Mandatory Code of Conduct – SME Commercial Leasing Principles During COVID-19 Pandemic

On 7 April 2020, the National Cabinet released the Code of Conduct (Code) applicable to all commercial tenancies (including retail, office and industrial tenancies) affected by the COVID-19 pandemic.

The Code envisages the affected tenants and landlords will engage in good faith negotiations to amend their existing leasing arrangements and sets out a series of mandatory principles for tenants and landlords to guide and regulate these good faith negotiations. It is envisaged that the Code will be implemented uniformly across all States and Territories.

Which tenancies fall within the application of the Code?

The Code applies to all non-residential tenants that:

1. are eligible for the Commonwealth Government’s JobKeeper program; and
2. have an annual turnover of $50 million or less.

For franchises, the $50 million turnover threshold will be applied at the franchisee level. For retail corporate groups, the threshold will be applied at the group level.

The Code applies to tenants of all business structures, whether the tenant is a sole-trader, partnership or corporation.

The Code may cease to apply to any tenant that fails to abide by the substantive terms of its lease (subject to any amendments negotiated under the Code).

What are the principles under the Code?

The following principles apply and must be followed when tenants and landlords negotiate and implement arrangements in response to the COVID-19 pandemic:

1. (No termination) Landlords must not terminate leases due to non-payment of rent during the COVID-19 pandemic period and reasonable subsequent recovery period. The COVID-19 pandemic period means the period during which the JobKeeper program is operational.
2. (Rental waivers and deferrals) Landlords must offer tenants proportionate reductions in rent in the form of waivers and deferrals of up to 100% based on the reduction in tenants’ trade during the COVID-19 pandemic period and a subsequent reasonable recovery period.
   • Rental waivers
     Rental waivers must constitute no less than 50% of the total reduction in rent and should constitute a greater proportion if failure to do so would compromise the tenant’s capacity to fulfil its ongoing lease obligations. Regard must also be had to the landlord’s financial ability to provide rental waivers. Tenants may waive the requirement for a 50% minimum rental waiver by agreement.
   • Rental deferrals
     Rent that is deferred must be amortised over 24 months or the balance of the lease term, whichever is the greater, unless otherwise agreed by the parties. Further and in line with principle #4 below, the tenant must not be required to repay any part of the deferred rent until the earlier of the COVID-19 pandemic ending or the existing lease expiring.
3. (Reduction of outgoings) Landlords will be required to pass on to tenants any reduction in statutory charges. Where appropriate, landlords should seek to waive the recovery of outgoings during any period the tenant is not able to trade. In return, landlords can reduce the services provided under the tenancies.
4. (Repayments) Where negotiated arrangements under the Code require repayments, these repayments should occur over an extended period and no repayment should commence until the earlier of the COVID-19 pandemic ending or the existing lease expiring.
5. (No drawing on security) Landlords must not draw on tenants’ security for the non-payment of rent during the COVID-19 pandemic period and subsequent reasonable recovery period.
6. (Freeze on rent increases) Rent must not increase for the duration of the COVID-19 pandemic period and a subsequent reasonable recovery period.
7. (No penalties for closing shop) Landlords must not penalise tenants for reducing opening/trading hours or ceasing to trade due to the COVID-19 pandemic.
8. (Lease extension rights) Landlords must offer tenants the option to extend their existing leases on the same terms for a period equal to rental deferral period.
9. (Landlord to share mortgagee concessions) Landlords should seek to share with tenants in a proportionate manner any benefit received due to deferral of loan payments provided by a financial institution as part of the Australian Bankers Association’s COVID-19 response.

What if the landlord and tenant can’t reach an agreement?

The Code recommends such matters should be referred and subjected to the applicable retail or commercial leasing dispute resolution processes for binding mediation. We anticipate the finer details of the mediation process will be set out in the local legislation and regulation used to implement the Code.

What should tenants and landlords do now?

The Code is a significant step taken by the combined Commonwealth and State and Territory governments to provide relief and protection to commercial tenants and, to a lesser degree, landlords. Currently, the Code has no practical legal effect and requires the parliaments of the States and Territories to implement the principles contained in the Code through local legislation and regulation. We expect the States and Territories will move quickly in this regard.

Tenants and landlords alike should be reviewing their leases and their financials to take stock of their legal and financial position. Tenants and landlords are encouraged to start transparent, constructive and good faith negotiations in line with the principles set out in the Code. Once a negotiated outcome is reached, leases should be varied in a formal and appropriate manner and with the appropriate legal input.

Example of the application of the Code

Assume:

• a commercial office tenant has a turnover less than $50,000,000 and is eligible for the JobKeeper program;
• the tenant has experienced a 50% loss in trade due to the pandemic;
• the tenant has 40 months left on its lease; and
• the pandemic and associated recovery period for the particular tenant is 9 months.

The Code applies to the tenant as follows:

1. the monthly rental instalments for the next 9 months (given the assumption of a 9 month COVID-19 pandemic period and associated recovery period) will be reduced by 50% (given the assumption of a 50% loss of trade for the tenant);
2. of that 50% reduction in rent, half of it will come 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;
3. the tenant must continue to pay the 50% balance of the rent as it falls due, or risk losing the benefit of the Code; and
4. after 9 months, when business returns to normal and the lease has 31 months left to run, the total amount of the deferred rent will be divided equally over each of the 31 months left in the term of the lease and added to the ordinary rent payable.

Problems with the Code

The Code is an attempt to provide a one-size-fits-all approach to thousands of different commercial arrangements and was never going to be perfect. Some obvious issues with it include:

• uncertainty and risks for landlords where leases expire prior to the minimum 24-month rental deferral period, as the mechanism by which landlords can “secure” the required lease payments (such as the deferred rent) after the lease expiry may be problematic;
• a lack of certainty around key application periods given the expansion of the term “COVID-19 pandemic period” to include “a reasonable subsequent recovery period” and whether that will be applied on a case by case basis or by reference to the economy as a whole;
• how mediation processes might operate, particularly for lease arrangements not currently the subject of agreed mediation mechanisms or in circumstances where the lease itself may have a mediation process that may contradict what may be mandated in response to the Code;
• how these changes may affect agreements for lease where the contemplated lease itself is not yet operational; and
• whether the Code will prohibit landlords from exercising rights in respect of historic arrears incurred prior to the COVID-19 pandemic period or whether the moratorium only relates to rent unpaid during the COVID-19 pandemic period or subsequent reasonable recovery period.

Where to from here?

We will continue to monitor the implementation of the Code by the States and Territories closely and provide a further update in due course. In the meantime, we encourage landlords and tenants to contact us for assistance.