Tenant hardship in the UK: Advice for landlords to help avoid debt and distressed assets
The coronavirus crisis continues to present serious challenges for businesses. With so many aspects of the world’s social and economic fabric to consider, it is understandable that many of the measures to address the impact of COVID-19 on the real estate sector have focused on the occupiers of property rather than the landlord community.
In the current climate of economic uncertainty, rent concessions may be part of a landlord’s approach to avoiding debt and distressed assets.
Companies are citing high property costs as a partial cause of business failure and tenants have increasingly turned to negotiating with landlords to reduce such costs. For the foreseeable future, aligning commercial landlords’ and tenants’ interests (especially those in the retail sector) may be increasingly difficult. Though landlords are being urged to give their tenants breathing space, tenants are being asked to pay rent – or at least part of it – where they can afford it in recognition of the strains felt by commercial landlords.
This will be of little comfort to landlords severely impacted by non-payment of rent by tenants. They will be looking ahead to what will happen regarding their own debt and liabilities under their banking and finance covenants.
Opening lines of communication
For some tenants, the most practical route out of the immediate difficulties they face will be some form of adjustment, temporary or otherwise, to the rent payable under their lease. Not many landlords will wish to take back space at a time of market uncertainty. Far better to leave a tenant in situ, hopefully paying service charges and other outgoings and whatever rent they can afford, whilst interest continues to rack up, at the contractual rates, on unpaid sums. There will likely be an appetite from both parties to find middle ground and strike a deal.
A number of tenants are approaching their landlords with proposals for sharing the rental risk and reaching voluntary arrangements about rental payments due imminently. Tenants may request a reduction in rent or a re-gearing of their lease terms to take the pandemic into account. However, landlords are not expressly required to act in good faith and entertain such requests in a commercial lease scenario. Although there may be reputational and commercial pressure to renegotiate lease terms, there is no absolute legal obligation on landlords to do so. However, it may be in their interests to come to an accommodation with tenants to avoid debt and distressed assets.
Businesses and their advisers need to navigate a course through these unfamiliar waters. These are entirely novel circumstances and we have all been challenged to think differently. The institutional investor and the small property company will have a different outlook on the situation and widely varying abilities to cope with radically changed economic circumstances.
What is a rent concession?
Whilst it is impossible to predict the duration of the crisis, there are steps that landlords and tenants can take now to address immediate issues. One way to help alleviate the struggle to pay rents would be to agree a rent concession between the landlord and tenant. These arrangements, seeking to share some of the rental risk, will help to ease tenants’ pain in the short term. There is a need to move rapidly to provide the certainty that landlords and tenants require. Rent concessions include:
- Rent deferment where the tenant is allowed not to pay rent for a period but then to pay, by way of additional rent, the amount that has been deferred by equal monthly instalments over a specified period.
- Monthly rent where the tenant will pay rent monthly rather than quarterly for a specified period.
- Rent reduction where the tenant is allowed to pay a reduced rent over a specified period of time.
- Rent abatement where the tenant is not obliged to pay any rent during the specified period and there is no obligation to pay the rent at a later date.
When considering rent concessions, parties may also agree that landlords can draw down on rent deposit funds to alleviate tenants’ cashflow issues.
Practical advice for landlords
These are unprecedented times. Where possible, parties should work together to find a practical solution that works for them, and document and implement that solution in such a way as to avoid unnecessary disputes later. Parties are also strongly encouraged to be reasonable and proportionate in responding to performance issues and enforcing contracts; to act in a spirit of co-operation and aim to achieve practical, just and equitable outcomes for their collective benefit and the long-term benefit of the global economy.
Landlords need to act promptly. At the same time, care should be taken to document concessions appropriately, either through a temporary arrangement that does not create a permanent change to the lease terms or by documentation that creates a permanent change to the lease. Landlords should also look for some reassurance that tenants are not seeking unwarranted concessions, and that other landlords and creditors are not receiving preferential treatment. Landlords will have to continue with their attempts to make recoveries where they can without delay.
What remains to be seen is the impact of such agreements on landlords who need to service their loans. This will become increasingly difficult if they have reduced or no income, and we can expect to see a number of banking covenant breaches as the tests under facility agreements are applied.