Fact Sheet: Beyond Covid-19 – How can commercial landlords and tenants compromise now?

It has been so encouraging to see shops, bars and restaurants take their first tentative steps out of lockdown, but it’s probably fair to predict that it will not be business as usual for the foreseeable future: changes in consumer habits and routines, financial uncertainty for many, and simple fear, will all continue to impact directly upon the ability of commercial tenants to cover the rent.

In a recent piece, we talked about whether or not these tenants remain obliged to pay the rent during the unprecedented set of circumstances we find ourselves in. The conclusion was compromise; yes, the rent should be paid, but keeping tenants intact and in situ would also be high on the list of landlord priorities.

When it comes to compromising for the benefit of both parties to a lease, there are no hard and fast rules, but here are some of the possibilities to consider.

Adjustments to rent

Rent free periods

• A basic incentive – rent free periods are often used to incentivise new tenants to take on new leases – the GFC over a decade ago saw a huge increase in their use, and the current situation will continue to guarantee their popularity. And they might not be as unpalatable to landlords as they first appear – a one-time short sharp income-free period might be all that’s needed to get a tenant through the worst, or to get a new tenant into vacant premises.
• Rent free after break date – scheduling rent free periods just after a break date is a well-trodden path for landlords to incentivise tenants to stay put beyond a potential future exit point, and makes sense in the current climate. Tenants will be looking for relatively short-order break options – they need to see how things unfold in the short to medium term. Any incentive to keep them in place beyond a break date will benefit the landlord and the cost of a rent free period can be offset against re-letting costs.
• Deferred Payment – can a tenant see its way to deferring any unpaid rent until a later date? Whilst there are cash flow benefits for the tenant, there is risk here on both sides – rolling up liability for the tenant, and no guarantee that any deferred rent will ever be paid if the tenant cannot recover longer term.

“Structured” Rents
Looking slightly beyond the immediate crisis, a certain level of rental income is going to be required, with added pressure on landlords because of debt secured on property and obligations and covenants related to servicing that debt. Parties to existing or new lettings might think about the following:

• reduced rent – either a reduction in a current rent or a lower starting point than would ordinarily be agreed in a new lease;
• stepped rent i.e. dropping the rent to (or starting at) a lower level and then gradually increasing it again; and
• a turnover rent – whilst on the face of it these might be wholly unpalatable to landlords in the current situation, they may offer some degree mutual benefit. Consider structures whereby the tenant pays a base level of rent, topped up according to the tenant’s income (i.e. a fixed percentage of the tenant’s net turnover). Over a temporary period, this could serve to provide the landlord with a certain amount of income whilst recognising the difficulties faced by so many tenants. Please see our piece “Beyond Covid: A Turnover Rent Resurgence?” for more detailed discussion.

Any of these structures could work in tandem with an element of deferred rent as described above.

Other financial concessions
Other options worthy of consideration include the following:

• rent paid monthly instead of quarterly;
• rent paid in arrears rather than in advance;
• temporarily reduced service charges;
• all-inclusive charges – where rent, insurance and service charges are payable at a fixed flat rate for a period of time at a level manageable for both parties; or
• an express plan for a landlord to draw on any rent deposit whilst the tenant takes a rent holiday.

A “second wave”?

Looking beyond solely the rent provisions, here are some further points to consider.

• Can a period of rent suspension be agreed pre-emptively? Suspension might be during periods of further government-ordered national or local lockdown, or during the imposition of restrictions which would affect the operation of a tenant’s business whether due to closure, or restrictions such as social distancing which would impact on the scale of its operations.
• Break clauses are likely to be firmly on the radar too. We may see break dates falling slightly earlier in the term of new leases than before, or simply more of them during the term of a lease, or perhaps rolling breaks i.e. the option to break at any time subject to a notice period. Such rolling options might be exercisable up until a certain date in the term. We talk above about linking later break dates to rent free periods to incentivise tenants to remain in occupation rather than to break.
• Whilst rather tenant-friendly in the shorter term, concessions may provide a degree of landlord leverage – parties to existing arrangements might for example settle an outstanding rent review, or perhaps delay a rent review until there is a generally more positive outlook. Landlords might achieve the removal of future tenant break clauses or other particularly tenant-favouring provisions in return for fairly generous short-term concessions.

Compromise with caution

If a compromise can be reached, always consider the following:

• carefully document the time period for which any concessions will apply, and how and when any deferred rent will be paid;
• does the letting document in question contain any break clauses, and is it conditional upon payment in full of rent (or any other sums) up until a given date? Ensure that the operation of the break is not frustrated by reason of payment of a reduced rent, or no rent, however temporary;
• are there any rent reviews due during any concessionary period? Be express about how the parties intend any concession to impact on rent review – will it be disregarded or not?
• is the lease potentially due for renewal? Beware the possibility of concessionary terms being carried over into a new lease – existing terms are often the starting point for renewal leases, particularly those within Part II of the Landlord & Tenant Act 1954;
• are the concessionary terms, however temporary, binding either parties’ successors in title?
• if there is any guarantor who will need to be a party to documentation? Make sure that they are so as to avoid inadvertent release from guarantor obligations;
• are any third party consents required, from lenders or superior landlords or the like? Obtain these so as to avoid a breach of superior lease covenants and/or loan documentation;
• check rent deposit arrangements and whether even an agreed payment of a reduced or nil rent would amount to a failure to pay rent, and an entitlement for the landlord to draw on any deposit.With new rent deposits, be clear as to whether they can be drawn upon during any pre-agreed period of potential rent suspension or reduction – a tenant may see an ability to draw as defeating the object of rent suspension, but a landlord might argue that it still offers some breathing space for the tenant;
• if documentation needs to define a trigger for any future concession arrangement i.e. further lockdown or other similar restrictions to manage Covid-19, ensure that any definitions work for the specific lease, tenant, business, or location in question; and
• if leases are varied (rather than concessions being made) always seek tax advice particularly in respect of Stamp Duty Land Tax.