Mandatory Code of Conduct - SME commercial leasing principles during COVID-19

Apr 2020 | Commercial Property

Introduction

Various measures implemented by the Australian Government in a bid to reduce the transmission of COVID-19 have immediately impacted the economy causing commercial disruption and financial hardship. To support those suffering financial stress and hardship as a result of the current COVID-19 pandemic, the National Cabinet has agreed a Mandatory Code of Conduct (Code) with respect to commercial tenancies that will come into effect in all states and territories on a date to be defined by each jurisdiction.

What is the Code?

The Code is the basis for new state and territory specific legislation aimed at managing cash flow for both landlords and tenants, and directing parties to a commercial lease to act in good faith when negotiating amendments to leasing arrangements which transpire due to the economic impacts of the COVID-19 pandemic.

Further information will be available once state and territory legislation has been passed, including details on the duration of the Code’s application and how it will operate in conjunction with existing leasing legislation. We will provide further updates as they come to hand.

Who does the Code apply to?

The Code applies to all 'SME tenants', defined by:

  1. eligibility to participate in the Commonwealth Government’s JobKeeper programme*; and
  2. an annual turnover of up to $50 million.

What are the current leasing statutory or common law provisions in relation to rent relief as a result of COVID-19?

There are no provisions of the Retail Shop Leases Act 1994 (Qld) (RSLA) which would require a landlord to provide rent relief to a tenant as a result of the COVID-19 pandemic, provided the landlord does not take any precipitous action to prevent the tenant from accessing the premises and it complies with lawful requirements regarding allowing continuing access to the premises.

Usually if a landlord restricts access to the premises of a retail tenant, compensation would be payable pursuant to s 43 of the RSLA. However, if buildings or premises are forced to close or restrict access by government direction, that compensation provision will not apply - this is reinforced by the provisions of s 43AB of the RSLA.

Generally, most leases will not contain 'force majeure' type clauses which could relieve the tenant of the requirement to comply with the lease and the effects of the COVID-19 pandemic are unlikely to give rise to common law frustration of leases - this is a very high bar to prove, and such a claim is unlikely to be successful given the temporary nature of any premises closure.

What are the principles of the Code?

The Code sets out leasing principles which will apply to negotiating amendments in good faith to existing leasing arrangements on a case-by-case basis taking into account the particular circumstances of each affected tenancy. 

The key principles are:

  1. Landlords must not increase rent or terminate a lease or draw on a tenant’s security for non-payment rent during the COVID-19 pandemic period and a reasonable subsequent recovery period;
  2. Tenants must honour their obligations under their lease, subject to any amendments negotiated under the Code. Any material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under the Code;
  3. Landlords must offer tenants rent reductions proportionate to the tenant’s reduction in turnover comprised of waivers and deferrals. Waivers must account for at least 50% of the reduction and any amount of reduction provided by a waiver may not be recouped by the Landlord over the term of the lease. For example:

If the tenant’s revenue has fallen by 100%, then at least 50% of total cash flow relief is rent free/rent waiver and the remainder is a rent deferral. If the qualifying tenant’s revenue has fallen by 30%, then at least 15% of total cash flow relief is rent free/rent waiver and the remainder is rent deferral;

  1. The payment of any rent deferrals by the tenant are to be spread over the balance of the lease term and for a period of no less than 24 months, whichever is the greater. Tenants should also be provided with an opportunity to extend their existing lease term for an equivalent period of the rental waiver to allow for additional time to trade on the same lease terms during the recovery period after the COVID-19 pandemic concludes;
  2. Any benefit a landlord receives or reduction in statutory charges or insurance are to be passed onto the tenant in the appropriate proportion applicable under the terms of the lease. Likewise, any expense should be waived where appropriate during the period that the tenant is unable to trade. Landlords have the right to reduce services as required in such circumstances; and
  3. No fees, interest or charges are to be applied with respect to rent waived or deferred.

The Code does not appear to apply to existing tenancy disputes, rather only those which transpire during the COVID-19 pandemic period or subsequent recovery period.

Negotiating in good faith

The Code requires landlords and tenants to negotiate in good faith.

Over the last decade or so there has been considerable judicial attention given to the meaning of good faith in the context of contracts and negotiations. In broad terms, acting in good faith does not require a party to subordinate its legitimate interests to those of the opposing party. Rather, it requires parties to act honestly and with fidelity with a view to the bargain between the parties, to act co-operatively in matters related to performance, and to have due regard to the legitimate interests that both parties have in the performance of the contract they have made.

Parties who display conduct which is dishonest, capricious, arbitrary or motivated by a purpose other than to resolve a dispute will likely not satisfy the requirement of good faith and, potentially, face the risk that such behaviour could also be characterised as misleading and deceptive, in breach of the Australian Consumer Law.

What happens if the parties can’t agree? 

The Code requires that in the event the parties to a leasing arrangement cannot reach an agreement, the matter is subjected to applicable state or territory retail/commercial leasing dispute resolution processes for binding mediation. 

It is unclear what the Code intends by the term ‘binding mediation’, and landlords and tenants will therefore need to wait for clarification once the Code is legislated. A mediation is generally a process whereby a mediator acts as a facilitator and seeks to assist a parties to reach an agreement. It is unclear whether the Code is intended to merely provide for a mandatory mediation process, or instead provide for a process by which the mediator can determine the temporary arrangements in a binding matter (similar to an arbitration). If it is the latter, in addition to the need to take care in preparing and conducting negotiations, we anticipate that disputes could arise in relation to the conduct of any such mediation and any determination made.

Further relief for landlords and tenants?

On 22 March 2020, the Australian Government introduced a new insolvent trading ‘safe harbour’ specifically to provide companies additional financial relief for debts incurred by a company in the ordinary course of its business on or after 25 March 2020 for a period of six months. This could provide further assistance to struggling landlord and tenant companies and help prevent insolvent trading liabilities and the associated consequences for a longer period of time.

What can we expect next?

In addition to information from states and territories on how the Code will be applied in each jurisdiction, we can expect announcements on further relief on land tax and rates, as well as guidance in relation to the support to be offered by banks.

.....

*The Commonwealth Government’s JobKeeper programme is a $130 billion JobKeeper payment provided as a subsidy to eligible businesses as of 30 March 2020. Employers of eligible businesses will receive a payment of $1,500 per fortnight per eligible employee for up to six months in order for the eligible employers to get back on their feet quickly after the pandemic ends. For further information on the JobKeeper programme, see https://treasury.gov.au/coronavirus/jobkeeper.

This article may provide CPD/CLE/CIP points through your relevant industry organisation.