COVID-19 – how is it affecting agreement for lease and lease negotiations?

1. Rent suspension

Some tenants (primarily retail/food and beverage tenants, rather than office tenants) are requesting a clause which suspends the annual rent if, to prevent or delay the spread of COVID-19 or another pandemic or epidemic disease, the Government imposes a measure that requires the tenant not to use the premises or requires the landlord to prevent or restrict access to the premises so that the tenant cannot use the premises. How should a landlord react to such a request?

In our experience, most landlords will not agree to such a rent suspension clause because, unlike rent suspension where the tenant cannot occupy the premises as a result of an insured risk, the landlord is unlikely to be covered by its insurers for loss of rent incurred as a result of a pandemic. However, so much depends upon the commercial “drivers” in the transaction. The landlord may have void space and payment obligations to its lenders such that it must let that space.

If a landlord were minded to agree to such a clause, our advice would be:

1. To ensure that it only applies where there is a “mandatory” measure that results in the tenant not being able to use its premises. In the absence of “mandatory”, the tenant has much more flexibility to use the rent suspension clause to its advantage.
2. To carefully consider whether a rent suspension clause of this type should be limited to the COVID-19 pandemic, rather than any other pandemic or epidemic, which widens the rent suspension grounds substantially.
3. Rather than agreeing a full rent suspension clause, to propose a compromise whereby the landlord and tenant agree to share the loss. For example, the tenant pays 50% of the rent. Another alternative is for there to be a cap on the rent suspension and once the cap is reached, the tenant must start paying the rent again.
4. Whether the deal is a full rent suspension, sharing the loss or a capped suspension, consider whether the clause should appear in the lease or in a side letter. The advantages to the landlord of including the rent suspension provisions a side letter are that:
   • The side letter can be expressed to be personal to the tenant and therefore would not benefit an assignee should the tenant assign the lease – provided of course that the tenant accepts this restriction.
   • The side letter will not bind its successors if the landlord disposed of its interest. A buyer cannot therefore use this as a reason to “chip” the price – again, provided the tenant accepts this restriction
   • The terms of the side letter are not be taken into account when calculating the new rent during a rent review, unlike where such a clause is incorporated into a lease which could lead to a reduced rent.

If business interruption insurance becomes available at competitive premiums to cover future lockdowns caused by pandemics landlords may feel more inclined to agree rent suspension clauses – they can then agree clauses which mirror the cover it has under such business interruption insurance. In this way, they are not exposed. Drafting would need to be very tight to ensure that landlords are not exposed should the insurance not provide adequate cover.

2. Carve out from 'keep open' covenant

In the retail/food & beverage sector, many units are let on a “turnover rent” basis, i.e. where there is a “guaranteed” base rent, with a turnover rent top up rent, based on the turnover derived from that unit. To ensure that a tenant stays open for as long as possible and generates as much turnover as possible, most turnover rent leases will contain a covenant requiring the tenant to “keep open” for trade, subject to certain specified circumstances in which they are not required to open for trade (e.g. whilst the tenant is carrying out alterations to the premises or whilst the tenant is making arrangements to hand over the premises to an assignee).

To ensure that a keep open covenant in a lease has some “teeth” and that the landlord has some recourse against a tenant if it fails to open, it will normally be accompanied by a clause which  allows the landlord, if the tenant closes in breach of the keep open covenant, to estimate the turnover that the tenant would have generated had the tenant remained open.

As mentioned, most keep open clauses will specify that the tenant is allowed to close in certain circumstances. A tenant will now invariably seek to add “Covid closure” to this list of circumstances, thus ensuring that the tenant is not in breach of the covenant if it closes as a result of a measure imposed by the Government. How should a landlord react? Most landlords will regard this as a fair request. However, as with any rent suspension clause, agreeing to such a provision should be limited to a “mandatory” measure.

If a landlord agrees to this request, the landlord also needs to be aware that if a mandatory closure is specified as a circumstance for which the tenant can close, then the landlord cannot estimate the turnover that the tenant would have generated had it been open and therefore, turnover rent will only be calculated on the turnover that the tenant actually generates.

As stated, whilst we are seeing a number of tenants request the provisions referred to in this note, whether such provisions are agreed is often down to the commercial negotiating power between the landlords and the tenants. Any agreement in relation to such provisions should be noted at heads of terms stage to avoid ambiguity in relation to the parties’ agreement when it comes to the legal drafting.