Landlords and COVID-19: navigating a path in the commercial and retail leasing space

As the economy continues to suffer as a result of the COVID-19 pandemic, and increasing restrictions are placed on social interaction and the operation of businesses, landlords need to consider how to deal with the increasingly likely scenario that many tenants will be falling into default under their lease over the coming weeks and months, if they haven’t already done so. Landlords will have to consider what support, if any, might be offered to tenants. In this alert we will address some of the key issues which landlords need to consider in light of the COVID-19 pandemic, and associated government directives and economic downturn. 

Am I legally obliged to provide assistance to tenants?

Force Majeure 

Over the past few weeks, there has been much discussion about force majeure clauses in contracts, and businesses have been quick to review their contracts and seek legal advice in that regard. 

In general terms, a force majeure clause may relieve an affected party from its contractual obligations if:

1. an event or circumstances occur which are beyond the control of the party and which have the effect of impacting, whether by prevention or delay, a party’s ability to perform its contractual obligations; or
2. the affected party is not reasonably able to prevent or overcome the event or circumstance by the exercise of due diligence.

Whether COVID-19 is considered to be a force majeure event, and what the consequences of that classification are, will depend on the interpretation of each force majeure clause and the particular factual circumstances of each case. Definitions will vary from contract to contract, but will often specify a list of events and circumstances which are expressly captured, including “acts of God”, “natural disasters”, “infectious diseases (including epidemics and pandemics)”, “fire and explosions”, “riots and civil unrest”, “war”, “acts of hostility by foreign enemies and terrorism” and “industrial strikes”.

Most landlords’ standard leases for commercial and retail tenancies do not contain a general or broad force majeure clause, although sometimes larger tenants have sufficient negotiating power to incorporate a force majeure clause into the lease. 

However, many leases will contain a “damage or destruction” clause that applies if premises, or the centre within which the premises are situated, are physically damaged so as to render the premises or centre totally or substantially unfit for the use and occupation of the tenant or substantially inaccessible. This clause, is generally limited to where there is physical damage or destruction to the premises or centre involved. 

Other relevant clauses which are contained in most standard leases for commercial and retail tenancies include a general requirement that the tenant, at its own cost, obtain all necessary authorisations and approvals and otherwise comply with all laws and requirements of government authorities in relation to the permitted use of the premises. Generally speaking, this places the risk of the intended use of the premises on the tenant. 

Frustration 

A further relevant legal issue is whether the common law doctrine of “frustration” may apply. Frustration is a common law concept which recognises that, after a contract has been entered into, an event may occur, through no fault of either party, which renders performance of the contract impossible or fundamentally different. 

There are conflicting authorities on whether the doctrine of frustration will apply to executed leases. Notwithstanding that there have been some cases where executed leases have been held to be frustrated, the general view is that in practice a lease would rarely be frustrated.

Each particular scenario will turn on its own facts, but discharge or termination of a contract by frustration is generally difficult to establish. If an event caused by COVID-19 merely changes the circumstances of performance of a contract, or makes performance of a contract more onerous or expensive, a court is unlikely to find that the contract has been frustrated, particularly in the case of a lease.

Theoretically, if a tenant’s use of or access to its premises are restrained due to a government directive in response to COVID-19 for a prolonged or indefinite period of time (as opposed to a reduction in trade caused by the pandemic generally), there may be a basis for a court to find that a lease has been frustrated. 

Statutory rights of certain tenants

In the context of a retail shop lease, section 43 of the Retail Shop Leases Act 1994 (Qld) (RSLA) provides for a landlord to compensate a tenant in various situations, including (but not limited to) where a landlord:

1. substantially restricts the tenant’s access to the leased shop;
2. substantially restricts, or alters access by customers to the leased shop, the flow of potential customers past the shop or causes significant disruption to the tenant’s trading in the leased shop or does not take all reasonable steps to prevent or stop significant disruption within the landlord’s control. 

However, section 43AB provides that a landlord is not liable to pay compensation to a tenant for loss or damage suffered because the landlord takes action as a reasonable response to an emergency, or in compliance with any duty imposed under an Act or resulting from a requirement imposed by an entity acting under the authority of an Act.

As the federal and state governments are exercising their statutory powers pursuant to various Public Health and Biosecurity statutes (which are “Acts” for the purpose of section 43AB) in response to the COVID-19 pandemic, any reasonable action which a landlord takes in compliance with a government directive issued in response to the COVID-19 pandemic is likely to be protected pursuant to section 43AB of the RSLA.

Even if I’m not legally obliged to provide assistance to tenants, should I do so anyway?

Whether assistance should be provided to tenants regardless of any legal obligation will be a commercial decision for each landlord and will need to be assessed on a case-by-case basis.

Consideration should be given to:

1. whether a tenant was in default prior to the pandemic, or has only recently fallen into default (or may be anticipating falling into default) as an immediate consequence of the pandemic or any associated restrictions which have been imposed by the government on the tenant’s ability to operate its business;
2. the commercial prospects of securing a replacement tenant, and the time and costs involved in that process. In a retail shopping centre context, consideration should also be given to the effect of the loss of a particular tenancy on the centre as a whole;
3. the remaining duration of the term of the lease, including whether any option is yet to be exercised or whether the tenant is willing to extend the term of the lease by formal variation;
4. the true state of a tenant’s financial position. This should include a consideration of: 

• the nature of the tenant’s business and the likely effect of the pandemic (and any associated government restrictions on trade) on the business;
• the structure of the tenant’s business, including the number of staff that it employs and the nature of their employment;
• any business interruption insurance or government assistance (including subsidies, tax relief and other forms of stimulus) available to the tenant which might mitigate the financial loss that the tenant suffers; and

6. the likelihood of the tenant being able to continue to trade and/or financially survive during a period of economic downturn (including the likelihood it will be able to re-open in the event of a partial or full government directed shutdown).

Taking into consideration the above matters and other commercial objectives, in some cases, a landlord may be best served by assisting tenants and delaying any enforcement action against tenants. 

How should assistance be provided?

The way in which assistance may be provided to tenants will vary on a case by case basis and is likely to change over time in light of the continually evolving nature of the present pandemic and economic circumstances. 

Rent deferral 

Landlords may initially put in place short-term measures, such as a “deferral” of rental charges (that is, a moratorium on taking action in respect of any rental default), whilst reserving their right to require that any arrears be paid at some stage in the future. Any interim arrangements with tenants should be:

1. clearly documented, stipulating the lease charges (for example, rent and outgoings, or rent only) and the period (for example, for a particular number of months) to which the moratorium applies;
2. made on the basis that the tenant provides the landlord with full disclosure of its financial circumstances and any other information about the tenant’s business as may be reasonably required, in order to enable the landlord to assess and monitor the tenant’s ability to pay rent; and
3. negotiated on the basis that the arrangements are otherwise “without prejudice” to the landlord’s rights under the lease. 

Rent reduction 

Ultimately, arrangements may need to change over time, and a formal reduction (or abatement) of rent (and outgoings) may need to be negotiated with tenants, in order to see them through this period. Again, any arrangement for a formal rent reduction should be negotiated on a “without prejudice” basis and clearly documented, stipulating the lease charges (for example, rent and outgoings, or rent only) and the period (for example, for a particular number of months) to which the reduction applies. 

For long term tenants with good prospects of trading through the period of economic downturn, consideration may be given to providing a rent reduction for a period of time on the basis that the lease term is extended (whether by exercise of option or variation) so as to provide the landlord with some benefit, or that rental charges be increased later in the lease term in order to account for the short term reduction of rent. 

Default action

If a tenant fails to comply with its lease, subject to the particular terms of the lease, a landlord may be entitled to take default action against the tenant, including:

1. issuing a notice to the tenant to remedy its default (whether a notice pursuant to the lease or a Form 7 notice to remedy breach of covenant pursuant to section 124 of the Property Law Act 1974 (Qld));
2. taking steps to remedy the default on behalf of the tenant, and recovering any associated costs of doing so from the tenant as a debt under the lease; 
3. applying the tenant’s security (for example, a security bond or bank guarantee) in satisfaction of any amounts owing by the tenant under the lease; 
4. terminating the lease and evicting the tenant; and/or
5. making demand upon any guarantor of the tenant’s obligations under the lease. 

Landlords will need to consider the purpose and utility of taking default action against a tenant. In some cases, taking the step of issuing a Form 7 notice may be necessary in order to ensure that the landlord is not delayed in taking possession of the premises as and when it wishes to do so. However, in other situations, taking default action may not serve any utility and may be detrimental to the landlord’s broader objectives. For example, where security is held by a landlord under a lease in the form of a bank guarantee, careful consideration should be given to the flow-on effects of drawing down on the bank guarantee. If a demand is made upon a bank guarantee provided by a tenant, there may be consequences which flow to the tenant in relation to its funding arrangements.

Conclusion 

These are, without a doubt, unprecedented times. However with government directed social distancing and business closures, it is clear that landlords and their tenants will feel the impact of the economic downturn which has already commenced. 

There are a number of options available to landlords in dealing with tenants in the current environment. By considering each tenancy on a case-by-case basis, working actively with tenants to assess and monitor their individual situation and likelihood of being able to endure the impending economic circumstances at the outset, landlords will be well placed to protect their interests and recover from this period of economic difficulty and uncertainty.

However, the landscape is changing on a daily basis and landlords should keep an eye on any future government announcements that may impact their rights.

For further information, or further discussion, please contact our Litigation and Dispute Resolution team at HopgoodGanim Lawyers.