We would also like to acknowledge Ross Watkins, Lawyer, for his contributions to this article.
The National Cabinet Mandatory Code of Conduct: SME Commercial Leasing Principles during COVID-19 (the Code) came into effect on 7 April 2020 and is now legislated in most jurisdictions. It provides an overarching obligation for tenants and landlords to negotiate in good faith. The lessons learned from early adopters of the Code provides valuable insight into the best approach to negotiations and underscore the importance of striking the right deal now to secure the economic survival of each business now and into the future.
Perhaps the most important thing to note is that the Code, and related State legislation, do not of themselves remove the obligation of a tenant to pay rent. Broadly speaking these rules defer the obligation to pay rent, and provide tenants with protection from termination of the lease during the COVID-19 period, in the expectation that it is up to the landlord and tenant to both negotiate in good faith to reach a mutually acceptable arrangement. But unless a deal is done, rent still accrues.
Be proactive; show value
Although in the short term the tenant has an advantage, as the landlord is not receiving rent and the proportionality principle applies, the closer things get to the end of the COVID-19 period, the more the advantage is with the landlord if rent has accrued but not been paid and no deal has been agreed.
You should be proactive about negotiating with the landlord, presenting yourself as a business concerned about the present, but with a long term future. If the landlord has other locations you may also wish to convey a growth story, and an interest in additional locations.
A lot of focus has been on reducing rents, and it is obviously critical to be able to survive through the pandemic. However there may also be opportunities to secure additional locations vacated by other tenants, or concessions on issues such as lease tenure, refurbishment requirements or some form of business exclusivity in return for acceptance of slightly higher rent. It is sensible to do your homework on what other future opportunities might arise, and be aware of the current terms of your lease so you can move quickly if you see an opportunity.
It is important to understand the landlord’s position through this pandemic. Owing to the Code and the downturn in economic activity, they may also be facing financial stress, and be worried about the future. Major shopping centres are valued in different ways, so it is good to know what applies to each landlord. For some landlords the dollar amount of the rent may be critical, for others the vacancy level. Some landlords may happily accept rent as a percentage of turnover for an initial period, but for others this framework may cause them problems. Some landlords may happily agree to extent a lease term, whereas others may prefer to give a concession in another way.
Landlords will be looking to secure tenants who will provide stability and growth on the other side of the pandemic. The more you can understand the landlord’s position, the better you are likely to be able to negotiate. On the other hand if the landlord feels you are being opportunistic they are likely to defer doing any deal, leaving you with a ticking time bomb in terms of accrued rent.
By approaching the landlord and showing your commitment to working with them through this crisis and beyond, this can signal that your business is valuable to the landlord. In turn, your business may be considered a long-term prospect, for which the landlord may be willing to be more generous in the terms they negotiate to ensure your business survives the pandemic.
Know what you want; beware of traps
It is vital to know what you want overall, and on a site-by-site basis. The first decision to make is whether you want to continue with the lease. If so, a deal should be the focus. If not, there may be legal means to exit the lease that can be explored.
You should have a plan when entering negotiations; a benchmark which defines your minimum acceptable terms, failing which you would rather attend mediation. Some things to consider are how much of a decrease in rent is acceptable? What proportion of rent reduction would you prefer as waivers (rent discounts you will never have to pay back) compared to deferrals (rent discounts you will have to repay at a later point)? Would you consider tying rent to turnover on an ongoing basis, or for a short-term period until things return to normal? And what is the measure of “normal”, noting that economist predict a significant reduction in consumer spending driven by high unemployment.
You must be aware of some traps in negotiating. For example, terms attempting to clawback waived or deferred rent, or terms which alter the future rent review process can undo all the relief negotiated and compound your financial problems once you emerge from the pandemic.
Negotiations should be conducted with an eye to recovery and beyond. While showing your business as a long-term prospect has advantages, you must consider how any deal will impact your business in the medium- and long-term. You do not want to be locked into a deal that is beneficial now, but may cause significant problems later, as this can undo any of the short-term benefits negotiated.
There is also merit in building in future flexibility. It may be that no vaccine is developed, or the virus mutates. There may also be multiples waves of the virus and Government closures or reactions. Foot traffic may not return to normal, anchor tenants may vacate or consumer behaviour may change permanently in a way that impacts your business. Some form of agreed exit or viability measure may be appropriate.
Know your rights
It is important to understand your rights in negotiations so that you enter the negotiation on a level playing field and obtain the best result for your business.
Landlords are asking tenants for financial information to prove their decrease in trade. This is a legitimate request, as the Code requires rent reductions at least proportional to the tenant’s decrease in trade, and in order for landlords to provide this reduction, they need to verify how much trade has reduced by. However, tenants should be wary of requests for any other financial information, and should make it clear that the information being produced is to be used solely for the purpose of identifying decrease in trade for the rent negotiations.
Some landlords are also providing tenants with confidentiality agreements to prevent them discussing their negotiated agreement with other tenants. Subject to individual circumstances, there is no general legal requirement to sign these documents.
Striking the right leasing deal now is about more than just survival during COVID-19. The most effective negotiations will cast an eye to the future and how you can emerge from the pandemic. For now, you should assess your business, make your plan, and prepare to demonstrate your value to the landlord in order to strike the right leasing deal that will see you through the crisis and enable you to thrive once the pandemic ceases. Get advice on the terms of the lease, including any terms that should be included to give you future protection.