Lease renewals in a COVID market: case law update

The impact of the COVID-19 pandemic on many tenants, and subsequently landlords, has been significant.The market is seeing tenants looking for greater flexibility going forward and are often pushing for landlords to share the financial pain of any future lockdown.

A big question for both parties is, in the context of a lease renewal under the Landlord and Tenant Act 1954, what factors are the Courts taking into account when considering terms during the course of the pandemic? We discuss some of the main talking points from two recent cases.

WH Smith Retail Holdings Limited v Commerz Real Investmentgesellschaft mbH [2021]

The case is the first recorded judgment of a lease renewal the impact of COVID-19 and focuses on WH Smith Retail Holdings Ltd, who operate a large retail branch at the Westfield Centre, Shepherd’s Bush.

The original lease was for a term of 10 years commencing in 2008 and continued under the Landlord and Tenant Act 1954 (the Act). The passing rent of the unit was £953,000 per annum based on a 2013 rent review.

The parties agreed on a renewal lease of just 5 years. It was noted by the judge that, at present, no retail tenant wants to enter into a long-term commitment. He also acknowledged market difficulties even before the pandemic with retail facing a battle against online sales.

After assuming a starting point of £255psf, Zone A (the landlord's starting point), the judge considered relevant deductions. An overall discount of 54% was applied to the rent including a:

• 20% reduction due to the pandemic
• 24% discount for location
• 10% discount for size.

Consideration was given to the effect of rental values in the main part of the shopping centre by other tenants not renewing when their leases ended in 2018, by CVAs, and a shift of some tenants to be nearer the John Lewis flagship store.

The new rent was fixed at £404,666 per annum, a huge reduction of circa £550,000 per annum.

The parties agreed that a pandemic rent reduction clause should be included in the renewal lease to avoid the landlord facing a further 10% rent reduction to reflect the onerous liability of paying full rent during a lockdown. The parties also agreed that it should be based on the tenant paying 50% of the rent and the whole of the service charge. The judge agreed that such clauses have “become something that all tenants want, and that the market has now priced it in".

Additionally, the tenant succeeded in arguing for a trigger based on the shutdown of just non-essential retail as opposed to the landlord's argument that it should only apply on a complete shutdown of trading.

The interim rent payable from October 2018 was fixed at £758,785 per annum, showing how much the market has changed.

S. Franses Limited v The Cavendish Hotel (London) Limited [2021]

The second judgment relates to the lease of a textile dealer who occupied premises at 80 Jermyn Street.  The parties were previously involved in litigation regarding the landlord's proposed redevelopment.  The tenant’s two leases of the premises had expired in 2016 but were continuing pursuant to the 1954 Act.

The tenant’s expert considered that a renewal rent of £96,500 per annum was appropriate whilst the landlord’s expert put the figure at £174,750. Both of these figures were well below the passing rent of £220,000 per annum under the tenant’s existing leases.

The judge did not attribute any particular fixed percentage reduction in rental values as a result of the pandemic.  Instead, the judge relied on a traditional rent zoning methodology and arrived at a reduced Zone A rent reflecting recent post-COVID comparable evidence.

Overall, the judge’s conclusion was that an appropriate rent for the renewal leases would be £102,000 per annum, less than half the passing rent under the previous leases.

The parties had also been unable to agree an interim rent, a significant point given the leases had contractually expired some six years ago.

The judge accepted the tenant’s expert valuation of £140,650, however, concluded that an interim rent of £160,000 per annum was appropriate on the basis that the expert valuation was "too low for at least the first 3.5 years of the occupation both because of the difference between it and the passing rent at the end of the existing tenancy but also because of the evidence about the market value of Jermyn Street properties over that time".

Our comment

As the first cases considering the impact of COVID on rents and pandemic clauses, it’s safe to assume the market will be keen to see how the Courts approach challenges brought by the pandemic.

The landlord's acceptance of the inclusion of the pandemic-related rent suspension clause requested by WH Smith shows how these provisions have quickly become the market norm. It will likely be a challenge for a landlord to resist the inclusion of such a pandemic clause, particularly in retail leases hit hard by previous lockdowns.

It is also clear that comparable evidence in renewal proceedings will matter now more than ever, with judges considering real valuation evidence before considering the question of deductions.

A wave of similar cases are expected in the coming months, but will judges follow suit?