On 7 April 2020, the National Cabinet announced the Mandatory Code of Conduct for small and medium sized commercial tenancies impacted by the COVID-19 pandemic (the Code).
Since then several States and Territories have enacted legislation or regulation implementing the Code in their respective jurisdiction. We published an extensive summary of the Code including updates on jurisdictions that have since enacted the Code in a separate article available here: https://www.twobirds.com/en/news/articles/2020/australia/australia-leasing-measures-to-combat-covid19
This article highlights some practical considerations and lessons learnt on advising landlords and tenants when navigating the Code.
- Assessment and calculation of rental reduction
An area where landlords and tenants frequently face difficulties during negotiations is agreeing on how the proportionate reductions are to be assessed.
Under the Code, landlords must offer tenants who are eligible under the Code (SME Tenants) a reduction on rent proportionate to the reduction in the SME Tenant's turnover over the course of the COVID-19 pandemic period and for a reasonable subsequent recovery period.
The Code states that the assessment of reduction is to be consistent with the assessments undertaken for eligibility for the Commonwealth's JobKeeper program. Under the JobKeeper program's eligibility criteria, businesses may choose to assess their reduction in turnover compared to last financial year for any given month (starting from March 2020) or for any given quarter (starting from the quarter of 1 April 2020 to 30 June 2020).
Where a quarter is selected but has not concluded, the business will need to form a 'reasonable estimate of the reduction' (including documents which support their estimate) compared to their actual turnover in the equivalent quarter last financial year.
An assessment of a business' financials for the month of May 2020 against the month of May 2019 shows a 60% reduction in turnover. The SME Tenant will be entitled to a 60% total reduction in rent, of which:
- at least 30% must be in the form of a complete rental waiver; and
- the remaining 30% may be in the form of rental deferrals.
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.
Both landlords and tenants should keep front of mind that any assessment of reduction should comply with the Code's overarching principle of good faith negotiations and for the parties to act in an open, honest and transparent manner. This means that in the course of negotiating, tenants should avoid any attempts to 'game' the system and provide landlords with sufficient and detailed information to accurately assess the likely reduction of turnover due to the COVID-19 pandemic.
- Consideration of the COVID-19 period and a 'reasonable recovery period'
We observed that another area stalling negotiations is disagreement on the length of time for the rental reductions. As noted above, the Code requires landlords to offer rental reductions for: (a) the duration of the COVID-19 pandemic; and (b) a reasonable subsequent recovery period. In practice, difficulties arise in translating these open timelines into defined months/years.
In negotiating the appropriate period, landlords and tenants should consider various factors such as the length of the lease remaining, options or extensions available under the existing lease and any extensions the terms of the existing lease that are agreed upon under the Code.
- Concept of 'groups' – what is covered what is not
Some uncertainty exists surrounding the eligibility of tenants to the Code who are part of a larger international corporate group or who have overseas parent companies. Under the Code, the entire corporate group must have an annual turnover of AU$50 million or less to be eligible for protection. Subsequent state and territory regulations have complicated this issue with some regulations (such as the NSW Regulation) defining 'group' as entities which are considered related bodies corporate under the Australian Corporations Act 2001 (Cth) (Corporations Act). It is unclear whether foreign parents and/or overseas entities are covered under the Corporations Act.
Our analysis of the Corporations Act and overall interpretation of the legislative framework of the Code would indicate that the overall turnover of any foreign parent company and/or overseas companies within the same corporate group are all included within the calculation of annual turnover. However, this will not be entirely clear until it has been determined by the Courts.
- Wash-up or clawback clauses
Due to the difficulty of estimating the likely reductions in turnover and the length of the COVID-19 pandemic period, some negotiated agreements have incorporated "wash-up" or "clawback" clauses to offset the uncertainty and prevent one party from being unfairly disadvantaged.
These provisions incorporate a reconciliation mechanism at the end of the COVID-19 period, in which the total rent reduction received is reconciled against the actual reduction turnover experienced by the SME Tenant over the course of the COVID-19 pandemic. Depending on the final net position, one party will then be required to repay the difference to the other, ensuring the total rent reduction received by the SME Tenant accurately reflects their actual reduction in turnover due to the COVID-19 pandemic.
- Foreign tenants – changes to FIRB thresholds
In response to the unprecedented economic implications of the COVID-19 pandemic, the Australian Federal Government announced via the Treasurer new Foreign Investment Review Board (FIRB) temporary measures, effective from 10:30 pm on 29 March 2020, in pursuit of protecting the national interest. All proposed foreign investment into Australia subject to the Foreign Acquisitions and Takeovers Act 1975 (Cth) (FATA) require approval from the Foreign Investment Review Board (FIRB) regardless of value or nature of the foreign investor.
For the purposes of FATA, this means that any foreign person (tenant) proposing
- to enter into a new lease (including any occupation or usage licence); or
- to negotiate an extension of the existing lease term,
that has a term (which under the new lease; or as a consequence of new negotiations extends an existing lease to a term) greater than 5 years (inclusive of any options to renew) may be required to apply for and obtain FIRB approval. Some applications may now take up to 6 months to be considered and for a decision to be made. The additional processing time must be taken into account (by both the landlord and foreign tenant) when negotiating any new lease or extension.
How we can help
Bird & Bird are providing advice to 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, including preparing, applying for and obtaining FIRB approval for our clients.
Please do not hesitate to contact us should you require any assistance with negotiations.