Covid-19 will affect the real estate sector as it will the rest of the UK economy.
As the pandemic takes hold, offices, retail and industrial premises are all likely to experience interruption at best, and possibly much worse. If the government’s response evolves to a level where social distancing becomes necessary on a large scale (and all the indications are that it will), it is surely inevitable that the occupation of premises and buildings across the country are likely to be very seriously affected.
Cause for disputes
Building closures will bring a number of legal issues into focus. Tenants might seek redress from landlords in the form of compensation for loss of business, rent and service charge payments or rent abatement; or even seek to extricate themselves from their leases altogether. Landlords may have to prevent their tenants from accessing premises that they would otherwise be entitled to occupy, and could incur additional costs (for example the cost of a deep clean), which tenants may be reluctant to pay for under the service charge. What about leases where the rent is determined as a percentage of turnover? What happens if an anchor retail tenant in a shopping centre decides unilaterally to close its business due to the outbreak against a landlord’s wishes? It is not difficult to see how disputes might arise.
Cause for frustration?
The first question raised is whether a tenant could potentially get out of its leasehold obligations altogether in the light of the pandemic? Legally, it is highly unlikely. Whilst Brexit now appears to be yesterday’s news, it was at the centre of what is now the leading case on the contractual doctrine frustration in the context of leases in a dispute last year between Canary Wharf Limited and the European Medicines Agency . In that case, the EMA argued that Brexit would frustrate its lease. The High Court disagreed. The fact that the lease contained alienation provisions (common in commercial leases) that would allow the tenant to dispose of the lease if it could no longer continue its operations in the UK militated against the argument that the lease was frustrated.
The case of a pandemic is arguably even less persuasive as a frustrating event. The essence of frustration of a contract is that there has to be some intervening illegality or failure of common purpose that renders performance of the contract impossible or so radically different from the parties’ expectations that frustration is justified. It seems unlikely that this test would be met by the outbreak of disease. In particular, pandemics are rare, but they are not unprecedented, and could quite easily be held to be within the contemplation of the parties at the time the lease was granted.
Rent abatement clauses
So if a tenant is unable to get out of its obligations altogether as a result of the pandemic, might it be able to withhold rent payments if premises have to close? Again, the answer is likely to be no. Whilst almost all commercial leases have rent abatement clauses, such clauses are usually predicated on the premises becoming unfit for occupation as a result of some form of damage to them, for which the landlord is insured. It is very unlikely that an existing rent abatement clause in a commercial lease would be triggered as a result of the premises being uninhabitable by virtue of a reason not directly attributable to the premises themselves.
Keep open clauses
Of course, tenants may decide to close their business (and so their premises) temporarily during the peak of the outbreak, not out of compliance with any decree from government, but of their own volition. If such a tenant were, for example, a major retail tenant within a large shopping centre, the freeholder could be very concerned at the likely reduction in footfall caused by the closure of the anchor tenant’s premises. In such a case, landlords might seek to rely on a ‘keep open’ clause, which is a common clause in a commercial retail lease, requiring the tenant to open for business during normal business hours.
Historically, the courts have taken the view that whilst a landlord could obtain damages for any provable loss as a result of a tenants breach of a keep open clause, it would not be able to take steps to force the tenant to remain open and trading where it did not wish to do so. A landlord could therefore not rely on a keep open clause in order to address the issue directly.
Even if premises are not forced to close as a result of the pandemic, we are now seeing tenants – especially those in the already beleaguered retail sector – taking stock of their rental obligations in the light of reduced footfall as a result of the pandemic. Debenhams and H&M, for example, have already approached their landlords asking for rent concessions or even rent free periods in response to the spread of the virus and the attendant impact on their businesses. Such requests are often underpinned by the (implicit or sometimes even explicit) threat that the tenant will go into some form of insolvency regime (administration or, a CVA for example) if the landlord does not acquiesce. Laura Ashley, for example, collapsed and called in administrators. These are big names, and in the landlord and tenant world the collapse of the tenant can often be a far worse outcome for the landlord, an unsecured creditor, than agreeing to the tenant’s proposal.
Rent linked to turnover
Equally, where a tenant’s rent payments are linked to turnover, this would go a significant way to insulating the tenant from rental costs if the tenant were forced to close. Such arrangements have become more common in recent times, again, particularly in the retail property sector, which has been suffering at the hands of online retail for some time already. It may be that they are more common in new leases going forward.
An evolving landlord and tenant relationship
In spite of all the uncertainty, what is clear is that, much like the rest of the country, landlords and tenants are likely to have to work together and compromise if the threat to health and the economy posed by COVID-19 is to be overcome. This might mean landlords and tenants have to step outside their comfort zones and co-operate beyond the realms of the traditional landlord and tenant relationship in order best to preserve their respective interests. It may be that we see landlords and tenants trying to cater for unforeseen events in new leases going forward, and a move away from the strict enforcement of rights set out in existing leases in order to combat which is clearly a very serious threat to health and business.
Articles and commentary by our legal experts on the impact of COVID-19 are all available here.