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Coronavirus and commercial leases: What landlords and tenants need to know

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23/03/2020

How does COVID-19 impact commercial lease obligations?

As the UK begins to tackle the challenges caused by the spread of Coronavirus/COVID-19, Walker Morris has received a number of enquiries from landlord and tenant clients as to how this may affect their property arrangements and obligations.

It is now clear the outbreak will significantly disrupt the market. We have already seen the challenges faced by the travel sector, with countries closing borders and planes being grounded. Following the UK government ordering pubs, restaurants and theatres and cinemas to close, retail and service industries are also being affected.  The office sector will not be immune to challenges as more businesses advise their employees to work from home.

In light of current indications that it is likely to be months rather than weeks before the spread of the virus, and its human and economic impact, begin to dissipate, it is essential that land owners and occupiers in all sectors understand the implications for their real estate-related rights and liabilities.

So, what are the key issues and concerns facing commercial landlords and tenants?

Can a tenant withhold rent or terminate a lease?

Given the potential adverse financial impact on tenants, a common question is whether tenants can refuse to pay rent, pay less rent and/or seek to terminate the lease prematurely.

The starting point is to review the terms of the particular lease. The relevant provisions to consider include:

  • Any break clause that may enable the tenant to terminate the lease early;
  • Any turnover rent provisions that are dependent upon the income generated from the premises; and/or
  • Any force majeure clause (although these are rarely found in commercial leases and there is no common law right to terminate for force majeure).

Most modern commercial leases will provide for rent to be payable without deduction or set off. In those circumstances a tenant is unlikely to be able to withhold payment of rent for Coronavirus-related reasons unless any specific provision in the lease enables it do so, or unless it reaches an agreement with the landlord.  Where a tenant unlawfully withholds payment of rent, the lease will be vulnerable to forfeiture [1].

Rent suspension clauses generally only apply where premises have been damaged or destroyed.  Tenants may therefore struggle to argue for a rent suspension in reliance on such provisions. However it is important to check the precise wording of the clause.

Some consequences of Covid 19 (for example perhaps civil unrest or damage or destruction arising out of looting etc) may fall within the definitions – much will depend on both the drafting of the lease and, more importantly, what risks a landlord actually insures against.

The important point to note is that the rent cesser is typically only available where there is damage or destruction – therefore if a tenant closes voluntarily because of the virus then, unless there is damage or destruction to the premises, the tenant will not get a rent cesser.

Some leases may allow a rent cesser if the premises are inaccessible (again, depending on the drafting of each lease and, potentially, whether it is in a shopping centre or on a high street). For example, rent cesser might be available for a tenant in a shopping centre which the landlord closes such that the tenant cannot access the premises.

Tenants may look to the common law doctrine of frustration where the lease provides no express option for early termination.  To terminate a lease or any other commercial contract by frustration, a party has to prove that there is some form of illegality or failure of common purpose that renders performance of the lease/contract impossible or so radically different from the parties’ expectations that termination is justified.  Importantly, however, the doctrine operates within very narrow confines.  The courts will not lightly relieve parties of their contractual obligations and the bar for a successful frustration claim is high.

Has the lease been frustrated ?

It is possible, in light of the scale of the outbreak and the unique underlying economic context, that the impact of the Coronavirus could, depending on the facts of individual cases, found successful frustration claims.  However, potential claimants could face arguments that public health issues were not so far outside the parties’ contemplation at the time the lease was granted that they could not have negotiated lease terms to allocate any associated risks; and that any inability to occupy premises would be for a short period of time only (when compared with the term of the lease), rather than a permanent arrangement. In addition, it is incredibly  difficult to successfully argue for frustration in the case of a lease, because a lease affords a tenant the benefit of the demised premises whether or not the tenant wishes to make use of it, plus there usually remains the possibility of the tenant assigning or subletting [2].

Should any formal ban on certain activities come into force, affected tenants may have a stronger argument for frustration on the basis of illegality.

Can landlords and/or tenants choose to close premises?

Some modern commercial leases (particularly in the retail sector) contain ‘keep open’ clauses and/or ‘operating/opening hours’ clauses.  Whether or not a tenant could lawfully opt to close its premises would depend on the existence and terms of any such provisions.  In the hospitality sector where the UK government has taken action to enforce closure of premises, any ‘compliance with legislation’ provisions may legitimise a tenant’s closure.  If a tenant voluntarily decided to close premises in breach of any keep open or similar provisions, however, the lease could become vulnerable to forfeiture and/or the tenant could face a claim for breach.  Whilst the courts are generally very reluctant to order specific performance of keep open provisions to force tenants to re-open, a tenant could become liable to its landlord in damages.

If a landlord was to choose to close a building, such action might amount to a derogation from grant or a breach of the covenant for quiet enjoyment [3]. Whether a landlord’s closure of a building was lawful would depend on the facts of the particular case.  For example, it might be legitimate for a landlord to close premises to protect staff, tenants and visitors or to comply with a government directive.  The opposite may be true, however, where a landlord simply chose to close a building due to, say, a lack of available staff.

Specialist advice would be required on a case-by-case basis.  It would be prudent for any party contemplating closing premises to keep clear records of all relevant factual, decision-making and economic evidence as the effects of the virus unfold.

Will insurance help?

Tenants may also want to consider if any business disruption insurance they hold will allow them to recover losses suffered due to centre closure – or if they close (whether voluntarily or otherwise) due to COVID-19.

Landlords and tenants should speak with their brokers/insurance companies to understand the cover available to them. Some policies include business interruption cover but this may only be in place where there is a damage to property or where government action has meant that it is illegal for premises to remain open.  In many cases, cover for infectious diseases will have been an opt-in extra and most will require the disease to have been classified as ‘notifiable’. The UK government’s declaration on 5 March 2020 that COVID-19 is a notifiable disease will assist in such cases.  Landlords and tenants should note that invoking a force majeure or a frustration claim can impact insurance policies and, in any case where cover may be available, parties should ascertain and carefully comply with any notification requirements.

Who will be liable to provide/pay for additional services?

The starting point is that landlords remain liable to provide, and tenants remain liable to pay for, services in accordance with the express service charge provisions in the lease.

Where a lack of staff or materials rendered it impossible for a landlord to provide certain services, whether a landlord’s failure amounted to a breach of the lease would depend on whether the lease contained any carve-out for circumstances where a landlord is prevented from complying with its obligations due to circumstances beyond its control.

The ability of a landlord to recover from tenants the costs of the enhanced cleaning regimes that are currently underway in the majority of premises will also depend on the terms of the particular lease. Generally speaking, most service charge provisions include the recovery of cleaning costs and, whilst the costs of enhanced cleaning may exceed usual expenditure, we would anticipate that such costs would be likely to be seen by the courts as reasonably incurred subject to any cap that may apply. Alternatively, a landlord might be able to rely on any ‘catch all’ provision regarding costs associated with good estate management.

What other options might be available?

There have recently been a number of high profile Company Voluntary Arrangements (CVAs), particularly in the retail sector, that have been used to reduce lease liabilities. This virus may contribute to a trend towards CVAs in other sectors too.  However, given the rent quarter is fast approaching, there may be insufficient time for many tenants to complete a CVA, and sufficient landlords/creditors may not be amenable to such a proposal in any event.  This may leave some tenants with no option but to seek urgent rent concessions, lease surrender by agreement or some form of administration or other insolvency process.

In many cases, it will be sensible for parties to consider commercial and reputational risks, alongside strict legal issues. For example, in such exceptional circumstances, parties may wish to consider being flexible about re-gearing or restructuring rent payment schedules or debts so as to preserve relationships, even where there is no legal right or obligation to do so.  If and when any alternative arrangements are agreed, it will be important, from both parties’ perspective, to ensure that these are properly documented and accurately reflect the parties’ intentions and understanding.

What does a landlord or tenant do if there is disruption to postal services or such services are suspended? How does that impact on the service of notices under a lease?

It is important to check service provisions in leases and under statute very carefully to establish whether alternative methods of service can be used such as by hand. Most property notices cannot be validly served by email only.

In addition, it is vital that landlords and tenants inform their legal advisers at the earliest opportunity as to likely requirements to serve notices over the next few months so that preparation and planning can be undertaken in case there was to be a disruption to the postal service or to any of the services that are provided by Royal Mail such as guaranteed next day delivery. It is also likely to be necessary to build in extra time to allow for service.

As many businesses prepare to close in response to coronavirus it is important to give thought to how your business will monitor post during this period. Notices or Court papers may be received that require a response within a specified period. So for example if a landlord wishes to object to a tenant’s request for a new tenancy it must do within 2 months otherwise the right to object is lost.

Businesses should put in place arrangements to continue to collect post during any period premises are closed, even if this is temporary. You should check if your business address is also your registered office address at Companies House, or the address for service given at Land Registry for any property you own or lease. Alternatively if your company registered office is the address of a third party you should enquire how post to that office is being monitored.

Some contracts allow the parties to notify each other of alternative addresses for service. If your contract allows you to do this you should if necessary give notice of a suitable  alternative address as soon as possible.

Even if your contract does not contain a specific provision allowing you to change the address for service by giving notice, it may be a helpful practical measure to inform parties of an additional address at which you can receive notices in the event your place of business is closed. However, you may not be able to insist notices be served on the new address if your contract does not provide for this.  It is unlikely to be practical to formally vary all of your contracts for a temporary period, but if you have a concern about a particular contract where time-sensitive notices are likely to be served in the coming weeks (for example an option agreement) you might consider varying those contracts. This will require an agreement which will need to comply with the necessary legal formalities. From a practical point of view the most sensible amendment would be to permit service by email.

WM Comment

Whether you are a landlord or tenant, it is important to understand your legal obligations and commitments; to act responsibly; and not to assume that you are or will be automatically released from your legal obligations under a lease even in light of current exceptional circumstances.

However, regardless of the legal framework, in the majority of cases it will remain in both parties’ interests for tenants’ businesses to withstand the significant difficulties the Coronavirus outbreak will create. Given there is likely to be a sudden and negative impact on cash flow for most tenants, the most sensible option may be for landlords and tenants to try and agree practical and commercial solutions to navigate the coming months.

When disputes do inevitably arise, it is sensible to check whether the particular lease contains any mandatory dispute resolution provisions.  An effective dispute resolution clause requires the parties to follow a pre-agreed route to resolution, which can prevent any potential secondary dispute about whether and how the primary issue should be resolved; minimise the scope for any tactical game-playing (thereby helping to preserve commercial relationships); and ensure that the time and costs of dealing with formal litigation are only incurred as a last resort.

In terms of future lease agreements or renewals under the Landlord and Tenant Act 1954 , it will be interesting to see how the market reacts and the type  of clauses parties seek to negotiate to allocate the commercial risks that may arise from public health crises or other unexpected and significant events.

Finally, please note that this article aims to provide a high level summary of the key issues and concerns facing commercial landlords and tenants in these unprecedented times.  Should you require any specific advice – whether from a risk management or a dispute resolution perspective – please do not hesitate to contact Martin Mckeague, David Manda or Lewis Couth in the Real Estate Litigation team.

 

[1] See our earlier article on the basics of forfeiture

[2] See our earlier briefing on the Canary Wharf v EMA case for further advice and information on frustration in the context of commercial leases

[3] The principle of quiet enjoyment ensures that a tenant is free from disturbance as a result of the exercise of adverse rights over the property it occupies. Quiet enjoyment overlaps with a second principle, derogation from grant, which stems from the rule of common honesty and provides that a landlord cannot give with one hand and take away with another (i.e. a landlord cannot grant a lease and recover rent, whilst interfering with the tenant’s possession and enjoyment of the premises).

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