On 7 April 2020, the National Cabinet announced the Mandatory Code of Conduct which will apply to small and medium sized commercial tenancies impacted by the COVID-19 pandemic (the Code).
The Code aims to distribute and balance the share of financial risk and cash flow impact of the COVID-19 pandemic proportionately between SME Tenants and landlords. However, it is incumbent on the individual States and Territories to enact legislation or regulation that implements the Code within their respective jurisdiction.
Update: On 24 April 2020, the New South Wales Government enacted the Retail and Other Commercial Leases (COVID-19) Regulation 2020 (NSW) (NSW Regulation) which implements the Code in New South Wales. The NSW Regulation will apply for six months until 24 October 2020. While largely consistent with the Code, the NSW Regulation clarifies that the calculation of turnover of a business includes any turnover derived from internet sales of goods or services. This may impact tenants who have experienced a reduction in retail sales but an increase in online sales due to the COVID-19 pandemic. Further, it is unclear at this stage how centralised online sales of large franchises will be incorporated into the turnover calculations of each individual franchised store.
As of 27 April 2020, the Victorian and Queensland governments have not announced a definite timeline for implementing the Code in their respective States. We will update this article as further developments and announcements become available.
The Code establishes a framework of good faith principles and various conditions which, at a minimum, any negotiated commercial arrangement must satisfy.
It is intended that landlords will negotiate and agree on appropriate amendments to their existing commercial lease agreements (incorporating the conditions of the Code) for each SME Tenant on a case-by-case basis.
The Code applies to businesses with:
1. an annual turnover of up to AU$50 million; and
2. are eligible for the Commonwealth Government's JobKeeper program,
The AU$50 million threshold will be applied in respect of franchises at the franchisee level, and in respect of retail corporate groups at the group level (rather than at the individual retail outlet level).
To be eligible for the JobKeeper program, a business must have suffered, or estimates to suffer, a fall in turnover of 30 per cent or more.
Good faith negotiations
One of the primary overarching principles of the Code is that in negotiating in good faith, the landlords and SME Tenants will act in an open, honest and transparent manner, including providing sufficient and accurate information within the context of the negotiations.
This poses several important considerations that both landlords and SME Tenants entering into commercial negotiations need to be aware of (examined in detail below).
Proportionate rent reductions
Under the Code, landlords must offer reductions in the rent payable by the SME Tenant that is proportionate to the reduction in the SME Tenant's turnover over the course of the COVID-19 pandemic period and for a reasonable recovery period thereafter.
The rent must be reduced by the proportionate reduction in the SME Tenant's turnover and consist of:
1. no less than 50% of the total reduction must be in the form of a rental waiver; and
2. the remainder of the reduction is to be in the form of a rental deferrals amortised over a period of no less than 24 months.
Payment of the rental deferrals by the SME Tenant must be spread over the greater of the balance of the lease term or a period of no less than 24 months.
In addition to the rental reductions, the Code includes a range of SME Tenant protections designed to frame any commercially negotiated agreements between the parties. Similar to the rent reductions, these protections will apply for the duration of the COVID-19 pandemic and for a reasonable recovery period thereafter.
Some of the SME Tenant protections include:
– Freeze on rent increase – landlords must put a freeze on rent increases (except for retail leases based on turnover rent);
– Extended terms – SME Tenants must be provided with an opportunity to extend the lease for an equivalent period of the rent waiver and/or deferral period (to provide additional time to trade, on existing lease terms, after the COVID-19 pandemic concludes);
– No fees – no fees, interests or other charges should be applied to any rent waiver or deferred rent;
– Securities – landlords must not draw on the SME Tenant's securities for the non-payment of rent;
– No penalties ¬– landlords may not penalise tenants who reduce operating hours or cease trading due to the COVID-19 pandemic;
– No termination – landlords must not terminate leases due to non-payment of rent during this period;
– Waiver of outgoings – landlords must, where appropriate, waive recovery of any other expenses (including outgoings) payable by an SME Tenant, during the period the tenant is not able to trade; and
– Passing on benefits – landlords are required to pass on any savings that it receives, as a result of any reduction in statutory charges (such as land tax, council rates) or insurance, to the SME Tenant on a proportionate basis.
Tenant A is paying a monthly rent of AU$10,000 and experiences a 60% decrease in turnover as a result of the COVID-19 pandemic. The remaining balance left on Tenant A's lease term is 12 months.
At a minimum, Tenant A will be able to negotiate with the landlord a rental reduction of AU$6,000 per month consisting of:
– at least AU$3,000 in the form of a rental waiver; and
– the remaining amount (being AU$3,000) in the form of rent deferral to be recouped over a period of not less than 24 months (even though the balance of the lease term is only 12 months).
Note: Parties are free to make alternative commercial arrangements to this formula provided the minimum requirements are met (i.e. in relation to proportionate reduction, rental waivers and rental deferral periods).
As noted earlier, a key obligation of the Code is that each party to provide sufficient and accurate information within the context of commercial negotiations. Landlords will be within their rights to request that SME Tenants provide certain financial information/documentation (including information generated from an accounting system or statements from a financial institution) related to the SME Tenant's revenue, expenses and overall profitability.
Accordingly, landlords should consider preparing the list of questions and documentations that they will require in order to verify the SME Tenant's financial position and decrease in turnover. We have set out below examples of the type of questions a landlord should consider asking their SME Tenants.
Correspondingly, SME Tenants should, prior to commercial negotiations, consider the measures that their businesses have taken (if any) to reduce or mitigate their losses from disruptions caused by the COVID-19 pandemic. This may include steps taken to secure available government subsidies, discussions with insurers and other cost mitigation strategies that the SME Tenant has implemented.
In determining whether the Code applies and to assist in verifying the Tenant's financial position, we have compiled a list of recommended questions that landlords should consider asking tenants, or tenant should expect to be asked to answer:
1. Is your annual turnover less than $50 million (therefore qualifying your business as an SME as defined under the Code)? If so, please provide evidence.
2. Is your organisation eligible for the Commonwealth Government’s JobKeeper program? If so, please provide evidence that your business is either eligible for, or currently receiving JobKeeper payments.
3. Has your business experienced a reduction in turnover as a direct result of the COVID-19?
4. If so, please provide evidence of this reduction in turnover and any other commentary that might further explain your position.
5. What changes have you implemented to your business operations to reduce or mitigate your losses and disruptions caused by the COVID-19 pandemic?
6. What Commonwealth, State and/or Local Government assistance packages and stimulus measures has your business applied for? What packages or stimulus measures has your business been granted? Please provide evidence.
Bird & Bird are actively providing advice to both landlords and tenants who are seeking guidance how to best navigate their rights and obligations during this difficult and constantly changing environment.
We provide practical, pragmatic and tailored advice that is sensitive to the needs of your business. Please do not hesitate to contact us should you require any assistance with negotiations.