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Tuesday, 17 March 2020

COVID-19 and Commercial Leases – What Can a Tenant Do?


The Coronavirus Covid-19 pandemic presents immense challenges for our healthcare system and our economy and poses an existential threat to many businesses.

The government has announced today that it will do “whatever it takes” to support businesses, backed up with unprecedented measures including business rates holidays, non-repayable cash grants and access to interest-free loans. We’ll have to wait and see how effective these measures will be, and the government has said there are more to come.

Nevertheless, faced with having to close premises for lengthy periods of time, tenants will want to know where they stand under the terms of their lease.

There’s been a flurry of very useful articles in the legal press on the issues that arise.

Although in many cases the position will be fact specific, I shall attempt in this piece to draw together what I think are the main points that have been discussed.

Force majeure

Force majeure clauses, which allow a party to terminate a contract for a force majeure event or “act of God” are very rare in modern commercial leases.

I can’t recall ever seeing one, other than in commercial contracts or in leases that were drafted in the US (where such clauses are much more common), so this is very unlikely to apply in England and Wales. Even if there is such a clause, it would need to be drafted in a way that applies to a disease outbreak.

Frustration

Will a tenant be able to claim its lease has been frustrated by the outbreak?

As the law currently stands, this looks unlikely.

Frustration, based as it is on largely ancient law, is a doctrine rarely used as a way of getting out of contracts. It operates to bring a contract prospectively to an end because of the effect of a supervening event.

To succeed you must be able to demonstrate that something unforeseeable has happened after completion that makes it impossible to fulfil the contract and unjust to hold a party to its obligations.

It’s not something that can be demonstrated easily.

We saw that last year when frustration was examined closely by the High Court in a case involving the European Medical Agency. The Court concluded that Brexit did not frustrate the EMA’s lease.

The EMA was granted leave to appeal that decision to the Court of Appeal, but subsequently settled its case and so unfortunately for us the arguments were not tested before a higher court.

I think the other reason why frustration is likely to fail as an argument is that although the closures may end up being for a lengthy period, they will still be temporary.

Still, who’s to say someone won’t try and run this argument as the crisis unfolds? If they do, frustration could find its way back on a path to the Supreme Court.

Rent suspension

Most rent suspension clauses too are unlikely to come to the aid of the tenant.

Those clauses normally apply where premises have suffered substantial physical damage and, as a result, they cannot be occupied, or are incapable of being accessed.

That’s not the case here as there’s been no physical damage to premises.

The loss will be purely financial and so is not one that’s likely to be covered by the landlord’s insurance policy.

Leases often also deal with damage by uninsured risks, but again these clauses tend to focus on damage to the premises themselves, rather than financial losses.

Having said all that, given the scale of the problem and the fact that it affects the whole country, landlords may be forced, as a matter of commercial good sense, to react more proactively.

If they can afford to do so, some landlords may decide it’s better to waive rental payments during a period of lockdown rather than allowing all their tenants to go bust, leaving them with an empty shopping centre, a trail of resentment and reputational damage.

Keep open clauses

Many shopping centre leases, for example, contain covenants requiring a tenant to keep its premises open during the centre opening hours.

So, what happens if the government imposes a lock down forcing centres to close, or if a tenant is forced to close due to staff self-isolating?

If a centre is closed by government lock down, then it’s hard to see how a landlord could argue the tenant was in breach of a keep open covenant. There’d be no way of opening in those circumstances.

Most leases also contain a tenant’s covenant to comply with statute and official guidelines, and so by a tenant complying with a curfew for example it would be fulfilling its obligation under that covenant, and I’ve seen it argued that this statutory compliance covenant will override the keep open clause, although there’s no authority on this yet.

If a tenant is simply forced to close for staff shortages, the precise wording of the keep open clause may assist the tenant.

If there are caveats in the clause, such as being able to close for reasons “outside the tenant’s control” or where staying open is unlawful, then a tenant may be able to use these as justifications to close.

The position is largely going to be fact specific.

What can a landlord do about closure in these circumstances anyway?

It’s established law that a landlord cannot enforce keep open covenants by injunction.

As for damages, it will be difficult for a landlord to claim it has suffered loss caused by the closure, rather than more generally by the pandemic itself, especially if it’s receiving rent and the rent isn’t based on turnover.

Even in the absence of a keep open covenant, a commercial lease is likely to require the tenant to inform the landlord if it’s leaving the premises unoccupied, and in standalone premises the tenant might have to put in place security arrangements for safeguarding.

Stopping paying the rent

Commercial leases nearly always have clauses that prevent a tenant from withholding payment of rent.

A tenant who stops paying rent will be in breach, which will entitle the landlord to forfeit the lease and sue for non-payment, or attempt to recover the arrears through the Commercial Rent Arrears Recovery (CRAR) statutory procedure.

Some leases reserve rent that’s based on turnover, and in those cases the landlord too will take a hit.

Who pays for the “deep cleans”?

Whether or not the landlord authorises a deep clean of the common parts in a shopping centre is likely to be at their discretion, although statutory compliance may be listed as a mandatory service in some leases.

The cost of deep cleans is likely to be passed on to tenants through the service charge.

Most service charge provisions are sufficiently widely drawn to allow for the recovery of this expense, even though it won’t be expressly stated, provided it’s reasonable and in the interests of good estate management (which it surely will be in a pandemic).

If cleaning routines are imposed by statute, then this makes it more explicit as most service charge clauses allow landlords to charge for statutory compliance.

There’s always the chance some landlords may take a different, more generous approach. It remains to be seen. Also, landlords may be able to offset some of this cost by withdrawing other services that are not needed during periods of closure, although sadly that will have knock-on effects with the contractors employed to carry out those services.

Closing the centre

From a landlord’s perspective, they may feel they have to shut down a centre to stop the virus from spreading.

This raises some difficult issues.

Landlords can generally impose reasonable regulations for managing the centre, such as limiting access to certain common parts, but the tenants themselves are responsible for health and safety within their premises, and so it may be difficult for a landlord to impose measures which are at odds with the tenant’s right to quiet enjoyment and non-derogation from grant.

If a landlord is forced to close a centre by law or government guidance, then it can rely on the tenant having to comply by virtue of its statutory compliance covenant.

Common sense, reputational concerns and the need to preserve good landlord/tenant relations ought to govern how things are dealt with in most cases.

Insurance

Tenants will be looking carefully at their business interruption insurance policies. However, most of these will be restricted to property damage or may themselves include force majeure provisions that prevent a claim from succeeding.

If the policies do permit a claim for a pandemic, in the announcement made today the Chancellor indicated that the government would ensure that successful claims can be made, even though the closures have not yet been mandated by the government. We’ll have to wait and see how that works in practice, and whether help is extended to businesses whose policies do not specify pandemic cover. The situation is changing daily.

Even if a claim does succeed, there’s a risk the money isn’t paid out before the tenant has gone bust - another area where government intervention might be necessary.

New leases

This outbreak is already having an impact on lease negotiations.

Many transactions will be put on hold or cancelled altogether. Where matters are ongoing, at the very least I would expect that tenants will be looking to beef up the rent suspension clause.

Perhaps tenants and their advisors will now also be looking to include termination rights for unforeseen events. The return perhaps of force majeure, where I started this piece?

This is a fast-moving situation, and we’re all learning as it goes along. There will be many other fact specific situations not covered here that will test the landlord and tenant relationship.

Commercial leases aren’t designed to cope with pandemics where freedom of movement becomes severely restricted or banned altogether.

The best thing to do is keep a close eye on all new government announcements (now daily) and any new legislation.

Most importantly, landlords and tenants should keep talking to each other, even if that now means via video conferencing. The best way through this will be co-operation rather than pouring over the small print.

Keep a record of any discussions and their precise timing relative to the government guidance that was in place at that time, bearing in mind it changes daily.

I’ll continue posting on twitter links to any articles I see that I think might be useful, alongside all the usual memes and other nonsense I feel compelled to tweet. Got to keep smiling after all!

Stay safe.

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