Last week we wrote about the 'hibernation' measures announced by Prime Minister Scott Morrison on 29 March 2020 and the ‘common set of principles’ that had been developed.
Since the initial announcement, the National Cabinet has worked with industry groups and key stakeholders to develop what is to become a legislated code of conduct (Code) for tenants and landlords in each of the States and Territories.
In anticipation of the Code being legislated in the States and Territories, it is prudent for landlords to familiarise themselves with what has been announced to date.
What is the Code of Conduct?
Designed to enable good faith negotiations and to preserve the tenant-landlord relationship, the Code establishes a set of principles to facilitate tenants and landlords agreeing on temporary and mutually beneficial lease arrangements. In short, the objective of the Code is for landlords and tenants to share, in a proportionate and fair manner, the financial burden suffered by a tenant as a direct result of COVID-19.
The overarching principles of the Code provide that:
- landlords and tenants have a common interest in working together to ensure business continuity and to facilitate the resumption of normal trading after the COVID-19 pandemic;
- landlords and tenants must negotiate in good faith to agree on appropriate temporary leasing arrangements;
- any arrangements must account for the impact of the COVID-19 pandemic on the tenant, having regard to its financial circumstances and the specific lease terms. Such arrangements are to be proportionate and appropriate; and
- landlords and tenants will act in an open, honest and transparent manner, and will each provide sufficient and accurate information for negotiations.
The Code contains several leasing principles which are to be applied as soon as practicable on a case-by-case basis. In summary, the leasing principles in the Code are as follows:
- Landlords are prohibited from terminating leases for non-payment of rent during the COVID-19 pandemic period or reasonable subsequent recovery period.
- Tenants must remain committed to the terms of their lease. Any material failure by the tenant to comply with substantive terms of the lease will forfeit protections afforded under the Code.
- Landlords must offer tenants a reduction in rent that is proportionate to the reduction in turnover of the tenant’s business due to COVID-19. Reductions will materialise as rent waivers and/or deferrals and may be up to 100% of the amount ordinarily payable.
- Unless waived by the tenant, rental waivers must constitute at least 50% of the total reduction in rent payable under principle 3. The waiver proportion should be higher in cases where a lower waiver would compromise a tenant’s capacity to fulfil its ongoing lease obligations, but also having regard to the landlord’s financial ability to provide additional waivers.
- Unless otherwise agreed by the parties, rental deferrals must be amortised over the balance of the lease term or for a period of at least 24 months, whichever is the greater. This may extend beyond the end of the current lease.
- Any reduction in statutory charges (e.g. land tax, council rates) or insurance will be passed on to the tenant in an appropriate proportion.
- A landlord should share with the tenant in a proportionate manner any benefit it receives due to deferral of loan payments by a bank as part of the Australian Bankers Association’s COVID-19 response, or any other loan repayment deferral.
- Where appropriate, landlords should waive recovery of any other expense (or outgoing) payable by a tenant during the period the tenant cannot trade. However, landlords may reduce services as required in such circumstances.
- If negotiated arrangements under the Code necessitate repayment, repayment should occur over an extended period to avoid unduly burdening the tenant. No repayment should commence until the earlier of the COVID-19 pandemic ending (as defined by the Government but generally, linked to the expiry of the JobKeeper program – currently at the end of September 2020) or the existing lease expiring, and accounting for a reasonable recovery period.
- No fees, interest or other charges should be applied to rental waivers and no fees, charges or punitive interest may be charged on rent deferrals.
- Landlords must not draw on a tenant’s security (i.e. cash bond, bank guarantee or personal guarantee) for non-payment of rent during the COVID-19 pandemic period and a reasonable recovery period.
- Tenants should be permitted to extend the lease for a period equivalent to the rental waiver/ deferral period.
- Rent increases will be frozen (except for retail leases with turnover rent provisions) during the COVID-19 pandemic and a reasonable subsequent recovery period.
- Landlords cannot impose a penalty or levy on tenants for reducing operating hours or ceasing to trade.
While relatively detailed, the principles contained in the Code aim only to provide a set of ‘minimum guidelines’ for tenants and landlords. The manner in which relief under a lease may be provided is intended to be tailored and bespoke, having regard to the particular circumstances of the lease.
Where agreement is reached between the landlord and tenant for relief arrangements, any material change(s) to the lease terms should be documented formally by way of variation of lease. Otherwise, any relief arrangement should be adequately recorded in a clear and concise manner to ensure that the risk of a dispute in relation to the arrangement is minimised.
Where agreement cannot be reached between tenants and landlords and negotiations reach an impasse, the Code provides that the parties should submit to applicable State or Territory dispute resolution processes for binding mediation (although that process cannot be used to prolong or frustrate an amicable resolution).
Who will the Code apply to?
The Code of Conduct will apply to tenants that are suffering financial stress or hardship as a result of the COVID-19 pandemic, as defined by their eligibility for the JobKeeper program – being businesses with a turnover less than $50 million that have experienced a 30% reduction in turnover and that are a small-to-medium size enterprise.
In relation to related entities or corporate groups, the $50 million turnover threshold will apply:
- for franchises – at the franchisee level; and
- for retail corporate groups – at the group level.
During negotiations, tenants are required to disclose sufficient and accurate (and potentially confidential) information to landlords, for example, to demonstrate that turnover has decreased to the extent necessary for relief. This includes financial information generated from accounting systems and provided to or received from financial institutions.
In circumstances where tenants do not meet the eligibility criteria for the Code, they remain free to negotiate with their landlords. However, the protections and relief measures in the Code will not apply, and landlords will maintain discretion as to the relief (if any) provided.
When will the Code commence and end?
The Code will come into effect on a date following 3 April 2020 to be defined by each State and Territory. It remains to be seen when the Code will be ratified and legislated by each State and Territory and whether it will have any retrospective effect to 3 April 2020.
The Code will apply to leasing arrangements for affected businesses for the period during which the JobKeeper program remains operational – which is currently a period of six months commencing 30 March 2020.
The Code answers many of the questions we posed in our alert last week. However, there are still some outstanding questions that we believe need to be resolved as the Code is legislated in States and Territories. For example:
- Will pre-existing rent relief arrangements be affected by the Code?
- What will constitute a reasonable subsequent recovery period after the end of the pandemic? That period may vary depending on a tenant’s particular business and its ability to recover after the pandemic ends.
- To what extent will the landlord’s financial ability to provide a rent waiver be relevant? As drafted, the Code anticipates a minimum 50% waiver based on the reduction in the tenant’s trade. The landlord’s financial position is only considered in respect of any waiver greater than 50% - however, the Code is to be applied on a case-by-case basis.
- What powers will be given to the mediator in a ‘binding’ mediation? For example, will the mediator be given powers to impose an agreement on the parties if they are unable to reach agreement in that binding mediation? Such powers would be contrary to the usual nature of a mediation (and inconsistent with the existing mediation process that may be provided under relevant retail shop leases legislation, for example), and more akin to a binding arbitration or expert determination.
- To what extent will the banking institutions assist landlords by waiving interest payments on loans - so far the position of the Australian Banking Association has been that banks will offer loan repayment holidays, with interest being deferred and capitalised over the balance of the loan. But without a waiver of interest by banks, commensurate with any waiver of rental payments, it would appear that landlords will be expected to bear the majority of the burden.
- What conditions can a landlord include in any negotiated outcome? One of the overarching principles of the Code is that landlords ultimately bear the risk of default and must not seek to permanently mitigate this risk when negotiating temporary arrangements under the Code. This would seem to prevent a landlord from seeking additional security as part of any negotiations. However, it is not clear if a landlord would be able to, for example, require a replacement bank guarantee where the existing bank guarantee expires prior to the expiration of the 24 month period allowed for repayment of any deferred rent or for any agreed extended term of the lease.
- What obligation (if any) will there be on tenants to trade through this period (and thereby continue paying some portion of the rent)? If a tenant closes their doors their revenue will, in many cases, be reduced to nothing and the landlord cannot enforce any trading obligation in the lease.
- Will the reduction in rent be a one-off determination or be reconsidered from time to time? Tenants’ revenue will more than likely change (for better or worse) through this period.
- Will the tenant still be required to pay outgoings whilst it is trading from the premises? The Code mentions that the landlord should seek to waive outgoings and expenses during any period when the tenant is unable to trade, however doesn’t appear to expressly deal with outgoings whilst the tenant is trading (other than requiring landlords to pass on any reductions in statutory charges or insurance).
While the Code may not yet be legislated, landlords and tenants should maintain open communication and cooperation regarding rent relief arrangements which are consistent with the Code.
In the meantime, landlords should continue to pay attention to any further clarification from the State and Territory Governments. We will continue to monitor the development of the Code and provide further updates in relation to its implementation.
If you would like further information or assistance with negotiating or documenting relief arrangements in accordance with the Code please feel free to contact our Property or Dispute Resolution team.