We have been following the travails of the high street for over 12 months where changing shopping habits, business rates and rent increases have been contributing to a growing strain on many landlord / tenant relationships. The Covid-19 pandemic has not only turned a bad situation critical for many retailers and hospitality venues but has also turned the spotlight on the wider commercial sector too.
Almost all businesses operating across the country have suffered financially to a greater or lesser extent as result of the economic downturn precipitated by the imposition of lockdown in March. Despite the economy slowly emerging from lockdown, the damage already done to company balance sheets will take months to heal and nowhere is this more evident that the negotiations ongoing between commercial tenants and their landlords.
Code of Practice designed to promote ‘reasonable behaviour’
The government issued a Code of Practice at the end of June designed to “to reinforce and promote good practice amongst landlord and tenant relationships as they deal with income shocks caused by the pandemic.” The intention is clearly to reinforce government support to date for otherwise viable businesses. The Code encourages landlords and tenants to take a proactive, reasonable approach to negotiating their way out of what is a financial crisis for both parties by exploring “arrangements outside of the existing letter of their leases in order to create a shared recovery plan.” The motivation for landlords and tenants to behave ‘reasonably’ is considerable.
Although much of the government’s focus has been to protect tenants (including extending the protection from eviction from 30 June to 30 September, suspending Commercial Rent Arrears Recovery (CRAR) procedures unless rent is more than 189 days overdue, and the temporary suspension of the insolvency rules), rents due (which include any amount payable under the lease) will continue to accrue while these measures are in place. Thus, it is in both parties’ interest to maintain a collaborative dialogue as once the current legislation lapses, landlords will be able to claim forfeiture for unpaid rent.
How landlords and tenants are adjusting to the new reality
In April we noted that lease re-gearing, which allows tenants more flexibility to review their lease on more favourable terms (including negotiating revised rents and the opportunity to invest in the property and / or to extend the contractual period) was gaining considerable traction, not only on the high street but also among non-retail tenants. The pandemic has simply lent more urgency to negotiations, with non-collection of unpaid rent in exchange for longer-term commitment to a lease, monthly rather than quarterly rent payments, delay of rent reviews and use of the rent deposit all being considered.
Turnover leases gaining in popularity
Reports of large retail tenants using their commercial clout to renegotiate their leases have been joined by reports of landlords taking a more proactive, creative approach to keeping their tenants onside. Just recently a number of large landlords including the Howard de Walden, Cadogan and Millfield Estates have all announced that they will be offering rents based on a percentage of their tenants’ turnover. Turnover leases have long been in favour with retailers: landlords can benefit in the good times while sharing the pain in bad times. However, it is worth bearing in mind that what is actually included under such a calculation is subject to negotiation – retailers will try and exclude certain elements from their turnover rent calculations, such as items returned to a store, products purchased online and collected in store, and other such “click and collect” transactions. They are also administratively burdensome requiring details of what has been sold and provision of turnover certificates to the landlord. Nonetheless, if surveyors and lawyers are involved early on to ensure the right arrangements are put in place, costly delays and disputes further down the line can be avoided.
Keep open covenants
Other aspects of commercial leases that may be irreversibly changed by the experience of trading through a pandemic is the inclusion of keep open covenants. Such clauses requiring the premises to remain open will have been overridden by legislation requiring closure (as per the order for all non-essential premises to shut in March). As leases are renegotiated to take account of new trading conditions, it is almost certain that these covenants will be part of any review, and it is quite possible that they will only be retained in very particular circumstances.
New world order
This pandemic has turned everyone’s world upside down. It is true to say that the relationship between landlord and tenant was already in flux before Covid-19 struck. Now, everyone realises that there is no going back – the genie is out of the bottle and both landlords and tenants are having to find new ways of working together. The more flexible and agile we are in the way we operate, the better equipped we will all be, as businesses, to deal with the next one.