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Everyone is working at home – can you save costs on your lease?

Words:
Scott Keown

Negotiate with your landlord – they will need solvent tenants when the Covid-19 crisis passes

When cutting costs what grounds do you have to renegotiate the office lease? For some architects the lease is not a problem, as with RIBA Award winning Cob Corner in Devon, designed by David Sheppard for his practice.
When cutting costs what grounds do you have to renegotiate the office lease? For some architects the lease is not a problem, as with RIBA Award winning Cob Corner in Devon, designed by David Sheppard for his practice. Credit: Joakim Borén

Virtually all UK businesses rent their premises under commercial leases. As the economic impact of Covid-19 becomes clear, an increasingly common question is: 'What steps can I take concerning reduction (either permanently or temporarily) of my tenants’ leasehold liabilities until such time as the consequences of Covid-19 have passed?'

Each case must of course be considered on its own merits, and specific legal advice must be taken on a case by case basis, but the following key points are arising repeatedly:

Frustration
In the present context, this is where a tenant would argue that the lease is 'frustrated' by an event rendering it physically or commercially impossible to fulfil the terms of the lease or where the obligations have been made radically different by the frustrating event and radically different from that contemplated at the time of the lease. This doctrine has always been construed narrowly and in the 2019 Canary Wharf v European Medicines Agency (EMA) case the Supreme Court held that neither the UK’s departure from the EU nor the EMA’s head office move were frustrating events. As the effect of frustration would be to end the lease entirely (and so end the tenant’s own rights and obligations under it), even if the particular circumstances of the case meant that frustration could be successfully argued, it might not be an appropriate remedy for many tenants. Many will simply have temporary cash flow difficulties, and will therefore be looking for a temporary relaxation of payment obligations, as opposed to a complete end to the lease. Tenants looking for a temporary relaxation of payment obligations may be well advised to explore a company voluntary arrangement instead, but this would of course affect the landlord’s investment values and so would be resisted.

Force majeure
The contractual principle of force majeure is being talked about a lot, which in the present context is where one or both parties might not have to perform the lease obligations due to the occurrence of certain events outside of the control of one or both parties. This might be argued to include the Covid-19 virus response. The party in question would not be liable for its failure to perform its obligations, such as payment of rent for example. The difficulty for a tenant is that commercial leases rarely include such a provision and in that absence a tenant cannot argue for it (see more on force majeure in contracts).

Compliance with legislation
A tenant is usually required to comply with all legislation concerning the use and occupation of the premises. If the Covid-19 response was for a complete shutdown of the premises and this was (as it would need to be enforceable) passed into law, then the tenant would not be able to occupy the premises at all; but this would not of itself entitle the tenant to stop complying with its payment obligations, although it might provide a basis for commercial negotiations with the landlord, who will need to consider carefully its response to what may be seen to be a unique situation.

Insurance
The landlord will usually have insured the premises for what are defined as 'insured risks' and is given wide discretion in what to insure over and above the usual risks. Whether acting for landlord or tenant, a quick review of the policy will likely show that all risks covered entitling withholding of rent will be limited to situations where the premises are unusable as a result of physical damage or destruction. Further, apart from the ability of a tenant to avoid paying under such a rent suspension clause, the general rent payment clause will prevent any withholding of rent for any reason, even if the tenant had its own claim  against the landlord for any reason. If acting for a tenant, their own business interruption insurance cover should be checked to see if there is anything that might be of help, depending on the particular circumstances in which their own insurer might pay rent.

Alienation provisions
In the EMA case the court noted that the EMA was able and had agreed to assign the unexpired remaining term in its lease to a third party as a way to avoid ongoing liability to its landlord. The alienation provisions of the lease should be carefully scrutinised in the context of the tenant’s appetite or operational feasibility of giving up the whole or only part of the leased premises. For example, it might wish to assign the lease and downsize into cheaper serviced accommodation or share occupation with a third party for a short period and thereby share its payment liabilities. Would a landlord would be able to let any part of the premises to a different tenant entirely and on better terms?

Rent review provisions
If a rent review is pending or ongoing, the tenant could seek to agree a rent holiday or reduction for a certain period along with a corresponding agreement as to how and in what circumstances it might be terminated and perhaps with an agreement about the future treatment of rent review provisions. For example, in exchange for a temporary relaxation of its leasehold payment obligations, a tenant and landlord may pre-agree a fixed uplift of rent on a future date, by which time the effects of Covid-19 may have passed.

Break clauses
If there is tenant break clause its terms should be scrutinised carefully. Often where a tenant does not exercise a break clause it will be entitled to a reduced rent (or rent free) period, in which case it may be possible to renegotiate the break date and/or the reduced rent period with a view to it bringing forward so the benefit can be applied during the current crisis. Alternatively, a landlord may be persuaded to agree a temporary relaxation on lease costs in exchange for the tenant agreeing to drop or reset a future break date, or to extend the remaining lease term if it is quite short. There are a number of ways in which an existing break clause could be restructured via negotiation between landlord and tenant for mutual benefit in the longer term, particularly if this might improve the chances of there still being a solvent and rent-paying tenant once the immediate crisis had passed.

Ideally, negotiations are conducted without prejudice to the lease’s existing terms and, depending on the parties’ wishes, would either be formally concluded by a deed of variation to the lease or a less formal 'side letter' setting out the temporary or permanent solution agreed. Landlords may prefer the side letter route as it is often expressed to be personal to the parties and would not be subject to registration at the Land Registry – and could therefore be more easily kept confidential between the landlord and the particular tenant. A tenant should expect to be asked to provide financial information evidencing how the Covid-19 crisis is adversely affecting its business and its proposals to the landlord in terms of lease payment restructuring should be aimed at addressing those adverse effects. This could include the effect on its turnover, ability to run the business if staff are not present in the office and whether, and to what extent, it would be able to make other savings across the business, for example in relation to relaxation of business rates or reduction in staff numbers.


Scott Keown is partner, Commercial Real Estate, at JMW Solicitors

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