The Federal Government has announced a Code of Conduct (“the Code”) to impose a set of good faith leasing principles to apply to commercial tenancies only (e.g retail, office and industrial properties). In this post, we explore and summarise the details of the Code and its impacts on landlords and tenants of commercial premises, importantly noting that in many instances the landlord may be an SMSF.
Which tenancies are affected?
The Code will apply where the commercial tenant:
- is an eligible business for the purpose of the newly legislated JobKeeper program; and
- has an annual turnover of $50 million or less (referred to as ‘SME Tenants’)
All other tenancies are not affected by the mandatory Code.
It is possible for Tenants who do not meet the requirements of the Jobkeeper program to be able to access the Code if they can show sufficient “financial stress or hardship”. That is, that their business is unable to generate sufficient revenue as a direct result of the pandemic that causes the Tenant to be unable to meet its financial and/or contractual commitments.
Duration of the Code
The Code envisages that it will be operational during the pandemic period, which is defined to be the period during which the JobKeeper program is operational. Based on previous national cabinet announcements, this is expected to be a period of six months.
Details of the Code
In negotiating and enacting appropriate temporary arrangements under the Code, the following 14 lease principles should be applied as soon as practicable on a case-by-case basis:
- Landlords must not terminate leases due to 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, subject to any amendments to their rental agreement negotiated under the Code. Material failure to abide by substantive terms of their lease will forfeit any protections provided to the Tenant under this Code.
- Landlords must offer Tenants proportionate reductions in rent payable in the form of waivers and deferrals of up to 100% of the amount ordinarily payable, on a case-by-case basis, based on the reduction in the Tenant’s trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.
- Rental waivers must constitute no less than 50% of the total reduction in rent payable under principle #3 (above) over the COVID-19 pandemic period and should constitute a greater proportion of the total reduction in rent payable in cases where failure to do so would compromise the Tenant’s capacity to fulfil their ongoing obligations under the lease agreement. Regard must also be had to the Landlord’s financial ability to provide such additional waivers. Tenants may waive the requirement for a 50% minimum waiver by agreement.
- Payment of rental deferrals by the Tenant must be amortised over the balance of the lease term and for a period of no less than 24 months, whichever is the greater, unless otherwise agreed by the parties.
- Any reduction in statutory charges (e.g. land tax, council rates) or insurance will be passed on to the Tenant in the appropriate proportion applicable under the terms of the lease.
- A Landlord should seek to share any benefit it receives due to deferral of loan payments, provided by a financial institution as part of the Australian Bankers Association’s COVID-19 response, or any other case-by-case deferral of loan repayments offered to other Landlords, with the Tenant in a proportionate manner.
- Landlords should where appropriate seek to waive recovery of any other expense (or outgoing payable) by a Tenant, under lease terms, during the period the Tenant is not able to trade. Landlords reserve the right to reduce services as required in such circumstances.
- If negotiated arrangements under this Code necessitate repayment, this should occur over an extended period in order to avoid placing an undue financial burden on the Tenant. No repayment should commence until the earlier of the COVID-19 pandemic ending (as defined by the Australian Government) or the existing lease expiring, and taking into account a reasonable subsequent recovery period.
- No fees, interest or other charges should be applied with respect to rent waived in principles #3 and #4 above and no fees, charges nor punitive interest may be charged on deferrals in principles #3, #4 and #5 above.
- Landlords must not draw on a Tenant’s security for the non-payment of rent (be this a cash bond, bank guarantee or personal guarantee) during the period of the COVID-19 pandemic and/or a reasonable subsequent recovery period.
- The Tenant should be provided with an opportunity to extend its lease for an equivalent period of the rent waiver and/or deferral period outlined in item #2 above. This is intended to provide the Tenant additional time to trade, on existing lease terms, during the recovery period after the COVID-19 pandemic concludes.
- Landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period, notwithstanding any arrangements between the Landlord and the Tenant.
- Landlords may not apply any prohibition or levy any penalties if Tenants reduce opening hours or cease to trade due to the COVID-19 pandemic.
Compulsory Mediation to apply where there’s no agreement
Where Landlords and Tenants cannot reach agreement on leasing arrangements (as a direct result of the COVID-19 pandemic), the matter should be referred and subjected (by either party) to the Victorian Small Business Commissioner. Landlords and Tenants must not use mediation processes to prolong or frustrate the facilitation of amicable resolution outcomes.
To understand how this will apply, let’s take a look at the following example how the Code will operate:
ABC Architects operate out of commercial premises in Melbourne. They have a turnover of $1.2 million. As a result of the pandemic they have lost 50% of their trade and they are therefore eligible for the JobKeeper program.
They have 36 months left under their existing lease. The lease rent is scheduled to increase by 3% on the 1st July of each year. It is assumed that the JobKeeper program will operate for (6) six months (“Pandemic period”). It is also assumed that the associated recovery period will be (3) three months.
As tenant, the Code will operate as follows:
- the monthly rental payments will be reduced by 50% for the next 9 months (based upon 50% loss of trade)
- of the 50% reduction in rent, half will be in the form of a rental waiver and will not be recoverable by the Landlord, the remaining half will be in the form of a rental deferral.
- ABC Architects as tenant must continue to pay the remaining 50% of the rent due during the 9 month period. Any breach will mean that the Tenant will not have the benefit of the Code.
- After the 9 month period, the rent will return to its normal level and the rent deferred will be divided equally over the remaining 27 months of the lease and added to the Tenants ordinary rent payable.
- As the tenant is still trading, outgoings under the lease will be payable, but reduced in proportion to any relief offered to the Landlord.
- The Landlord offers the tenant a 9 month extension of the current lease term, which the tenant accepts.
- The fixed increase in rental that was to occur on 1 July 2020 will be delayed by 9 months until 1 April 2021.
Current issues with the Code
Having spent time reviewing the Code as it currently stands, there are a range of issues to be aware of:
- It is important to note that in some states this Code is not yet law (e.g. Victoria).
- There is uncertainty about what is a “reasonable subsequent recovery period” and whether it will be applied on a case by case basis or across the economy as a whole.
- In determining the appropriate reduction of rent, it is necessary that the Tenant be transparent in providing its financial details to the Landlord. Many Tenants will be reluctant to share this information. The Code contemplates that information will be sourced from an accounting system and information provided to or received from a financial institution. This is likely to result in dispute as to what would be an appropriate rent reduction that is to be waived and deferred.
- It is unclear whether the Code would restrict the Landlord recovering arrears of rent and outgoings that pre-existed pandemic period, or just the areas that existed during the pandemic period.
- As indicated in the Code above, the rent deferred must be paid after the pandemic period and recovery period over a timeframe of no less than 24 months. Unless correctly documented, there may be issues in recovery of rent deferred if the lease expires within the 24 month period.
- It is presently unclear what happens if there is no agreement about the rent reduction (e.g. alleged inaccurate financial information) and what happens if there is no agreement and mediation is unsuccessful.
- The Code does not apply to license agreements or Agreements for Lease affecting commercial tenancies. For good or for bad, these agreements allow for the Code to be circumvented.
It is important for Landlords and Tenants affected by the Code to ensure that any arrangements that are to be put in place are properly documented as a Variation to their lease, to ensure that the negotiations
between the parties are binding and do not impact on other obligations under the lease.
Smarter SMSF works with Hill Legal to support our members across a range of legal and estate planning matters. If you unsure about the application of the Code, you can contact the team at Hill Legal to assist further.