Is your asset protected? Commercial tenancies in the time of COVID-19

OPINION: AS legislation comes into effect to support commercial tenancies impacted by COVID-19, many landlords are now experiencing the practical implications this is causing to their investments.

Regardless of property size, all landlords have a legal entitlement to protect their assets, understand their rights and ensure a mutually beneficial arrangement between landlord and tenant.

Any business that has experienced a COVID-19 related reduction in income is likely to request rental relief. So how does a landlord know if a tenant has experienced a genuine downturn and is not simply taking advantage of the situation?

There are several pieces of evidence landlords can, and should, ask tenants before negotiating rental terms, including:

1. Gain an understanding of the current financial position of the business. Including:

• Is the business currently registered or entitled to register for JobKeeper?
• Does the business have a turnover of less than $50 million?
• Is the business part of a company group for income tax purposes and, if so, is combined turnover of that company group over or under $50 million?
• Has the business suffered a drop in turnover as a direct result of the COVID-19 pandemic and, if so, what is the percentage of that drop?

2. Ask for documents to support the above, for example:

• Profit and loss statements and assets and liabilities statements for the last two years, prepared or certified by an external accountant.
• Business financial statements for the period from 1 July 2019 to 31 March 2020.
• Monthly turnover figures for the last 24 months for retail tenancies, or monthly profit and loss statements for commercial tenancies for the period from 1 April 2019.

3. Ask for written details of how the business has adapted to mitigate the loss. This may include:

• The nature of any Government assistance that is available to the business and confirmation of the extent to which the business has taken up that assistance.
• Confirmation from their insurance company of whether the business interruption policy will cover COVID-19 disruption to their business.
• Advice from their bank in relation to any assistance that is available to the business including business interest deferral options or overdraft facilities.

Beware of unintended consequences of rent deferrals

When finalising lease terms with your tenants, it is important to ensure that the GST impact of the deferral will operate as intended. The drafting of the rent deferral agreement is crucial to avoid any unintended consequences regarding the potential GST impact.

For deferred rent, technically there is no ‘reduction’ in the consideration payable for the supply of the premises each month as the parties have just agreed to defer payment of that part of the rent. Technically, this should require an invoice to be issued each month for the full rent amount, including any deferred rent. GST will then need to be remitted based on each full rental charge even though some part of the rent will only be paid at the end of the deferral period.

For a rental reduction or abatement, these attribution rules do not usually pose an issue as the parties have agreed that for the relevant periods, the rent will be reduced and GST should only be payable (and the tenant invoiced) for the reduced rent.

As such, the best approach is likely to be for the parties to reduce the rent due for the relevant period, and then increase the rent proportionately following the end of the deferral period. This method will allow the landlord to simply invoice for the rent paid each month, whether that be a lesser, or increased, amount.

There may be other alternatives to this suggested approach, and each landlord should seek independent advice based on their individual circumstance.

You are not alone!

Many landlords, particularly small to medium sized landlords with limited cash reserves, are rightly concerned that that sharp declines in rent as a result of COVID-19 may lead to breaches of their lending covenants and bank enforcements which may then push them further into financial distress.

As there are currently no legislated restrictions on banks enforcing their lending covenants, the landlords are encouraged to have discussions with their lenders regarding a freeze on enforcement of lending covenants as a matter of priority. As part of these discussions the landlords may look to obtain a deferral or waiver of interest proportionate to the rental losses experienced. Alternatively, the landlords may be able to negotiate a break from fixed rates which were negotiated in the pre-COVID-19 economic climate.

Land tax relief measures have now been implemented by most Australian jurisdictions. While the details and the extent of the relief available varies between States and Territories, these measures generally involve waivers, deferrals and reductions to land tax charges for landlords who have experienced financial difficulties caused by COVID-19. Landlords should investigate their eligibility for land tax relief with relevant State Government bodies. Keep in mind that some jurisdictions have set timeframes to submit a relief application and requirements to pass on the benefit to the affected tenants.

Dispute management should be the last resort

When negotiating rent relief with tenants, landlords would be wise to consider the value of maintaining a positive relationship with their tenant. Aim to negotiate a mutually beneficial outcome in the shortest possible time to provide certainty of rental income and ensure that relief is provided quickly to the tenants impacted by the pandemic.

If a mutually acceptable agreement cannot be reached between the landlord and the tenant, the parties may rely on the dispute resolution process introduced by the States and Territories in respect of the recently legislated National Code of Conduct – SME Commercial Leasing Principles. Those looking to cease private negotiations and engage in a dispute resolution process involving mediation or court proceedings should consider the cost, potential time delays and certainty of outcome to ensure it is worthwhile.

By Eva Vicic, Partner, McCullough Robertson Lawyers.

Eva has extensive experience in property and real estate law, with a particular focus on all aspects of property development. She advises large corporations, property trusts, private syndicates and developers. Eva is a key member of the real estate team and has a particular focus on property development, property sales and acquisitions, and commercial and retail leasing transactions. She is experienced in drafting and negotiating sale, acquisition and project documentation for all types of real estate assets. This includes preparing strata documentation and project contracts for large scale off-the-plan developments and managing all aspects of the project.

Eva’s expertise also extends to title and leasing due diligence and acting for institutional landlords and major tenants in a wide range of leasing transactions ranging from drafting and negotiation of major leases to advice on complex agreements for lease and make good arrangements.