Reaching a temporary agreement with your tenant may seem like the best solution for all concerned, but be sure to consider all the implications, warn David Hutber and Tom Paton.
In June, the government published the Code of Practice for commercial property relationships during the Covid-19 pandemic. The object of the Code is to support as many businesses as possible by facilitating discussions between landlords and tenants.
In the lead up to the June quarter day, a large number of tenants requested further concessions from their landlords. Where tenants cannot agree acceptable arrangements, landlords may find they have to accept the less generous terms of a company voluntary arrangement. It remains the case that CVAs are often voted through despite opposition from landlords, leaving them with little option but to accept very significant rent reductions. The risk of the tenant entering into administration or liquidation, most likely resulting in the premises being vacated with the landlord left liable for business rates, is even less attractive.
Against this background, landlords have been negotiating a variety of solutions with tenants. Rent holidays and deferrals are some of the most common solutions. With the introduction of the new 20 business day moratorium under the Corporate Insolvency and Governance Act 2020, tenants in financial difficulties will have greater time and opportunity to approach landlords, so these types of arrangements are likely to increase.
While the Code encourages landlords to work with tenants, it is voluntary and can only set out a range of options available to the parties. It does not prescribe how new arrangements should be structured. When faced with the immediacy of the problems, landlords are agreeing short-term solutions to help tenants through the next few months.
These temporary arrangements are seen as quick fixes, but landlords should be alert to the longer term implications of these concessions if circumstances change and in particular if the tenant becomes insolvent.
Transparency and good faith
One of the core principles of the Code is that landlords and tenants must act reasonably, in good faith and with transparency. However, this can be difficult. Landlords will only want to grant concessions to tenants that genuinely need support and would prefer all landlords to be treated in a comparable manner. There is no independent person supervising the arrangements to ensure no individual party is prejudiced as there would be under insolvency procedures. These are private arrangements which rely to a great extent on trust.
Landlords starting negotiations could require a commitment from their tenant to act in good faith and disclose all relevant information. The concession could also be subject to a condition that the tenant provides regular financial updates with the ability of the landlord to revoke the concession if its financial position changes.
Subsequent administration
Many landlords are agreeing short-term rent holidays or reductions. If the tenant then succumbs to administration during the concession period and the administrator decides to continue to trade from the premises, the landlord may well want to charge the full rent (as opposed to the nominal or discounted rent agreed as a concession) as an expense of the administration for the period that the premises are used. The point was considered in Re SHB Realisations Ltd (formerly BHS Ltd) (in liquidation) [2018] EWHC 402 (Ch), in the context of the BHS administration which followed a CVA.
The liquidators argued, among other points, that the obligation to pay full rent on the termination of the CVA was an unenforceable penalty and that the CVA had varied the lease. The landlord was successful but the court relied heavily on the fact that this was a CVA and that usual contractual principles did not apply.
To ensure that the landlord can require the full rent if an administration follows and the administrator requires the premises, the landlord should deal with a rent concession by means of a waiver which can be revoked at any time.
Terminating the concession
Rent concession letters often include the right to terminate the concession early and then charge the shortfall on termination. Landlords should exercise caution when introducing this arrangement as this could be construed as a penalty. In Vivienne Westwood Ltd v Conduit Street Development Ltd [2016] EWHC 350 (Ch); [2017] EGLR 11, the court found that the right to terminate a side letter for any breach of the lease or side letter and recharge the shortfall constituted a penalty. In that case the impact of the tenant’s breach was out of proportion to the effect on the landlord’s financial interests and the side letter formed a key part of the deal. It seems less likely that the right to terminate concessions granted to assist tenants in financial difficulties would be held to be a penalty, though landlords should still choose their termination wording carefully.
Voting rights under a CVA
The overall debt due to a landlord will determine the value of its vote in the approval of a tenant’s CVA. Landlords should be aware that by agreeing to waive any outstanding rent they will be reducing their voting power should a CVA ever be proposed in relation to the tenant. Landlords may wish to consider deferring rent rather than a complete waiver to maximise the value of the admitted claim.
Preserving the right to forfeit
The Coronavirus Act 2020 restricts a commercial landlord’s ability to forfeit for non-payment of rent, currently for a period expiring on 30 September 2020. Section 82(2) of this Act states that no conduct of a landlord is to be regarded as waiving the right of forfeiture unless the landlord gives an express waiver in writing.
It is possible that a rent concession letter might be treated as an express waiver. To avoid this, the concession agreement should specifically state that a right to forfeit will apply if the tenant does not pay deferred rent on pre-agreed dates.
Existing rent deposits
If a landlord agrees to a rent concession where it has the benefit of a rent deposit, the landlord will want to be able to revoke the concession and draw down the full rent if the tenant goes into administration or liquidation. With carefully drawn terms this should be possible. Rent deposits are often considered “financial collateral arrangements”, which means that the usual restriction on enforcement of security if a company enters administration will not apply to them.
Reversionary leases
Reversionary leases are suggested by the Code as something that could be offered by the tenant in return for a concession. When negotiating the terms of a reversionary lease, some tenants have begun to request the inclusion of a “Covid-19 clause”, which grants automatic rent suspension or reduction if there is another lockdown.
Landlords should exercise caution when agreeing to such a clause. It is very unlikely that a landlord would be able to obtain insurance for a Covid-related rent suspension and they are unlikely to secure the same “holiday” under their own funding arrangements.
Landlord obligations under finance documents
Landlords who purchased their property with the assistance of a lender should check that a rent concession will not breach any interest cover ratio covenants or whether the lender’s consent is needed. If a concession would breach the terms of any finance documents then an express waiver should be sought from the lender.
Insurance
Prior to accepting a rent concession for a period of forced closure, it would be as well for a landlord to verify that there is not a possibility of a claim under the tenant’s business interruption policy. A test case seeking to clarify the extent to which business interruption insurance covers losses arising from the Covid-19 pandemic – The Financial Conduct Authority v Arch Insurance (UK) Ltd and others – was heard by the High Court from 20-30 July, and, depending on the outcome, it could open the gates to many more claims.
Landlords must also consider claims for loss of rent if an insurable risk occurs during the rent concession period. The landlord will want to claim for the full rent so the concession must be revocable to allow the landlord to do this.
Existing guarantees
The impact of a rent concession on guarantors should be considered to avoid inadvertently discharging them. Any guarantor should be a party to any arrangement or give their express written consent.
Side letter waiver or variation
Most rent concessions are being dealt with by side letter and are intended to take effect as a waiver and not a variation of the lease, but in law a rent concession might be a variation. For many reasons landlords want the ability to revoke the waiver. A personal concession will not bind any successor landlord, which is often unacceptable to tenants, but if the wording of a letter tried to bind other parties this could indicate a variation. However given the difficult circumstances most landlords prefer to use a letter which can easily be signed.
Rent review
In an open market rent review clause, the rent following review is often expressed to be the higher of the rent payable under the lease at the date of review or the open market rent. In the current market the open market rent is unlikely to be increasing, so landlords will want to ensure that any temporary rent reduction is disregarded and not considered the rent payable under the lease at the date of review. If it is not disregarded then the temporary reduction could become permanent following review. This issue should be dealt with expressly in the side letter.
Tenant an individual
If the tenant is an individual, and the arrangement involved deferred payments, care should be taken to avoid creating a regulated credit agreement.
Summary
As can be seen from the above, there are a number of difficult issues that landlords will need to consider over the coming months. It is of course difficult to predict the future, but when engaging in negotiations with their tenants, landlords will need to tread a fine line between treating their tenants fairly and looking ahead to ensure their own interests are protected. There is a temptation to deal with rent concessions by a quick and easy letter but care should be taken to avoid this having unexpected consequences.
David Hutber and Tom Paton are solicitors at Irwin Mitchell LLP
