Commercial leases in a time of COVID-19

Business tenancies have been under the spotlight during the COVID-19 pandemic and the landlord and tenant relationship has been put under unprecedented strain. What, then, of the balance of power? Have tenants been given the upper hand? Is it right to say, as Nick Leslau (Chairman of Prestbury) has stated, that landlords have been “utterly castrated”?

The short answer is that, while “utter” castration may be going a little far, it is a fact that, currently, landlords have very few meaningful remedies available to them. With the June quarter day fast approaching, and the cash reserves of many tenants dwindling at an alarming rate, rent collection is more of a concern than ever for the whole commercial property community.

What is actually going on and what has changed?

Landlord remedies

Starting at the beginning, under normal circumstances landlords enjoy a varied repertoire of remedies for dealing with defaulting tenants. By way of brief reminder, these are:

• Forfeiture. Almost every income generating lease contains a forfeiture clause (or right of re-entry) for non-payment of rent, which allows a landlord to take back possession and evict a tenant if it fails to pay the rent. This is the most basic and binary tool in a landlord’s armoury, and one without which a landlord feels exposed.
  
  
• Commercial Rent Arrears Recovery (CRAR). Although a landlord’s right to send in the bailiffs has been reduced / complicated in recent times, the ability to enter premises and remove a tenant’s effects to satisfy a debt is a crude but effective measure that is hard-wired into the commercial landlord and tenant relationship.
  
  
• Statutory Demands. Another option is the statutory demand, a relatively straightforward procedure that can ultimately result in the winding-up of a tenant company if the underlying debt is not paid. The statutory demand is intensely disliked by tenants, mainly because it often achieves the desired outcome.
  
  
• Debt claim. A less potent method for the recovery of arrears is the debt claim. Subsequent enforceability / recovery can be time-consuming but the great appeal of suing a tenant for arrears is the simplicity with which judgement can be obtained.
  
  
• Enforcement of security. Finally, where available (and appropriate) landlords may enforce against any security they have against the tenant’s non-performance. Depending on what the landlord is able to negotiate at the beginning of the landlord and tenant relationship, this can take a number of different forms: from drawdown under a rent deposit; to claiming against guarantors and/or former tenants who may still be on the hook; to requiring sub-tenants to pay their rent to a superior landlord directly upon service of notice.

This collection of remedies has underpinned the commercial property investment market for many years and is one of its fundamental tenets. However, swift Government action taken since lockdown has, effectively (if temporarily), rendered landlords far more impotent than they would like.

What has changed?

The Government has, so far, stopped short of suspending rent payments altogether, but the net effect of its actions to date is the provision of considerable protections to tenants. This has been achieved by some speedy legislative action.

1. Coronavirus Act 2020

On 26 March, the Government brought in the Coronavirus Act 2020, a wide-ranging statute addressing issues of immediate concern as the pandemic spread through the UK at an alarming rate. The Government’s opening salvo against the hidden enemy, the Act seeks to provide relief to tenants crippled by COVID-19 and the effects of the nationwide lockdown. The Act fundamentally alters the landscape for commercial landlords in two ways.

• Forfeiture. Of most significance is the moratorium on the forfeiture of commercial leases for non-payment of rent during the relevant period (26 March until 30 June 2020, or such later date as may be specified). “Rent” has a broad meaning under the Act, and it can be construed to include all payments required to be made by a tenant – including service charge, insurance payments and interest, and the Act applies equally to arrears that accrued before the relevant period and where their accrual had nothing to do with COVID-19. During the relevant period, a landlord cannot evict a tenant for the non-payment of sums due under a lease and the Courts are unable to make an order for possession.
  
  
• CRAR. The Act also prevents landlords, until at least 30 June 2020, from using CRAR unless they are owed 90 days or more of unpaid rent. CRAR is also no longer available where a tenant has made a partial payment of the outstanding sum. The exercise of CRAR was already mired in logistical difficulties as a result of lockdown, but its treatment under the Act has made it even less likely to be used.

The Act doesn’t apply to short leases (less than six months), or to contractual arrangements that do not amount to a lease, but otherwise its net is cast over the whole of the commercial property world.

2. Corporate Insolvency and Governance Bill

On 20 May, the Government went a step further when it published the Corporate Insolvency and Governance Bill. While it is not yet law, the Bill is being fast-tracked and will soon be on the statute book, presumably pretty much in its current form. The Bill, as drafted, is wide-ranging and much of it goes way beyond simply responding to the pandemic. As it concerns commercial property, the Bill represents a hardening of the Government’s position on the use of the insolvency procedure by landlords to recover arrears.

Statutory Demands and Winding-up Petitions

At the core of the Government’s thinking is their statement that “insolvency proceedings…are not intended to be used as a tool for debt collection but are to deal with financial failure and tackle companies that are no longer viable”. This is clearly reflected in the (temporary, at least for now) approach that the Government has taken to the use and operation of statutory demands and winding-up petitions, which can be summarised as follows:

• Winding-up petitions cannot be presented on or after 27 April based on a statutory demand served during the “relevant period” of 1 March to 30 June 2020 (or, if later, one month after the legislation comes into force).
  
  
• A petition based on an inability to pay debts cannot be presented by a creditor in the “relevant period” unless the creditor has reasonable grounds for believing that: (i) coronavirus has not had a financial effect on the company; or (ii) the company’s inability to pay was not caused by the COVID-19 pandemic.
  
  
• For petitions presented in the period between 27 April and the legislation coming into force, the Court can make appropriate (retrospective) orders to restore the debtor’s position to what it was before the petition was presented if the creditor did not hold the necessary belief about the non-impact of COVID-19. Furthermore, winding-up orders which would not have been made had the legislation already come into force are rendered void (although protection is given to a liquidator in respect of any actions taken based on the order).

• Although they will only apply for a limited period, these restrictions are extensive and are likely to prevent almost any debt-based winding-up petitions being presented during the “relevant period” unless the debt(s) relied upon arose long before the COVID-19 crisis. In particular, it is worth noting the requirement that the Court must be satisfied that Coronavirus (rather than the national lockdown) did not have a financial effect on the company; potentially, this is extremely broad and could include the fall in consumer confidence that pre-dated the UK’s first Coronavirus case. It is likely, therefore, that many creditors will err on the side of caution and not present a petition between now and the end of the “relevant period” given the risk of any winding-up order being voided.

Moratorium

The other key feature of the Bill, from a landlord and tenant perspective, is the permanent introduction of a new free-standing “gateway” moratorium process, under the Insolvency Act 1986, and the repeal of the existing small company CVA moratorium. This is an important addition to the recovery options available to struggling companies.

The provisions are detailed but, in brief, the moratorium provides almost all companies with breathing space from creditor action if the company is, or is likely to become, unable to pay its debts and it is considered that the moratorium will allow the company to be rescued as a going concern. This is an important distinction from, say, administration, as the focus of the moratorium is on the recovery of the company rather than the realisation of its assets.

The moratorium will last for an initial period of 20 business days, but can be extended: (i) by the directors of the company for another 20 business days; (ii) with creditor consent for a total period (including the initial 20 business day period) of a year; and (iii) by the court for an unlimited period. The directors of the company will continue to run it, subject to the requirements of an independent “monitor” (an insolvency practitioner) who will be appointed to oversee the moratorium.

The treatment of the company’s debts during the moratorium is not entirely straightforward, but it is clear that pre-moratorium debts (which fell due before the moratorium and those falling due during the moratorium but arising from an obligation incurred prior to the moratorium) benefit from a payment holiday during the moratorium – the purpose of which is to ease the company’s cash flow. Certain pre-moratorium debts will not benefit from that holiday, including rent in respect of a period during the moratorium, which at least is good news for landlords.

The moratorium does prevent certain actions without court consent, with the effect that (as and when they are available again) the usual insolvency regime bar will be placed on: commencing insolvency or legal proceedings; the use of CRAR; enforcing security over property (possibly including rent deposits); and forfeiture by peaceable re-entry.

While this creates another layer of protection for defaulting tenants, this new regime has not been met with undue criticism from creditors. Indeed, while there is nothing in the Bill requiring the company to pay debts that do not benefit from a holiday, the company’s directors have to confirm that the debts have been paid before they can extend the moratorium – and the monitor has to bring the moratorium to an end if he thinks the company is unable to pay these debts. Together, these provisions should provide some comfort to landlords that the company will continue to make rent payments during the moratorium. 

That said, the interpretation, application and implementation of these provisions may give rise to disputes concerning the monitor’s obligations to terminate a moratorium if moratorium debts are not paid. These issues could have a direct effect on landlords and their ability to take timely action against defaulting tenants to protect their interests. Time will tell how these will ultimately be ironed out.

With all that in mind, what can, or perhaps should, landlords do now?

Some remedies remain available

It is important to stress that there are still remedies available to landlords. In addition to operating around the fringes of what remains permitted within the CRAR and statutory demand regimes, landlords do have options.

• Forfeiture otherwise than for non-payment of rent. Landlords may still forfeit for tenant breaches other than non-payment of rent, including tenant insolvency (although that brings additional complications and is rarely a straightforward process). Certain landlords have been exploring this avenue as a possibility and, while forfeiture for anything other than non-payment of rent can be time-consuming, uncertain and costly, it remains available.
  
  
• Debt claim. Landlords remain able to bring debt claims for non-payment of rent. As identified earlier, however, the tricky bit has always been enforcement / recovery of monies, and that is now likely to prove trickier than usual, reputationally as much as legally. It is also the case that the Courts are operating a skeleton service and their backlogs are growing larger than ever. Even if a claim is filed, it will probably take many months to be issued and served, let alone concluded.
  
  
• Enforcement of any available security. Where landlords have the benefit of security – whether in the form of a surety, a former tenant, an AGA, a rent deposit or a bank guarantee – then, subject to the terms of that security and in the absence of anything else (eg the effect of any moratorium on actions by a creditor), there is no reason why security cannot be called on to satisfy a debt.

To act or not to act?

The bigger question is whether taking any of these options really represents a satisfactory solution to the problem, particularly given the wider socio-economic circumstances and the need for landlords to have regard for their reputations in the market.

The current hiatus might present an ideal opportunity to unseat a troublesome or vulnerable tenant, and in those situations landlords’ temporary impotence must be a source of great frustration. It is worth remembering, however, both that this situation is temporary and that the consequences of current tenant failures will live on. The debts owed by tenants, and the interest accruing on them, will not simply vanish when the world gets back to something like normal, and any action taken by landlords during the operation of the emergency provisions will not waive the right to forfeiture.

Perhaps more importantly it should be kept in mind that, in the vast majority of cases, forfeiture or any of the other more nuclear landlord remedies tend to be pretty low down the “to do” list of most landlords. That is particularly the case now, when taking back empty space and difficulties with re-letting make lease expiries and subsequent voids (and the costs associated with them) extremely unappealing.

Better to play the long game?

While some will flex their muscles when the going gets tough, for the majority of landlords, patience and collaboration tend to bear greater fruit in the long run. The ability to foster and sustain good landlord and tenant relations is one of the real skills (if not the hallmark) of good asset management, and the pandemic presents an excellent opportunity here. Time taken to speak to tenants and to really understand their business and their long-term plans can reap rewards over time.

It has been noticeable how a good number of landlords have worked hard to make something of a virtue of the mess that the economy has been landed in. As well as ensuring compliance with the Government’s plea that landlords and tenants work together and helping to shed the image of the “greedy landlord”, by granting temporary rent deferments, monthly concessions or even reductions, landlords have managed to turn the situation to their advantage through savvy and far-sighted active asset management.

For instance, a comparatively short rent suspension (of three to six months) to a fundamentally sound tenant in exchange for a re-gear adding an extra five to ten years at the end of the lease feels like a good deal. Similarly, the grant of an affordable rent free to a charity, community-focused or ESG tenant is a good story in the face of the unprecedented challenges facing those sectors of the economy, and the ever brighter light being shone on the environment.

The lesser of two evils

Another key benefit of a less aggressive approach is that a deal done now to help ease a tenant’s short-term financial pain may help avoid, or at least delay, the need to engage an insolvency rescue procedure that the tenant might otherwise have felt compelled to fall back on.

A quick glance at the business section of almost any newspaper will inevitably include grim tidings of yet another household retail or leisure name entering administration or a CVA – and the raw deal meted out to that businesses’ creditors. If that can be avoided, then so much the better, and with rent representing a key overhead for businesses, currently at the eye of the storm, landlords are uniquely well placed to help do just that.

Papering up the problem

All that being said, times change and it may well be that down the line a landlord will wish to switch tactics, if the tenant’s business is showing no signs of improving. Equally, inevitably the market will pick up (it will, it always does) and a landlord may decide to dispose of its investment or use it to secure a refinancing. Either way, now is a time for landlords to take stock and to get their house in order – keeping their powder dry, perhaps to fight another day. 

It is now more important than ever to keep a paper trail and to make sure that any arrangements agreed with tenants, however temporary, are documented. It can be tempting not to take this step, but sound asset management is more important than ever in difficult times – and is likely to prove essential as we slowly drift back towards something resembling normality.

If you require further information about anything covered in this briefing, please contact Mark Gauguier, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, June 2020