COVID-19 technical update: Commercial tenancy changes for SMEs

Estimated reading time: 9 minutes

What effect do the changes to commercial tenancy arrangements brought in to combat the financial impact of COVID-19 have on SMEs?

COVID-19 technical update: Commercial tenancy changes for SMEs

28 April 2020

Summary

  • In response to anticipated temporary insolvency of small-to-medium sized enterprises, the Retail and Other Commercial Leases (COVID-19) Regulation 2020 was introduced in NSW on 24 April 2020
  • The regulations are set to be in place for six months commencing on 24 April 2020
  • It covers leases governed by the Retail Leases Act 1994 (NSW) (i.e. retail shops) and Conveyancing (General) Regulation 2018 (i.e. all other commercial leases).
  • The basic protection given to tenants is that they temporarily can’t be evicted for failing to pay rent, outgoings or not being open
  • Landlords and tenants must also attempt to re-negotiate the existing lease before any landlord can exercise enforcement or eviction rights

New COVID-19 laws: commercial tenancies

  • On the back of forced closures of thousands of businesses across Australia due to the COVID-19 pandemic and in furtherance of the National Cabinet’s economic ‘hibernation’ policy, certain relief measures are being introduced in each state and territory in respect of retail and commercial tenancies.
  • On 25 March 2020, the New South Wales Parliament passed the COVID-19 Legislative Amendment (Emergency Measures) Act 2020 (the Act). Certain provisions in the Act give the relevant minister the power to make regulations relating to landlords reclaiming possession of premises, the termination of leases and the exercise of rights under a lease.
  • On 29 March 2020, the National Cabinet agreed to a “common set of principles” (the Principles) to provide guidance for each state and territory to implement short-term measure to assist commercial tenancies during the pandemic.
  • On 7 April 2020, the National Cabinet agreed that states and territories would implement a mandatory Code of Conduct (the Code) relating to SME commercial leasing during the pandemic. Each state and territory will introduce legislation or regulations to give effect to the Code and the Principles, which NSW did on 24 April 2020 by enacting the Retail and Other Commercial Leases (COVID-19) Regulation 2020 (the Regulations).

Listen to Ben Sewell interviewed for the Tax Talks podcast on the COVID-19 changes to tenancy law and commercial leasing arrangements.

COVID-19 Legislative Amendment (Emergency Measures) Act 2020

The Act introduced on 25 March 2020 does not itself make any regulations that directly affect the rights of commercial landlords and tenants. Rather, the Act only confers the power on the relevant minister to make regulations. This is necessary to expedite the process of reacting to the needs of landlords and tenants alike, by removing the need to follow the usual process of passing legislation (and therefore having to recall parliament).

The Act inserts section 87 into the Retail Leases Act 1994 (NSW) (the Retail Leases Act), which is the source of the power of the minister to make regulations effecting the operation of a ‘relevant Act’ to:

  1. Prohibit a landlord from taking possession of a commercial premises back from a tenant;
  2. Prohibit the termination of a lease by a landlord;
  3. Regulate or prevent the exercise or enforcement of another right by a landlord;
  4. Exempt a tenant from the operation of a provision of the relevant Act or agreement relating to a lease.

What is a ‘relevant Act’?

The reference to a ‘relevant Act’ (i.e. the legislation that would otherwise give a landlord the rights referred to in (a) to (d) above) includes:

  • Agricultural Tenancies Act 1990 (NSW) (i.e. farm tenancies);
  • Retails Leases Act 1994 (NSW) (i.e. shop tenancies);
  • Any other Act that related to leases for commercial purposes.

The amendment has been purposely drafted to have a broad application so that the Minister’s power will ensure businesses have adequate protection from landlords in certain circumstances.

Commonwealth Government Response

The Commonwealth Government does not have the power to make law pertaining to commercial leases that are within the jurisdiction for each State and Territory. For this reason, its response has been limited to providing guidance to the States and Territories.

The Principles

The initial national agenda for what the regulations should look like are set out in the Principles and include:

  • A temporary prohibition on eviction of a tenant for non-payment of rent;
  • Rent relief or temporary amendments to a lease, by agreement between landlord and tenant;
  • The reduction or waiver of rent for a defined period;
  • The ability of a tenant to terminate a lease due to financial distress;
  • Landlords to ensure that any benefit they receive is passed on proportionately to their tenant;
  • Those not significantly affected by the pandemic are expected to honour their lease obligations;
  • Government at all levels to consider mechanisms for cost-sharing or deferral of losses.

National Cabinet Mandatory Code of Conduct – SME Commercial Leasing Principles During COVID-19

More detailed guidance was provided by the National Cabinet on 7 April 2020 when it released the Code, which includes a requirement to “impose a set of good faith leasing principles for application to commercial tenancies” for landlords and tenants when negotiating lease amendments during the pandemic.

Tenants covered by the Code are those who have a turnover of up to $50 million and are suffering financial stress or hardship due to the pandemic. The threshold for financial stress and hardship is the same as the JobKeeper programme, whereby a SME must show that its turnover has decreased by at least 30%.

The Code’s overall objective is to aid the management of cashflow for SME businesses on a “proportionate” basis and includes the following leasing principles for landlords and tenants during the pandemic or reasonable subsequent recovery period:

  1. Landlords must not terminate leases for non-payment;
  2. Tenants must remain committed to the terms of their lease or any amended lease otherwise they will lose protection of the Code;
  3. Landlords must offer reductions (waiver or deferral) in rent, proportionate to the reduction in trade of the SME business;
  4. At least 50% of the reduction in rent must be waived;
  5. The total amount of the reduction categorised as a deferral during the pandemic must be paid back to a landlord over a period of no less than 24 months;
  6. Any reductions in statutory charges payable by the landlord is to be passed onto the tenant in an amount proportionate to the reduction;
  7. Landlords should seek to share the benefit of any deferral in loan repayments to their bank in the proportion of the deferral;
  8. Landlords should seek to waive the recovery of expenses or outgoings, under the terms of a lease;
  9. Any negotiated arrangement between a landlord and a tenant in respect of repayment of any amount, should not commence until after the pandemic has ended or existing lease has expired;
  10. No fees, interest or charges should be applied in respect of rent waived or deferred;
  11. Landlords must not draw on a tenant’s security for non-payment of rent;
  12. Tenants should have the opportunity to extend their lease for the equivalent waiver and/or deferral period;
  13. Landlords agree to a freeze on rent increases;
  14. Landlords may not prohibit or levy penalties against tenants who reduce opening hours or cease to trade.

In circumstances where landlords and tenants are unable to reach an agreement, the matter should be referred to mediation, utilising processes of dispute mechanism in each relevant state or territory.

It is incumbent on each State and Territory to make regulations or pass legislation to give effect to the Code, which the NSW Government did on 24 April 2020.

Retail and Other Commercial Leases (COVID-19) Regulation 2020

The object of the Regulations is to give effect to the Code and in particular:

  1. Prohibit and regulate the exercise of rights of landlords and ‘impacted lessees’ during the pandemic period; and
  2. Requires landlords and impacted lessees to re-negotiate rent and other terms of commercial leases in good faith, having regard to the Code and before any enforcement action is commenced.

Who is an impacted lessee?

Section 4 of the Regulations define an ‘impacted lessee’ as:

  1. A lessee who qualifies for the JobKeeper scheme (i.e. for most SME’s, income has reduced by at least 30%); and
  2. A lessee who turns over less than $50 million in the 2018-2019 financial year.

What is a landlord prohibited from doing for the next six months?

  1. A landlord is prohibited from taking prescribed action if a tenant doesn’t pay rent, pay outgoings or is not open for business during the hours required by a lease.

‘Prescribed action’ is defined in the Regulations, among other things, as:

  • Eviction
  • Exercising right of re-entry
  • Payment of interest
  • Recovery of security bond
  • Performance by a tenant or guarantor pursuant to a guarantee
  • Termination of the lease
  1. A landlord is prohibited from increasing the rent of an impacted lessee.
  2. A landlord is prohibited from taking action against an impacted lessee after the end of the six months for failing to pay, during the pandemic period, an amount equivalent to any purported increase in rent.
  3. A landlord is prohibited from failing to pass on reductions in land tax and other statutory charges.
  4. Compliance with any law (Commonwealth or State) that was created in response to the pandemic that has the effect of a tenant breaching a commercial lease, is prohibited from amounting to a breach and cannot constitute grounds for termination.
  5. A landlord and a tenant are not prevented from taking action by agreement.

Are landlords and tenants obligated to re-negotiate rent?

If a landlord or impacted lessee make a request to re-negotiate rent during the pandemic period, both parties are obligated to re-negotiate in good faith.

A landlord is prohibited from commencing or continuing any prescribed action against an impacted tenant if they have not re-negotiated rent in good faith.

The terms of any re-negotiated commercial lease must be in accordance with the leasing principles set out in the Code. For example, a landlord must offer to an impacted lessee a reduction (either waiver or deferral) in rent, proportionate to the reduction in trade of the SME, with at least 50% of the reduction in the form of a waiver.

How long will the regulations last?

Any regulation made by the Minister pursuant to the amendment will expire six months after the day that the regulation is made or an earlier day as decided by the NSW parliament. The Act will therefore expire six months from 24 April 2020.

Should owners of SME’s stop paying rent?

If the business qualifies then this should be considered.

Owners of SME’s who operate their business from a commercial tenancy and:

  1. turn over less than $50 million per year; and
  2. have had their income reduced by more than 30% due to the pandemic,

may immediately stop paying rent (in part) and should contact their landlord or agent to re-negotiate their lease. The final figures for waiver of rents will need to be verified over time or the Landlord will have a claim for unpaid rent.

Key takeaways

The Regulations introduced by the NSW Government provide commercial tenants who have been impacted by the pandemic with considerable protection.

Landlords are prohibited from evicting commercial tenants or terminating the tenancy for the next six months on the basis of the failure to pay rent, outgoings or being open for business as mandated.

Impacted commercial tenants should immediately contact their landlord or agent and request a rent reduction in the same proportion to lost income as a result of the pandemic.

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