FAQs: How is COVID-19 affecting commercial leases?
Written by Domenica Caridi
The Australian Government has adopted, and is continuing to adopt, urgent and unprecedented measures to contain the escalation of the Coronavirus Disease (COVID-19) pandemic. These are having a significant effect on business and social life within the country.
Last week, ‘non-essential’ indoor gatherings of more than 100 people were banned by the Federal Government as Australia responds to the pandemic.
Commercial landlords and tenants are assessing their respective rights and obligations. So, what is their position in these extraordinary times?
In this article we have pulled together answers to some ‘Frequently Asked Questions’ that are likely to arise between landlords and tenants. As much of the following discusses the relevant issues at a general level, we recommend to seek legal advice on specific questions.
What steps should a landlord or tenant take in the event of a general quarantine or lockdown?
Following the statement by the Prime Minister on 23 March 2020, a general quarantine or lockdown is government policy for ‘non-essential’ businesses.
Landlords and tenants are advised to seek legal advice regarding the impact and process of closing commercial premises, from both a landlord and tenant's perspective, and the interplay with specific lease terms, such as rights of access and ‘keep open’ clauses.
What recourse may landlords and tenants have if contractual arrangements are affected?
Both parties have limited remedies under Australian common law for avoiding contractual obligations where a contract becomes diﬃcult or impossible to perform. Two such remedies are (1) the presence of a contractual force majeure clause; and (2) the common law doctrine of frustration.
A force majeure clause operates to delay or absolve one or both parties to a contract of all or part performance of their obligations on the occurrence of certain events which are outside their control. These may include acts of God, natural disasters, epidemics or pandemics, war, strikes and acts taken by governments. Such clauses are not usually seen in commercial leases under Australian common law, but whether or not the coronavirus will constitute a force majeure event will depend on the relevant contractual wording and interpretation.
In the absence of an express clause, contracting parties may be able to argue that the impact of COVID-19 has "frustrated" the contract.
Frustration brings a contract to an end where, through no fault of either party, an intervening, post-contractual event has occurred which makes performance of the contract impossible or radically different. As above, whether frustration has occurred will depend on the terms of the lease and circumstances of the case. While there may be an argument that a government ban on occupation of, or trading from, the premises could frustrate the lease agreement, frustration has a narrow scope and is difficult to establish. Case law indicates that a temporary change, such as the short-term closure of rented premises, would ordinarily not be enough to frustrate a lease. It is likely the lease will continue during any period of forced closure.
However, that is not to say that an epidemic or pandemic, or events associated with it, cannot amount to frustration. Given the dramatic impact of the Covid-19 pandemic, there would appear to be scope for the doctrine of frustration to apply in many cases, depending on all the circumstances.
What action can landlords take if tenants cannot afford to pay rents due to business interruption as a result of COVID-19?
In the usual way, a landlord may forfeit a lease for non-payment of rent either by possession proceedings, if the premises are residential or by peaceable re-entry or proceedings if the premises are commercial. It may also take any other enforcement steps against the tenant. However, there is already a trend beginning to appear of tenants in difficult situations approaching landlords to seek rent concessions such as a change to the frequency of payments (e.g. quarterly to monthly).
On 30 March the government announced that commercial tenants who cannot pay their rent over the next six months because of COVID-19 will be protected from eviction. This provision will only delay the right of forfeiture and does not otherwise impinge on a landlord’s right to claim forfeiture or recover rent at the end of this period.
No doubt landlords and tenants will open dialogues with each other to discuss particular issues to help tide them over this difficult period.
Can an existing lease be brought to an end by either a landlord or a tenant because of the impact of COVID-19; or, can a landlord or a tenant refuse to enter into a new one under an existing agreement for lease?
Ending a lease, or refusing to enter into a new one, solely on the basis of an intervening event, could only arise in very exceptional circumstances. Without a contractual right to do so, landlords and tenants cannot simply terminate leases early.
Most commercial leases provide that the landlord may re-enter the premises and terminate the lease upon breach of a tenant covenant and, specifically, non-payment of rent.
As regards COVID-19, landlords and tenants should refer to the express terms of their leases/agreement for leases to ascertain whether the present circumstances are likely to be covered.
In what circumstances (related to COVID-19) will a tenant be entitled to withhold rent?
Most leases will contain wording preventing a tenant from withholding, offsetting or deducting sums reserved as rents in a lease.
Tenants are typically only permitted to withhold the payment of rent where damage or destruction has been caused to the premises by an insured risk (and sometimes uninsured risks, too) such that the tenant cannot occupy or access the same.
Instead, tenants could request temporary reduced rents or short rent-free periods. Although landlords do not have to enter into negotiations, many landlords and tenants are already reaching voluntary arrangements about rental payments. If accepted, concessions should be personal to the relevant tenant, with appropriate rent acceleration provisions for any deferred rents upon any future lease assignment.
Will landlords and tenants be covered by insurance?
Landlords and tenants will need to consider whether their particular insurance policy covers losses suffered during a disease outbreak. It is common for policies to exclude losses caused directly or indirectly by a disease outbreak. However, insurance policies may provide for business interruption coverage, which protects businesses against losses incurred as a result of disruptions to their operations. Landlords and tenants should review their insurance policies carefully.
What provisions should landlords and tenants consider inserting into new leases to deal with the impact of COVID-19?
Given the daily developments of COVID-19 in Australia, landlords and tenants should be checking their lease documents and thinking about what current actions may be required, and preparing for any future actions as developments in the outbreak progress. At the same time, clauses dealing with infectious disease, harm to health, access and abatement of rent should be carefully considered in the drafting of new leases.
Our team of commercial lawyers can help draft bespoke provisions which can be built into a new lease for the protection of either party.
Get it right
During these uncertain times, seeking legal advice prior to making a decision under a contract is paramount as failing to do so may likely result in your business suffering significantly.
If you would like more information about the contractual effects of the coronavirus outbreak or would like to discuss a potential or existing contract, please contact us by telephone on (03) 9311 8911 or by emailing our office at email@example.com.
*The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.