In this article, we highlight issues for landlords to address when asked by tenants for rental concessions during the COVID-19 outbreak, particularly as the March quarter day looms.
CURRENT SITUATION AND SOURCES OF INFORMATION
Here you can find the latest government information and advice that recognises the virus as a "significant challenge for the entire world". The Coronavirus Bill is due to have its second reading on 23 March.
Here you can find our article on the real estate impact of COVID-19.
MAIN ISSUES TO CONSIDER
- Leases commonly require payment of rent on “the usual quarter days” and, with one approaching, landlords are being asked to forego payment by hard-pressed tenants.
- There various options:
- accept monthly payments instead of quarterly payments
- offer a rent discount (e.g. reduce to a concessionary level for one or more payment periods)
- offer a rent free period
- offer a rent deferment (here, the obligation to pay the rent doesn't go away but it is delayed until a specified time – e.g. the March quarter's rent becomes payable at the same time as the June quarter)
- If payment is being deferred, the parties will need to agree on a payment plan for the deferred amount. If the March quarter’s rent is deferred, it might be payable in full on the June quarter day (with the June quarter’s rent). Or it might be spread in instalments over subsequent quarters.
- With a deferred payment, there is also the issue of interest. Should landlords charge default interest or compensatory interest? Would landlords want to charge interest from the original payment date or from the date to which payment is deferred under the concession letter? If the deferred amount is payable by instalments, should non-payment of an instalment accelerate the remaining instalments?
- Should the concession relate to just the annual rent or to the service charge as well (there is no obvious reason for insurance rent to be affected)?
- If the concession applies to a service charge, some leases might have a fixed service charge whereas others might be payable on-account with a balancing payment.
- If the concession applies to an on-account service charge, the parties will need to address what happens when it comes to the balancing charge. If the tenant is not required to pay it on the quarter day, should it be credited to the tenant as part of the balancing charge?
- Consideration will need to be given to how apportionments will work if there is a reconciliation date during the deferment period.
- If there is a turnover rent (usually with retail leases), how should this be addressed? If the ‘base’ rent is deferred, should there be any adjustments to the turnover arrangements for the rest of the year? Depending on the nature of the tenant’s business, turnover might improve above the norm if consumers ‘catch-up’.
- Side letters issued as a result of the COVID-19 outbreak are (it is hoped) likely to be short-term waivers making the letter likely to be personal to the tenant and not binding on successors in title.
- Landlords need to consider whether they want to make the letter personal to themselves or are prepared to bind their successors in title. If a proposed payment plan is to last for some time, then binding the landlord's successors in title may be preferable to the tenant, but will also impact on value.
- Landlords need to address the events that bring the concession to an end, such as insolvency, other events leading to forfeiture, assignment, underletting and general breach of the lease obligations. Arguably, the provisions should not be too draconian. For example, pubs, cafés and restaurants are switching to provide take-away food, and this might be breach of the user provision in the lease. The tenant would not expect that to terminate the concession.
- The termination events may differ for the type of concession. A short rent holiday might just need to be terminated for insolvency or a severe breach of the repairing covenant. Contrast the position where a payment plan might stretch over a year or more: in such circumstances then a landlord may want to include a full range of termination events and acceleration if an installment is missed.
- If a termination event occurs, then the obligation to pay rent (s) in accordance with the lease terms would immediately resume, with provision for interest, either on the lease terms or on some bespoke terms in the letter.
- These letters will need to be put into place quickly. They may also be issued to more than individual tenants, or to one tenant on multiple sites. The simpler they are, the more quickly they will work.
- The Vivienne Westwood Ltd v Conduit Street Development Ltd case raised concerns about side letters. A letter was issued contemporaneously with the lease. It contained a concessionary rent that the landlord could terminate on the tenant’s breach of covenant. On termination, the rent payable became, retrospectively, the higher rent stated in the lease. The landlord terminated the letter but the court held that payment of the higher lease rent was a penalty and therefore unenforceable. Landlords will be concerned to avoid this result.
- The legal reasoning in the Vivienne Westwood case is complex, drawing on a recent Supreme Court judgment that reviewed the law of penalties. The case was however considered as part of a challenge to the BHS CVA. The important point is that in Vivienne Westwood the higher lease rent was held, as a matter of law, never to have been payable by the tenant, so there was never a concession to a lower rent. But in the context of these COVID-19 rent concessions, the lease rent was previously payable and so these are genuine concessions. There can be no penalty if landlords are simply reverting back to that to which they are entitled.
- Any lease guarantor should be a party to a side letter.
- This is because the letter gives ‘time or forbearance’ to the tenant and therefore can act to the guarantor’s prejudice. Lease guarantees will usually provide that this does not affect the guarantee, but the safe course is to get the guarantor’s agreement to the letter.
- Landlords will want to know whether the tenant has agreed to the terms of the letter – not least because a deferred rent will have terms as to repayment. The parties will need to know where they stand.
- Traditionally, a physical letter would be issued and a copy counter-signed by the tenant (and guarantor). Over the last few years, case law has established that emails can result in binding contractual obligations, and the rent concession letter can safely by accepted by email.
- Landlords may receive multiple requests from tenants on a particular estate and so need to consider streamlining the requests and monitoring the acceptance process.
- Landlords wanting to issue estate-wide letters are unlikely to have the luxury of reading each and every lease. The letters should, therefore, be couched in general but clear terms that need not tie back to particular lease definitions (e.g. saying the ‘annual rent’ is a clear reference even if a lease calls it ‘the rent first reserved’).
- Landlords should bear in mind that their solicitors have regulatory obligations and, depending on the particular nature of their instruction, solicitors may need to undertake conflict checks. Early discussions between client and solicitor will ease this process.
- Landlords might want to satisfy themselves that their tenants are not covered for lease costs under any business interruption insurance (whether or not in respect of the outbreak of infection from COVID 19).
- A rent concession letter might be given on the basis that the tenant is unable to claim business interruption insurance for loss or damage to its business in respect of lease payments.
COMMENT: PRACTICAL RAMIFICATIONS (SHORT AND LONGER-TERM)
Many tenants will struggle to meet rental payments. It raises difficult issues of balancing interests between trader, investor and funder.
A further complication is whether tenants are acting under government advice or compulsion. It can be that only the latter unlocks certain benefits (such as insurance).
The use of the Company Voluntary Arrangement (CVA) process by many companies (particularly retailers) to reduce lease liabilities has steadily risen. There could be a new wave of CVAs particularly in the retail, hospitality and leisure sectors;
What is more likely (particularly with the March quarter day imminent) is a material, and sudden, negative impact on revenue meaning there is no time for a CVA and tenants will have to seek a rent holiday/concession or, worse, the protection of administration or another insolvency process;
The UK government has estimated that, in a worst-case scenario, up to a fifth of the workforce could be absent from work at any one time. This will inevitably result in a surge in remote working where parts of organisations and offices are closed. Businesses that make this work well may see a future with more remote working and less need for physical space. Agile working is not a new phenomenon, but COVID-19 could be the catalyst to a sudden, significant and possibly permanent change in occupational requirements in the office and business sectors. But for the retail, hospitality and travel sectors, the situation is more complex. Rental concession letters can seek to alleviate some of the immediate pain.