This article was first published in the September 2020 edition of Property in Practice, the magazine of the Law Society’s Property Section.
Lockdown has presented unprecedented challenges for both landlords and tenants. Nikki Bensoor looks at the impact on commercial lease arrangements, now and in the future.
Nikki Bensoor is a Senior Associate in the Commercial Property department at NSS Legal Limited.
Following the shutdown of non-essential businesses in England just before the March quarter date, many tenants sought rent deferrals and/or reductions. This forced landlords to ask themselves how they can preserve their investments and relationships with tenants at the same time as managing obligations to their lenders.
Since May, businesses have started to reopen, but many premises are still empty, with rent unpaid. One major London commercial landlord has said that just 28% of rents were collected up to the June quarter date from its commercial tenants. Could amendments to traditional commercial leases help reduce the shortfall?
COVID-19 is likely to have a longer-term effect on lease terms. Many landlords and tenants are demonstrating the “collaboration and transparency” highlighted in the government’s recent Code of Practice for commercial property relationships during the COVID-19 pandemic (the code). However, the code is voluntary, so it is not clear whether all parties will adopt it when negotiating new leases, or if the market and the parties’ relative bargaining powers will prevail.
Trends in the Leasehold Market
Many tenants now want to include, if possible, a rent suspension clause if they cannot use their premises. This suspension could specifically relate to COVID-19, or if premises are forced to close due to government-imposed restrictions. This is known as a “coronavirus clause”. Interestingly the code does not propose full rent suspension, but encourages discussions around what tenants can afford to pay and the support landlords can provide. Tenants seeking to rely on the code may need to present financial and other information to support their requests. If landlords reject tenants’ proposals, they must justify this. Landlords, or tenants for that matter, keen to maintain the status quo in the longer term may be more prepared to negotiate.
Traditionally, leases do not include force majeure clauses – those that allow either landlord or tenant to end the lease where certain specified events occur. Such clauses may become more popular following the pandemic, as tenants seek relief from paying rent and other liabilities if they cannot occupy their premises.
Shorter Lease Terms and Break Rights
It seems tenants are seeking flexibility – release from lease arrangements – often more than security, although their stance will depend on the nature of their businesses. Some tenants are therefore requesting shorter lease terms and additional breaks. The recent period of imposed closures and the risk of future lockdowns mean tenants are more likely to push back on break conditions requiring “vacant possession”, since they may not be able to access premises to remove and reinstate in the usual way.
Typically, leases with rents based on turnover generated at the premises have been used in the retail sector, and are becoming more common in other sectors, including serviced offices. A turnover lease could lend itself to a more collaborative approach, where both parties’ interests are more closely aligned. However, landlords may want to ensure that turnover leases include a guaranteed rent, with a top-up based on turnover.
Keep Open Clauses
Linked to turnover rents, more leases could include ‘keep open’ clauses obliging tenants to maximise business. A widely used exception for tenants allows them to remain closed if events happen “outside of their reasonable control”. Closures caused by COVID-19 could fall within this category. For clarity, tenants may seek specific exclusions in the event of future government-imposed closures.
Landlords with maintenance obligations should assess whether additional services will be required as a result of COVID-19, such as more frequent cleaning of toilets, eating areas, desks, door handles and handrails. Landlords are likely to hold firm on the ability to recover these costs as part of the service charge, and assert that they form part of costs associated with “good estate management” or “required by statute”. However, tenants may argue that such additional costs should be excluded, as there could be an unreasonable spike in outgoings.
The dynamics of the relationship between landlord and tenant has never been more important than in these unprecedented times. The landlord’s lender may also have a part to play. We wait to see whether parties will embrace the code and accept the need to share costs and business risks. In my view, the code will play a more important role in negotiations, so the conventional lease will need to evolve, and possibly include some of the provisions referred to above. How landlords and tenants react in the post lock-down environment will ultimately be determined by how business practice, the market and the wider economy develops.