virus

COVID-19 and real estate: Top ten tips for UK landlords

Publication March 2020


Introduction

Coronavirus (COVID-19) has spread with startling rapidity. In response, government advice and policies are being revised at an accelerating pace and are increasingly draconian.

It is to state the obvious that the impact of the pandemic on many businesses will be catastrophic. In a bid to protect their employees from infection, or as part of the wider community effort to delay the spread of the virus, many businesses are limiting access to their office and other locations or closing them entirely. The government has told cafes, pubs, theatres and restaurants to close and further such announcements may well follow. On March 19, 2020, a Coronavirus Bill had its first reading, its purpose being to give the government powers to contain the spread of COVID-19, including powers to issue directions in relation to events, gatherings and premises. That Bill has just been amended to prevent the enforcement of a landlord’s right to forfeit a business lease for non-payment of “rent” (which includes service charges) until at least June 30, 2020.

What is the impact on landlords of commercial property from a legal perspective? Here are answers to ten frequently asked questions.

1. Can tenants terminate their lease before the end of the contractual term?

There are two ways in which a tenant may be entitled to terminate its lease before the end of the contractual term:

  • By arguing “force majeure”

  • Typically force majeure provisions allow for (i) the suspension of contractual obligations (ii) non-liability for failure to perform (iii) extensions of time to fulfil obligations and (iv) termination, in circumstances of unforeseen events. Unlike civil law legal systems, in English law, force majeure, is not defined, either by statute or under case law, and the concept of force majeure will not be implied into a contract. That means the parties can only rely on this concept if a force majeure provision is expressly set out in the contract.

    Leases governed by the laws of England and Wales rarely contain force majeure provisions so it is highly unlikely that a tenant would be able to argue that its lease obligations have come to an end due to the intervention of a force majeure event.

    In the unusual situation of a lease containing force majeure provisions, their applicability in the current situation would depend entirely on the way in which the provisions are drafted.

  • If a lease does not have a force majeure clause, a tenant may argue that restrictions being put in place to combat the spread of COVID-19 have “frustrated” the lease.

  • In general terms, frustration is the legal doctrine that operates to discharge the parties to a contract when an event which was not reasonably foreseeable and not due to the fault of either party occurs after the formation of the contract and renders further performance of the contract either impossible or illegal or makes it radically different from that contemplated by the parties.

    Arguably, the COVID-19 outbreak is not such an occurrence – in recent years, SARS and swine flu have emerged as risks to public health. Accordingly it could be argued that public health issues should be within the contemplation of the parties at the time of grant.

    In a case decided in Hong Kong following the 2003 SARS epidemic1, the applicant tenant argued that its tenancy agreement was frustrated due to an isolation order issued by the authorities against the premises, closing them for 10 days. The courts held that 10 days out of a 24-month lease with 11 months remaining was an insignificant duration. The courts also expressed the view that even though the outbreak of SARS could arguably be considered an unforeseeable event, the effect of the isolation order did not go as far as to alter radically the fundamental rights and obligations arising from the tenancy agreement.

    In the UK, recent case law (notably Canary Wharf Limited v. European Medicines Agency [2019] EWHC 335 (Ch), where the European Medicines Agency failed in its argument that Brexit would frustrate its lease) has shown that the bar is set very high when it comes to successfully arguing that a lease has been frustrated.

    All that said, if the government introduces draconian measures to control societal interactions, and those measures are of an unprecedented nature, we may well see courts asked to consider claims that leases have been frustrated.

In addition, of course, the lease may contain a contractual break clause in favour of the tenant, although this would only arise at a specific point or points during the term and the tenant would have to comply to the letter with the requirements of the clause in order to exercise the break right successfully.

2. Can tenants insist on a rent reduction or suspension of rent?

Most commercial leases only allow a suspension of rent if the premises are damaged or destroyed due to an insured risk. Otherwise the tenant will be legally obliged to pay the rent with no reduction.

The exact position will depend entirely on how the suspension of rent provisions are drafted and these would need to be checked to see if there is a suspension in the event of the premises becoming inaccessible or unusable independently of damage or destruction by an insured risk (which might arguably apply in the case of a lockdown or forced closure of premises by the government).

3. What should I do if a tenant asks for a rental breathing space?

While in most cases tenants will not legally be entitled to a rent reduction or suspension, given the current extraordinary circumstances and the potentially catastrophic consequences for many tenants, particularly in the retail sector, it may be commercially sensible to take a collaborative approach with affected tenants. This would also complement the government’s strategies and measures to keep businesses afloat.

We suspect that many landlords may adopt this stance – for example, press reports suggest that one major UK developer landlord has announced that it is waiving rent for three months at one of its developments so that stores, restaurants and bars within it will not have to pay rent until the end of June whether they remain open or closed.

In addition to a temporary suspension or reduction in rent payments, another option would be to agree to a switch to monthly, as opposed to quarterly, instalments in advance. This would help with a tenant’s cash flow while preserving current income stream levels for landlords. It would be important, however, to ensure that this is done as a temporary concession by way of a side letter as opposed to a variation of the lease itself.

4. Can we recover the costs of any additional steps we take as a result of COVID-19, such as deep cleaning the premises?

This will depend entirely on the wording of the service charge provisions in the lease.

Typically a lease of part will impose obligations on the landlord in relation to the provision of services to the building and common parts, with the right to recover from the tenants the costs of providing those services.

Anticipated services are specified. However most leases will also include a “sweeper” clause intended to give the landlord the flexibility to provide, and recover the cost of, any other service or amenity that it thinks it would be reasonable to provide for the benefit of the tenants and occupiers of the building or in the interests of “good estate management”. The first question is therefore whether the additional steps taken would be covered by the definition of the “services” in the lease.

The service charge provisions may also entitle the landlord to recover:

  • The costs of complying with the recommendations and requirements of the insurers of the building.
  • The costs of complying with legislation relating to the common parts (or even the whole building in some instances).

If so and the additional steps taken are an insurance or legal requirement, the costs incurred may be recoverable under those provisions.

In summary, all will depend on the lease terms.

5. Will any COVID-19 related losses we incur be covered by insurance?

Again, this will depend on the risks covered by insurance policies and the policy terms and the risk appetite of the insurance company issuing them.

Landlords may have purchased business interruption (BI) insurance. The aim of BI cover is to restore the policyholder to the position they were in before the event occurred in terms of lost profits or additional expenditure. Thus, there may be cover for loss of profits/extra expense in circumstances where there has been denial of access to business premises by government order and, depending on the extensions to cover available, even a loss of use of premises due to virus contamination.

The specific wording of the relevant BI policy will need to be scrutinised for certainty of coverage, but it is common for a BI policy generally to include a requirement that insured “property” has sustained damage. The damage must occur during the currency of the policy, giving rise to loss of profits or additional expense during the period after the occurrence of the peril insured against. Typically, such damage arises from events such as fire, storm or flood.

However, some policies may afford extra expenses cover where a “Notifiable” or communicable disease extension is obtained. Some policies offer “denial of access” cover which normally requires a mandatory closure of premises by legislation or government order as a result of defined disease.

6. Do we have a duty of care to our tenants or any other obligations in relation to COVID-19?

There are currently no statutory duties or obligations imposed on landlords specifically in relation to COVID-19 (for example to notify local authorities) as there are with something like legionella. However, this may change as government measures become increasingly stringent.

Landlords do have general obligations under the Health and Safety at Work etc. Act 1974 to take “reasonable” measures to protect the health and safety of their tenants, anyone else entering the building and their employees.

What are “reasonable” measures in the context of COVID-19? Following government guidance is a good starting point. Public Health England has published Guidance for Employers and Businesses on Coronavirus (COVID-19) and this should be seen as the baseline for such measures. This was first published on February 25, 2020, and has already been updated several times.

The Guidance includes advice on limiting the spread of COVID-19 in businesses and workplaces, advice on cleaning and waste and other good practice measures.

While some of the recommendations may be more relevant to tenants than to landlords depending on the nature of the demised premises and the terms of the lease, they would be relevant to landlords in their entirety in relation to their own employees, common parts and other areas within the landlord’s control.

Landlords may also be well advised to ensure that their tenants are aware of the Guidance and, if the lease gives them the right to impose regulations on tenants, require that it is followed.

It is also important to continue to monitor the situation as the position is very fluid. Guidance is updated on an almost daily basis and emergency legislation is also on the cards.

7. Would we have any liability to our tenants if we denied access to the premises?

Landlords covenant with their tenants to give them “quiet enjoyment” of their premises and not to “derogate from their grant”. In plain English, this means that landlords must not interfere with their tenant’s possession and use of, or access to, the demised premises under risk of being sued for damages for breach.

However, insofar as common parts are concerned, leases typically reserve the right for landlords from time to time to prevent or restrict access to any of the common parts if reasonably required in case of emergency. A landlord’s argument that there is an emergency would be bolstered if closure is ordered by government.

As to the demised premises themselves, leases invariably contain an obligation on the part of the tenant to comply with all laws relating to the property. A tenant would therefore be obliged to leave the premises if closure is ordered by emergency legislation.

8. Can we require our tenants to keep their premises open for business?

Some leases contain what is referred to as a “keep open” covenant. These are most common in the retail sector where landlords may want to maintain the commercial attractiveness of a retail park or shopping centre by ensuring that shops and businesses – particularly anchor tenants – are kept open and keep trading.

Following the House of Lords decision in Co-operative Insurance Society v Argyll Stores (Holdings) Ltd [1997] UKHL 17, the courts in England and Wales are reluctant to allow landlords to obtain an injunction to enforce a keep open covenant. Instead, a breach of a keep open covenant may entitle the landlord to damages.

However, tenants also usually covenant in leases to comply with any laws relating to the premises and their use. What, therefore, would the position be if the government introduced emergency legislation for the closure of premises subject to a keep open covenant? It is difficult to imagine the courts awarding substantial damages for a landlord’s losses in such a scenario.

In the absence of a keep open covenant, a landlord cannot force a tenant to remain in occupation or continue trading, although rent would continue to be payable.

9. We have entered into an agreement for lease with a prospective tenant who no longer wants to proceed. Can we force it to take the lease?

A prospective tenant cannot unilaterally withdraw from its contractual obligations under an agreement for lease simply because taking the lease is no longer an attractive or viable economic proposition for it.

As in the case of a tenant wishing to terminate its lease before the end of the contractual term, there are two ways in which a tenant may be entitled to exit an agreement for lease: by arguing “force majeure” or that restrictions being put in place to combat the spread of COVID-19 have “frustrated” the agreement. Similar considerations apply here as they do in 1 above.

Where an agreement for lease simply governs the timing of the grant of a lease, force majeure provisions allowing one party to terminate the agreement are very rare.

Force majeure provisions are, however, typically seen where the agreement for lease also includes building obligations. In this respect, force majeure provisions either operate directly, by the agreement for lease defining what amounts to force majeure and making express provision for what will happen in the event of force majeure, or indirectly, by the agreement referring to delays or suspensions by reference to any periods of time allowed to the contractor under the relevant building contract.

10. Are there any COVID-19 related issues we should consider when negotiating leases in the future?

Landlords and their advisers will want to ensure that service charge provisions are wide enough to cover the additional costs they may incur in relation to the building as a result of infectious diseases such as COVID-19 and that there is a specific reference to them.

Where they are under an obligation to provide services in relation to the tenants and the building, landlords may also want to make it clear that they will not be liable if any of these are temporarily suspended as a result of any such disease.

COVID-19 has also highlighted the predicament of tenants who are bound into leases that are no longer economically viable as a result of it and government measures in response. Landlords may therefore also find that, going forward, tenants ask for force majeure provisions in agreements for lease and leases and more extensive rent suspension provisions.

The content of this briefing is current as at the date of publication. Please note that government advice and policies are constantly being updated.

If you would like to discuss any of the issues covered in more detail, please contact Sian Skerratt-Williams or Wasim Khan.


Footnotes

1   Li Ching Wing v Xuan Yi Xiong [2004] 1 HKLRD 754



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