be agreed between the parties. A few examples are:
Monthly rental payments
Although monthly rent payment dates are becoming increasingly common, a large proportion of commercial tenants still pay quarterly in advance. Where there is a disruption to cash flow, it may be that granting the tenant the temporary right to pay monthly is sufficient to keep the tenant afloat.
Rent deferral or rent abatement
The landlord may take the view that a rent concession for a short interim period is a small price to pay to keep good tenants in situ. If a complete rent abatement is not acceptable to the landlord then allowing the rent to be paid at a later date may be more palatable.
A supplementary option is to agree that the rent may be suspended or deferred in return for the tenant giving the landlord extra security. For example, the tenant may:
- waive their right to exercise a break option; or
- agree that they will extend the term of their lease commensurate to the period of the suspension.
Release of rent deposits
Rent deposits are normally held by the landlord and are generally equivalent to three or six months' basic rent. Normally, the landlord will have the ability to withdraw funds from the rent deposit without the tenant's consent and require the tenant to "top-up" the deposit within a set period.
Either releasing the rent deposit or agreeing that the deposit will not be required to be "topped up" for a longer period may be a reasonable compromise for the parties.
Service charge deferral
Service charge is calculated on the basis of the cost to the landlord of providing services for the benefit of the tenants (e.g. cleaning and maintenance of the common parts). Where a building is unoccupied, the necessity to carry out some services will lapse. As such, the tenant's liability for service charge is likely to decrease in any event but a landlord may be minded to defer or suspend the tenant's responsibility for the service charge on the basis that the cost of carrying out the reduced services would be an acceptable debit in the landlord's accounts.
Widening permitted use clauses
Generally all commercial leases will contain obligations on the tenant not to use the premises for anything other than a specified use. The narrowness of the permitted use varies substantially but landlords generally favour leases with very restrictive user clauses so they can retain control over their property.
Whilst narrow user clauses are normally beneficial to the landlord, businesses are quickly diversifying and adapting in an effort to keep trading through Covid-19. For example, the new social distancing guidance introduced in recent times means that a lot of restaurants have temporarily turned into takeaways to facilitate trading. A lease of restaurant premises will generally permit use as a restaurant but not as a takeaway but a temporary relaxation of these provisions may protect the tenant's ability to keep playing rent.
The parties should, however, be aware that a landlord's consent to use the premises for a certain purpose will not necessarily mean that it can be used for that purpose. Before any concession is granted, the parties should ensure that they will not be breaching any other regulations or laws (planning law, in particular).
Relaxation of obligations to trade
Some leases (particularly retail premises) contain obligations on the tenant to keep the store open during "normal working hours" or similar.
It may be that a tenant has cash reserves which will allow them to continue paying their rent but to keep the premises open would impose a financial drain to them. For example, keeping a retail shop open when there is a substantial reduction in footfall. Allowing the tenant to close would reduce their costs whilst maintaining the landlord's income stream.
Granting their tenants limited or temporary concessions may be very appealing to landlords. However, landlords should ensure that they will not be exposing themselves to a different risk by granting such concessions. In particular:
- Landlords may have to notify their insurer if the building would be left vacant. Some insurance policies may be invalidated if the property is left unoccupied. Alternatively, damage by certain insured risks (e.g. vandalism, theft or sprinkler damage) may be excluded if the building is vacant.
- If the landlord holds the property under a head lease, the terms of that head lease may prevent the landlord agreeing to a concession in terms of a sub-lease without the head landlord's approval.
- If the landlord's interest in the property is subject to a mortgage or similar security, the terms of their facility agreement may prevent them from agreeing to a concession without the lender's approval.
Regardless of whether the parties are minded to negotiate with each other, the rule of thumb in these uncertain times is that the provisions of the lease remain front and centre. It is the primary document from which the landlord and the tenant will derive their rights and, as such, parties to the lease should take advice and check the provisions of their leases carefully in order to effectively assess their options.