The commercial lettings market is fast changing with COVID-19 and the current economic climate. We summarise below some recent developments, relevant for both landlords and tenants.
Recovery of rent and negotiations
The landlord’s tools to recover rent have been very much blunted by recent legislation.
- Forfeiture (or re-entry) – is the landlord’s ability to bring a lease to an end due to non-payment of rent or breach of other tenant covenants. It is not possible to forfeit a business tenancy for non-payment of rent until after 30 September 2020 (may be extended).
- Commercial rent arrears recovery (CRAR) – is where a landlord can take control of a tenant’s goods and sell them at auction with the proceeds of sale being applied against the arrears. This will only be available if there are 189 days of rent arrears and this applies until 30 September 2020 (may be extended).
- Statutory demands – a written demand for payment of a debt, such as rent arrears. If the demand remains unsatisfied after 21 days, this can be used to support a winding-up petition (i.e. as evidence that a company is unable to pay its debt). However, no winding-up petitions are to be presented on or after 27 April 2020 if they rely upon statutory demands served between 1 March 2020 and 30 September 2020.
So what are the options for the landlord?
- A money only claim – remains possible and a landlord may be able to seek contractual interest and costs under the terms of the lease. That may help in creating some negotiating leverage. However, there are likely to be delays due to the backlog of Court cases. Also, enforcement of any money judgment needs to be carefully considered prior to commencing Court proceedings, particularly as the risk of company insolvency is now much higher.
- Rent deposit – this is still available for the landlord to use, subject to terms.
- The remedy of CRAR – the tenant will need to be in 189 days of rent arrears and this is likely to be quite limited i.e. it may be difficult to take control and auction goods due to social distancing measures.
- Claims against former tenants / guarantors – this is possible; there is a strict 6-month time limit to recover sums from former tenants or guarantors, on which we can provide further advice.
- Forfeiture for non-rent grounds is available – where effected by peaceable re-entry and where service of a section 146 notice is first required. Forfeiture is unlikely, however, to be desirable in view of challenges of re-letting premises and the landlord may find itself with an empty premises, at risk to squatters.
Time to negotiate?
Whilst it may not be appropriate in all cases, landlords and tenants should try to work together during this difficult period to reach commercial compromises. Amongst other things, landlords may need to consider rent deferrals, temporary concessions or turnover leases (see below). Landlords should take further advice and exercise care when sending side letters to avoid permanent variations to terms of the lease. If the landlord has a large site, where they might be negotiating terms with multiple tenants, confidentiality provisions may be important.
Turnover rent leases
One way for landlords and tenants to overcome current market challenges is to consider turnover leases. In particular, the uncertainty in the retail, leisure and hospitality industries may see an increase in turnover rents: rents calculated by reference to the turnover generated by the tenant business at the leased premises. This arrangement shields the tenant from the financial impact of an economic downturn, whilst allowing both landlord and tenant to share the benefits of any uplift in business if there is the “V-shaped” recovery predicted by some market commentators.
Future of office space, break notices and market trends
The pandemic has accelerated the already growing trend of working from home, with companies making the most of technology to ensure their workforce can carry out their duties seamlessly from remote locations. Some market experts predict that professional service companies in London may reduce their office space requirements by up to 50%. The current uncertainty is affecting the retail, leisure and hospitality industries most severely.
As a result of these developing trends, a fall in demand for both retail and office space is anticipated and the historic London office-cost premium is expected to fall from its current levels (prime square footage in the capital costs three times as much in other southern cities and seven to nine times as much as elsewhere in Britain).
Possible trends to look out for:
- Short-term leases and smaller premises – it seems likely that tenants will want a smaller premises with a shorter term. The average commercial lease term has previously been in the region of 5 to 15 years (historically 25 year leases had not been uncommon). Faced with the alternative of vacant premises and increased liability for rates and services, landlords may have to consider shorter term leases.
- Break notices – many tenants, locked into leases with substantial rents over large premises, may want to consider exercising a break notice to terminate the lease. If there is a tenant break option (particularly one with a fixed break i.e. it must be exercised by a certain date), tenants should diarise and be in touch with their advisors well in advance. Break notices need to be prepared with care and it is important that the correct landlord is identified. If there are pre-conditions to exercising a valid break option, these should also be looked at closely – for instance, in one case in 2011 non-payment of default interest in the sum of £130 invalidated a break notice. In challenging lettings markets, the landlord may well look to dispute break notices if it can. This is something tenants will obviously want to avoid.
- Rent reviews – where a lease provides for a rent review, it will generally be revised on the basis of the open market rent of the commercial premises at the relevant review date. A market rent is the best rent that could be obtained for the property being let (that is, the open market value of the premises). The convention for market rate rent reviews is that they are on an “upward only” basis, meaning that the rent paid by the tenant cannot go down, even if the market rent at the relevant review date is lower. Considering the level of uncertainty now and in the foreseeable future, it may not be unreasonable for tenants to seek a rent review clause, permitting a reduction in the rent if that reflects the market.
Lease renewals under Part II of the Land and Tenant Act 1954
Certain tenants may now be in a strong position when it comes to negotiations for a lease renewal under Part II of the 1954 Act.
- Rent-free period – if the tenant is exercising a Section 26 Request for a new lease, they might want to consider asking for a rent-free period. A tenant could potentially propose a specific term in the lease on this; or, alternatively, put forward the proposed annual rent to take account of a % rent reduction amortised over the term to reflect a rent-free period. Further advice should be taken from solicitors on this.
- Opposing a new lease on Ground B (persistent delay in paying rent) – due to recent developments in legislation, the landlord will not be able to oppose a new lease on the basis of a persistent delay in paying rent (Ground B) between 26 March 2020 and 30 September 2020.
- Prospects of landlord opposing a new lease – whilst every case is different, it does seem unlikely that landlords will want to oppose lease renewals given the state of the market. If they do, they could well be left without any tenant.
Interim rent – this is another factor that will need careful thought and such applications can be made by the landlord or tenant. For example, parties should be alert to making applications on interim rent i.e. where there is a continuation tenancy and the rent payable before the new lease comes into existence differs substantially to rent under the new tenancy.