The Prime Minister released the “Mandatory Code of Conduct” for SME Commercial Leasing Principles during COVID-19 on 7 April 2020 (the Code). 

Elizabeth McDonald, Principal of our Property and Planning team, unpacks the Code and what implications it may have for you as a landlord or tenant.

What is the Code?

The Code is a set of 14 “good faith leasing principles” which should be applied, as practicable, during the COVID-19 pandemic.  The Code will be put into effect through new state and territory laws.

Who does the code apply to?

The code will apply to commercial tenancies (including retail, office and industrial properties) where the tenant:

  • has a turnover of less than $50 million (SME Criteria); and
  • is eligible for the Federal Government’s JobKeeper payments (Hardship Criteria).

For franchises and retail corporate groups, the $50 million annual turnover threshold will be applied:

  • for franchises at the franchisee level; and
  • for retail corporate groups at the group level (rather than at the individual retail outlet level).

Do tenants still have to pay rent?

The key question we are being asked by tenants and landlords is whether landlords are obliged to offer rent relief. 

The Code makes it clear that, if the SME and Hardship Criteria are met, the landlord needs to offer a rent reduction.  That reduction should be at least proportionate to the loss of turnover experienced by the tenant.  For example, if the tenant suffers a 100% loss of turnover, the rental reduction must be 100%.

Will the tenant’s obligation to pay rent be waived or deferred?

At least half of the total reduction in rent payable must be provided in the form of a rent waiver.  The waived rent will not be recoverable by the landlord at a later date - the tenant simply does not have to pay this amount. 

If rent is deferred, when will it need to be paid and will interest accrue?

If the parties agree that some of the rent will be “deferred”, the landlord must allow that rent to be repaid over a period of at least two years to reduce the financial burden on the tenant.  Repayment should not be required until either the COVID-19 pandemic ends (as defined by Federal Government) or the existing lease expires.

Any interest payable on the deferred rent must not be punitive. 

Will rent review provisions continue to apply?

Landlords must not apply rent increases for the duration of the COVID-19 pandemic and a reasonable subsequent recovery period.  Notably, this does not apply to turnover rent charged in retail leases.

What if parties cannot reach agreement?

The message from the Prime Minister has been clear for some weeks now – landlords and tenants should be talking to each other and doing their best to come up with a workable solution.  The Code intends that landlords agree to “tailored, bespoke and appropriate” temporary arrangements for each SME tenant, taking into account their particular circumstances on a case-by-case basis.

For parties who are unable to reach an agreement, a binding mediation process will be available.  Those parties should refer to the applicable state or territory commercial leasing dispute resolution process including the Small Business Commissioners, Champions and Ombudsman where applicable.

SWS Observations

Even before the Code was announced, we have been observing landlords with a long-term focus take a commercial approach to dealing with tenants.  The best outcome through this unprecedented time will, in nearly every case, be achieved by negotiating an arrangement that will ensure the tenant still has a business and a need for its commercial lease after the COVID-19 pandemic. 

The Code is useful for providing a baseline for this discussion, but it is intentionally non-prescriptive.  It should be used as a guide for negotiations, but the parties should also consider the overarching principles of the Code including for landlords and tenants to negotiate in good faith.  In light of the sudden impact of the pandemic on many businesses, we are of the view that “good faith” on the landlord’s behalf should include an obligation to respond quickly to tenants’ requests to negotiate as many of these tenants urgently need certainty so that they can plan for surviving the pandemic.

For owners of office buildings, it will be important to factor in the ways this pandemic will change the demand for commercial offices.  With remote working arrangements suddenly becoming normal, property professionals are observing business owners starting to reconsider whether they will ever need the same sized premises again.  While this consideration does not arise in the Code, it is important commercial consideration when deciding how to plan for, and accommodate, future requirements of commercial tenants

Finally, we recommend owners and agents carefully consider whether interest should be charged on deferred rental payments.  If interest is to be charged, the Code requires that interest not be “punitive” and parties would be wise to consider the significant body of case law around penalty interest when interpreting this directive.  In circumstances where the cash rate is at an all-time low, we are of the view that landlords and agents should propose a rate that is appropriate to the current market rather than simply applying the rate they may have in their standard suite of documents. 

This article is not legal advice.  It is intended to provide commentary and general information only.  Access to this article does not entitle you to rely on it as legal advice.  You should obtain formal legal advice specific to your own situation.  Please contact us if you require advice on matters covered by this article.

Elizabeth McDonald

Elizabeth McDonald -

Principal

Property law specialist