Commercial Rent Reduction Negotiation: Getting a great result for all parties

What to do when a commercial tenant asks for a rent reduction

The starting point for a landlord is to understand what new regulations may apply to the lease.

Currently (as at 1 May 2020) in Western Australia the only change to commercial tenancy laws that has been made to respond to the COVID-19 pandemic comprises the enactment of the Commercial Tenancies (COVID-19 Response) Act 2020 (“the Act”). 

The Act does not apply to all commercial leases.  It applies only to what it defines as “small commercial leases”, which comprise retail shop leases, leases taken out by small businesses or leases taken out by incorporated associations.

The Act does not contain any provisions requiring landlords to provide commercial tenants with any rent relief.  What it does provide is a prohibition on landlords taking certain actions (described as “prohibited actions”) following a failure by a tenant to pay rent (or a failure by a tenant to operate their business during operating hours required by a lease). 

The “prohibited actions” include evicting the tenant or otherwise re-entering or taking possession of the leased premises, terminating the lease, claiming damages or charging interest on unpaid moneys, calling in any securities (including bonds, bank guarantees or personal guarantees) or exercising any other remedy otherwise available to the landlord. 

The Act also contains provisions allowing disputes about its operation to be referred to the State Administrative Tribunal (“SAT”).  If a dispute is referred to the SAT, the SAT has powers including requiring a party to pay money or to order the termination of a lease – although, the SAT cannot make an order terminating a lease, or make any other order to the disadvantage of a tenant, unless the SAT is satisfied that the tenant’s breach was not as a result of the tenant suffering financial hardship as a result of the COVID-19 pandemic or restrictions imposed as a consequence of the pandemic.

The Act also provides that, generally, rent cannot be increased.

The Act will apply from 30 March 2020 to either 29 September 2020 or any other day that is subsequently prescribed.

Consequently, nothing in the Act requires any landlord to grant any tenant any rent relief.  The Act operates by limiting the rights which the landlord can exercise in the event of a failure by the tenant to pay rent.  The tenant’s liability to pay rent will remain – and can ultimately be enforced by the landlord when the operation of the Act has concluded, or in the event that the SAT makes an order requiring payment by the tenant of some or all rent.

Also, there is a National Cabinet Mandatory Code of Conduct SME Commercial Leasing Principles During COVID-19 (“the Code”).  However, the Code has not yet been adopted in WA.  Consequently, a landlord in WA is presently under no obligation to comply with the terms of the Code.  It is expected that a code of conduct will be implemented in WA – but the extent to which this will mirror the Code, and the timing of the adoption of such a code of conduct, remain uncertain.

The terms of the Code provide that the Code will apply to a tenant if the tenant is suffering financial stress or hardship due to the COVID-19 pandemic – which will be deemed to be the case for a tenant having an annual turnover of up to $50 million and being eligible for the Commonwealth Government’s JobKeeper programme (which, generally, requires a 30% or greater reduction in monthly income from 1 March 2020).

If the Code was to apply, then the landlord could not terminate a lease due to non-payment of rent or call in any securities that it may have (such as cash bonds, bank guarantees or personal guarantees); and the tenant may have an entitlement to rent relief, comprised of rent waivers and/or rent deferrals proportionate to the reduction in the tenant’s trade (with at least 50% of the relief taking the form of a rent waiver). The application of the Code would also preclude rent increases, potentially require waiver of some outgoings recovery, require the landlord to share the benefits of relief it receives on liabilities such as bank loans, land tax etc and potentially provide for the lease to be extended to give the tenant time to resume trading following the COVID-19 pandemic.

If the Act does not apply to a lease (because the lease is not a “small commercial lease”), and whilst no code of conduct is adopted in WA, then any request by a tenant for a rent reduction will be a matter of negotiation based on usual commercial principles – and the landlord will need to consider whether it could obtain a better outcome by insisting that the full rent be paid and possibly terminating the lease or suing for arrears if payment was not forthcoming, or whether in the current rental market its interests would be best served by agreeing to some level of relief (reducing or deferring the rent payable).

What to do if your tenant refuses to pay rent

If the Act applies (because the lease is a “small commercial lease”), the only action that the landlord can take consequential upon a failure by the tenant to pay rent would be to refer the dispute to the SAT and seek orders requiring the tenant to pay rent and/or providing for the termination of the lease.  Such orders would only be made if the SAT was satisfied that the failure by the tenant to pay rent was not caused by any financial hardship suffered by the tenant because of the COVID-19 pandemic or any restrictions imposed as a consequence of the pandemic. 

Otherwise, if the Act applies, the tenant’s liability to pay rent will be unaffected – it is just that the landlord will not be able to take action as a consequence of the tenant not complying with that obligation.  When the Act ceases to operate (29 September 2020, or any other day that may be prescribed), the landlord can then exercise all available remedies. 

So far as the Code is concerned, even if it was to be adopted in WA and was to apply to a tenant, unless the tenant’s business substantially or completely ceased to trade, then the Code would generally not allow the tenant to wholly cease to pay rent. Instead, there ought be rent relief (waivers and/or deferrals) proportionate to the reduction in the tenant’s trade.

If a tenant to whom the Code applied refused to pay rent at all, the landlord should enquire about the level of reduction in the tenant’s trade, and if trading was still continuing, seek to negotiate proportionate rent relief. If no agreement could be reached, the matter can be referred (by the landlord or by the tenant) to a binding mediation.

Should a tenant still decline to pay rent at the level determined by the binding mediation process, the landlord could not terminate the lease or call in any securities that it may have (such as cash bonds, bank guarantees or personal guarantees). However, the rent that accrues (insofar as not waived or deferred) will be a debt owing by the tenant to the landlord, and the landlord could sue and obtain a judgment enforceable against the tenant for arrears of rent.

If the Act does not apply to a lease (i.e. the lease is not a “small commercial lease”), and whilst no code of conduct is adopted in WA, then the landlord can exercise all of its usual rights, including terminating the lease and/or suing for moneys owed.  The landlord can also serve a statutory demand on the tenant, but the amount owing must now be $20,000 and the tenant will have six months within which to comply.

How to maintain the relationship with the tenant during COVID-19 rent negotiations

Whether or not the Act applies, and whether or not any code of conduct is adopted in WA, a landlord can maintain its relationship with its tenant by engaging in open and constructive dialogue about the extent of any financial hardship which the tenant is facing because of the COVID-19 pandemic, the extent to which the tenant can afford to maintain payment of rent and the extent to which hardship would be visited upon the landlord if rent was to be reduced or not be paid at all.

How a landlord can collect arrears owing

Even if the Code applies to a tenant, with the result that the lease cannot be terminated (and the tenant evicted) for non-payment of rent, any rent that accrues (insofar as not waived or deferred) will be a debt owing by the tenant to the landlord. The landlord could sue and obtain a judgment against the tenant for arrears of rent. The judgment could then be enforced against the tenant by way of the usual judgment enforcement processes in the State or Territory. These include orders allowing the seizing and sale of the tenant’s property and orders requiring that debts payable to the tenant (for example, the tenant’s trade debtors) be paid directly to the landlord. The landlord can also serve a statutory demand on the tenant for arrears of rent, but the amount owing must now be $20,000 and the tenant will have six months within which to comply.

Even if the Act and/or a code of conduct that is adopted in WA applies to a tenant, with the result that the lease cannot be terminated (and the tenant evicted) for non-payment of rent, any rent that accrues (insofar as not waived) will be a debt owing by the tenant to the landlord.  However, so long as the Act remains in operation (i.e. until 29 September 2020, or any other date that is prescribed), the landlord will only be able to take any action to recover the rent by having a dispute referred to the SAT, and the SAT then ordering that the tenant pay rent to the landlord and/or that the lease may be terminated – which will only happen if the SAT is satisfied that the tenant’s failure to pay rent was not caused by financial hardship suffered by the tenant because of the COVID-19 pandemic or any restrictions imposed as a consequence of the pandemic.  Once the Act’s operation has ceased, the landlord will be free to terminate the lease and re-enter the premises, enforce any securities that it holds (such as a bond, bank guarantee or personal guarantee) and/or sue and obtain a judgment against the tenant for arrears of rent. The landlord could also then serve a statutory demand on the tenant for arrears of rent, but the amount owing must now be $20,000 and the tenant will have six months within which to comply. 

Because the Act (and, if adopted in WA, the Code, except insofar that rent is waived or deferred) will not affect the tenant’s underlying obligation to pay rent, tenants who do not pay all of their rent during the period in which the Act is in operation will face the prospect of their landlord immediately exercising their rights to extract payment of rent or to terminate the lease and re-enter the property immediately upon the Act’s operation ceasing. 

Landlord’s insurance during COVID-19

Some landlord’s insurance policies cover the landlord against a tenant failing to pay rent. However, the terms of a specific policy will need to be considered to ascertain whether such cover is provided – specifically whether the application of the Act, of a code of conduct (whether or not in terms of the Code), and/or an agreement to voluntarily waive or defer rent because of hardship being experienced by the tenant because of the COVID-19 pandemic, are events which attract cover under the policy – and if so the maximum amount of rent that the policy provides cover for.

Also, if a landlord is contemplating taking out a new landlord’s insurance policy to cover against the potential for a tenant obtaining rent relief under the Code or otherwise seeking to negotiate rent relief, the possibility of specific exceptions relating to the COVID-19 pandemic will need to be checked.

Who to contact if negotiation is not working

If negotiations are not working, the landlord can seek to refer the dispute to the State Administrative Tribunal.

Speak to our Property Law team for more.