In this article, we highlight some of the key issues that may arise from a real estate perspective and consider some practical steps that businesses can take to maintain business resilience in a situation which is rapidly evolving.
Current Situation and Sources of Information
The situation is in a state of flux. Events are moving quickly and it is important to keep up to date with advice published by the government and regulatory agencies. Businesses need to consider their position and keep their contingency planning under review.
Here you can find the latest government information and advice which recognises the virus as a "significant challenge for the entire world".
- Landlord and Tenant Considerations
Withholding of Rent
- Most leases do not allow the tenant to withhold rent regardless of the circumstances;
- Many commercial leases include a provision for the suspension of rent in the event that, for example, a shopping centre is destroyed or damaged by an uninsured risk. However, even if the closure of a shopping centre due to COVID-19 was to fall within the definition of an "uninsured risk", the rent suspension provisions will usually only apply in the event that the shopping centre is damaged or destroyed. It appears improbable that closure of the premises to deep clean would constitute damage. It may be very difficult to prove;
- Some leases may be drafted to provide for the rent suspension provisions to kick in where the premises are inaccessible, notwithstanding that there is no damage to the property. It is by no means certain that closure of the premises for deep cleaning would cause the rent suspension provisions to bite;
- Tenants may have procured business interruption policies but these are usually linked to actual property damage. The specific wording of policies needs checking. Tenants could continue to trade online or implement agile working policies;
- Landlords and tenants will need to review their insurance policies to ascertain whether loss of rents/business interruption losses will be recoverable notwithstanding that it may be difficult to evidence physical damage to the property;
- From a tenant's perspective, unilaterally withholding the payment of rent could result in a forfeiture claim or the landlord attempting to recover rent arrears through the Commercial Rent Arrears Recovery (CRAR) statutory procedure;
- From a practical perspective, it may be wise for landlords and tenants to talk on how to share the pain: consider the impact on cash-flow by moving to monthly billing or reduced rents. These are commercial considerations and careful thought needs to be given on how to document any changes and legal advice sought.
- Lease Termination
- Can you bring a tenancy to an end (or refuse to enter into a new one under an existing agreement for lease) on the basis of force majeure?
- A force majeure clause usually provides that upon the occurrence of a specified event (e.g. following a catastrophe or "act of God" outside of either party's control), the parties can either terminate a contract or possibly suspend/delay performance of their obligations;
- Force majeure clauses are commonly included in commercial contracts but are far less common in leases. As the impact of COVID-19 is not a specific act/event but rather an evolving state of affairs, it is likely to be difficult to establish that it is a force majeure event to permit it to be used as a reason to terminate a lease. However, we are living through uncertain times;
- Force majeure clauses can also benefit landlords as they permit landlords to suspend the provision of services under a lease. Again, it depends what the lease says.
- The legal doctrine of frustration is set at a high bar. A contract will be frustrated if an unforeseen event occurs that renders it impossible to perform an obligation or the obligation is radically different to that originally envisaged when the contract was made;
- It seems unlikely that a tenant could successfully argue that its lease has been frustrated in the context of COVID-19, particularly if any period of non-occupation is only temporary (which seems to be the likelihood at the moment but matters are evolving quickly);
- Would a government imposed closure be significant enough to set the lease aside? There are no reported cases in England where a lease has been held to be frustrated. This is largely because land demised by a lease will nearly always be capable of enjoyment in some form, even if this becomes very difficult or impossible for a period of time (e.g. a 20 month closure caused by a local authority was not sufficient to frustrate a 10 year lease).
- The landlord or tenant may have rights to break the lease, particularly if closure is for an extended period. The wording of any break clause needs to be checked carefully.
- It is not known whether the government will direct businesses to close buildings as part of emergency measures to contain COVID-19. The closure of premises may constitute an insurance trigger. Policies may cover the compulsory closure of the property. It tends to be standard practice for insurance policies to exclude losses caused by communicable diseases "or the fear thereof". It will depend on the specific terms of the insurance policies;
- Following the government's decision that COVID-19 has been declared a "notifiable disease", the Association of British Insurers (ABI) has commented that it may be possible to buy consequential business interruption cover for notifiable diseases as an extension to a business insurance policy. The formal classification required by many insurance policies may enable those tenants with business interruption cover to make a claim under the insurance policy, depending upon its specific terms. Insurers may be faced with pressure from government to implement changes.
- Lease Obligations
Derogation from Grant/Quiet Enjoyment
- Where a landlord decides to close premises (e.g. a shopping centre) of its own volition, tenants may be able to make a claim against the landlord for derogation from grant and/or breach of the covenant for quiet enjoyment which could include a claim for loss of income;
- However, where the landlord's actions are consequent upon government advice, (e.g. to close premises), a tenant may find it has a difficult case to establish;
- Landlords may wish to consult with tenants before embarking on a particular course of action (if time permits).
Keep Open Clauses
- Retail tenants and other tenants with keep open covenants in their leases need to consider the impact of closure if it becomes necessary. Closing a store may result in tenants breaching their keep open covenant;
- It tends to be only in exceptional circumstances that the courts in England and Wales will enforce keep open covenants by ordering specific performance. Should a tenant elect to close a store of its own volition, it is unlikely that a landlord would obtain a court order forcing them to re-open but may have a damages claim instead;
- It can, however, be difficult for a landlord to substantiate its losses; for example, how to value a reduction on footfall? It can be easier if a lease contains turnover rent review provisions;
- Closure of premises may also impact upon any turnover-rent provisions contained in a lease.
Landlord and Tenant Obligations
- Landlords may have responsibilities under health and safety law to the extent that they exercise relevant control over parts of premises and are responsible for implementing measures (for example, legionella where the law imposes a duty on relevant persons to assess and address legionella risks at a property). Such a duty may rest with landlords as legionella can spread through water systems. This is different to the situation with COVID-19 which appears to be passed via humans rather than being linked to buildings or their infrastructure;
- Consider the nature of the property: is it a single - let property with no services being provided by the landlord? Is there more than one tenant and/or the landlord is providing services such as cleaning or other maintenance services? The situation should be assessed on a case by case basis and Public Health England Guidance followed in the first instance;
- Landlords and tenants who are employers owe duties of care to their employees and visitors regarding risks posed from infection diseases. See our health and safety briefing note. Employers will need to decide what steps are appropriate or necessary to take in the light of changing news about the outbreak. It is prudent to keep abreast of government advice. An organisational response strategy is key. See here to refer to our guidance note for employers for handling workplace issues and here to refer to our guidance note on what companies can do to safeguard their employees.
Additional Services: Who Foots the Bill?
- Implementing measures such as supplying extra cleaning services to combat the spread of COVID-19 will cost money. Landlords should check the service charge provisions to ensure that such charges are recoverable;
- Leases will often allow a landlord providing services to recover from a tenant the costs incurred as part of “good estate management” or as “required by statute” or "applicable laws." There could be a limit to the amount that can be recovered, if, for example, there is a service charge cap or any specific exclusions;
- Landlords and tenants alike should review what their leases say in respect of these potential costs;
- It might also be worthwhile checking insurance policies to see if any additional costs can be recouped through an insurance claim;
- Landlords need to consider their obligation to provide services under the lease and whether in circumstances where they are unable to provide the required services, they may be in breach of covenant which would leave them open to a claim for damages from their tenants;
- Landlords should consider the impact on commercial supply chains including force majeure clauses, interaction with insurance coverage, alternative supply arrangements and any government measures affecting manufacturing and sales.
Real Estate Impact
- It is anticipated that the impact will be felt well into the future amid speculation that businesses are likely to postpone taking leases and entering into contracts, pending the outcome of the COVID-19 outbreak;
- Reduced footfall and imposed self - isolation, coupled with an increase in online shopping, is hitting retailers hard: some landlords of shopping malls in China have reportedly already taken action to try to help their tenants to stay in business, providing relief in the way of rent reductions and suspension of operating costs. It may be that UK landlords will have to follow suit;
- The potential impact on responsibility to pay business rates is by no means certain if premises are voluntary closed or closed following government intervention.Possible additional avenues to explore include where there is a material change of circumstance (MCC). It would appear unlikely that the virus itself would be a MCC but, possibly, government action such as shutting a shopping centre could be. The argument would be that the hypothetical rental value of the property reduces to zero. The key in any such application to the Valuation Office Agency (VOA) or Scottish Assessors is identifying a specific MCC date. Another option could be Occupation Prohibited by Law (known as OPBL). The Non-Domestic Rating (Unoccupied Property) (England) Regulations 2018 and Non-Domestic Rating (Unoccupied Property) (Scotland) Regulations 2018 both make provision for zero liability for unoccupied property if it cannot be occupied because it is prohibited by law. The specific circumstances would need to be considered and whether the property was actually vacant. Thinking longer term, if the effect is still being felt as at 01/04/2021, (let's hope not), then there could be an argument to reduce the rateable value at the next valuation date. Revaluation happens on a 5 yearly cycle in Scotland (the last in 2017);
- On 14 March 2020, the Scottish Government announced rates relief for the retail, hospitality and leisure sector of up to 75%. In England, the Chancellor announced business rates relief measures for all hospitality, retail and leisure firms with a rateable value of less than £51,000 for twelve months. Businesses with a rateable value of less than £51,000 will also be eligible for a £25,000 grant. However, state aid issues may need to be considered.
- Keep up to date with the latest government guidelines;
- Prepare IT systems for potential additional remote access usage and capacity enhancement;
- Provide enhanced cleaning measures;
- Review obligations in leases, supply contracts, construction contracts;
- Review insurance policy terms.
We will keep you informed of further updates as the situation progresses.