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Coronavirus and Commercial Rent – Who Bears the Cost in a Time of Crisis?

22nd May 2020

Updated to include the changes proposed by the Corporate Governance and Insolvency Bill which had its first reading on 20 May 2020. 

As a result of the raft of social-distancing measures introduced by the government to slow the spread of COVID-19, many commercial tenants have been forced to close their premises.  For the vast majority, the obligation to pay rent continues under their leases even though they can no longer trade.  Landlords have their own problems, facing a dramatic reduction in rental income, yet retaining their own financial obligations such as mortgage payments.

In a time of universal crisis, what options are available to landlords and their tenants to deal with the payment – or rather, non-payment – of rent?

Option 1: The Insurers Pay

Most commercial leases contain a rent suspension provision triggered when the premises become incapable of occupation.  Rent suspension is usually defined by reference to “Insured Risks”, meaning that the building insurers rather than the tenants cover the rent. Unfortunately, the policy terms are generally restricted to physical damage to the property such as fire or flood.  There are, however, exceptions – albeit rare – making a review of these provisions worthwhile.

Tenants may also carry their own business interruption insurance.  Most policies do not cover pandemics, often being an “add-on” that tenants have not purchased, but again it is worth investigating.

Option 2: The Parties Share the Cost

As with all things, agreement is the best option and landlords and tenants have been finding solutions that include rent waivers, reductions, deferments and instalment payments with or without interest.

If agreement can be reached, the legal consequences need to be properly documented – such as whether it is to be a formal variation of the lease or an informal waiver, whether third party permissions are required from funders or others and what happens in the case of default.

Option 3:  Enforcement Action

The narrative of “we are all in this together“ often belies the reality. Many large occupiers immediately announced their intention to pay no rent for the foreseeable future, despite sitting on cash reserves or, in some cases, continuing to trade. Not all landlords are cash rich.  Many are small private investor whose property is charged.  The benevolence landlords are expected to show to their tenants is not shown to them by their own funders.

The options available to a landlord to recover arrears of rent include drawing down on a rent deposit, calling on a third party with liability such as a guarantor or previous tenant, issuing court proceedings, forfeiting the lease, pursuing the Commercial Rent Arrears Recovery (CRAR) process, or serving a statutory demand threatening the tenant with insolvency.

Parliament has assisted tenants directly by restricting some of the rent recovery options available to landlords.

The Coronavirus Act 2020 came into force on 23 March 2020 and introduced a few measures to buffer commercial tenants from the immediate financial impact of the lockdown.  (see our article “The Perpendicular Wave – Coronavirus and Business”)

The most publicised provision was the introduction of a three-month moratorium on forfeiture of tenancies until 30 June 2020 to protect tenants from the most draconian action available to landlords for non-payment of rent.  With the lockdown only slowly lifting, the financial position of many tenants will undoubtedly worsen.  Even when premises open again, it will take time to rebuild business and cash-flow.  It seems likely that the government will extend the protection beyond 30 June 2020 to cover the June rent quarter.

The protection that the moratorium gives is limited to forfeiture for non-payment of rent.  It does nothing to stop rent arrears accruing – although many tenants have interpreted it as a reason not to pay rent.  In any event, landlords only look to forfeit in a buoyant market when they can readily re-let.  There are few landlords that would willingly take property back in the current climate.

Pursuing the debt by way of court proceedings remains an option but proceedings are slow and relatively expensive and, even when a judgment is obtained, do not guarantee payment without further enforcement action.

CRAR has been of some limited assistance – albeit hampered by the availability of enforcement officers and constraints imposed by social distancing.  This has now been the target of further government restriction.

On 23 April 2020, the Ministry of Housing, Communities and Local Government announced further legislation to prevent landlords from using what it labelled as “aggressive debt recovery actions”. It is unclear whether this has been the case, but rather the consequence of tenants refusing to engage in dialogue and leaving landlords with no option but to enforce their legal rights.

The Taking Control of Goods and Certification of Enforcement Agents (Amendment) (Coronavirus) Regulations 2020 came into force on 25 April 2020 and imposed temporary restrictions on the use of CRAR, until 30 June 2020 intially.  Before, if a tenant had arrears of seven or more days’ worth of rent, a landlord could serve notice demanding payment. If the sum remained unpaid, the landlord could instruct an enforcement agent to follow a statutory procedure to seize and sell the tenant’s assets to pay off the arrears.  The tenant must now have 90 days’ rent arrears before the landlord can use CRAR.   Goods held at residential premises or on a highway are exempt whilst the stay at home restrictions remain in place.

Aside from CRAR, the landlord’s “enforcement method of choice” has been the service of a statutory demand which is a cost-effective way of focussing a tenant on the need to pay its rent under threat of liquidation or bankruptcy.

After some delay, provisions protecting companies from this type of action have been included in part of the Corporate Insolvency and Governance Bill which had its first reading in the House of Commons on 20 May 2020.  It is expected that the Bill will be fast-tracked.  More importantly, it will have retrospective effect.

The Bill brings in a blanket ban on the presentation of winding-up petitions on or after 27 April 2020 on the ground that the company has failed to satisfy a statutory demand served between 1 March 2020 and 30 June 2020.

The Bill also restricts the presentation of a winding-up petition between 27 April 2020 and 30 June 2020 or one month after the Bill comes into force (if later) on the ground that a company cannot pay its debts unless the creditor has reasonable grounds for believing that (a) coronavirus has not had a financial effect on the debtor, or (b) the debtor would have been unable to pay its debts even if coronavirus had not had a financial effect on the debtor.

Coronavirus has a “financial effect” on a debtor if its financial position worsens in consequence of, or for reasons relating to, coronavirus. This is a low threshold.

There are related provisions that allow the courts to unscramble the effect of any petition presented or winding up order made on or after 27 April 2020.

A word of warning to tenants who interpret these various restrictions on rent recovery as an excuse to default with impunity. The restrictions are temporary and only relate to non-payment of rent. More broadly, a failure to engage now may adversely affect the landlord and tenant relationship in the future – to the detriment of the tenant.

So who should bear the cost of rent default? 

There is no doubt that tenants, particularly retail and leisure tenants, are suffering, and that government assistance is a necessity for their survival; however, landlords are suffering as well.  The legislation and the financial relief packages to date favour tenants.  Ignoring insurers who continue their policy of avoiding liability at all costs, the financial burden has been shifted onto landlords in the absence of similar landlord relief packages – especially for smaller investment landlords.

It is naïve to think that tenants who are fighting for their own survival will pay rent voluntarily; however by restricting the landlords’ tools of enforcement, they have deprived landlords of their negotiating position to ensure tenants too share the financial burden. In doing so, they are leaving many landlords in a precarious financial position.

The government claims to be talking to banks and to landlords in relation to possible financial assistance measures that may be made available to them.

With the June quarter day approaching, they need to come quickly in order for some form of balance to be restored.

If you need advice on the impact of COVID-19 on the payment of rent or on any other aspect of the landlord and tenant relationship, please contact:

 

Caroline DeLaney, Head of Real Estate Disputes

Email: caroline.delaney@rosenblatt-law.co.uk

Phone: +44 (0) 20 7955 1423