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COVID-19 Lockdown: Next steps for varying commercial lease agreements


Monday, April 6, 2020

The unprecedented commercial shock being experienced by commercial landlords and tenants as a result of coronavirus (COVID-19) will require both sides to work together to their mutual benefit while seeking to protect their investments and businesses. This can happen in a fair and reasonable manner but it is important to ensure that agreements reached today do not have more far-reaching unintended effects.

Any well drafted commercial lease agreement will push all risk arising from the use of a commercial premises through from a landlord to a tenant. With this risk allocation in mind it is useful to examine general, practical considerations within which any negotiations should be framed. Communication is key and below are some areas which should be to the fore in parties’ minds.

  • Rent

Agreement on the responsibility for payment of rent should be clear. If rent is temporarily “suspended” the side letter recording that rent suspension should at a minimum provide for the following:

i. that the obligation to pay the contracted rent continues to apply notwithstanding the temporary rent suspension concession;
ii. any temporary suspension to the obligation to pay the contracted rent shall not be capable of being used as evidence of passing rent at rent review;
iii. confirmation of whether “Default Interest” shall apply to the shortfall of rent paid;
iv. a mechanic for repayment of suspended rent once the suspension period is at an end; and
v. a mechanism for terminating the rent suspension period (most probably at the election of the landlord acting in its absolute discretion).

  • Service Charge

Agreement on the obligation to continue to pay service charges should be clear. Whilst a dip in landlord cash flow from rents not being received is problematic, that problem will be compounded if the asset is not maintained in accordance with good estate management practice. Service charge contributions are typically met quarterly and tenants should continue to pay their due proportion to ensure there is not a gap in the payment of the service charge rent. In no circumstance should a landlord permit a policy of property owner’s insurance to lapse and ensuring payment of insurance rent remains as important as always.

It should be noted that in a common “rent suspension clause” (suspending the obligation to pay rent where use of a premises is destroyed or damaged by an “Insured Risk” event) that suspension applies to rent only and not service charge rent or insurance rent.

  • Rent Free Periods

Where a tenant currently has the benefit of a rent free period it is unlikely that a landlord will agree to “stop the clock” on that period until the current difficulty ends.

Most well drafted side letters dealing with rent free periods will provide for the period being suspended in the event a premises is damaged or destroyed by an Insured Risk event. While an extension to this period could be requested, a landlord would not be under any obligation to agree to any further concession on this point.

  • Break Options

At the outset it should be noted that break options (like all option agreements) are strictly construed by the courts. The drafting used by the parties’ solicitors will dictate whether a tenant retains the ability to exercise its break option upon the closure of a premises. Precision in the drafting used is, as always, key and broadly speaking the main point at issue will be a tenant’s ability to yield up vacant possession of a premises.

The concept of vacant possession is itself strictly interpreted and so the risk that the current situation could invalidate a tenant’s ability to successfully exercise its break option is significant.

Specific advise should be obtained as to how a break option is to be successfully exercised or,
where possible, re-negotiated.

  • Forfeiture

Unlike the UK which has enacted the Coronavirus Act 2020 and introduced a moratorium on the forfeiture of commercial leases until 30 June 2020, no such restriction applies in this jurisdiction.

However, as forfeiture is an equitable remedy a landlord now seeking to forfeit a lease based on recent rental payments being missed would be well served by having attempted to reach agreement with a tenant. If an agreement was reached with and then breached by a tenant, a landlord’s claim to forfeit the lease would be more likely to succeed.

This is separate to where a tenant was in significant arrears prior to the current situation, as such a
tenant would find it difficult to conflate a prior covenant breach with new breaches arising due to the current situation.

As a general comment the below covenants would not be considered essential covenants on which a claim for forfeiture should now be based:

i. Breach of a keep open clause in a lease of a shopping centre unit;
ii. Breach of a minimum trading hours clause;
iii. The closing up of “openings” (such as the boarding up of windows in retail premises); or
iv. Breach of a clause requiring an on-site security presence.

  • Rent Deposit

A well drafted Rent Deposit Deed will permit a landlord to sweep any arrears of rent howsoever arising under a lease from a separate deposit account. In preparing a Rent Deposit Deed the landlord’s advisors should have recorded the landlord’s right to have recourse to the deposit sum in any circumstance, that right being unimpacted as a result of the current situation.

  • Guarantor

In a well drafted guarantee there should be an express waiver permitting the landlord to recover any shortfall of rents directly from a guarantor without first having to seek payment from a tenant. When agreeing any of the concessions contemplated above it would be best practice to join a guarantor as party to any such supplemental agreement.

  • Funder

Where a landlord’s interest in commercial property is subject to a charge, a variation to the terms of an occupational lease within that property is, in the vast majority of cases, subject to the consent of the party entitled to that charge. In the current climate obtaining that consent within the required timeline could be problematic. Agreeing to a variation of the terms of an occupational lease without prior funder consent would be a technical breach of most underlying security documents. As such where a variation is being contemplated a landlord should engage with its funder so that the funder is on notice of the intended variation as early as possible in the process.

Whilst each commercial lease agreement will place unique obligations and responsibilities on its parties the above is a general checklist of issues to be considered in the course of any negotiations undertaken in the current, unsettling environment.

 

For further tailored information on better understanding your own commercial lease obligations and rights please contact Tom Conway or your usual Philip Lee contact.


Author

Tom Conway

PARTNER


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