The provisions of the Coronavirus Act 2020 have left UK retail landlords in a difficult position. The retail and leisure industry has been hit particularly hard, with some leisure businesses having been shut for nine months out of twelve. For almost a year, the government has repeatedly extended the prohibitions on landlords taking action against tenants for non-payment of rent. The latest extension expires on 30 June 2021.
The suite of remedies available to retail landlords against non-rent paying tenants are currently drastically curtailed. Landlords are restricted in their ability to serve statutory demands or winding up petitions in an effort to induce the payment of rent; commercial leases cannot be forfeited for non-payment of rent and there is a requirement for there to be at least 366 days’ rent due from 25 December 2020 to use the Commercial Rent Arrears Recovery action (CRAR).
Without these remedies, the pandemic has brought a shift in the balance of power between commercial property landlords and tenants. It has been reported that the government’s policy has contributed towards rent arrears reaching an estimated £4.5 billion.
As soon as the moratorium on evicting business tenants ends (which should be in June 2021 if the easing of lockdown continues as envisaged) landlords will be able to demand payment of all unpaid rent that has accumulated and if the rent remains unpaid invoke the various enforcement methods that are detailed above and are currently prohibited. However, the problem does not necessarily end there. Tenants in the retail and hospitality sector have had little or no income for almost a year and, even if the current easing of lockdown is successful, the sector may not be running at full capacity for some time, if social distancing measures continue. If the tenant is unable to trade in any real sense and there are no cash reserves then there may be little point in trying to recover rent. It remains to be seen how long it will take for retail and hospitality to recover, especially if there are recurring waves of the pandemic.
Some landlords may feel that particular tenants have little chance of recovery in a post-Covid market and may prefer to evict and find a more financially stable tenant. However, the empty stores on our high streets tell a story of there being less demand from the retail tenants and arguably the aim should be to find an arrangement with the current tenant that benefits both parties and shares the pain of the losses of the past year.
With the plethora of large high street retail or hospitality chains that have entered into company voluntary arrangements (CVA) in the last year, we have seen landlords willing to re-approach the negotiating table with their tenant and agree to either close some stores or re-negotiate lease terms seeing either a reduction in rent or a switch to a turnover rent structure. Some landlords are taking the view that a tenant paying rent, albeit reduced, is favourable to an empty unit and the business rates that would follow.
Whilst there is rumour that the government may be bringing in guidance on how the losses are to be shared between landlords and tenants, we have set out below our view of the practical options open to the landlord in the forthcoming months.
Rent concessions continue to be the “go-to” option between landlords and tenants as a way in which both parties can balance the risk between themselves. The tenant benefits from some breathing space until a time it can trade normally and the landlord benefits from having a tenant in situ, rather than a tenant entering administration, leaving an empty unit for which a new occupier needs to be found.
As a firm, Gardner Leader have seen various forms of rent concessions negotiated throughout the past year including one-off rent reductions, rent waivers and deferrals of lease payments. Some in return for a release of a tenant break or perhaps an extension of the term.
Whatever may have been negotiated and agreed, landlords should be wary about entering into any type of side letter or deed of variation without appropriate legal advice. These can present traps for the unwary. For example, extensions of the lease term will require a reversionary lease being put in place as without one, the old lease would be deemed surrendered resulting in implications for stamp duty and the release of liability of any former tenant or guarantor. Care also needs to be given on whether a lender’s consent will be required for a rent concession and whether or not the concession causes an inadvertent breach of banking conditions. Any side letter will also need to contain provisions to automatically terminate the concession in the event of a CVA so that the landlord’s voting rights are based on the full rent rather than the concession rent.
There has been a move in the last year for landlords to agree to vary their leases so that rent is based on a percentage of the tenant’s turnover. Turnover rents are not new and have been used by shopping centre landlords for many years. Historically, turnover rents have typically been drafted with an 80% base rent with the remainder topped up on a percentage of sales. However, in a tenant led market these percentages could drop to a 50-60% base rent or perhaps even a lease structure purely based on turnover. As with rent concessions, the aim is to share the risk between the parties.
However, the turnover rent approach is not without its problems. Turnover provisions are lengthy and expensive to negotiate and are not easy to slip into an existing form of lease. Consideration would need to be given to how on-line sales, click and collect and the marketing presence of the physical store may affect over-all sales and which of these the landlord should take a percentage from. Landlords also need to consider what happens in the event of assignment or sub-letting: would the turnover provisions continue for the incoming tenant? How would that work? Sometimes a shorter term prohibiting alienation (transfer or subletting) can be an answer.
Going forward, this may be the opportunity to consider a more flexible leasing structure for incoming tenants. We are seeing arguments that the industry should move away from the rigid constraints of longer leases, quarterly rent payments and regular upward only rent reviews towards a more versatile structure that balances market swings. Shorter leases, with upward and downward rent reviews, turnover rents, more frequent break options or even rolling breaks, with sub-letting of part permitted might be the balance required. In return, landlords could ask for larger rent deposits or personal guarantees from several of the tenant directors.
Court proceedings for non-payment of rent remain an option for landlords and are particularly useful where the landlord has reason to believe that the tenant has been able to operate successfully despite the Covid restrictions and therefore seems to be exploiting the moratorium. In these circumstances, proceedings can be brought now and landlords do not have to wait for the prohibitions to end. Most leases also provide that interest accrues on unpaid sums and therefore will be payable on any rent arrears despite the suspension period.
It may be that enforcing the tenant covenants and seeking possession of the premises is in the landlord’s interest, particularly if the long term sustainability of the tenant is questionable or if the landlord could re-let the premises to a tenant that can pay the rent. Currently forfeiture for non-payment of rent is unavailable but forfeiture on any other grounds could still be exercisable. Notice will need to be served on the tenant giving the tenant reasonable time to remedy any breach and only after that time has elapsed can the landlord re-enter the premises.
If you need any help or advice dealing with the impact of Covid-19 on your business and property, please do not hesitate to contact Clare King in our commercial property team.