Since the first wave of the COVID-19 pandemic and the early rent concession discussions, landlords and tenants have been grappling with providing for future pandemics. Early thinking that pandemic disruption should be an occupier risk was made difficult by the approach of insurers to occupiers' business interruption polices (now the subject of a Supreme Court decision). Whatever the ultimate outcome for 2020 policies, future insurance is unlikely to be the answer. So landlords and tenants have been trying to strike a balance in new lease drafting to deal with the risk of future pandemic disruption. But what is normal? What is fair?
A county court judgment has tackled COVID-19 rent suspension clauses and other familiar terms that tend to come up when negotiating lease renewals. Whilst this judgment is not binding on other courts, it provides a useful illustration of judicial thinking in this area.
The dispute related to a retail unit in a shopping centre (which included a post office and was therefore able to stay open throughout the pandemic as essential retail). When COVID-19 restrictions forced the closure of most shops, footfall to shopping centre fell dramatically. When the contractual term expired and the tenant sought a renewal lease, it asked to include a term that allowed for rent suspension during a pandemic.
In accordance with s.35(1) Landlord and Tenant Act 1954, a court will determine terms for a renewal lease if the landlord and tenant failed to agree them. The court will have regard to the terms of the current tenancy and to all relevant circumstances. There must be a good reason for the court to impose a new term not in the current lease against the will of either party. Further, the party proposing the change bears the burden of persuading the court for its inclusion.
Lesson 1 - Pandemic Rent Suspension Clauses Are Here To Stay
It is important to note that the parties agreed that there should be a pandemic rent suspension clause in the new lease, which reflects a growing acceptance in the market of such clauses. As this was not being imposed on the landlord against its will, the usual burden on the proposing party to justify the inclusion of the new term did not apply.
Before trial the parties also agreed as to the extent of the rent suspension - that 50% of the principal rent was payable, and any rebate or subsidy package received by the tenant should be paid to the landlord insofar as it related to the principal rent.
However, the parties disagreed as to what should trigger the rent suspension - was it sufficient that non-essential shops around an essential retail unit had to close, creating a poor trading environment, or instead was rent only reduced if the tenant itself had to cease trading?
Lesson 2 - Rent Suspension Clauses Are For Tenants Who Stay Open (But Maybe Not On The High Street?)
In this case, the tenant was an essential retailer and so could trade throughout the pandemic. Therefore, although the landlord agreed to a pandemic rent suspension, it argued that the only trigger should be a compulsory cessation of trading. The tenant disagreed - although not forced to close, it had been severely impacted by the closure of surrounding retail in the shopping centre, which dramatically reduced footfall. If rent suspension was triggered only by the tenant's closure, then the tenant (and other tenants who were essential retailers) would not be able to take advantage of reduced rent during a pandemic. In fact, it was more burdensome to remain open and trading in poor conditions with the attendant costs.
Bearing in mind this was a rent reduction rather than a complete suspension, the tenant proposed a trigger when non-essential stores were required to close (regardless of whether the tenant came within this category).
The court thought that the advantage of a tenant being able to remain open when non-essential shops were closed, was largely notional - trading was very restricted and there was no real competitive advantage to remaining open. The trigger for this rent suspension clause should be the closure of non-essential retail, even if the tenant did not fall into this category.
How far can this reasoning be applied to all shops, not only those in shopping centres? The judge had undertaken a site visit to the centre and noted how poor trading conditions were, noting, "I cannot imagine what competitive advantage the tenant could gain in circumstances of such restricted trading. Matters might be very different on the high street, but…if the non-essential retailers which surround the tenant…are closed, there is no advantage of any substance to the tenant in remaining open."
This is an important consideration - the entire physical trading environment should be considered when negotiating rent suspension clauses. It may be arguable that a rent suspension clause of this type should not be included where a shop is, for example, on a high street or surrounded by other amenities that attract footfall. If these other amenities remained open during a pandemic, or there are strong reasons for visiting a high street (because it is a main thoroughfare or close to popular green space), then it is arguable that footfall would not fall as sharply and such a clause should not be included in a renewal lease.
Lesson 3 - Promising to adhere to 'Principles of good estate management' will not allow a landlord to slip in vague new terms
The landlord sought to expand the service charge provisions so that more expenditure could be recovered from the tenant, such as costs of energy audits and obtaining Energy Performance Certificates. This was on the basis that it reflected reasonable modernisation, as the wider provisions were contained in the latest form of precedent lease Westfield tenants were required to sign. The tenant argued that the new wording would allow charges for substantial new works - to which the landlord countered that it would be obliged to act reasonably in accordance with 'good estate management principles'.
The court thought that the proposed new service charge terms were vague, and a landlord could not compensate for this vagueness by relying on the 'uncertain mantra' that everything will be conducted in accordance with principles of good estate management. Landlords should be able to explain exactly what new liability proposed terms will cover (if any) and, if relying on a general qualification, how this qualification will operate to ensure fairness to the tenant. In this case, the terms were vague, could create further litigation and unfair liability for the tenant, and 'good estate management' did not create a clear check on the landlord.
We have been considering appropriate lease terms to deal with energy efficiency improvements and the strategic drive to comply with increasing minimum energy standards through service charge and otherwise. We think there is a fair and balanced way to achieve this without relying on uncertain concepts. It will be interesting to see how this particular issue is dealt with in higher courts in the future as landlords grapple with regulatory requirements and market demands to improve the energy performance of their buildings.
Finally, whether in lease renewals or new leases, landlords and tenants should consider early and ensure there are clear agreed positions on both pandemic disruption risk and energy efficiency improvements. Pandemic clauses in particular are here to stay - particularly in retail property.
Key points to consider for pandemic rent suspension clauses
- What is the risk? - Covid-19 restrictions or any future pandemic related restrictions.
- Trigger? - Is the suspension triggered by trading conditions, occupier decision to close, local or national restrictions etc.? What if the occupier can trade (e.g. an essential retailer) but chooses not to? Or chooses to operate in a reduced way (e.g. click and collect, takeaway restaurant).
- End date - what will end the suspension? Is it a fixed period? The release of restrictions or the date the occupier chooses to re-open?
- Rent or more? - What is suspended? Just rent or will other financial payments be suspended? In some cases, it may be appropriate for other ongoing tenant obligations that require physical occupation to be suspended. Particular care is needed over service charge as a landlord may need to continue to provide services even though occupiers are not trading (e.g. security and maintenance).
- Suspended, reduced or deferred? - Is the occupier relieved of its obligation to pay altogether or liability reduced or only deferred to a later date?
- Landlord obligations - Should any landlord obligations or services be expressly suspended?
- Circumstances - Some clauses apply automatically and some factor in circumstances at the time (e.g. the availability of insurance, government support etc.)
- Termination - Will the clause allow the landlord to terminate the lease if the suspension continues for a particular period?
Get in touch with us if you would like to discuss what this will mean for your business.