On 23 April 2020, the UK Government announced that it will be implementing additional measures to protect tenants against aggressive debt recovery actions by landlords during the coronavirus pandemic. In addition to the measures introduced previously under the Coronavirus Act 2020 (the “Act”), statutory demands and winding up petitions issued to commercial tenants are to be temporarily voided, and changes are to be made to the use of Commercial Rent Arrears Recovery.
The Act received Royal Assent on 25 March 2020 and has already introduced measures postponing a landlord’s ability to exercise its right of forfeiture in respect of non-payment of rent[1] against a business tenant[2] during the period commencing on 26 March and expiring on 30 June 2020 or such other date as determined by the relevant Secretary of State (or Welsh Minister in Wales) (the “Relevant Period”).
The introduction of the Act and the subsequent announcement made on 23 April 2020, together with the global pandemic that prompted them, have resulted in us receiving numerous queries from landlord clients asking about the impact of the legislation and the announcement and what they mean in practice. Here, we answer the key questions we are being asked by our UK landlord clients:
1. Does the Act mean that our tenants are still obliged to pay the rent under their commercial leases?
Yes, tenants are still obliged to comply with their rent payment obligations under their leases.
The Act itself does not amount to a waiver of a right of forfeiture for non-payment of rent, unless the landlord expressly waives its right to forfeit in writing to the tenant. Instead, the landlord’s ability to exercise the right to forfeit is simply delayed until after the expiry of the Relevant Period.
Tenants are still required to pay all rent due but, once the Relevant Period has expired, if they do not pay any arrears of rent from any preceding quarters (including any interest), they will again be at risk of forfeiture
The draft legislation to implement the announcement made on 23 April has not yet been published and so it is not entirely clear whether the references to shops and other companies under strain being “asked to pay what they can during the coronavirus pandemic” will actually impose a state-imposed waiver of rent on the UK property industry. Our best guess is that this is not what will be proposed, given the serious interference with private property rights that that would entail.
Instead, we expect that the measures will be generally limited to an effective extension of the moratorium on forfeiture for non-payment to those other forms of debt recovery action.
2. What are the consequences of non-payment of rent by our tenants and what are our options if they do not pay?
Pursuant to the Act, the tenant is able to withhold the rent during the Relevant Period without risk of forfeiture for non-payment of rent BUT:
(a) the tenant will remain liable for such payments after the expiry of the Relevant Period (together with any interest due in accordance with the terms of the lease); and
(b) whilst the landlord is unable to forfeit the lease for non-payment of rent during the Relevant Period, the landlord (subject to the restrictions imposed by the Government’s announcement on 23 April 2020 as set out below) still has the following alternative remedies to forfeiture:
- Debt claim: The Act does not prevent the landlord from making a claim for breach of the obligation to pay the rent as a debt claim through court proceedings.
- Rent deposit: The landlord may also draw down from any rent deposit held.
- Guarantor claim: The landlord may seek payment from a guarantor under the lease (subject to the financial viability of the relevant guarantor).
- Commercial rent arrears recovery (“CRAR”): This allows the landlord to enter the rented premises and seize assets of the tenant of an amount equivalent to the rent owed. This is often not seen as a sensible solution by landlords as seizure of assets instrumental to the tenant’s business is likely to cause further harm to the performance of the business in the long-run. This option is, therefore, often used by landlords as a threat in order to bring the tenant to the table with a view to reaching a settlement.
- Statutory demand: The landlord may issue a statutory demand in relation to unpaid rent as a first step towards threatening winding up proceedings.
3. What impact does the Government’s announcement from 23 April 2020 have on landlords?
In addition to the protection afforded by the Act, further tenant safeguards are to be introduced[3] surrounding landlord use of statutory demands and winding up petitions issued to commercial tenants, and changes are to be made to the use of Commercial Rent Arrears Recovery.
Under these new measures, any winding up petition that claims that the tenant is unable to pay its debts must first be reviewed by the court to determine why. The law will not permit petitions to be presented, or winding up orders made, where the tenant’s inability to pay is the result of COVID-19. The new legislation to protect tenants will be in force until 30 June and can be extended in line with the moratorium on commercial lease forfeiture under the Act.
Legislation will also be brought in to prevent landlords using CRAR unless 90 days or more of unpaid rent is owed.
It is interesting to note and worthy of comment that the Government press release was entitled “New measures to protect UK high street from aggressive rent collection and closure”, yet there is no suggestion at this stage that the protections will solely benefit retail tenants. It would seem likely that the new legislation, just like the Act, will apply to all “business tenants”.
4. What should we, as landlords, be doing?
Whilst there is a proportion of tenants who are diligently paying their rent, it is likely that landlords will currently be mostly concerned with three categories of non-paying tenants.
There will be those tenants who cannot pay their rent owing to short-term cash flow problems resulting from the COVID-19 lockdown but who ultimately have financially viable and sound businesses. To the extent that landlords can themselves endure the hiatus in rental payments (and swallow the knock on effect on any interest payments due under their own lending and subject to availability of Government‑backed relief), the obvious solution is to sit and wait until things get back to “normal” and come to individual interim arrangements with the relevant tenants.
However, there will no doubt be a large number of tenants whose businesses were either ailing and failing prior to the pandemic or whose businesses have been terminally damaged by the impact of the pandemic and who will be unable or unwilling to continue trading and pay rent.
In addition, there will also be a number of tenants who have continued trading/occupying premises during the pandemic and whose businesses remain strong or whose balance sheet is, in any event, healthy but who will be taking the (possibly cynical) opportunity to avoid paying rent.
Landlords should be identifying which category their relevant tenants fall into as this will be the main driver for strategic asset management decisions and will be the basis of any choices as to which of the courses of action (if any) outlined under Section 2(b) above (as amended by the Government’s announcement) to pursue. That said, while the new draft legislation remains to be seen, on the face of it, we would expect it to be difficult for landlords to prove to a court that a tenant’s failure to pay is not as a result of COVID-19 and that courts will tend to side with tenants in the case of any doubt. Therefore, in all but the clearest cases (e.g. a supermarket or pharmacy still open and trading well from premises), it may well be a waste of time and money for enforcement action to be taken.
Nevertheless, where the property is security for a loan, landlords should be reviewing their own facility agreements with their lenders to better understand their covenants, obligations and rights under those agreements. Needless to say, there is not, as yet, any COVID-19-induced moratorium on interest payments or enforcement of facility documents, so leveraged landlords are caught between a rock and a hard place. But it is not just a case of servicing the debt. In addition, landlords should be considering the following:
(i) What action is the landlord permitted to take against the tenant under the facility agreement? The facility agreement will likely contain provisions preventing the landlord from doing any of the following without the consent of the lender:
- agree to any amendment, supplement, extension, waiver, surrender or release in respect of any occupational lease;
- exercise any right to break, determine or extend any occupational lease; and
- commence any forfeiture or irritancy proceedings in respect of any occupational lease.
(ii) What action is the lender permitted to take against the landlord under the facility agreement? Will a tenant insolvency directly or indirectly trigger an event of default under the facility agreement? How will the reduction in actual rents being paid affect the landlord’s ability to comply with its financial covenants under its facility agreement (e.g. interest cover ratios)? Are there any notification obligations imposed on the landlord?
(iii) Is the landlord in breach of its facility agreement if it chooses to sit on its hands and wait out this period of uncertainty? In not actively pursuing tenant arrears, are landlords risking being in default of their own obligations to their lenders? The facility agreement will likely contain a provision requiring the landlord as borrower to:
- diligently collect or procure to be collected all rental income;
- exercise its rights and comply with its obligations under each occupational lease; and
- use its reasonable endeavours to ensure that each tenant complies with its obligations under each occupational lease,
in a proper and timely manner.
Landlords would be well advised to make early contact with their lenders if a breach of their facility agreement is likely to agree a waiver or an amendment to the terms in order to avoid the loan being accelerated. The Financial Conduct Authority, the Financial Reporting Council and the Prudential Regulatory Authority have issued a joint statement encouraging investors and lenders to take into account the issues arising directly from the COVID-19 pandemic in responding to potential breaches of covenants.
We have also been advising landlord clients to think about how and where they can cut costs by, for example, furloughing non-essential staff and cutting service charge costs where possible (and while still being mindful of their contractual obligations under their leases). Potential savings may include reductions in their marketing and advertising budgets and the postponement of any projects requiring capital expenditure.
Whereas it would be very unusual for any landlord to be required by the specific terms of their occupational leases to have insured their property against the pandemic directly, there is a (admittedly remote) chance that tenants’ failure to pay rent may be covered under their landlord’s policies. Landlords should be checking their business interruption policies (if any) and any extensions to their cover to ascertain whether they may be able to make a claim (for example, for loss of rent due to the impact of notifiable diseases or to cover denial of access caused by government action) and, if so, pursuing those claims in a timely manner where there is scope for a payout to mitigate against non-payment of rent by tenants.
5. Is there anything else we should bear in mind when deciding on our course of action?
(a) The Act does not restrict the landlord from exercising its right to forfeit a lease for another reason, such as insolvency of the tenant or for breach of the other covenants in the lease, for example, the repairing obligations. However, while not expressly addressed in the Act, it is probably likely that, given the current climate, a court would be minded to grant relief from forfeiture at least until the end of the Relevant Period while the COVID-19 measures remain in place. Practically, it would be difficult for the tenant to exit the premises during a lockdown period.
(b) Ultimately, decisions on individual tenants cannot be made in isolation and need to be viewed against the existing economic landscape. For example, if a landlord is minded to proceed with forfeiture for non‑payment of rent after the Relevant Period (or for insolvency or breach of another covenant in accordance with the terms of the lease), how easy will it be for the landlord to find a replacement tenant? Is the landlord better off allowing arrears to accrue pursuant to an existing lease (albeit with the likelihood that he will have to fight to recover the arrears or have to wait some considerable time to recover them) rather than running the risk of an empty unit with no prospect of income and a certain service charge void? Further, where is the landlord likely to rank if the tenant is pushed, or jumps, into an insolvency process?[4] The answers to the questions posed will turn on the facts of each individual circumstance and will require independent analysis. There is no “one size fits all” solution.
Right now, we would expect most landlords’ motivation in attempting to forfeit a lease or take the other enforcement actions set out under Section 2(b) above would be as a threat in order to prompt the payment of rent rather to gain vacant possession of the premises. However, the likelihood is that an empty unit could well be the inadvertent (and undesirable) consequence of such action if successful.
(c) There is no doubt that the combined effect of the Act and the Government announcement will be a general assumption by tenants that they can regard their rent payment obligations as voluntary, at least for the time being. Even those who can afford to pay will be wondering why they should when they know that their competitors are not. It is clear that the Government has focused its rescue efforts on tenants (and in particular struggling retailers) and is leaving landlords and banks alike to fend for themselves. Swathes of tenants are likely to want to wait and see how far the Government bail-outs and reliefs will go before deciding what rent they will pay and when.
Given the dismal payment statistics in respect of the March Quarter Day rents (pegging at approximately 50% according to Remit Consulting, and, anecdotally, we have heard from clients experiencing much lower rates), we can assume that the June Quarter Day will yield an even lower rent collection rate owing to the full brunt of the lockdown being felt between 25 March and 24 June, and the Government measures that have reduced most of the legal risks to a tenant arising from non-payment.
It would seem improbable that the Government protections for tenants will automatically end on 30 June 2020 and that landlords will immediately be able to pick up where they left off in terms of ability to forfeit for non-payment of rent, statutory demands and winding up petitions. If a tenant could not pay before, it would seem unlikely that they would be able to after a protracted lockdown period. Moreover, it cannot be envisaged that the lockdown will end and, effective immediately, all businesses are able to resume trade and activity at normal levels. As we are all aware, hotels, restaurants, bars, clubs, theatres, shops and offices will all have to deal with re-employment of employees who may have been let go or furloughed during the lockdown, disrupted supply chains and all-encompassing changes to their premises and practices to cater for a prolonged period of social distancing. Life (and trade) will not be resuming as before for quite some time – if at all – so the end of the lockdown will not magically translate into immediate cash flow for tenants and an automatic ability to pay what is due together with arrears. So how will landlords go about reclaiming the arrears that are owed by tenants and is this process going to be subject to yet further Government intervention and legislation? With so many unknowns, it would sensible for landlords to engage early with their tenants to better understand the individual business issues they are facing in order to create a sensible and realistic schedule for collection of arrears.
There is at least a chance that tenants will repay rents quicker to those landlords with whom they have come to negotiated arrangements than those who have buried their heads in the sand and not engaged with them.
6. What will our tenants be doing right now?
(a) Tenants in serious financial difficulty will be looking to reduce costs particularly their property costs if offices or commercial units are not actually in use. Landlords should be cognisant of the terms of their existing leases to be well prepared for every eventuality. This includes being aware of the following:
- Duration of the term – how long is the tenant tied in for?
- Break option – does the lease contain a break right for either the tenant or the landlord or both?
- Alienation provisions – is the tenant able to assign its lease or sublet its premises (whole or part) and if so, on what terms? Will the landlord’s permission be required and if so, can it be withheld and on what terms? What conditions does the lease impose regarding the covenant strength of a potential replacement tenant?
- Dilapidations provisions – what condition is the property going to be in if it is recovered in a contentious manner or from a financially distressed (former) tenant?
- Forfeiture provisions – in what circumstances is the landlord able to terminate the lease?
- Rent deposit – is there a rent deposit? If so, how much is it and what are the terms upon which the landlord can have recourse to it?
- Guarantor provisions – is there a guarantor? If so, what is its current financial strength and is it worth pursuing?
(b) Tenants in temporary financial distress directly linked to this immediate period of lockdown but who want to remain in occupation of their premises will be or should be approaching their landlords to negotiate rent payment holidays, rent reductions or alternative payment schedules for the coming quarter and beyond, as a means of easing the financial burden once the Government relief measures under the Act come to an end, and to ensure that their landlord does not invoke any of their other rights as set out in section 2(b) above as amended by the Government’s announcement. It may be reasonable for the landlord to request financial information about the tenant’s current performance before agreeing to any delays or rent holidays. This could be board packs, management accounts and details of the Government‑backed loan schemes in which the tenant has participated. These will all indicate if the tenant is genuinely in need of the landlord’s help and how temporary such assistance is likely to be.
(c) As mentioned above, it is possible that landlords may have purchased insurance policies that include business interruption coverage and extensions, for example, loss of rent due to the impact of notifiable diseases or to cover denial of access caused by government action. Consequently, tenants may requesting copies of landlord insurance policies to ascertain if the insurance rent that they have been paying under their lease has been used by their landlord to purchase such a policy.
Conclusion
The pandemic is an incredibly unsettling time for many of those involved in commercial property, and its impact is likely to be felt long after the lockdown is relaxed and may lead to fundamental changes in the commercial property market. While no one has any concrete answers as to what the future of commercial property looks like, landlords should be proactive in managing their portfolios and tenants, seeking to understand their obligations and rights under their leases as well as the impact the pandemic is having on each of its tenants. In particular, they should be prepared for what actions they may take in various scenarios, including if their tenants default or go insolvent. This will give them the best chance of protecting value and being able to weather the economic storm and exit in a positive position.
As mentioned above, while the Relevant Period is scheduled to end on 30 June 2020, we find it hard to believe the UK Government will allow a rush of enforcement action against tenants after that, even if the current “lockdown” ends before then. It will clearly not ease any post-pandemic economic recovery if retailers and other commercial businesses (many of whom have availed themselves of the various Government-sponsored lending schemes and have employees furloughed at a cost to the public purse) are pushed into insolvency the moment they are allowed to reopen for business. Consequently, landlords should brace themselves and plan for substantial reductions in rental income for a potentially much longer period.
There are a wide range of legal and practical options open to commercial landlords, and we would encourage landlords to take appropriate advice to decide how best to proceed. Please do not hesitate to get in touch with us at Morrison & Foerster so that we can help you and your business navigate this unprecedented and unpredictable landscape.
[1] The definition of “rent” is broadly drafted to include any sums due under a lease, so not just annual rent but also service charge, insurance rent and other outgoings.
[2] A “business tenancy” is one where property is occupied for the purposes of a trade or profession within the meaning of the Landlord and Tenant Act 1954 (LTA 1954), s 23, which provides that a tenancy is within the LTA 1954 if the whole or a part of the demised premises is occupied by the tenant for the purposes of his business or for those and other purposes.
[3] The measures will be included in the Corporate Insolvency and Governance Bill.
[4] Landlords should appreciate that, should these tenants end up in administration or liquidation in the future with rent arrears, such arrears will be unsecured debts of the tenant and are unlikely to be fully recoverable.
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