COVID-19 business interruption – advice for landlords and tenants

Insights23 Mar 2020

With state governments announcing comprehensive shut-downs to ‘non-essential’ services due to #COVID19, what happens under a commercial lease to obligations to trade and to make rent payments? Jane Baddeley examines the obligations and options of commercial tenants and landlords.

By Natalie Bannister, Maurice Doria, and Jane Baddeley

Earlier this week, ‘non-essential’ indoor gatherings of more than 100 people were banned by the Federal Government as Australia responds to the COVID-19 pandemic. Prime Minister Scott Morrison said Australia should prepare for at least six months of disruption as health authorities attempt to contain infections.

In a given occupied space, there must be a density of no more than one person per four square metres of floor space. For settings where there is ongoing movement and an increased number of interactions between individuals, an individual’s attendance should be less than two hours duration.

At the time of writing, the VIC and NSW State Governments both announced that the states will proceed to a comprehensive shutdown of ‘non-essential’ services over the next 48 hours. The ACT has also announced a similar shutdown. Although details of the measures are to be clarified, supermarkets, petrol stations, pharmacies, convenience stores, freight and logistics, and home delivery will remain open. This leaves a very wide range of businesses which we can assume fall in to the ‘non-essential’ category.

A key question is: what happens under a commercial lease to obligations to trade and to make rent payments in this climate where businesses are facing increased pressure to minimise access to their premises? What happens when a government directive forces complete closure of these premises?

Obligation to trade

If the landlord has not chosen to restrict access to the premises, can a tenant elect to cease trade from the premises?

The majority of retail leases require a tenant to keep premises open for trade, and not suspend or discontinue its business during the term of the lease. This obligation appears in many commercial office and industrial leases as well.

The strict legal position is that a tenant must continue to trade if the lease and the landlord requires it. It is rare for a lease in Australia to include a general force majeure clause relieving parties of obligations if circumstances outside its control make it impossible to perform them. Leases do deal with events which result in the tenant being unable to access and use premises, but rent abatements and termination rights are usually limited to events which cause physical damage to the premises.

A landlord of retail premises may take the view that a significant reduction in foot traffic, and presumably in sales due to external factors, is a risk the tenant bears under the lease. The tenant should have taken business interruption cover to protect against this risk.

Consider, though, that a tenant has an obligation under health and safety laws to provide a safe workplace. It is most likely obliged to do so under the terms of its lease as well. Arguably the tenant can rely on this obligation as a basis for temporarily ceasing trade and vacating the premises if to continue to operate would expose its staff to a risk of infection.

Looking at where we are now, it would be hard to see how landlords could justify forcing tenants to keep their premises open, despite what the leases say.

Rent abatement

The Victorian Government has announced rent relief for commercial tenants in government buildings – a move private landlords are also being encouraged by the Victorian Government to undertake.

But what is the legal position? Is rent still payable under a lease?

As noted above, damage and destruction clauses which entitle tenants to rent abatement and termination rights if the premises cannot be used, are usually limited to instances of physical damage to the premises or building, not pandemics. The concepts of force majeure, frustration and change of law provisions do not apply given that the current pandemic is, as everyone hopes, short lived.

So if a tenant elects to close its business, even if the landlord waives an obligation to trade, it is most likely that rent will still be payable under the terms of the lease.

What if the building or the premises must be closed by law?

If the landlord is compelled by law to close down a building, it will most likely happen in circumstances where the tenant is also required to close down its business. Both parties would be acting in compliance with law as the lease requires them to. Given the recent announcements made by the various State Governments, this scenario is fast becoming a reality.

It is unlikely that any rent abatement clause in the lease will expressly cover such a situation like this. While each lease needs to be considered upon its own wording, generally speaking the tenant will be obliged to continue to pay rent and other payments under the lease because the abatement provisions under the damage and destruction clause do not apply.

The landlord may argue that the tenant’s business interruption cover should respond to meet the required payments. The tenant in turn would argue that the loss of rent cover that the landlord takes out and for which it is reimbursed via outgoings should protect the landlord’s income in these circumstances.

Each party needs to investigate whether their insurance cover extends to COVID-19. It may not.

Governments will increasingly ramp up their business assistance packages. However, at present both in Australia and overseas the focus is on keeping wages flowing to employees, as opposed to covering other business costs like rent.

Options

Practically speaking, though, there will have to be some commercial resolution to the issue of rent payments to avoid significant numbers of businesses failing permanently as a result of this COVID-19 crisis. As most businesses are facing similar challenges, is it not better for the landlord to bear some drop in income rather than have to find new tenants? Even if businesses like professional services firms and other corporates can continue to operate remotely, and even if retailers can maintain their online presence, the forecast economic downturn will see many businesses fail.

Some options to consider are:

The grant of a temporary rent holiday, with the value of the waived rent added to resumed payments over the balance of the term once the business returns to some degree of normality (presuming that the tenant’s business is still viable).
Building operating costs will reduce if they are not being used, but not wholly as there will still be rates, taxes, insurance and maintenance costs to meet.
Converting base rent payments under a retail lease to turnover-only rent for the duration of the government-enforced measures.

Note that leases will require formal variation to give effect to these changes.

Termination of the lease

If the landlord restricts access to premises, a tenant could claim that the landlord is in breach of the covenant for quiet enjoyment by compelling the cessation of trade or business. A lease commonly provides that subject to the landlord’s rights, while the tenant complies with its obligations under this lease, it may occupy premises without interference by the landlord. On its face, forcing a tenant to temporarily vacate premises constitutes a breach of quiet enjoyment, but the obligation on the landlord is usually subject to its rights reserved under the lease. This includes rights to do anything to comply with any law or the requirements of authorities.

Under commercial contracts, significant events like a COVID-19 outbreak could enable a party to that contract to avoid its obligations by triggering a force majeure clause or by invoking the common law doctrine of frustration. The contract must contain a force majeure clause that operates to relieve a party of obligations if circumstances outside that party’s control prevent it from complying. While leases are a type of contract, they very rarely contain force majeure clauses.

A contract will terminate at law automatically when a frustrating event occurs that makes performance of the contract impossible. The frustrating event must significantly change the nature of the contractual rights or obligations. This would be hard for a tenant to prove, particularly as the disruption will not be permanent.

Another common feature of a contract is a ‘change in law’ provision where an unforeseen legal requirement can release a party from an obligation. This could include a declared state of emergency. However, leases rarely include such a clause.

Notification of infectious diseases

Landlords and tenants should also check their leases to see whether they have any notice obligations to the other party in the event of an outbreak of disease. As a failure to comply with these provisions may result in a breach of the lease, strict compliance should be observed, particularly in light of the gravity of COVID-19.

It is clear that the evolving situation with COVID-19 is significantly impacting the bricks and mortar industry, leaving landlords and tenants in an immensely challenging position. However, as leases are different, we suggest careful consideration of your lease terms and seeking legal advice based on your specific circumstances before taking any action.