**UPDATED** 8.50am Monday 30 March 2020
You can well imagine that we are fielding a large number of questions during this new “COVID-19 Era”. Some of the most common questions we are being asked relate to the operation of commercial leases.
The law is moving fast in this area, as both State and Federal Governments attempt to control the mass exodus of tenants from leased premises. It can be said however that the commercial real estate industry will be impacted for a considerable period of time once this “situation” is over.
For any business (other than those operating online), the rent of premises is one of, if not the, largest fixed cost they have. Given such an immediate and unexpected downturn in the economy, many small to medium businesses face the pressure of paying large amounts of rent for premises that they simply cannot currently use, or manage going forward.
This article looks at the various circumstances for which we have had to give legal advice in the past week when it comes to commercial leases.
“Am I protected by new emergency legislation brought in this week by the Government?”
In short, not yet….however it appears that help is on its way.
On Friday, 27 March 2020, Prime Minister Scott Morrison announced that measures would be put in place to ensure that tenants of commercial leases may avoid being “saddled by debt and rental payments and other liabilities that they won’t be able to open on the other side”. This was confirmed last night, being Sunday 29 March 2020.
Little detail has been given. We know that all states and territories are on board with this idea that there will be a “moratorium” on the evictions of tenants from their residential and commercial premises.
What we do know is that there is likely going to be a “criteria” in order to determine who gets access to this moratorium. We imagine tenants will need to show that they are under “financial distress”.
However we give this strong warning: there is a strong likelihood that the rent you cannot afford now will need to be paid within six months, so as to avoid being evicted in six months time. There is nothing to suggest that this “rent moratorium” is a rent “freeze”.
We will keep you up to date on this as it progresses. However, during that press conference from the Prime Minister, he indicated that there needs to be discussions between the tenants and landlords to find a way to manage the current situation.
“My business cannot pay its rent right now. The downturn in my business is likely only for a short period of time, but what do I do in the meantime?”
It would be highly unusual for a term within a commercial lease to allow tenants to simply not pay rent – regardless of whatever event has transpired. The payment of rent is an essential covenant and material term of a commercial lease, and therefore the failure to pay the rent is a material breach of that lease. Many leases state that if there is a failure to pay rent by a tenant for a period longer than fourteen days, the landlord can exercise their right to terminate the lease and re-enter the premises. They are then able to pursue the tenant for that rent owed, and in some circumstances, the tenant may face the cost of ongoing rent up until a new tenant can be found for that commercial premises.
If it looks like your business can pay the rent in the foreseeable future, but the landlord terminates and re-enters the premises for a breach of that covenant that requires the payment of rent, the tenant may wish to consider applying to a court for relief against the forfeiture of a lease.
This option is available where:
- The landlord failed to give reasonable notice of the breach;
- That there was no breach;
- That the breach is trivial; or
- That the breach will be rectified promptly.
Before you consider this as an option, please contact us to discuss whether these circumstances apply to you and your business. A court may not be sympathetic to those businesses that suffer hardship if the landlord has terminated the lease for good reason. However, a court will take into account circumstances where a tenant had made rental payments up to the date of the proceedings and there is clear evidence that the tenant will honour the lease obligations going forward.
“My business is not going to survive this. What do I do with this lease?”
You may have read a previous article by us on “Force Majeure” and you may have heard us talk about the “doctrine of frustration” in recent seminars and articles. The reality is that some businesses are simply not going to survive. This is a scary reality, made worse with the understanding that your business operates on a premises through a long term lease.
The first thing that we advise our clients is to look at your lease (which is, in effect, a contract) to see whether there are any “hardship” clauses or a “force majeure clause”. We have gone into more detail about the operation of “force majeure” clauses in this article here: https://hallettlaw.com.au/2020/03/25/covid-19-will-my-force-majeure-clause-save-me/
Leases generally do not contain force majeure clauses. However, this does not mean to say that you cannot rely on common law principles which underpin any kind of contract. By this, we mean the common law doctrine of “frustration”. It may be possible for tenants to rely on this legal doctrine to escape leases immediately if certain circumstances exist – importantly, there needs to be a “frustrating event”.
There is no definitive list as to what constitutes a “frustrating event”. Rather, it is necessary to consider the factual circumstances within the terms of the contract and ask whether performance has become impossible or “radically different”.
Ordinarily, in the past, we would have advised that the likleihood of a “frustrating event” ever happening would be rare. Fast forward to today, the question has opened up – can COVID-19 be defined as a “frustrating event” with respect to leases?
Frustration takes place when:
- There is no default of either party;
- There is an event which so significantly changes the nature (not merely the expense or onerousness) of the outstanding contractual rights and/or obligations;
- That event was one that parties simply could not have reasonably contemplated at the time of the execution of the contract; and
- That it would be unjust to hold the parties to the literal meaning of the contract.
Where these factors are present, the law may declare both parties to be discharged from further performance – meaning, the contract can be ripped up with no obligations on either party moving forward.
We caution everyone to not get immediately hopeful that this doctrine can assist when comes to leases – cases in the past have shown that there is a high bar to clear in order to access this doctrine when it comes to leased premises. However, its still worth having your lawyer look at the doctrine to see whether it may apply to you. Its important that you seek legal advice before you consider raising this concept with your landlord. There are pieces of legislation in existence which may impact the legal advice given.
In considering whether this doctrine may assist you, we will likely ask you (among other questions) the following:
- How long is your lease? How many months or years are left on that lease?
Courts will need to see that the frustrating event will cause a prolonged inability to use the premises. Given we are yet to see how long COVID-19 will impact our businesses, the shorter the term of the lease, the better. The law has been hesitant to void contracts unless there is a complete destruction of the premises, rendering it entirely impossible for the premises to be used again for the remaining part of the lease.
- Has the government mandatorily forced your business to close?
Courts will most likely need to see that the event was outside the power and control of the parties. It may not be the case that merely by being told to stay at home and isolate, the use of the premises is an impossibility. The Courts will most likely want to assist only those parties who have been forced, through legislation or regulations, businesses to close their doors and be forced to do so for a very prolonged period of time.
It is important to stress, again, that a contract will not be frustrated by mere reason of commercial impracticability or where performance has simply become more onerous. If the contract is performable – albeit at a severely reduced level – the contract will not be frustrated.
“My business is in a shopping centre. Can the Centre Management force me to keep my doors open if I am being told to stay at home?”
Retail leases often include a covenant requiring the tenant to keep their premises open for trading. There is some risk that these provisions will cause some problems, whether it be now, or even when Government guidance is relaxed and people need to make the decision to return to trading.
Firstly, look in your commercial lease for a requirement to abide by all relevant legislation and regulations. If a health and safety direction has been issued by any competent government authority or emergency legislation, then businesses are required to do so, merely through the provisions of the lease itself.
Even if the lease itself is silent, tenants should be comforted by the fact that courts will see that a tenant abiding by emergency laws is superior consideration for a business than contractual provisions, purely on a public policy basis.
The question will be whether the landlord can force the payment of rent during this time. The reality is that we simply do not know, as the matters have not come before the courts as yet. However, in this instance, we would always recommend that you need legal advice so as to be guided by your lawyer to minimise your risk. Our concern is that landlords that have “trading covenants” in their leases may still require you to pay that rent.
Before speaking with your lawyer, you should also review your insurance policies to see whether you are able to rely on any business interruption coverage. We also encourage you to look closely at that insurance policy and be sure that it covers pandemics such as COVID-19.
“What general advice can you give me?”
Disputes during this extraordinary and unprecedented times need to be avoided at all costs. With so much uncertainty, its strongly advised that you remain open and honest with your landlord about your businesses financial capacity and plans for the future. It is important to remember that commercial landlords also face considerable financial uncertainty and so it would not necessarily be in their best interests to remove you from the premises. If anything, they will most likely want to negotiate a short term arrangement. In this regard, we recommend that you ensure that these temporary arrangements are determined and placed in writing to ensure the expectations of each party are clear.
If you wish to discuss your leasing arrangements, or need to discuss any aspect of your business from a legal perspective, please do not hesitate to contact Kathryn Adams on 0452 614 454 or email her on firstname.lastname@example.org.