The Prime Minister’s office has released the text of the new mandatory Code of Conduct (the Code) for commercial tenancies announced last week.  The Code will be given statutory effect via separate State and Territory legislation to be enacted in each jurisdiction.

Operation

Each jurisdiction’s legislation will define the date on which the Code is to take effect, but the effective date will be some time after 3 April 2020.

The Code will be in effect for the period during which the Commonwealth JobKeeper programme remains operational.  Previous announcements have indicated that the JobKeeper programme will be operational for six months after the relevant legislation is passed.  Despite this, various “principles” outlined in the Code will apparently apply during an undefined “subsequent reasonable recovery period” beyond the initial “Covid-19 pandemic period”.  The latter is “defined by the period during which the JobKeeper programme is operational”.

Purpose and Application

The purpose of the Code is said to be to “impose a set of good faith leasing principles for application to commercial tenancies (including retail, office and industrial [tenancies]) … where the tenant is an eligible business for the purpose of the Commonwealth Government’s JobKeeper programme”.  This is reinforced by a statement that the Code applies to all tenancies, with an annual turnover of up to $50 million, that are suffering “financial stress or hardship” as a result of the Covid-19 pandemic (SME tenants).  Financial stress or hardship is said to be “defined by … eligibility for the Commonwealth Government’s JobKeeper programme”.

Whilst the above suggests that the Code applies only to JobKeeper programme eligible businesses, the Code provides that the principles expressed in it “should nevertheless apply ‘in spirit’ to all leasing arrangements for affected businesses”, presumably whether or not those businesses are eligible for the JobKeeper programme.

General Structure

The Code outlines a set of “overarching principles” and a separate set of “leasing principles”.

The overarching principles will guide the negotiation process between landlords and tenants seeking to agree “tailored, bespoke and appropriate temporary arrangements” for each SME tenant.

The leasing principles specify the minimum content for each temporary arrangement and are to be implemented “as soon as practicable on a case-by-case basis”.  There is some, albeit limited, scope for the parties to contract out of these requirements, eg see Leasing Principles 4 and 5 below.

Where parties cannot reach agreement on the appropriate leasing arrangements, it appears to be intended that either party will be able to refer the matter to any applicable State or Territory retail or commercial leasing dispute resolution processes for “binding mediation”.  This is likely to be of reduced utility in Queensland, which provides only for non-compellable mediations of retail tenancy disputes.  Where mediation is available, the Code provides that the parties must not use the mediation processes to prolong or frustrate the facilitation of amicable resolution outcomes.

Overarching Principles

The objective of the Code is expressed as being “to share, in a proportionate, measured manner, the financial risk and cashflow impact during the Covid-19 period, whilst seeking to appropriately balance the interests of tenants and landlords.”

To this end, the Code expresses an intention to that landlords will agree tailored, bespoke and appropriate temporary arrangements for each SME tenant.  In summary form, the overarching principles designed to guide the negotiation of those arrangements are as follows:

  1. Landlords and tenants:
  • share a common interest in working together to ensure business continuity and to facilitate the resumption of normal trading activities at the end of the Covid-19 pandemic and during a reasonable recovery period thereafter;
  • will be required to discuss relevant issues, negotiate temporary arrangements and work to achieve mutually satisfactory outcomes;
  • will negotiate in good faith;
  • will act in an open and transparent manner, and will each provide sufficient and accurate information within the context of negotiations to achieve outcomes consistent with the Code; and
  • will assist each other in their respective dealings with other stakeholders in order to achieve outcomes consistent with the objectives of the Code;
  1. Any agreed arrangements will:
  • take into account the impact of the Covid-19 pandemic on the tenant, with specific regard to its revenue, expenses and profitability; and
  • be proportionate and appropriate based on the impact of the Covid-19 pandemic plus a reasonable recovery period;
  1. It is recognised that all premises and commercial arrangements are different and so it is not possible to form a collective industry position. Nevertheless, the Competition and Consumer Act 2010 (Cth) is intended to apply according to its terms and spirit;
  1. The landlord must not seek to permanent mitigate the “risk of default on commercial leases” in negotiating any temporary arrangements envisaged by the Code;
  1. All leases must be dealt with on a case-by-case basis. Relevant factors will include:
  • whether the SME tenant has suffered financial hardship due to the Covid-19 pandemic;
  • whether the tenant’s lease has expired or is soon to expire; and
  • whether the tenant is in administration or receivership.

Leasing Principles

The paraphrased leasing principles are as follows (emphasis added):

  1. Landlords must not terminate leases due to non-payment of rent during the Covid-19 pandemic or a reasonable subsequent recovery period;
  2. Tenants must remain committed to the terms of their lease, subject to any amendments to rental agreement negotiated under the Code. Material failure to abide by substantive terms of their lease will forfeit any protections provided to the tenant under the Code;
  3. Landlords must offer tenants proportionate reductions in rent payable in the form of “waivers and deferrals” (as defined) of up to 100% of the amount ordinary payable, based on the reduction in the tenant’s trade during the Covid-19 pandemic period and a subsequent reasonable recovery period;
  4. Unless waived by the tenant, rental waivers must constitute no less than 50% of the total reduction in rent payable under Leasing Principle 3 for the duration of the Covid-19 pandemic period. This should constitute a greater proportion of the total rent reduction where failure to do so would compromise the tenant’s capacity to fulfil its ongoing obligations under the lease agreement.  However, regard must be had to the landlord’s financial ability to provide any such additional waivers;
  5. Unless the parties otherwise agree, payment of rental deferrals by the tenant must be amortised over the greater of 24 months or the balance of the lease term.
  6. Any reduction in statutory charges (eg land tax and council rates) or insurance will be passed on to the tenant in the appropriate proportion applicable under the terms of the lease;
  7. A landlord should seek to share any benefit it receives due to deferral of loan repayments from its own financiers with the tenant in a proportionate manner;
  8. Landlords should, where appropriate, seek to waive recovery of any other expense (or outgoing) payable by a tenant during the period that the tenant is not able to trade but may reserve the right to reduce services as required in such circumstances;
  9. If negotiated arrangements under the Code necessitate repayment, this should occur over an extended period in order to avoid placing an undue financial burden on the tenant. No repayment should commence until the earlier of the Covid-19 pandemic ending (as defined by the Commonwealth Government) or the existing lease expiring, and taking into account a reasonable subsequent recovery period;
  10. No fees, interest or other charges should be applied with respect to rent waived under Leasing Principles 3 and 4, and no fees, charges or punitive interest may be charged on deferrals in Leasing Principles 3, 4 and 5;
  11. Landlords must not draw on a tenant’s security for the non-payment of rent (be this a cash bond, bank guarantee or personal guarantee) during the Covid-19 pandemic and/or a reasonable subsequent recovery period;
  12. The tenant should be provide with an opportunity to extend its lease for an equivalent period of any rent waiver and/or deferral period so as to provide the tenant with additional time to trade, on existing lease terms, during the recovery period after the Covid-19 pandemic concludes;
  13. Landlords agree to a freeze on rent increases (except for retail leases based on turnover rent) for the duration of the Covid-19 pandemic and a reasonable subsequent recovery period, notwithstanding any arrangements between the landlord and the tenant; and
  14. Landlords may not apply “any prohibition on levy and penalties” if tenants reduce opening hours or cease to trade due to the Covid-19 pandemic. Presumably, the words in quotations marks are an error and should read “any levy or penalties”.

Brief Observations

Regrettably, rather than provide clear guidance for affected parties the Code provisions are more likely to raise additional questions and confusion in their practical application.

Amongst other things, any negotiations between parties will need to address the following issues:

  1. What is contemplated as a “reasonable subsequent recovery period”? Given that this is a factor to be taken into account under numerous Leasing Principles, the lack of any clear definition of this term is ripe for disputation.  Importantly, it gives rise to significant uncertainty as to when a Landlord can and cannot enforce a tenant’s security under Leasing Principle 11;
  2. What will constitute a “material failure” to abide by “substantive terms” of a lease on the part of a tenant?  Does this apply only to breaches of obligations going to the root of the contract according to ordinary contractual principles, or does it extend to breaches of specified “essential” obligations?  This is crucial issue given that tenants will forfeit any protections under the Code if they overstep the mark;
  3. What is the intended inter-relationship between Leasing Principles 5 and 9? Are deferred payments under principle 5 also covered by principle 9, so that the minimum 24-month period under principle 5 cannot even start until the earlier of the dates specified in principle 9?
  4. How exactly is a landlord expected to apply Principle 7? If a landlord negotiates a loan repayment “holiday” with its financier, is it expected to pass on that benefit to its tenant whilst being left to shoulder the full burden of any additional interest accumulating over that holiday period?
  5. Is the prohibition on fees and charges under Leasing Principle 10 intended to preclude landlords from passing on any legal costs associated with documenting any arrangements negotiated under the Code bearing in mind that Queensland’s Retail Shop Leases Act permits the recovery of costs in relation to rental concession requests? And what is contemplated by “punitive” interest on deferrals under this principle in any event, particularly when landlords are bearing significant financial burdens themselves?
  6. Is it permissible for landlords to require that leases be amended to oblige tenants to “catch up” on any rental increases that should have applied during the moratorium on rental increases under Leasing Principle 13, or are such requirements precluded by the terms of paragraph 4 discussed above under “Overarching Principles”?
  7. Can the landlord demand security to mitigate the solvency risks inherent in any arrangement negotiated under the Code, including the possibility that the tenant will fail in any event and that any payments actually received from qualifying tenants will be tainted as voidable transactions?  Is any requirement for such security even permissible given the terms of paragraph 4 discussed above under “Overarching Principles”?

Parties should also be mindful of the Code definitions for various terms. In particular, whilst “waiver and deferral” is defined expansively, “waivers” cannot be recouped over the term of the lease.

On first impressions, the Code presents as a knee-jerk reaction to a complex issue, replete with ill-defined and under-developed “principles”.  Despite the lip-service paid to balancing the interests of landlords and tenants, little regard appears to have been had to the fact that not all landlords are created equally except, perhaps, for the limited concession given under Leasing Principle 4.  For smaller landlords in particular, the financial impact of implementing these principles may simply be to substitute the landlord for the tenant in the Centrelink queue.

It can only be hoped that the language of the Code finds clearer articulation when ultimately reduced to legislative form.  Of course, it may well be that the lack of clarity in the Code is a deliberate proxy for an altogether unstated principle, namely that the parties should strive to reach a commercial resolution between themselves rather than risk becoming bogged in the legal quagmire created by the Code itself.

 

8 April 2020

Author: Brian Lambert

Contact: + 61 7 3251 6777.

Warning: The content of this post is intended only to raise the awareness of readers to the issues discussed. It is not intended to constitute, and should not be relied upon as advice of any kind. Readers should seek specific legal advice regarding their particular circumstances.

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